12 Major Banks Lack Stability

15 january 2018 | Rossiyskaya Gazeta

"12 of the biggest Russian banks lack stability, while 2 of them exhibit 3 vulnerability signs at the same time. Stricter supervision may result in regulatory measures having to be taken against them," writes Analytical Center expert Daniil Nametkin in an op-ed he penned for the Rossiyskaya Gazeta.

Daniil Nametkin
Daniil Nametkin
Department for Expert Analytics

Analysis of the top 30 banks (except for banks with state-ownerships and banks undergoing restructuring) shows that the following parameters can serve as signs of vulnerability for them.

First, there is the low safety margin with regard to capital sufficiency. Private banks are finding it harder and harder to compete with state owned banks as they have access to fewer resources and have to rely on more expensive funding. This is driving them to relax the non-price-related lending terms. In the event that reserves have to be expanded for such subprime loans, available capital may fall below the required sufficiency level. Low capital sufficiency safety margins (between 9.31 and 11.89% as per the H1.0 requirements at December 1) were found in 4 major banks.

Second, low diversification of sources of income. Most banks focus too much on making money off interest rates and that is a source of income that is less consistent than, say, commissions (for offering banking services that do not involve making loans). Of the banks that were analyzed 4 made as much as 85% of their operating profit before reserves for the 9 months of 2017 off interest revenue.

Third, the negative trend in the reserves for potential losses. Improvements in the quality of loans can help a bank free up some of the reserves it created earlier. However, boosting profits by freeing up reserves must be a one-off measure rather than something a bank resorts to on a regular basis. In addition, another sign that a bank is struggling may be a reduction in its reserves for possible losses at the same time as its capital sufficiency declines, a situation, which may suggest that the bank is reclassifying its loans in order to meet regulatory requirements. 4 of Russia's largest banks specializing in the retail segment are constantly exhibiting these trends.

Fourth, the status of the special administrator. The Bank of Russia notes that the deterioration in the financial state of such major players as FK Discovery and Binbank to a large extent stems from the problems of their subsidiaries. Thus, the bulk of the funds being allocated for FK Discovery is going to go on supporting its subsidiaries Rosgosstrakh and Trust Bank while the money's being allocated to Binbank is going to go on covering the capital shortage of Rost Bank. This is evidence of a very high level of risk incurred by banks acting as special administrators for other financial institutions. Only 5 of Russia's biggest banks are currently acting as special administrators for other banks.

Fifth, some banks have among their shareholders large financial and industrial groups that hold significant stakes in them, which is one of the signs of the captive business model (in which the bank mostly lends money to finance big projects of its biggest shareholder and to companies related to it). With banks like that (there are 2 of them in the group analyzed) the regulator is going to primarily focus attention on adherence to the H25 (risk of related parties) and H6 (risk of one or a group of related borrowers) requirements that say the maximum level of such loans must not exceed 20 and 25% of the total capital respectively.

These signs are emerging against a backdrop of stagnating credit portfolio of legal entities: by December 1, 2017 it totaled RUB 30.18 trillion, which is 4% less than the year before. A certain role was played in this by the strengthening of the ruble by 8.8%, which resulted in a negative reappraisal of the loans in foreign currencies, the share of which in the credit portfolio is 29%.

In addition to the reappraisal factor, another factor that is holding back corporate loans is the significant deterioration in the risk to profitability ration in the overall economy. Despite numerous calls for profitability, companies continue to make less and less money in net profits. In the first 9 months of 2017 the average profitability of sales in the economy fell to 7% from the 8.16% and 9.14% in the same periods of 2016 and 2015 respectively. When profit margins are falling in business, the debt load expressed as EBIT/Interest Payable goes up. As a result, even minute deviations from the business plan can cause serious problems for the company.

In the context of lending this manifests in the form of companies cutting back on investments while banks become more conservative when it comes to reducing interest rates. For example, in the small and medium sized business segment, which is traditionally viewed as more risky for banks, the weighted average interest rates for loans of up to one year went down by 1.37% in January-October 2017 while the key interest rate of the Bank of Russia was slashed by 1.75 percentage points in the same period.

In addition, introduction of stricter regulatory requirements for Russian banks also may have made the situation with lending to companies worse. When the transition to proportion regulation is completed, the regulatory burden on banks that hold universal licenses will increase as from January 1, 2018 they are going to have to meet additional requirements.

Source: Rossiyskaya Gazeta

Photo: from open sources