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. Last Updated: 07/27/2016

New Rule Adds Teeth to Banking Oversight

The Central Bank got new teeth this week in its campaign to root out inflated capital estimates from the country's banking system, amid bankers' worries about just what shape those teeth will take.

A new regulation gives Central Bank investigators the authority to inspect banks' capital structure and require revisions if they find that the numbers were inflated using fictitious assets. The inspectors' first reports are due in May.

The sanctions that guilty banks will face have yet to be fleshed out, but the Central Bank is likely to require them to go public with the more modest, accurate figures.

Bankers argue that such sudden revelations would have a bombshell effect, driving away clients and jeopardizing their viability.

This initiative, approved by the Justice Ministry, is the first of many initiatives expected from Chairman Sergei Ignatyev's Central Bank team.

Richard Hainsworth, an analyst at Renaissance Capital, said it has been common for Russian banks to pad their balance sheets, because "In past years, the Central Bank has cared more about quantitative liquidity and lending ratios rather than the quality [of those numbers]."

Smaller banks have been the most prone to inflate their numbers, analysts said, though some top-tier banks, including state-owned ones, might be caught as well.

There are several manipulations banks can use to increase their capital without investing real money. Shareholders can buy up additional shares in the bank in return for promissory notes of the same value. These notes are then tallied in the asset column during the bank's capital calculations -- but shareholders have no intention of buying them back, so the notes have zero value.

Another way is to extend a loan, which then gets passed through several different borrowers, ultimately winding up in the hands of bank shareholders. The loan is then used as an asset to boost the bank's capital, but like the promissory notes, it will never be redeemed and thus has no value.

The question remaining to be answered is how far the Central Bank is willing to go to punish banks found guilty of cooking their books.

BIN Bank vice president Alexei Gouskov said the Central Bank should consider the bank's commercial survival when judging any wrongdoing.

Adjusting a bank's capital downward might have little affect on its overall financial strength, he said. "If the adjustment is not big, then it might have no affect on liquidity and lending ratios."

If the correction would jeopardize the bank's business, Gouskov said most bankers would prefer that the Central Bank keep its findings quiet, allowing a given bank's shareholders time to replace bad assets.

Alternatively, the Central Bank could publicize the inflated capital numbers. For banks, this is the worst-case scenario, as it could send tremors through the market and even push the errant bank to bankruptcy, Gouskov said.

Even the possibility of Central Bank sanctions against a bank could prompt the rest of the banking community to cut ties with it, "which, in fact, means the end of its business," Gouskov said.

Alfa Bank economist Natalya Orlova said some banks might recoup damages by contesting Central Bank investigators' calculations in court.