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. Last Updated: 07/27/2016

Key Changes Set Banking Reform in Motion

MTA deposit insurance scheme is designed to prevent runs on banks like last summer's.
For years, the stalled banking reform has resembled an old joke: When Leonid Brezhnev's train breaks down, the Soviet leader simply pulls down the blinds and declares it's still moving.

Lately, the engine of banking reform has finally begun to chug forward. Key changes are set to take place this year, including the establishment of a deposit insurance scheme and a switch to international accounting standards that may reshuffle the industry.

The reforms come at a time when speculation is increasing that the government may finally sell a stake in the country's No. 2 bank, Vneshtorgbank, and Russia is being pressed to allow foreign banks to open branches as a condition for membership in the World Trade Organization.

For Russian consumers, however, the reforms are largely about building confidence in a sector that was prone to collapse during the 1990s and wobbled briefly last summer.

A powerful instrument for instilling trust in the system is a law that requires retail banks to insure personal deposits up to 100,000 rubles ($3,570).

Out of 1,140 lenders that applied, the Central Bank has so far accepted some 400 banks into the deposit insurance system, with new names being added every week.

Since most of the country's biggest banks have already been let in, it is estimated that about 85 percent of accounts will be covered.

But because not all banks will be admitted to the insurance program, analysts say there could be trouble ahead for those left out. Some banks could come tumbling down if clients suddenly have reason to question how safe their funds are.

"Put yourself in the shoes of the client of a bank that was not admitted to the system," said Sergei Donskoi, banking analyst at Troika Dialog. "You would rather go and take your money out."

Lenders not accepted into the scheme by the end of next month will have the right to appeal to the Central Bank. But if they are denied, these banks will have to stop taking new accounts and eventually phase out retail services.

While nobody knows how many banks will be excluded -- experts say anywhere from 50 to 300 -- throwing hundreds of banks out of the retail business may not be as jarring to the sector as it might seem.

For one, most of the biggest banks have already been accepted, so system-wide panic is not likely to spread. Nevertheless, some market watchers do not rule out a run on individual banks.

Just last summer, the closure of two second-tier banks prompted a short-lived panic among depositors.

"Pretty much all of the big banks are getting in, but there might be one or two surprises," said Andrew Keeley, a banking analyst from Renaissance Capital. "In light of what happened last summer, that could be quite interesting."

But other experts say that banks have had plenty of fair warning to get their act together -- or face the consequences.

"If there is a retail run on a bank because they weren't included in the deposit insurance scheme, then it is essentially the bank manager's fault," said Richard Hainsworth, CEO of RusRating, which rates Russian banks. "They deserve no sympathy."

Deposit insurance should help stabilize the sector and help prevent a repeat of last summer's abrupt drop in confidence.

Some observers say that the application process itself has helped increase transparency in an extremely opaque sector.

"The criteria that [banks] have to fill are very strict," Hainsworth said. "Some of the big banks sweated blood, right until the end."

Another significant change in the banking industry is the switch to international financial reporting standards, which should bring more transparency to the industry.

Although the change may seem technical, Russian and international standards differ markedly. In some cases, a bank that is profitable under Russian accounting standards might be loss-making following international rules.

The switch is being implemented cautiously. While all banks must begin reporting under international standards this year, they still do not have to make their reports public.

Also looming this year is the much-anticipated privatization of state-owned Vneshtorgbank. The European Bank for Reconstruction and Development is known to be mulling a stake, and in January, German media reported that Deutsche Bank is interested in a 10 percent stake.

While foreign banks are allowed to participate on the domestic market through local subsidiaries, the United States is pushing the government to allow foreign banks to open branches as a condition for WTO entry.

The outcome of negotiations, which could drag on for months, remains a wild card. Many observers say Moscow is not likely to budge on the issue.

Although the government has now jump-started reforms, private banks should step in to help push the process forward, said Yekaterina Trofimova, a banking analyst at Standard & Poor's.

In the past, vested interests have defended banks that might otherwise have been doomed, she said.

"In Russia, many banks have been everything but banks," she said. "Banks were even part of the comme il faut image: Setting up a bank was easy, and gave you good visibility. Then, when your group bank got big enough, maybe you started to do some real banking business."

Now, with private banks accounting for almost half of the sector, big financial groups need to rationalize their corporate structures and work to improve transparency, she said.

The current landscape of the banking sector -- where state-owned Sberbank towers with a 30 percent market share and most other banks account for less than 1 percent -- is untenable, she said.

"It's just not a balanced system, even from a physics point of view. There should be some consolidation -- and not just through regulatory changes, but through economic reasoning. We do not see much economic reasoning in the model of the banking sector right now."