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. Last Updated: 07/27/2016

The Trials of Bank Supervision

After a wild adolescence, Russia's private-banking elite currently face some serious decisions about its future. If the country's largest commercial banks are sensible, they will bolster attempts by the Central Bank of Russia, to regulate a precarious financial sector. But, if the banking elite remain wayward, continuing to resist Central Bank supervision and insisting on squabbling among its members, Russia's inevitable banking weed-out will be a lot messier than need be.


At the last meeting in April of the Association of Russian Banks, Central Bank Chairman Sergei Dubinin forecast Russia would soon see a banking crisis worse than that in August 1995. On that occasion, he hoped 70 percent of Russia's 2,100 banks would be wound up by the middle of 1997. Yet in Salzburg two weeks ago, the same Dubinin said he thought such a crisis would be avoided.


Dubinin's confusion might be one reason the Central Bank has been such an incapable -- or unwilling -- supervisory parent to Russia's banking upstarts. Granted, almost 150 commercial bank licenses have been revoked since the beginning of the year. Yet the serious controls such as charter capital requirements -- a fixed amount of money each commercial bank deposits with the Central Bank -- and reserve asset ratios -- an amount held by the Central Bank proportionate to each bank's deposits -- are often violated. The Central Bank's capacity to regulate depends more on the will of the prodigal sons of Russia's largest banks than it does on Dubinin.


Most Russian banks are not banks at all. The majority are "pocket banks" set up by state enterprises to channel state handouts. As subsidies have fallen, the pocket banks have been thankfully short of business. Less fortunately, most banks which began with good intentions -- namely, to lend -- are also being choked. Partly because subsidy cuts mean basket-case enterprises cannot service their loans, partly because Russians still save by stuffing dollars into jam jars, 51 percent of Russia's banks are capitalized below 500 million rubles ($975,000). Subsequently, in 1995, only 5 percent of total bank lending extended beyond six months.


Tiny banks have been throttled further by the ruble corridor, introduced in July 1995. Russia's currency has been "fixed" but continued inflation has appreciated the ruble in real terms -- by almost 30 percent since the band was adopted. Real currency appreciation prevents small banks from "playing the yield curve" -- pan-handling for dollar interest pickings during delays between fund presentation and settlement.


But by ending thumping returns on high-volume currency speculation, the ruble fix has also dented the profits of Russia's banking elite. And because Russian banking liabilities are in rubles and assets generally in dollars, due to currency risks, the large banking thoroughbreds have suffered disproportionately from the unavoidable balance sheet squeeze connected with the real ruble appreciation.


It was in this context -- collapsing small banks and disgruntled large ones -- that Dubinin took over the Central Bank from Tatyana Paramonova in November 1995. By this time, the money-making game had switched from currency speculation to government debt. Small banks survived and large banks got fat on high yielding short-term treasury bills, GKOs. Dubinin was initially determined GKO yields would fall; by expanding broad money in December, he armed Sberbank, the state's savings bank, with purchasing power on the secondary market for GKOs. But, as yields came down, the small banks screamed and the big banks growled. Political pressure mounted to keep small banks afloat, and deep-pocketed banks happy, in the run-up to the June presidential election. Dubinin's regulatory task is politically treacherous and logistically unenviable. Inter-locking debts turn the Central Bank's task of distinguishing between a lack of liquidity and insolvency into guesswork. Several months ago, on IMF prodding, the Central Bank again insisted commercial banks immediately disclose cash shortages. But problems continue to go undetected until banks lie prostrate at the Central Bank's discount window.


Some of the worst cases suffer from state non-payment. Avtovazbank, Russia's 28th largest, used government debts on its books to lobby for a bail-out. It was eventually "taken over" by the Central Bank, apparently because it is the Volga region's only bank, actually because its patron is First Deputy Prime Minister Vladimir Kadannikov. In fact, since Dubinin began his term, the Central Bank has "taken over" half a dozen banks. But nobody seems to quite know what "taking over" means in practice, including Dubinin.


When Paramonova hiked reserve-asset ratios in the spring of 1995, she effectively secured her own downfall -- the State Duma's banking lobby refused to endorse her as Central Bank chair and President Boris Yeltsin eventually had to sack her. Dubinin is determined not to make such a mistake.


Dubinin almost managed a regulatory move in February, when charter capital requirements were raised to 5 million ecus ($6.2 million). Less than 7 percent of Russia's banks would cross this threshold. High charter capital requirements would limit bank start-ups and encourage bank mergers. If weaker banks were subsumed by stronger ones, accounts would transfer: bank numbers would fall without leaving depositors high and dry.


One problem is that the requirement's binding date was set for 1999. The delay is, perhaps, inevitable. An immediate raise in charter capital would push Russia's entire banking system theoretically to the wall. Russia's banks will eventually have to start banking -- taking deposits and spreading branch networks; a merger boom will eventually emerge. But a spate of takeovers is unlikely to get solve the current banking mess.


Equally inevitable is the time it will take for Russia's biggest banks to learn that increased supervision is in their own interests. The banking elite is showing signs of maturity; Vladimir Vinogradov, president of Inkombank, last month spoke out for increased Central Bank supervision. But Inkombank's own difficulties suggests that even this display of the bank's public spiritedness was nothing other than raw self-interest.