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Nov 3, 2017 | 20:45 GMT

8 mins read

Russia Cleans Up Its Banks on Borrowed Time

Russian Prime Minister Dmitri Medvedev (C) meets with members of the government's finance and economy ministries in 2014 to discuss policy
(DMITRY ASTAKHOV/AFP/Getty Images)
Highlights
  • As its economy stagnates, Russia's central bank will continue cleaning out the banking sector with bailouts, nationalizations, closures and reforms.
  • The state will take over or bail out the largest private banks to prevent a social backlash ahead of the 2018 elections.
  • With its finances limited, the state cannot nationalize the entire banking sector; the political, social and economic fallout from some bank closures will add to the Kremlin's troubles.

Turbulence has characterized the Russian banking sector since the fall of the Soviet Union. In the economic free-for-all of the 1990s, newly minted oligarchs, politicians, business executives and criminal groups opened private banks to grow their asset bases, massage their books and funnel money to their various interests. More than 2,500 banks had popped up in Russia by the middle of the decade. With no clear rules or strategy to guide it, the sector grew unchecked, contributing to the financial crisis of 1998. The Kremlin began trying to bring order to Russia's banking system, and over the past 20 years, the Central Bank of Russia has shrunk the sector by closing, consolidating or nationalizing hundreds of failing banks. But deep problems persist. A stagnant economy and depleted resources are increasingly limiting the Kremlin's ability to intervene, stoking fears of a looming systemic crisis and threatening to exacerbate dissent in the government and on the streets.

Instability Gives Rise to Putin

Russia's 1998 financial crisis brought the banking sector's wild growth to a sudden halt. The ruble collapsed, pushing more than half of the country's population to the poverty line or below it. In the wake of the crisis, for which the Russian people blamed the government and the oligarchs, Vladimir Putin rose to power with promises of a stronger and more stable country. Putin quickly consolidated the bulk of Russia's businesses, assets and wealth — and, with them, much of the banking sector — back under the state's control. (Today, the state owns 60 percent of Russia's banking sector and controls the country's three largest banks, Sberbank, VTB and Gazprombank — which together account for 50 percent of Russia's assets.) The Kremlin set about winnowing the banks that had survived the 1998 crisis, and in the mid-2000s around 1,400 financial institutions remained.

In 2009, falling crude oil prices, a deepening global recession and souring investor sentiment after the brief war with Georgia left Russia in another financial crunch. The country's annual gross domestic product contracted by 7.8 percent that year. Fearing financial collapse, Russians withdrew an estimated $290 billion from the country's banks, much as they had done in 1998. The central bank closed some 70 banks in response, while state-run companies and banks — along with oligarchs whose help the government enlisted — bailed out many others. In addition, Moscow approved a $186 billion aid package to keep the financial system afloat.

A sharp decrease in oil prices, a decline in industrial output and the imposition of Western sanctions plunged the country into another recession in 2014. Over the past three years, Russia's central bank has shut down 300 failing banks — about one-third of the country's remaining banks — and many Russian economists advocate reducing the number to around 30 to optimize efficiency. A think tank backed by the central bank estimates that about half of the remaining institutions have capital shortfalls that total $50 billion, or 3.8 percent of GDP, while private Russian banking analysts figure the number is closer to $150 billion, 11.6 percent of GDP.

Russian Banking

Treading a Fine Line

As Russia slipped into recession in 2014, the big state banks gave some of the country's largest private banks — Otkritie, B&N Bank (also known as Binbank) and Promsvyazbank — low-interest loans to take over their struggling rivals. The goal was to bolster non-state banks, since Western sanctions had targeted most of the state banks. And the move paid off: B&N Bank's assets, for example, have grown fivefold since 2014 to reach $20 billion. But most of these assets were in worse condition than expected. To make matters worse, Russia's private debt has soared over the past decade, rising from 50 percent of GDP in 2005 to 90 percent of GDP in 2009, according to the Bank for International Settlements. Private debt holders have struggled to repay their loans over the past few years as low oil prices sent the ruble's value plummeting, unemployment rose and salaries fell. The percentage of bad loans in Russian banks officially grew from 6 percent at the start of 2014 to 10 percent today, though the International Monetary Fund believes the actual figure is closer to 14 percent.

The central bank, meanwhile, has been forced to tread a fine line between closing ailing banks, nationalizing them and letting them fail. The head of the central bank has created a new designation for banks that are too big to fail: "systemically significant." Among the institutions in this category is state-run Vnesheconombank, which received a bailout in 2016 reportedly worth $16 billion. Offering funding to state-owned banks is nothing new, but when the government started nationalizing some of Russia's largest private banks, it unearthed a larger problem.

The State Extends Its Reach

According to the central bank, only 40 percent of the assets purportedly held by the banks it has shut down or nationalized actually existed. When the state shut down Vneshprombank — one of the country's top 40 banks — in 2016, for example, investigators discovered that the $50 million the institution claimed to hold in a foreign bank was, in reality, only $10,000. The bank had forged records using a copy machine. And the problems don't end there. Since the central bank took over the country's largest private banks, Otkritie and B&N Bank, in August and September, investors have been dumping Eurobonds from other banks rumored to be in trouble, such as Promsvyazbank and Credit Bank of Moscow. 

Russia's Finance Ministry claims that by stepping in, the Kremlin prevented a domino effect in the banking sector. The central bank has established a fund to bail out struggling private banks and has reportedly spent an additional $47 billion over the past three years to compensate depositors in failed private lenders. As the next presidential election approaches, the Putin administration is particularly mindful of the payments' importance. When the central bank revoked the licenses of two regional banks in Tatarstan in March without compensating their customers, hundreds of protesters took to the streets, prompting Tatarstan's president to sharply criticize the Kremlin. Putin, who is seeking re-election for a fourth term as president, is trying to maintain the financial security he promised Russian voters nearly 20 years ago.  

But at more than $100 billion to date, the price tag for that security is getting unwieldy. The government may soon have to call on Russia's business leaders to bail out or invest in the banking system, as it did during the 2009 financial crisis. Today, however, the country's oligarchs and silovarchs have their own financial burdens to bear and may not be able to chip in as much money as they did before.

Depleted Resources, Tough Choices

Furthermore, the Kremlin today doesn't have the resources it relied on to muddle through previous periods of economic stagnation. Russia's reserves, including the National Reserve Fund and National Wealth Fund, currently hold less than $425 billion — down from nearly $1 trillion in 2009. Its obligations, on the other hand, are as sizable as ever. Between the social spending it needs to woo voters ahead of the March 2018 election and the various conflicts the country is involved in abroad, Russia has spread its finances thin. A series of anonymous government officials indicate that Putin has had to delay several banking bailouts to prioritize the Russian military's expansion. The banking sector's problems aren't the only financial crisis facing the Kremlin, either. Last year, the state gave the defense industry a $12 billion bailout, and now it's developing a program to help regional governments cover their staggering debts. International credit rating agency Standard & Poor's recently noted the risk that the state would incur by taking on such a financial burden.

In light of these concerns, the Kremlin will have to pick and choose which banks to save as it consolidates the sector. Some regional banks may have to fall, leaving oligarchs, executives and politicians without their power bases, and perhaps inviting more local leaders and elites to speak out against the Kremlin. Similarly, closing banks without compensating customers could feed into the growing protest movements. Weeding out illegitimate banks, moreover, could aggravate the politicians and business leaders who use them to buy political influence and support. 

Russia's banking troubles add to a complex, evolving landscape. Moscow faces growing opposition movements, demographic change, pressure from the West, a stagnant economy and an increasingly divided government. These issues are forcing the Kremlin to tighten its hold over the country's affairs and take on the weighty responsibility of managing every facet of the economy, including the banking sector. The difficulties that the Putin administration encounters as it tries to nationalize the banking sector will only ramp up the pressure. 

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