Russian Banking System: Current State and Prospects of Development

V.S. Belykh, Doctor of Law, Professor, Head of Entrepreneurial Law Subdepartment, Ural State Law Academy, Yekaterinburg, Russia

    One of the most important tasks of economic changes in Russia is to build an effective banking system. Over recent years, there have been noticeable positive changes in the banking sector of the national economy: the state monopoly over the banking industry has been liquidated in our country; the modern dual banking system has been formed; specific banking legislation has been developed and enacted. Also, competitive credit and financial infrastructure is gradually developing. Commercial banks are a major element of such infrastructure. Some of them have already obtained a high international ranking[1].    

    The Strategy of Banking Sector Development in Russia till 2008 contains the assessment of the banking sector state before the global crisis. Banking sector is said to be functioning on market principles. According to the results of the assessment of the RF financial sector made by International Monetary Fund and World Bank Mission in 2002-2003, a number of components of statutory banking regulation comply with or approximate to internationally recognized approaches, which is confirmed by asset growth rates in Russian banking: 44.1% in 2006 and 2007. But during the crisis the asset growth rates fell, e.g., in 2009, the growth was only by 5%, in 2010 - by 15%, in 2011- by 23.1%[2].    

    Thus, 2011 growth rates were much higher than those in the previous two years. But, before the crisis, the annual asset growth rate was at the level of 30-50%,which demonstrates that there is no return to the carefree pre-crisis time, and growth points are now harder to find.

     It should be noted that the Russian banking sector has great potential. Thus, in 2006, the above-mentioned ratio in France was 250%, in Germany – about 300%, in Great Britain – 360%[3]. These figures show that the gap in the growth rates is still significant.

    At the same time, the Russian banking system (as the entire world system) is going through a difficult period connected with a global economic crisis and its consequences. The financial crisis, including banking and mortgaging, arose in the USA; then the “infection” spread over the world. The economies of various countries suffered to a different extent. But the states with the open infrastructure and the developed market economy suffered the most. The higher is the integration level into the world economic order, the higher is the destructive impact over the state economy. Such countries as Cuba, Korea, and Nigeria can hardly feel the power of the crisis as everything was consistently poor there even before the crisis. According to experts’ forecasts, the consequences of the world crisis will be perceived for not less than 10 years, and the leading economies (e.g. Spain and Greece) will need at least 11 years[4] to reach the pre-crisis level of the economy.

    The Russian economy has become more integrated into the world economy (compared not only with the Soviet period, but with the period of its formation during the term of office of the First Russian president). At the same time, the economy is semi-closed for the intrusion of foreign elements. The said is true for all segments of the economy. The Russian stock market is another example for comparison. On the one hand, it is a part of the Russian economy. But on the other hand, the stock market is something separate, having for the most part no relation to the real economy. That is why the statement that Russian stock market has lost its specific peculiarities and vanished into the world market does not seem true.

     There is another example: a sharp fall of indices at the markets of the Moscow Interbank Currency Exchange and the Russian Trading System has not taken a noticeable effect over the general assessment of Russian economy on the whole and over the population. Domestic oligarchs have suffered in this situation; their virtual (speculative) capital has reduced sharply, and many of them have lost their high ranking in the lists of the richest people.  Most common people (workers) did not take part in these speculative games. This drawback of the market economy turns out to be an advantage for Russia. The same can be said about mortgage lending to people.

    The development of the Russian banking sector has been connected with serious problems. There are two main problems touched upon by scholars: 1) domestic banks are more dependent on external source of financing (at the end of September 2008, the external debt of banks without participation in the capital was $198.2 billion, i.e. about 20% liabilities of national banking system); 2) the level of bank capitalization is still low[5]. The USA mortgaging crisis of 2007 made access to international financial resources harder for the Russian banks, and they encountered first difficulties in an attempt to obtain funds. That was the first signal. Further developments in international political, economic, and military arena led to noticeable escalation of crisis situation (including problems at financial markets).

     In September 2008, prices for oil and mineral resources (ferrous and non-ferrous metals) dropped. There was a tendency for the setback in production and the rise in inflation. In 2007, the inflation was 11. 9% as against 9% for 2006, and  13.3% in 2008. This situation led to the increase in prices for foodstuffs[6]. Another indicator is gross domestic product that reduced by 9.5% in Russia. A. Klepach, Deputy Minister of RF Economic Development says that several factors influenced the reduction of gross domestic product:  the reduction in investments by 18% and the decrease in trade volume by 1.1% during the first quarter of 2009.[7] At the same time, there was the outflow (flight) of capital. Thus, for the period from 1991 to 1998, 270 – 500 billion US dollars flew illegally (according to estimation of various experts) out of Russia, which is considerably higher than the figure indicating foreign investments[8]. The mentioned figures can be compared to the following: in 2007, the flight of capital was 44 billion US dollars, and in 2008 the net outflow of capital was 139.1 billion US dollars[9], so it was 3 times total growth. In 2011, the net outflow of capital was 80.5 billion US dollars[10]. Alexey Ulyukaev, First Deputy Chairman of the Bank of Russia predicted the outflow of capital from Russia in October, 2012 but with less pace, and there was no change in this tendency in November and December, 2012.

    The experts of International Monetary Fund say that the Russian banking system is “strained because the rate of borrowings with arrear of payments is growing, and the volume of loans to private sector is reducing. Despite considerable budget support, the level of economic activity will decline in 2009, and it will be insignificantly restored”[11]. The category “the working-age population” is rather formal and depends upon the retiring age defined by the law and other various circumstances.

     Thus, Russia followed the way of more developed countries through the global financial crisis to recession. Now Russia needs to go on the way back without a hurry. In 2012-2013, Russia will probably see another crisis that can be more destructive for the economy than the crisis of 2008-2009. The experts forecast sharp decline in the ruble’s exchange rate and in prices for the exported oil and the economy[12]. 

    The global financial crisis showed a number of global problems, and those in the Russian economy in this number. The first one is the inefficiency of the existing economic model in Russia. We could not diversify the economy, we are still dependent upon raw materials. The second one is the inefficiency in the management of the economy and entrepreneurship. The current crisis in the Russian economy demands a serious analysis and requires regular forecasts.

   A number of consistent and vigorous actions should be taken in the banking sector of the Russian economy to improve it and to get out of the crisis situation. First of all, we support the provisions of the Concept for the Financial Market Development Till 2020.[13]  The main distinctive feature of the Concept is that it embraces all sectors of financial system – banking sector, insurance sector, securities market, pension system, and the investitutional investors. The scenario of breakthrough is not possible indeed until the development of capital market and the banking sector of the economy are not closely coordinated. Moreover, there are sectors that play a significant role in the financing of the economy in industrialzed countries. They are the banking sector, the insurance sector, and the pension sector. The respective organizations are big financial investors.

    Russia is turning to market relations, so insurance is becoming a particular type of commercial activity. However, the abundance of insurance organizations at the domestic market has not led to the growth in their influence on all spheres of public life. Nowadays, Russian insurance market is poorly developed but actively growing. Thus, the total volume of insurance premium including compulsory health insurance by 1 April, 2007 was 190 billion rubles. It is 23.2% more than for the same period of 2006. The total volume of payment was 98.1 billion rubles.[14] There are some facts to compare: 319.9 billion rubles were collected at the expense of individuals in 2011; 161.3 billion rubles were paid off. The premiums at the expense of legal persons increased by 19.9% in comparison with 2010 and totaled 343.7 billion rubles. Payments increased by 6.1%, and totaled 141.9 billion rubles. The part of premiums at the expense of citizens in total dues remained at the same level of 48.2%.

     The same appraisal is given to stock market. A. Tatyannikov says:

   “…now it is rather clear that the stock market acquires its own historical basis, and this is its main advantage.  Taking into account that we have entered into the world financial system, having only few possessions, then there is no escaping from comparison with countries with a “stable economy” (the inexactness of the notions in the realities of 2008-2009 is evident) and with such developing countries as our country.

    It is true that our stock market has seen everything during its short life: dependence upon foreign crises (Asian crisis in 1997), and its own crisis in 1998, and its acknowledgement as one of the most dynamically developing markets during the years of 2005-2006 (which is breathtaking), and its new financial and economic crisis together with the whole world in 2008 during the first stage of which it lost considerably more out of fright than it deserves”[15].

   Thus, the Russian stock market is not a significant instrument to accrue capital for the most part of citizens and the source of investment resources for the major part of enterprises, so it cannot exercise a full range of functions characteristic for the developed stock markets. The Russian total structure of investors is still characterized by a small share of private persons and institutions of collective investments[16]. At the same time, large-scale investments are needed for stable growth of the national economy and export potential. “International experience shows there is an alternative within certain limits. If a country has an excessive import, then the growth of investments is restrained. Investments go where goods do not go.”[17] There is a question: where do the investments go?

    As it is truly observed, the inflow of foreign investments into the Russian Federation has a number of peculiarities that prejudice stability and positiveness of the observed tendencies. Why does it happen? First, investments come mainly in the form of trade credits and other types of credits. At the same time, the majority of other countries attracting foreign capital have the prevailing number of the direct and portfolio investments which share is up to 90% of the total volume. The share of the direct foreign investments into the gross accumulation of capital in Russia is at an average of 2-5% from the total volume. There are certain figures for comparison: the share of the direct and portfolio investments in the USA during the latest economic upturn was up to 19%, in Brazil it was up to 28%, in Poland - up to 23%, in China it is stable - 10-15%, and in the Kazakhstan this rate was 56%. Second, foreign capital is invested mainly into fuel and raw material branches of the economy (oil and gas extraction and refining, ferrous and non-ferrous metallurgy) as well as in the food industry  and trade. Third, attracting investments from abroad into the real sector has not lead to reduction in capital export until recently. On the contrary, capital flight from the real sector gives every reason to believe that the foreign investments are of the Russian origin. These are monetary funds which were preliminarily (intentionally) taken out of the national tax control.[18].

    At the same time, in August – October 2008 the Ministry of Economic Development and Trade together with the Ministry of Finance, Federal Financial Markets Service and other federal executive bodies concerned, Bank of Russia, and the National Association of Securities Market Participants came up with the large-scale project– to organize an international financial center in Russia[19]. Financial centers are divided into global, international, national, and regional. Some experts say that there are only two global financial centers. They are London and New York, which act as intermediaries for all participants of financial market and cover all critical mass of institutions. International financial centers make a big volume of transboundary operations where at least two jurisdictions are involved. An example of such a center is Hong Kong, which concentrates a big part of financial transactions in Asia. National financial centers concentrate a big share of financial business of the country (e. g., Toronto is a financial center for Canada). Regional centers are characterized by the fact that their sphere includes a great part of business inside one country. Chicago is an example of such centers, as analysts say. As far as Moscow is concerned, the first research of GFCI (Global Financial Centers Index) ranked it 45^th among 46 cities, and the second research did not consider Moscow at all. So, a widespread opinion that Moscow concentrates all money of the country has a relative character[20].  Moscow concentrates far not all the money.

    The idea to turn Moscow into the biggest international financial center sounds both patriotic and attractive. But so far, this idea has been rather utopic (like making the Russian car industry a leading one), especially in conditions of the global crisis. A.V. Timofeev, Chairman of NAUFOR Executive Board said in his speech:     “The establishment of international financial center is a long-term task; it is important for us not to forget about these plans, taking steps of short- and long-term character”[21].

        But  at the V NAUFOR Conference “Russian Securities Market”, there was nobody to raise a question about an international financial center, and the question was not discussed[22].          

     Some conclusions and proposals. 1. The drafters of the Concept for the Development of Russian Financial Market think that one of the current key-tasks is to accumulate and attract long-term financial resources to the financial market, including banking sector.  The sources for the rise are: а) money of state funds; b) long-term resources (securitization, equity market, mortgage securities, housing accumulative and irrevocable deposits, pension savings and funds of the insurers, and borrowings from foreign markets); c) capitalization of non-financial assets (pledges, titles, registration of titles, natural resources and their financial turnover); d) a short rise in availability of financial services. 2. It is not a secret that the Russian pension system needs a radical reform, not just “cosmetics”. Now there is no coherent concept for reforming the pension system in Russia. The draft concept of development of the pension system up to 2030 developed by the RF government contains only basic directions of the strategy, but the paces are different. For example, the draft law on self-employment has been introduced into the State Duma. But the majority of key   positions are subjects under debate, as there is no unity of views. One of such positions is the cumulative part of the pension[23]. Vladimir Putin, the RF President, proposed to pass the law on pensions in 2014. In this connection, there are some matters of principle: a) there is an experience of pension reforms (e.g., the Chilean model of pension reform is usually referred to as the standard of financing pensions); b) there is no need to follow models of other countries. A model based on the realities of our own country should be created[24]; c) the pension system must be transparent and clear to every citizen. Moreover, only after preliminary (financial) calculations should a draft pension law be worked out. The pension formulae calculation should be made like in Mathematics. Otherwise serious consequences may follow. 3. Now it is time to integrate the capital, production, and business. Russia is joining the WTO, so there is a natural process of merging of small banks, insurance companies and investment companies; and there is no need to interfere with this process. 4. Modern banking policy of gaining profit at the expense of allowing overrated loans is immoral and destructive for the economy and business. In industrialized countries, there are a number of sectors where banks take an active part: a) investment projects; b) funding deals with the participation of the state and municipal entities; c) consumer loans with minimal interest rate; d) full-scale participation of banks into stock markets. 5.  To enlarge the sphere and participation of citizens in the stock market, a system of compulsory insurance in an insured event should be introduced. 6. At present, there is a discussion about possibility to delegate powers on regulation and control over all financial organizations to the Bank of Russia[25]. The said proposal has both supporters and opponents. This sphere of regulation needs to be reformed. The first points that need attention is excessive functions of the FFMS (Federal Service for Financial Markets) and the overgrown bureaucracy. We support the idea introduced by   O.V. Vyugin, Chairman of NAUFOR Board of Directors, that the inspection of FFMS functions should be conducted simultaneously with the reform. The excessive functions should be excluded and delegated to self-regulating organizations (e.g., NAUFOR). Also, FFMS regional offices should be closed or reduced in number. There is a need for an administrative reform. In Great Britain, the central organ for supervision over stock exchange markets is the Financial Services Authority - FSA. The FSA is an independent non-state body responsible for regulation and supervision over activities of all investment and banking companies on the territory of Great Britain[26]. In the USA, control over securities market is exercised by the so-called President's Working Group on Financial Markets. In European countries, banks are major stock-exchange operators. 6. In some way, legal regulation of the Russian financial market is lagging behind its real sector of the economy, not being an objective indicator of its state. There is a need for the complex program of legislative guarantees for the entire financial market and not for its separate parts.

Bibliography:

1. Makarov. Den’gi na starost’ [Money for Old Age] // Rossiiskaya Gazeta [Russian Newspaper], 2012.
2. D.N. Ananyev. Bankovsky sector Rossii: itogi i perspectivy razvitiya [Russian Banking Sector: Results and Development Prospects] // Den’gi i kredit [Money and Credit]. 2009. № 3.
3. Economic Security of Russia: General Course: Textbook / Ed. By V.K. Senchagov. Moscow, 2005. Р. 79, 1999.
4. I.K. Bogdanov. Itogi razvitiya strakhovogo rynka Rossii v pervom kvartale, 2007 [The Results of the Russian Insurance Market Development in the First Quarter of 2007].
5. V.A. Tatyannikov. Rossiisky fondovy rynok i vysovy sovremennosti [Russian Stock Market and Challenges to Today] // Problems and Perspectives of the Legal Regulation Development within the Scope of SCO, EurAsEC and Partnership with EC: Reports of Executive Committee at the III Session of Euro-Asian Juridical Congress. Yekaterinburg, 2009. Р. 47.