Can you bank on Russian Banks?
There have been many stories in the news recently saying this or that foreign consumer bank is shutting up shop in Russia. Is this part of a general plan, or is it just that retail banking is one of the few industries in which Western firms are not competitive with Russian ones? Since few Russian banks operate outside Russia, that seems unlikely. Perhaps there is some hidden agenda? Ian Mitchell fills in some of the background to this very important question.
In any meaningfully modern sense of the word—as something which makes the world go round—money came to Russia with Peter the Great, when he forbad nobles and the few merchants the country possessed from keeping their money hidden in chests or, as many did, buried in the ground. They had to use it, to put it into circulation.
Of course, Russia had coin and cash before that, but the main asset the country possessed, land, was worthless without serfs, and serfs had no income except in kind. For the few merchants in the towns who traded furs between Siberia and Europe, there was a law of usury through much of the early modern period, which prevented the development of banking. The country had a basically non-monetary economy, and the little money there was could not be bought and sold. There was nothing on which to build a system of credit or debit, which is why all foreign trade was financed by foreigners until well into the eighteenth century.
Europe had known credit banking for long-distance trade since the eleventh century. A necessary parallel growth was that of law and courts for arbitration of disputes between merchants. Insurance grew out of the non-justiciable risks, such as brigandage or storms at sea. By the time the Medicis founded their bank in Florence, Europe had a highly sophisticated system of financial services. But Russia was still under the Tatar yoke. For the next five centuries, banking was to all intents and purposes unknown in Russia.
It was only in the 1860s, after the emancipation of the serfs, who comprised 90% of the population, that the generality of the country could participate in the money economy. The first privately-owned commercial bank was founded in 1866, but even then, the main banking function was undertaken by the state, which saw its role as facilitating national economic development by command, usually through state-licensed concessions, rather than assisting the people at large to work independently and productively so that the economy might grow of its own accord.
Russian financial services grew rapidly during the hectic industrialisation of the late nineteenth and early twentieth centuries, but were still very unsophisticated by comparison with other European countries when, in 1917, the entire system was abolished by the Bolsheviks.
The day after Lenin seized power, he sent an armed detachment to the State Bank in Petrograd to get hold of the gold and the roubles there, which of course instantly became worthless without a bank to back them. The Bolsheviks’ understanding of finance was, for a Party which claimed to base its ideas on materialism and economics, almost unbelievably primitive. The history of Soviet banking is the history of the dawning realisation, on reluctant minds, that banking is to an economy what the operating system is to a computer: it does not do anything much of itself, but without it none of the more directly productive functions are possible.
By the 1960s, when the crude shortages of the Stalin period had been overcome, the Soviet emphasis on physical production rather than consumer satisfaction meant that money piled up in Soviet banks because the account-holders had nothing to spend it on. It could not be used abroad—that was currency speculation, which was a serious crime—and it could not be spent at home on anything productive—because that was either pure speculation, if you were passive, or “bourgeois adventurism”, if you were active and entrepreneurial. Both were also serious crimes. The money could be wasted, of course, and often was. But the only sensible thing the citizen could do was to convert it into desirable goods, like nylons, LPs, Teddy-Boy suits or other illegally-imported “luxuries” at exorbitant prices. The middle-men and profiteers in all these transactions were criminals who played a role that was part trader and part proto-merchant banker.
The result of this artificial, distorted situation was that when the Soviet system began to come apart at the seams in the late 1980s, and certain aspects of trade were liberalised, the only people in town with any of the skills needed to provide some form of banking services were those operating at or beyond the edge of the law. It is hardly surprising that the first Russian banks were founded mostly by people with an unsavoury past. It is also not surprising that these people took a short-term, highly personal view of the purpose of their banks: which was to make money for them personally and usually nothing more.
This is not the place to go into the history of post-Soviet banking, except to observe that the industry is highly fragmented— Russia has about 1000 licensed banks—and that most banks do not serve the public, only the owners and their related businesses. The few that do normal retail business charge rates of interest for loans that are astronomical by world standards, while paying low returns to depositors. Their spreads are huge.
Despite their healthy domestic cash flow, even the largest banks in Russia seem unable to compete on the world market, or perhaps they are simply unwilling to try when there are such enormous profits to be made at home.
The natural question which arises from this is: why do Western banks not come in and clean up by offering more competitive lending rates? There are several reasons for this, possibly the most obvious being the poor state of the Russian judicial system, which means that recovering money lent can be costly, or even impossible. However, there are less obvious reasons, one of which is that all foreign banks are required to register as Russian companies. Volkswagen can come and build its cars here without starting up a separate company, and Ikea can operate in Russia as a subsidiary of the global operation. But banks are subject to special rules. The nett effect of this is that banking is one of the most highly protected parts of the Russian economy. Why might that be?
Last summer, I visited Estonia and talked at length to Mart Laar, who had been Prime Minister there at the time the country achieved independence and also for a further period, in the early 2000s, when Estonia joined the EU and NATO. We were discussing the reason why Latvia is so different from Estonia, and he mentioned corruption. I asked him if he did not think that was common to all ex-Soviet republics and he said that Estonia had got rid of it. “How?” I asked. “By cleaning out our banks,” he said. “We understood clearly that the centre of all corruption is in the banking system. If that is clean, you have a reasonable chance of running a relatively uncorrupt economy; if your banks are corrupt, you have no chance.”
When I asked how they had gone about cleaning out the banks, he said they had started by identifying the corrupt ones, which were mostly laundering Russian criminal money that was looking for safe-havens. Then, when one of these banks needed a shortterm loan, and asked the government to help, they would be turned down out of hand. Since the government was the lender of last resort, this usually meant that they were forced by the refusal into bankruptcy, or to be sold to a foreign bank, a measure which the government, as ultimate licensee, had a right to insist on.
But what if they never asked for money? In that case, Laar told me, the government acted more aggressively. It would put funds on short-term deposit with the bank on a large scale over a long period, until it had accumulated a huge balance. Then one morning, without any warning, it would withdraw the whole lot. When the bank could not find the money by close of business that day, it was declared in default and put out of business. Today most of the banks in Estonia are subsidiaries of either Swedish or Finnish banks and the country has one of the lowest levels of corruption in Europe.
Contrast that with Russia, where so far from inviting foreign banks in to wage war on corruption, the country appears to be forcing them to leave. Though none will give a candid reason for their departure, the facts are suggestive. The most recent departures has been Svenska Handlesbanken. HSBC, the largest bank in Europe and second-largest in the world, is mysteriously unable to compete in retail banking in Russia. It invested $200 million in the Russian market three years ago, but is now selling its assets here for $11 million. Barclays announced shortly before PASSPORT went to press that it is selling its 32-branch retail operation in Russia. It paid $500 million for it in 2008 and is expected to realise no more than a tenth of that. Santander has already gone, selling its business to the Orient Express bank from Blagoveshchensk, not a place hitherto noted for its financial expertise. All these Western banks are well-established internationally, yet they seem unable to compete in Russia. Why?
My unofficial information is that all except two or three foreign banks—Raiffeisen and Citigroup have been mentioned— have been told they may continue to operate in Russia as investment banks for corporate customers but not the private sector. Since the Russian corporate elite is able to use banks abroad anyway, that is perhaps a concession without cost. But more importantly, due to the international mobility of the elite, they are not a captive market, whereas the ordinary Russian who saves his money in a tin safe under the bed, like the merchants in pre-Petrine Russia, is very much a captive customer of any domestic cartel.
Such people often pay up to 30% interest on a personal loan to buy a car, and nearly that for a mortgage. They are terrified of losing their jobs because of the cost of financing a roof over their heads, and so become docile in the work place. It is hard to resist the conclusion that this situation suits the people who own the commanding heights of the economy, which include the banks. But more than that, it must be very profitable for the lenders, unless the Russian banking system is so inefficient that it cannot make money on the huge margins it makes on domestic retail business.
I have also been told, off the record, that one of the main reasons why the World Trade Organisation negotiations have dragged on for so long is that Russia is unwilling to open its financial services industry to foreign competition. If Mart Laar is right about the essential locus of corruption, that might explain a lot.
But one thing which is not speculation is the current Bank of Moscow scandal. VTB, which is 75% owned by the Russian government, recently took over what was Russia’s fifth biggest bank. Now it turns out that there are billions of dollars of assets which are “doubtful”. The state has had to provide $14 billion to VTB to cover this unexpected “black hole” in the balance sheet. Did VTB know the Bank of Moscow was insolvent when it bought it? Apparently not, despite all the due diligence which one presumes it would have carried out. No-one seems to know how the money disappeared. Was it due to theft, incompetence, or a computer glitch of the sort that can happen to anyone, especially in a bull market when the rouble is strong and everyone feeling happy? Or is it just another example of the sort of pre-Petrine banking practices that Mart Laar wanted to stamp out in Estonia?
If corruption really is rooted in a country’s banking system, and the Russian state really is systematically excluding foreign retail banks, then the rational observer is forced to conclude that the powers-that-be want the current system to continue. If that is the case, then it is a fact of the highest possible importance for the future of the country. Corruption is here to stay. That is one thing you can bank on.