With interest rates at their lowest level for 40 years in the West, Russian banks are struggling to compete with their foreign counterparts in the lending market. Victoria Lavrentieva reports on the increasing presence of foreign banks in Russia and the implications this has for the banking sector.

With the Russian lending market still one of the most risky yet most profitable in the world, more foreign capital has poured into the coffers of Russian companies than ever before. But because of their sometimes shady behavior in the aftermath of the August 1998 financial crisis, Russian banks have hardly seen any of it.

The government and the Central Bank have worked tirelessly to protect the troubled banking sector from foreign competition by limiting the scope of foreign presence in the market and delaying the reform process. However, they have been powerless to stop the increasing interest rate margins between the United States, Europe and Russia, which has meant that Russian banks have found it difficult to compete with foreign banks in the lending market.

Despite an unenforced 12 percent limit imposed by the Central Bank on the participation of foreign capital in Russia's banking sector, the real scope of foreign activity -- if measured by lending volumes -- is already twice as much.

As a result, Russian banks, with their comparatively small asset base, are losing the battle for the largest and the soundest local borrowers to their foreign rivals.

Foreign Invasion

According to the Interfax Rating Agency, or IRA, the accumulated volume of outstanding loans provided to Russian companies by banks from 19 highly developed countries reached $14.5 billion through July 1, 2001.

"This is roughly 27 percent of all outstanding loans ever provided to Russian companies," said Mikhail Matovnikov, deputy director general of IRA. "This means that Russian banks already account for less than three-quarters of all loans to local borrowers."

The explanation is simple.

After nine rate cuts by the U.S. Federal Reserve, the base interest rate in the United States is down to 2 percent from 6.5 percent at the beginning of 2001. And the annual LIBOR -- the main interbank lending rate in the United States and Europe -- is currently just 2.5 percent in dollar terms, a record low for the past 40 years.

At the same time, the average annual lending rate in Russia for dollar loans is 16 percent to 18 percent, while interest on annual deposits in dollars averages just 9 percent to 11 percent.

As a result, Russian banks cannot compete with foreign banks on credit costs.

"The spread between the lending and deposit rates in Russia is enormous," said Christof Ruehl, the World Bank's chief economist for Russia. "This means that the Russian financial intermediation system is not functioning properly."

Russian Banks With 100% Foreign Ownership, as of October 1, 2001
Bank	Origin
1. Deutsche Bank	German
2. Dresdner Bank	German
3. Commerzbank (Eurasia)	German
4. WestLB Vostok	German
5. Garanti-Bank Moskva	Turkish
6. Finansbank (Moskva)	Turkish
7. Iktisat-Bank (Moskva)	Turkish
8. Yapy-Credit (Moskva)	Turkish
9. Credit Lyonnais Rusbank	French
10. Societe Generale Vostok	French
11. ING Bank (Eurasia)	Dutch
12. ABN AMRO Bank	Dutch
13. Citibank T/O	American
14. J. P. Morgan International	American
15. Raiffeisenbank Austria	Austrian
16. Credit Suisse First Boston	Suisse
17. First Czech-Russian Bank	Czech
18. Bank of China (Elos)	Chinese
19. HSBC	Hong-Kong
20. Michinoku Bank	Japanese
21. Small Business Credit Bank	mixed European
22. Investment Bank of Kuban	mixed European
23. DeltaCredit	mixed American
Source: Central Bank

Renaissance Capital recently identified the continued increase of interest rate margins between the United States, Europe and Russia as a potential catalyst for a new crisis in or even a collapse of the Russian banking sector.

"Russian banks will have difficult times competing with foreign banks for domestic companies, especially for those that foreigners want to lend to," said Renaissance banking analyst Kim Iskyan.

Matovnikov said foreign banks are lending mostly to the largest Russian companies, such as Gazprom, LUKoil, Transneft and Rosneft.

"These companies are interested in foreign loans, as they need to compete on the world markets and can't afford to pay twice as much for Russian loans," he said.

But as Ruehl pointed out, "One good thing about foreign banks coming to Russia is that they will bring rates down."

"Capital markets are international, and you have only two choices: either to close off the banking sector completely or to open it," he said.

Cutting Out the Middle Man

Syndicated loans have always been the most popular and least risky way of lending to Russian borrowers. There are no official statistics showing the real volume of such loans, and it is also hard to tell which foreign banks are lending most. But the numbers that are available are impressive.

If measured only by figures made public in the first half of 2001, syndicated loans from foreign banks have already reached more than $1 billion. Austrian-owned Raiffeisenbank and the 80 percent foreign-owned International Moscow Bank, or IMB, are the leading organizers. IMB was merged with Bank Austria in 2000 after German Hypo-und Vereinsbank bought Bank Austria and took over its activities in Russia. The German bank is the major shareholder of IMB.

"I can say that foreign banks are competing to lend to large-scale Russian companies now," said a banker with one foreign bank who asked not to be named.

"Almost any Russian company could get any money it wants if it comes out with a concrete project and sound financial statements under International Accounting Standards," he said.

Life would be easier for Russian banks if they could attract syndicated loans from abroad as easily as they did before the 1998 crisis.

As analysts say, it makes more sense for foreign banks to lend money to Russian banks than directly to companies because this way their risk is more diversified.

However, analysts say foreign banks have no intention of doing this because they remember the way they were repaid by Russian banks after 1998.

"Russian banks should have thought twice before ripping off their creditors," Matovnikov said.

Not much has changed since the crisis to make lenders feel more comfortable in Russia, Iskyan said.

"The Russian banking system is still considered a minefield by most foreign banks," he said.

Michel Perhirin, chairman of the board at Raiffeisenbank's Russian subsidiary, said that his bank, with a total lending volume of $450 million, has not written off any loan provided to Russian companies since 1996.

However, Perhirin said he still cannot forget the way some Russian banks behaved in forward-contracts disputes that were a question of "life or death" for many foreign banks in Russia in 1998.

According to foreign bankers' estimates, Swiss-owned Credit Suisse First Boston, or CSFB, lost $2 billion after the crisis, French bank Societe Generale $600 million and Raiffeisenbank $150 million in GKOs, nondelivery forwards and syndicated loans to Russian banks. And these are just a few examples.

"It goes without saying that banks have not forgotten the losses they suffered in Russia. We lost several credits given to Russian banks," Kurt Firmetz, chairman of the supervisory council of Hypo-und Vereinsbank, said in an interview with Vedomosti in November.

As a result, he said, "Western banks prefer to participate in syndicated credits to companies. The situation with the organization of credits to banks is more complicated because after the 1998 crisis Western banks are very cautious."

Top 10 Foreign Banks in Russia*
Bank	Assets, $ mln	Deposits,$ mln of Individuals	Loans to Nonbanks, $ mln
International Moscow Bank** (6)***	2,954.0	150.395	437.497
Citibank T/O (11)	1,308.1	19.641	581.094
Raiffeisenbank Austria (15)	835.2	153.032	375.917
Credit Suisse First Boston (18)	607.8	0.445	8.178
Deutsche Bank (21)	563.7	0	61.021
ING Bank (Eurasia) (28)	486.6	20.380	197.972
ABN AMRO Bank (29)	467.5	29.077	153.574
Dresdner Bank (43)	285.8	16.496	61.609
Credit Lyonnais Rusbank (48)	226.8	2.422	127.531
Commerzbank (Eurasia) (50)	202.9	0	98.120
* as of October 1, 2001 Source: Interfax Rating Agency ** International Moscow Bank (IMB) is not 100% foreign-owned, as 22% of its share capital is represented by Central Bank money. But as its major shareholder is German Hypo-und Vereinsbank (43%), most analysts consider IMB de facto a foreign bank. *** the number in the brackets shows the bank's place in the list of Interfax "Top-100 Russian banks" in terms of assets, as of October 1, 2001.
Source: Interfax Rating Agency

Moving Into Retail

Although foreign banks are well represented in Russia's corporate sector, only a few of them are working with retail customers, citing large costs, high risks and the low profitability of the business.

Most of them prefer to work within so-called "salary schemes" with large, mainly foreign-owned companies working in Russia whereby employees of the foreign companies have access to all retail banking services while they work for the companies.

Raiffeisenbank and Bank Austria have been the only foreign banks to actively work with Russian retail customers. Raiffeisenbank leads with $153 million in deposits and five branches in Moscow and one in St. Petersburg.

Before the merger with Bank Austria, IMB did not consider retail business a priority, but has since changed its concept to follow Bank Austria's experience. IMB has roughly $150 million in deposits.

IMB spokesman Sergei Levskoi said IMB had 8,000 retail customers before merging and got an additional 12,000 from Bank Austria.

"Now we are left with six Bank Austria branches in Moscow and one in St. Petersburg, and we intend to seriously develop our retail activities," he said.

Another bank that has tried to get into retail is Turkish-owned Garanti-Bank Moskva, which this year launched a large-scale advertising campaign targeting retail customers. But a financial crisis in Turkey together with a lack of interest shown by Russians forced it to sell its retail business to the Russian-owned Bank of Moscow.

Other European banks such as Dutch-owned ABN AMRO and ING Bank with individual deposits of $20 million and $29 million, respectively, feel more comfortable sticking with salary schemes in the present climate.

"For the time being, ING Bank provides retail banking services ... to employees of corporate clients only," said Hendrik ten Bosch, the general director of ING Bank (Eurasia). "The bank considers this business direction as a perspective one and plans to develop its retail capacity further during the next few years."

Foreign banks that have plans to launch retail business in Russia some time in the future include U.S.-owned Citibank and Germany's Deutsche Bank.

"We will be launching some level of retail activity in Russia within the course of next year, as we are positive about Russian market," said Allan Hirst, Citibank regional head for Russia and the CIS.

As for Deutsche Bank, its Russian subsidiary is still trying to convince its headquarters to move into retail banking and is reluctant to give any concrete dates.

"We don't usually decide on a specific country but rather on a region as a whole, which takes time," said Hubert Pandza, CEO of Deutsche Bank's Russian subsidiary.

"The reason for such a delay is not because the Russian market is not ready yet but more because our headquarters are not ready to make this decision," he said.

Foreign Expansion

According to the Central Bank, there are currently 23 licensed foreign banks in Russia.

When banks decide to start operations in another country, they take into account many factors but, first of all, they consider the external trade volumes between the two countries and the number of their clients already working with that country.

In the case of the four German banks represented in Russia, for example, the benefits of moving into Russia are clear as Germany accounts for almost 40 percent of Russia's foreign trade.

Trade volume is not an overriding factor, however. There are also four Turkish banks in Russia, even though Turkey is not Russia's main trade partner.

"In this case, you should not judge only by total [trade volume]," said Andrei Ivanov, banking analyst with Troika Dialog. "The number of small Turkish companies working with Russia exceeds that of Germany."

In addition, he said, "They are represented in a variety of sectors, starting with trade and finishing with the cement industry and construction."

Although the number of other European banks and U.S. banks in Russia is low -- Citibank and J.P. Morgan International are the only two major U.S. banks that have subsidiaries in Russia -- their importance to Russia's banking sector is evident if one looks at financial statistics.

Citibank has the largest assets of all foreign banks, with $1.3 billion through Oct. 1, 2001. It is the 11th largest bank in Russia in terms of assets, according to the Interfax Rating Agency. Citibank also leads among foreign banks in lending volumes, with $581 million in outstanding loans to Russian companies.

"In contrast to most U.S. investment banks, we like to be very involved in the domestic financial system," Hirst said. "Our strategy here is to serve both multinational and Russian companies, which currently account for an equal share of the bank's activities in Russia."

"We know the companies we would like to work with, which makes it easier, but we want to expand our Russian business in the future," he said.

Matovnikov said, "Citibank traditionally was a wholesale bank in Russia, working with a limited number of large companies, avoiding advertising campaigns and retail business. Nevertheless, it is one of the most profitable of the foreign banks in Russia."

The banking activity in Russia of J.P. Morgan International, which recently merged with Chase Manhattan, is far behind that of Citibank, while Morgan Stanley and Goldman Sachs still prefer to work through representative offices. Bank of America, which was given a license by the Central Bank in 1998, closed its Russian subsidiary soon after the 1998 crisis.

"I believe that all the [U.S. banks] that you would expect to see in Russia are represented in the market," Hirst said. "There aren't that many global U.S. banks left due to so much consolidation in the U.S. banking business -- and most of them prefer cross-border investments to general banking outside the U.S."

As for the expansion of European banks, Renaissance's Iskyan said, "It is quite logical, because Austrian and German banks have a limited scope of expansion in Europe, so they have to look at Russia as their closest neighbor."

Austria's Raiffeisenbank is in 15th place among the top 100 banks in Russia, with $835.2 million in assets, half that of Citibank.

Matovnikov said that the high activity of Austrian banks in Russia can be explained by the fact that "the only way for Austrian banks to survive is either to merge with other European banks, which we see in the case of Bank Austria, or to develop their business outside the country."

"External growth is the most important, if not the only factor of growth for them and Raiffeisenbank chose the second way," he said.

Raiffeisenbank's Perhirin agreed.

"Austria always served as a link between Western Europe and the Eastern European bloc, so we know this region better than others," he said. "We also proved that a medium-sized bank on the global scale can be as big as Citibank in Russia."

Other European banks, such as Deutsche Bank, ABN AMRO, CSFB, Dresdner Bank and Commerzbank, are servicing both their international and Russian clients in Russia and are very active in organizing syndicated loans.

They received more Russian clients after the 1998 crisis and the 1999 Bank of New York scandal -- in which top bank employees were accused of helping launder money through Russian accounts -- after which many U.S. banks closed correspondent accounts to Russian banks.

However, foreign bankers say that overall it is more complicated to do banking business now than it was several years ago.

"We all live in a different environment now, and we have very strict requirements with regards to money laundering and financial transactions in general," Hirst said.

Look Small

Most analysts agree that in the current environment of increased foreign competition Russian banks will have to diversify their business in favor of small- and medium-sized companies to survive.

"There is nothing left for the Russian banks other than to look at medium- and small-sized enterprises," Matovnikov said.

City of Moscow

Some Syndications, Organized by Foreign Banks to Russian Borrowers in 2001
Organizer	Borrower	Loan description, participants
no data available	Primorye Shipping Company	$209.8 mln Cristiana Bank and Fortis Bank
ING Barings and Societe Banque Generale	Sibneft	$175 mln. 2-year loan, rate 9,5% Commerzbank, Erste Bank, Cantonate Vadoise, IMB, KBC Bank
Glencore Int.	Slavneft	$160 mln 16 European banks, incl. Societe Generale, Standard Bank London, Credit Suisse, IMB, Dresdner Bank
IMB, Bayerische Hypo-und Vereinsbank	Rosneft	$140 mln BNP Paribas, Bayerische Landesbank, WestLB, Bankdenessellschaft Berlin, BCEN Eurobank
BCEN-Eurobank Paris, Bayerische Hypo-und Vereinsbank	Slavneft	$115 Bayerische Landesbank, Credit Agricole Indosuez, Mosnarbank, IMB
EBRD	Rosneft Sakhalinmorneftegaz	$90 mln, with $40 mln syndicated with ABN-AMRO, Raiffeisen Zentralbank and WestLB
CIB Bank (Hungary)	$32 mln Eximbank (Hungary), Credit Lyonnais, Hypo Vereinsbank
IMB	NK Vatoil	$30 mln Hypo-und Vereinsbank, DG Bank
Standard Bank London	Northern Oil	$25 mln Glencore International AG
EBRD	Sonic Duo	$138 mln International Finance Corporation, Nordeabank, other European banks
Source: Interfax Rating Agency, The Moscow Times

According to Troika's Ivanov, "Russian banks will inevitably diversify their business and start lending to medium-size companies."

"This will bring down the risk of the high concentration of loans, that we see now and also act as an engine of future economic growth," he said.

Currently, small companies suffer most from a lack of bank loans. As analysts point out, this negative impact will become increasingly apparent over the next two years, as real ruble appreciation continues to run its course, and as commodities prices -- and oil prices in particular -- eventually return to their long-term averages.

There are at least two foreign-owned banks ready to fill this gap.

Small Business Credit Bank, or KMB Bank, an arm of the European Bank for Reconstruction and Development, has been lending money to micro-, small- and medium-sized Russian enterprises since 1999. KMB specializes in micro and small loans, ranging from $100 to $500,000.

"We started 2 1/2 years ago, but we are still unable to satisfy the permanently growing demand in the market," said Reiner Mueller-Hanke, head of KMB Bank.

Since 1999, when the bank was founded, KMB has made more than 15,600 small and medium-sized loans worth $201 million.

DeltaBank, the small-business arm of the U.S.-Russia Investment Fund, is running a similar type of business. The bank, which started operations in June this year, mainly works with companies whose annual turnover ranges from $1 million to $50 million and loans range from $100,000 to $1 million.

DeltaBank plans to approve $10 million in loans by end of this year and a further $20 million in the first half of 2002.

"This business is not for people looking for hot money," said Sergei Boyev, president and CEO of DeltaBank. "You should build it on a long-term basis."

Both KMB Bank and DeltaBank are ready to share their experience with Russian colleagues and have seen a lot of interest in their work already.

Analysts say that one of the main reasons Russian banks prefer to stay away from this sector is that they don't have enough experience or a good methodology in the field.

In addition, Ivanov said, "Russian banks need to change their overall approach and diversify their business, which is currently focused on servicing chase flows of a dozen export-oriented companies."

"There is an attitude problem in Russia that big is good and small is bad," Ruehl said.

However, he was optimistic that there was room for both Russian and foreign banks in Russia.

"Russia's financial needs are so enormous that there is a niche for everyone, both Russian and foreign banks," he said.

This view was endorsed by Renaissance Capital research, which suggested that encouraging and facilitating greater participation in the Russian banking sector by foreign banks would, in the long term, significantly improve the stability of the sector and potentially ease it out of its present state of stagnation.