25 December 2017

To save or to let drown: the Central Bank’s difficult choice

Expert review for Forbes by Vladimir Tatarchuk, Board Chairman and Chief Managing Partner at Proxima Capital Group

After the emergency financial rehabilitation of two major banks – B&N and Otkritie – it’s difficult to talk about the predominance of market-based approaches and principles in the economy

The new rescue mechanism will perhaps become the rake the Central Bank will step on as it frees negligent owners from being held responsible for their mistakes.

Unfortunately, today, the dominant stereotype in the public consciousness is that a good bank or banker is the one who takes the side of troubled borrowers, supports them with new loans and allows them to postpone the fulfilment of prior obligations. Meanwhile, a true bank is an institution which, first and foremost, is responsible vis a vis those who entrusted it with their money, and more and more shifts its primary earnings away from risky loan products towards a variety of value-added services.

It would be a mistake to say that there is one specific deal which led to the fall of Otkritie.

In the banking sector, there have long been discussions around the major mistakes made by Otkritie Group in the course of its development, mainly due to poor-quality and slow integration of newly acquired banks. And, of course, the risky deals the group was famous for. In that sense, Otkritie, wishing to fix its own affairs, underestimated the risks associated with the financial rehabilitation of Trust Bank and with the acquisition and integration of other banks and institutions.
B&N is a totally different story. Of course, B&N Group was also ruined by its excessive infatuation with acquiring distressed banking assets for rehab, no matter the asset quality. And it is noteworthy that such rehabilitations are said to have taken place at the request of the regulator itself. There was one systemic problem clearly visible with B&N: its short-term liabilities were funded with long-term assets (primarily, with real estate).
I believe the common issue of Russian banks is entering into too many deals with affiliates and tending to ignore problems rather than solve them once and for all. The Central Bank, until recently, was extremely tolerant towards this kind of issues, particularly as regards major, “too big to fail” banks.
If someone believes that the problems outlined above affect only privately-owned banks, this is a big delusion. State banks don’t look better, but it’s just not so easy for the government to admit to it.
In that sense, the idea to create a new major state bank through merging B&N with Otkritie would be a step towards a downfall of the entire Russian banking market, unless the united institution is sold to private investors.
An actual bankruptcy of two major privately-owned banks is very bad news for the whole system. It is likely that the regulator was forced to act that way. There is hope that the Central Bank’s plans to eliminate all the issues and hand over the institution to private investors will be become a reality. It is crucial to make sure that the funds spent on bringing the banks back to normal do not exceed the Central Bank’s earnings from their sale. Otherwise, there is no reason to save these institutions.
It will be, to put it lightly, very difficult to sell the united bank on the market. It’s unlikely that potential buyers will line up for the chance to buy it. If the sale happens at all, then the buyers will most likely be organisations close to the government. I hope this will be the most pessimistic scenario.
Instead of being spent on saving the bank, money could have been used to pay out the mandatory compensation for retail deposits (up to RUB 1.4 million per deposit). For the economy, bankruptcy of inefficient players and market redivision among new market players would be much more helpful than attempts to help old players keep afloat. The new mechanism for financial rehabilitation is dangerous in that the “old” owners retain their shares in the bankrupt banks. They seem to cooperate with the regulator, but still keep their assets, which could have saved the situation, for themselves. I’m not talking just about the former owners keeping their stakes in the bankrupt banks, but also about the responsibility they should bear for the banks’ problems.
Of course, here the most important thing is not which form rehabilitation takes, but what the government and the Central Bank really intend to do. Everyone is waiting impatiently to see the outcome of Yugra’s bankruptcy. Everyone would like to see if the beneficiaries will be obliged to cover the losses.
One could say that investments in the banking sector across the globe and in Russia are becoming less and less attractive in the face of active regulatory measures aimed at reducing risk and thereby also the returns.
The government has all the capacity and tools necessary to avoid “surprises” and huge budgetary expenditures (both in the case of the banks it is rehabilitating and the healthy banks it holds significant shares in), provided that it consistently improves the management quality. This is being actively discussed in the banking circles these days. So, the regulator should hire qualified staff, fight against commercial bribery, identify and eliminate inefficiencies, introduce KPIs for banks and their top managers, and thoroughly monitor the situation in real time.
If banks (including state ones) ignore management issues at the very beginning, they will surely experience far more serious problems later, even if it seems that these issues can be pushed aside for now. Given the accounting and reporting specifics in the banking sector, a bank’s problems will always be very unpredictable in their nature and scale. For a bank, preparing financial statements is always a very creative process. In other words, a bank can cover up its problems and keep them undisclosed for quite a while.
Despite the fact that the Russian regulator continues to be very tolerant towards a major part of the problems banks are experiencing, attempts to finally put things right and steps to tighten supervision and control are actively supported by most of the professional community.