With the current Russian sanctions regime taking its toll on the country’s coffers, the Kremlin is increasingly finding new ways to draw money into state-controlled financial institutions. One of their newfangled methods is quite unconventional: for the past year, the Kremlin has been systematically destroying the largest private banks in the country. As a result, of the top 10 largest Russian banks today, the only privately owned one that has not been targeted by the authorities is Alfa Bank, owned by Putin’s long-time crony Mikhail Fridman.
The rapid restructuring of Russia’s financial sector over the past year has sent shockwaves throughout the business community: roiling investors, raising fundamental questions about the financial sector’s stability, and sounding alarm bells among the country’s remaining private banks. But Russia’s financial rollercoaster ride contains broader lessons as well. If present trends continue, the Russian state is poised to complete an immense consolidation of financial power in its own hands, enshrining a system of state capitalism to a degree unprecedented in Russia’s post-Soviet history. Indeed, the new reality eerily harkens back to Soviet days of yore, when the entire financial sector was concentrated under the sole aegis of the state.
To understand the extent of the Russian state’s reach, it helps to look at the current structuring of the financial sector. In the aforementioned list of Russia’s top banks, the first six positions are occupied by state-controlled banks, all of them sanctioned by the U.S. government. Alfa Bank ranks seventh. It is followed by the four largest privately owned banks, three of which are currently under the “rehabilitation” of the Central Bank of Russia (CBR), and one of which was acquired by a bank owned by Rosneft.
The state dominates the second tier of the banking sector, too. In spots eleven through twenty, there are only three other privately owned banks, all of them subsidiaries of reputable European banks: UniCredit, Raiffeisenbank and Societe Generale. There is also one domestic, privately owned bank under rehabilitation.
Rehabilitation (“sanatsiya” or literally “sanitation” in Russian) is the CBR’s preferred euphemism for its current method of destroying large private banks in Russia, with private owners losing their assets to the CBR. The process is reserved only for major, “systemically important” institutions. Smaller private banks simply have their licenses revoked, which has been happening a lot lately: 50 banks lost licenses in 2017 alone, and over 300 have been lost over the past three years.
Contrary to the central bank’s claims, however, these interventions are not done out of good will or any desire to fight corruption, help investors, keep jobs, or clean the system of bad assets. Rather, they are carried out to relocate the public’s money from privately owned banks into state-owned ones, because the latter need cash badly. For all the Kremlin’s bravado and insistence that sanctions don’t work, they have been effective at shuttering foreign financing for these state banks.
Indeed, the effectiveness of sanctions has been apparent for some time now: back in June 2016, for instance, Andrey Kostin, the CEO of Russia’s second largest bank VTB, travelled to Washington, DC on a lobbying mission to beg decision-makers in Congress, the White House, and the State Department to lift sanctions against his bank. Alas, this secretive visit, which we reported at the time, didn’t work out for Kostin, though that hasn’t stopped other players in Russia’s banking sphere from trying similar tactics. Just this week, Russia’s Life News reported that the state-owned Sberbank, which is majority controlled by the Central Bank of Russia, was actively lobbying the State Department in early 2017, painting itself as “an example of transparency and responsibility in the Russian banking system” to avoid falling under Western sanctions.
Incidentally, such pleas for sanctions relief suggests another explanation for the Kremlin’s bank nationalization spree: In the wake of Western sanctions, Russia has found very little success in attracting alternative foreign sources of financing—especially from China—as it hoped to do. Not only are no new investors coming to Russia, existing investors are fleeing. And that has left Russia’s state-owned monopolies—companies like Rosneft, Gazprom, and Transneft, which are in desperate need of re-financing—in a precarious position, heavily reliant on borrowing within the Russian banking system to service their debts to their Chinese counterparts (which today stand at roughly $70 billion).
The upshot is that the Kremlin has now turned its eye to those whom it can rip off endlessly: private citizens and small and medium businesses. Russia, of course, cannot officially declare its opposition to free market principles. But its sneaking consolidation of financial power shows that it can fully destroy essential elements of the free market, turning the country’s economic system into one of de facto state capitalism.
But what exactly happened to those four private banks that have been targeted by the CBR and acquired by Rosneft? Did they abuse the financial system, were they just trying to keep up with the CBR’s regulatory requirements, or did they simply grow too big for the government’s liking? The answer is probably all of the above.
There is a CBR regulation that allows the watchdog to demand banks increase their reserve funds at any time the CBR finds a particular loan to be troubled, insuring the loan in question for up to its full value. In other words, if a bank provides a $10 million loan and the CBR finds the loan troubled, the latter may require the bank increase its reserves by up to $10 million. The more funds are reserved for troubled loans, the lower the bank’s capital, since such reserves count as negatives on the balance sheet. But the CBR also imposes strict limits on the amount the bank’s holdings can decrease. Once below that level, the CBR can immediately proceed to punitive measures and sanctions against the bank, from enacting temporary administration to license revocation and bankruptcy.
State-owned banks in Russia, of course, do not suffer from the CBR’s scrutiny of bad loans and requirements for increasing reserve funds.
The four private banks recently taken over are Bank Otkritie, Moscow Credit Bank (MCB), Promsvyazbank (PSB) and B&N Bank: the eighth to eleventh largest banks in Russia, respectively, all of them systemically important. To satisfy CBR regulations, they all decided to issue subordinated bonds and buy them from each other, increasing each other’s capital. In short, they de facto conspired, knowing about each other’s financial holes, to help each other out by boosting their capital.
Prior to the takeover, Otkritie was the fastest growing financial holding in the whole country. From 2008 to 2017 its assets grew nearly twelvefold, while the whole banking sector in Russia grew only by a factor of 3.5. In the spring of 2017, Otkritie started preparing to acquire the largest insurer, Rosgosstrakh. Had the deal been closed, Otkritie would have become the largest private financial group with assets worth 4 trillion rubles ($65 billion) and 50 million clients.
But the deal was never closed. Instead, in August 2017, the Central Bank announced its intervention in Otkritie, estimating the bank’s balance sheet hole at 450 billion rubles ($7.5 billion). Earlier in 2017, the CBR was entitled to finance the bank’s rehabilitation from its own, newly created Banking Consolidation Fund. At first the CBR promised to take away only 75% of Otkritie while leaving the remaining 25% to its owners, considering the bank’s capital would stay positive. But in November, the CBR lowered the Otkritie stock down to one ruble and announced it would own 99.9% of the bank. The chairman of the board became the CEO of VTB-24 (a full subsidiary of the state-owned VTB).
The Otkritie intervention was followed by the bailout of B&N Bank and PSB. The owner of PSB, Dmitry Ananiev, said the CBR’s intervention into his bank came as a surprise after his long record of successful negotiations and cooperation with the CBR. The day before the intervention, the CBR required the PSB to increase its reserves by 100 billion rubles ($1.7 billion), an impossible amount. This demand was eerily similar to one the Central Bank made of the small private bank Ugra back in July. According to the director of the bank’s board, the CBR sunk Ugra by demanding it raise its reserve funds by 13 billion rubles ($230 million) within 24 hours; even when it pulled off that improbable feat, the CBR revoked its license on a technicality. The standoff has led to ongoing litigation, and in retrospect looks like a preview of CBR’s subsequent hardball tactics against larger banks like Otkritie and PSB.
In PSB’s case, the Central Bank’s decision was made in two weeks, with no explanation offered to Ananiev. A week later he left Russia, though he denies fleeing the country, saying his temporary departure had been previously planned. He has since accused the CBR of improperly acting as an all-in-one authority: at once a watchdog, a regulator, a business player, and a law enforcement body.
The destruction of the four banks began days after Alfa Capital analyst Sergey Gavrilov sent an infamous letter to his VIP clients, urging them to pull their money from those four banks and deposit it elsewhere. Gavrilov disclosed the subordinated bonds scheme and said that “the situation with the banks might be finally resolved by the end of the year.” The letter, sent on August 15, 2017, immediately became public. Gavrilov was called to explain his views before the CBR, and two weeks later Otkritie was chosen as the first victim—just as Gavrilov promised.
But Gavrilov’s letter could not have been a revelation for the CBR, nor the impetus for its interventions. CBR officials have been sitting at each large private bank for years, monitoring and reporting on all deals and operations. There is no way the CBR could not have known about the bonds scheme. In fact, the Central Bank did know and let it proceed. In Russia, that likely means that officials financially benefited from the arrangement—in other words they were bribed, up to the highest level.1
In the meantime, the Finance Minister of Russia has already supported the idea of consolidating the three banks bailed out by the CBR (Otkritie, B&N Bank and PSB) into one large bank, with an IPO in the near future. The minister made these comments even before two of the banks were taken away from their owners. Financial experts doubt there will be much public demand for such assets, and that the government is simply creating another state-owned financial giant: another entity, perhaps, to feed Igor Sechin or another top Putin crony.
However the chips may fall, the rapid reorganizing of Russia’s banks is clearly trending in the state’s favor. In other words, Russia is reverting to a familiar model: As the state accumulates immense control over the financial sector, we are witnessing a latter-day approximation of the State Bank of the USSR. In Russia these days, everything old is new again.
1 There are other theories about Gavrilov’s letter. One version runs that Alfa Bank used Gavrilov to take revenge on Otkritie for winning a tender for the bailout of a bank named Trust back in 2014. Even PSB’s owner, Dmitry Ananiev, said in an interview that he believed that information attacks were organized by competitors, until he came to the conclusion that it was done in cooperation with the highest levels of the CBR. A more credible version might be that the CBR took some help from the servile Alfa Bank to justify its interventions.