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. Last Updated: 07/27/2016

Consumers and Banks Wise Up on Credit

Listening to Vasily Babayev talk about the credit system sounds a bit like hearing street slang from Britain's Queen Elizabeth. For a 46-year-old building contractor, he seems astoundingly clued in, especially considering that five years ago, credit was about as foreign to Russians as a cricket field.

What irks him most is the effective rate on the 200,000 ruble car loan (then worth $6,450) he says he took from Russky Standart bank in 2003. "In principle, I was happy with it at the time," he said. "But now if you factor in the various premiums and account servicing, the effective rate on the loan was unreasonable and uncompetitive."

He is pledging to be wiser the next time around, as are a growing number of Russians in the same situation.

Rather than sign the first loan agreement shoved in their faces, consumers nationwide are starting to ask questions, to complain when they feel swindled, and it has kicked off a revolution in the world of consumer loans.

State regulators have begun a series of investigations against the country's biggest lenders, most notably Russky Standart, prompting them to tone down the aggressive tactics they used to pioneer the business.

"So far, [banks] have been pricing the products so high that they can absorb a high level of failure," said David Jones, chairman of Pristav, the country's leading collections agency. "It's very simple, crude -- but very effective."

Even though the underlying cost of giving a loan is around 5 percent, Jones said, and the default rate is less than 5 percent for most loans, banks charge an average of 35 percent in interest, and commonly ask for more than 50 percent on riskier products such as credit cards.

But until recently, you would not see such figures on most loan agreements unless you knew how to read between the lines. That is because banks have used a variety of methods to hide their effective fees.

Amid a growing chorus of criticism of such practices from disgruntled customers, consumer rights groups and lawmakers, the Central Bank earlier this year agreed to tighten up its rules on disclosures about effective loan rates.

Under new rules that came into effect July 1, banks must disclose effective interest rates, and some banks have been scrambling to change deceptive pamphlets and forms.

One popular method of hiding effective fees -- illegal in many Western countries, but widely used by Russky Standart -- is to require borrowers to open accounts when taking out a loan, and annually charging more than 20 percent to service the account -- on top of the 20 percent charged in actual interest. This practice was not prohibited under the new rules, however, leaving a potential loophole for the banks.

In a recent interview, Russky Standart CEO Dmitry Levin said the practice was "completely legal" as his bank had defended it in court many times.

Nonetheless, he said he was phasing it out.

"As the market leader, we feel our moral responsibility for this market, and we are going to end this practice," he said. "If there are any number of complaints against it, that means we have to react."

Paul Batchelor, CEO of Russia's second-biggest loan provider, Home Credit and Finance Bank, is also promising change.

Next year, the bank will introduce "risk-based pricing ... that will allow us to price lower for people that we know have low risk, and [for] people with higher risk, there's obviously a higher price," Batchelor said in an interview Tuesday. "That's good practice worldwide."

Because no comprehensive database of credit histories has so far existed in Russia, Home Credit, like all other lenders, has not discriminated between good borrowers and delinquent ones. As of the end of June, no matter who you were, effective rates for cash loans at Home Credit were 26.2 percent, and for credit cards 52.9 percent.

But once risk-based pricing is fully implemented, borrowers in the best standing can expect rates up to 50 percent lower than the riskiest borrowers, Batchelor said.

"The market is fundamentally changing, even though high rates are justified in the market as a whole, because the levels of risk in emerging markets are significantly higher," said Levin of Russky Standart.

To avoid losing out as interest rates drop, banks will have to find new ways of absorbing risk -- ways less "crude" than gouging every customer with double-digit rates.

Russky Standart's old rates "resulted from the fact that we were not fully able to understand our risks," Levin said.

Understanding them will depend almost entirely on the strength of credit databases.

So far, their development has been slow going. The first nationwide database, the National Bureau of Credit Histories, was only licensed to operate in February. A Merrill Lynch study released in March said only 2 percent of the population was included in these kinds of systems, which should allow banks to check whether potential customers have a history of not paying their debts.

This weak level of penetration is not surprising in light of the fact that most Russians still keep their money "under the mattress" -- an estimated $20 billion worth, according to MDM Bank.

"When retail loans began to appear on the market, the population was not entirely ready for them," said Natalya Matyunina, senior vice president of Nomos Bank, another leading lender. "In case of any financial need, the Russian consumer doesn't go to his banker, but looks to get advice from friends or relatives.

"The first goal is to overcome the mistrust people feel for banks," she added.

If this is achieved, more Russians would be encouraged to take out loans and their data would get into the system. The next step would then be to allow all banks to use those data in assessing their risks.

The two top lenders have combined histories for 42 million Russians, or about two-thirds of the bankable population -- 30 million from Russky Standart and 12 million from Home Credit, their CEOs said.

But Russky Standart has so far been unwilling to share, because no partner can yet match the mass of data it can offer, Levin said.

Marlena Hurley, one of the founders of the National Bureau of Credit Histories, said it was "the fragmentation of the credit bureaus that constitutes a challenge for the credit markets."

Without a unified database, risk assessments will be stunted, and credit reports will not be available for the vast majority of potential clients, as they are in the United States, for example.

But whatever the imperfections, most banks in the retail market are gradually beginning to use more sophisticated methods for covering their risk, matching interest rates to a client's record. The National Bureau of Credit Histories boasts more than 600 clients for its reports, and records for more than 11 million Russians.

Even if handled in-house, these new tactics will allow Russky Standart to be "more aggressive" in dropping rates, Levin said. And as lower rates attract more customers to the loan market, their data will in turn improve the accuracy of credit reports, and should bring the rates down further.

At least that's how the theory goes for the Russian banking sector, and Jones of Pristav, the collection agency, said it would come true in the next two or three years.

"Everything goes through a negative phase," said Matyunina of Nomos Bank. "When a child grows up, he gets sick, he gets bad grades, and nonetheless he continues to grow and become a mature individual."

But Babayev, the car loan customer, said he would not be convinced until he sees the results.

"I don't really care how they calculate them," he said. "I just want the rates to be fair."