RUSSIAN BANKING SECTOR'S SECOND CRISIS

C O N F I D E N T I A L MOSCOW 001182

SIPDIS

STATE FOR EUR/RUS, EEB/IFD
TREASURY FOR TORGERSON
DOC FOR 4231/MAC/EUR/JBROUGHER
NSC FOR MCFAUL

E.O. 12958: DECL: 05/08/2019
TAGS: EFIN ECON RS
SUBJECT: RUSSIAN BANKING SECTOR'S SECOND CRISIS

Classified By: Acting DCM Eric T. Schultz, Reasons 1.4 (b/d).


1. (C) Summary. Russia's banking sector is preparing for a
second wave of the financial crisis. Banks have been setting
aside a higher-than-required share of in-house resources as
provisions against an anticipated rise in non-peforming loans
(NPLs). Some observers, including Sberbank President German
Gref, nonetheless expect a dangerous level of NPLs before the
end of the year. The GOR is still considering the options
and conditions in which it would provide assistance to banks
carrying "bad loans." However, some banks have already
embarked on restructuring negotiations with their borrowers,
and as the economic outlook continues to deteriorate, an
increasing number of banks will struggle to manage the stress
that more NPLs will impose on their operations. In light of
limited reserves and other spending commitments, the GOR will
probably not be able to respond with a system-wide program to
support troubled banks, focusing instead on "systemic" banks
and allowing others to consolidate and even fail. Much will
depend on whether the government is able to manage this
process in an orderly fashion. End Summary.

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Banking Sector Prepares for Second Wave
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2. (C) Many banks have begun to impose stringent
requirements on borrowers, including for their long-term and
trusted clients who experienced severe losses at the outset
of the financial crisis. As VTB Investor Relations Director
Neil Withers recently told us, many banks "no longer accept
just a phone call from an oligarch as a substitute for
collateral." Borrowers, whether oligarchs or sole
proprietors of small businesses, must NOW pledge bona fide
assets that are in keeping with the size of the loans they
need. For new borrowers, which many banks have deemed
synonymous with "risky," the more daunting rules on
collateral are coupled with prohibitive rates of 20 percent
or more.


3. (C) In addition to elevated standards for collateral, the
sector as a whole has voluntarily raised its capital adequacy
ratio, a measure of a bank's long-term capital relative to
all loans earmarked as a provision against the possibility of
non-performing loans (NPLs). The Central Bank (CBR) has been
loosely enforcing the Basel-II capital adequacy standards,
but the banking sector overall currently boasts a ratio of
nearly 17 percent.


4. (C) According to MDM Bank Chief Economist Nikolay
Kashcheev, the higher-than-required ratio strongly suggests
banks anticipate problems with their loan portfolios.
Kashcheev told us the current ratio also partially explains
officials' frustration that banks have not supplied enough
credit to the economy. Rather than use 100 percent of the
government-supplied financing to provide credit to
businesses, banks have used a significant share of those
funds as a means of protecting themselves against possible
defaults.


5. (C) Some banks have also reportedly begun their own bad
debt restructuring programs. Trust Bank Chief Economist
Evgeniy Nadorshin told us Trust's "Banking Sector Navigator"
uncovered a slowdown in the growth of banks' corporate NPLs,
from a growth rate of more than 23 percent in January, to 22
percent in February, to 11 percent in March. Nadorshin said
the March figure did not reflect an improvement in economic
conditions but rather a concerted effort to restructure
problem loans. He speculated one reason for the
restructuring was banks' interest in presenting the best
possible indicators so they would continue to qualify for the
CBR's un-collateralized lending facility.


6. (C) The steps that banks have taken to mitigate the
effects of potential loan defaults supports officials' and
bankers' public expressions of concern about rising NPLs
later in the year. Sberbank President Gref recently echoed
Finance Minister Kudrin's concern that NPLs, and the fear of
NPLs, could hinder the GOR's anti-crisis plans. Gref said
NPLs could exceed 10 percent for his bank alone. Others,
including Alfa Bank's respected Chief Economist Natalya
Orlova, believe the rate may be as much as 15-20 percent
system-wide, reaching 30 percent or more in some banks.
Citibank Chief Economist Elina Ribakova told us that NPLs of
10 percent was part of her best-case scenario for the end of
the year.


7. (C) The implication of a dangerous level of NPLs has cast
doubts on the GOR's plan to support the banking sector
through systemic recapitalization. If NPL-related strains
were to emerge across the sector, the GOR would be compelled
to shift away from recapitalization and toward either
rescuing banks or organizing a "bad debt" restructuring
program.

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Inadequate GOR Response
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8. (C) For its part, the GOR has not yet modified its
anti-crisis response program to include a plan for the
banking sector's potential NPL problem. Officials
acknowledge the pressures of the ongoing slowdown for the
country in general and the banking sector in particular but,
to date, have not devised a concrete proposal on how the GOR
might support the sector as the crisis worsens. For the time
being, the message from the highest levels has generally been
to stay the course, with the modification that the GOR will
impose more rigorous conditions on the use of
government-supplied long-term financing. Prime Minister
Putin, for instance, told attendees at a recent government
meeting on economic policy that banks receiving long-term
financing from Vneshekonombank (VEB) must use 100 percent of
that funding to make loans and must not charge more than 3
percentage points above the CBR's refinancing rate. Ribakova
said that adherence to this policy was likely to be
counterproductive. The GOR continued to push for the
expansion of credit while at the same time using heavy-handed
supervision in terms of which areas of the economy should
receive priority consideration for loans.


9. (C) First Deputy CBR Chairman Aleksey Ulyukaev, moreover,
publicly disputed concerns that Kudrin, Gref and Deposit
Insurance Agency Director Turbanov have raised about the
likely severity of the NPL threat. Ulyukaev maintained that
neither the current level of, nor the rate of growth in, NPLs
presented a cause for concern. He argued in a recent
interview with Vedomosti that there would be no "second wave"
of the crisis because there was no "first wave." As the
crisis intensified last fall, the GOR succeeded in supporting
banks by supplying sufficient liquidity to the sector overall
and by facilitating the rescue of individual banks in
distress. According to Ulyukaev, economic policymakers
prevented a panic and would be able to repeat last fall's
achievement if necessary. (Note: Ulyukaev's interpretation
that the events of last fall did not constitute a "first
wave" of the financial crisis for the banking sector is a
stylized reading of the facts. The first round of the crisis
came at a time when surplus budget funds and substantially
higher reserves gave policymakers flexibility in their
options. Simply because the GOR was able to avert a panic
does not mean the first wave did not exist. End Note.)


10. (C) In a rare breaking of ranks, Finance Minister Kudrin
publicly disagreed with other officials concerning the scope
of the NPL problem. His comments have emphasized that the
rate of growth in NPLs could destabilize the sector,
prompting the collapse of many banks and, thereby, rupturing
confidence in the financial system. Policymakers, therefore,
needed to consider alternatives to the bank re-capitalization
aspect of the GOR's anti-crisis plan. However, disagreement
among officials on this point has meant the absence of a
contingency option to address the effects of a hazardous
level of NPLs.


11. (C) New Economic School Rector Sergei Guriev confirmed
for us that the GOR's internal disagreements, between the CBR
and First Deputy Prime Minister Shuvalov on one hand and
Kudrin and the Finance Ministry on the other, was hampering
the GOR's policy response. Guriev said Kudrin's more
pessimistic view was right and expressed hope that the
"stress tests" the CBR had begun conducting on Russian banks
(with IMF help) would lead to a more proactive GOR approach.

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Scenarios and Consequences
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12. (C) European Bank for Reconstruction and Development
(EBRD) Economist Alexandre Plekhanov told us he expects one
of three scenarios for the banking sector to begin to take
shape by the end of the year. First, Russia could imitate
the method by which China addressed its high NPL problem of
recent years. That is, a further devaluation of the ruble
could allow Russia more flexibility to export its way out of
the problem and harness the potential of an import-substition
response. The strains on the banking sector would work
themselves out in the process. Second, the GOR could set
guidelines for a domestic debt restructuring process, if not
an institution that would serve as a mechanism for clearing
the bad loans from banks' balance sheets. Third, banks could
"hide" their NPLs through a series of false restructuring
agreements.


13. (C) JP Morgan Chief Economist Peter Westin told us that
if the GOR's recapitalization efforts were to founder as a
result of growing stress on banks' balance sheets the GOR
would probably focus its attention on the 50 largest banks,
since they claimed the overwhelming majority of existing
deposits. Westin speculated the Deposit Insurance Agency
(DIA) might receive additional funding to facilitate the
takeover/acquisition of distressed banks by interested
investors. However, the DIA faced substantial personnel
constraints and would not be able to rehabilitate or rescue
more than 5 to 6 banks at any one time.


14. (C) Guriev told us that there would almost certainly be
bank failures given the GOR's dwindling resources. The GOR
had set aside $40 billion from the National Welfare Fund, the
remainder of the funds it had originally earmarked last fall
to support Russian equities, to recapitalize banks. However,
Guriev said it would not be enough. A more realistic figure
was $85 billion to recapitalize the sector, even if oil
prices stayed above $50 per barrel. His biggest concern, he
said, was that the GOR would wait too long or otherwise
mishandle the bank failures, further undermining the economy.

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Comment
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15. (C) The GOR will likely have neither the resources nor
the strategy for assisting with banks' bad debts. A budget
deficit of 8 percent this year and dwindling reserves give
policy makers little flexibility in responding to banks'
needs. Support for banks will probably be directed at
systemic banks and will be ad hoc, selective and less than
transparent. The second wave intimated by a steady climb of
NPLs threatens to find the GOR poorly prepared, with the CBR
and other parts of the government in denial about the depth
of the problem. Without the resources to repeat last year's
success in preventing a panic, the GOR will likely need to
get its act together soon if it is to manage this second wave
in an orderly fashion. End Comment.
RUBIN