Thought Leaders: Finance
The Banks of the Volga
Gregg S. Robins
08/01/06

The only country standing in the way of Russia’s bid to join the World Trade Organization by next spring is the United States. One of this country’s primary objections is that Russia does not allow foreign banks to open local branches—they are limited to forming Russian subsidiaries.

Our trade negotiators presume to speak for U.S. businesses, but, in truth, our banks do not really care about opening branches. More important to the global banking community and its investors is the fact that Russia’s financial services sector is growing at triple-digit rates. Over the past year, the Russian Trading System, the country’s largest stock exchange, has shown a 115 percent share appreciation, while banking sector shares have grown 307 percent. Russia’s middle class is rapidly expanding, spurring further development of the financial industry and new opportunities for foreign investors. U.S. demands that Russia allow local bank branches as a condition of WTO membership seems a petty sticking point in the face of the prospects that already exist to improve the system.

Despite its recent growth, Russia’s banking sector remains inefficient and, more importantly, undercapitalized for the challenges it will face. Consumer credit card interest rates, for example, remain onerously high, in part because the country has no central credit rating system. As a rudimentary system develops, banks will be more willing to lend, but they will need capital to do so. Consumers will also demand credit for larger purchases, notably autos and homes.

Today the capital held by Russian banks stands at only 5.7 percent of GDP. In much of Eastern Europe, this figure is closer to 10 percent. The International Finance Corp. and the European Bank for Reconstruction and Development are already supporting banking growth in the region with technical assistance and capital. But larger amounts of money will have to come from the capital markets, and much of this from foreign investors.

Although state-owned banks will continue to control the majority of the banking sector, large privately owned banks—such as Alfa and MDM—and foreign banks will up their ante to capture opportunities also. For foreign banks, this will mean bringing even more money into Russia. Between 2004 and today, their share of capital has increased from 6.2 to 11.2 percent.

Andrei Kozlov, deputy chairman of the Central Bank of Russia, hopes Russian banks will raise equity through initial public offerings in order to improve their capitalization and ensure their ongoing competitiveness. Economists expect nearly 30 Russian companies—in banking and other industries—to go public in the coming year, raising a total of approximately $25 billion.

Floating Branches
Russian debt markets have also grown dramatically. Corporate debt outstanding has increased from $200 million in 2002 to more than $20 billion today, with the numbers of issuers, sizes and tenors all increasing by 400 to 600 percent. As Russia develops its asset-backed securities market, financial institutions will have access to more capital that they can use to meet growing consumer demand for loans. In August 2005, Soyuz became the first Russian bank to issue domestic paper backed by receivables—in its case, auto loans. These short-term obligations are a sensible first asset to be packaged and sold in the early days of a securitization market. A market for more complex mortgage-backed securities will evolve over time, as the infrastructure and expertise to accommodate it develops.

An embryonic asset management industry, fueled by demand from both domestic and foreign investors, will also facilitate the development of a securitization market. Today’s Russian private asset management industry has only about $25 billion under management, roughly as much as a small New York asset manager. But it took the United States decades to move from a model in which banks controlled the allocation of capital to one in which that role is played by the capital markets. Russia will make this transition much more quickly.

Russia believes foreign bank branches would have unfair advantages over domestic institutions and would pose regulatory and money laundering risks. Nonetheless, other WTO members want Russia in the trade organization. They are able to see the bigger picture and realize that despite its ban on foreign branches, there are huge opportunities for foreign financiers looking to invest in the country’s rapidly growing financial sector.

Gregg S. Robins is an executive fellow at the NYU Stern School of Business; he recently led a tour of Russia for executive MBA candidates. He is the author of Banking in Transition.