Refocusing

Only a few years ago, the Russian banking sector was riding high on the back of an economic boom¹. While seen by some still as a new market, the current crisis affecting the country has changed things profoundly, and bankers' attitudes to issues such as risk management are beginning to alter dramatically. frontiers in finance spoke to Alexander Tutunnik for his perspective on the industry today.

frontiers in finance (FF) What's going on with banks in Russia? How has the crisis affected them?
Alexander Tutunnik (AT) The sector has seen serious changes in emphasis. Many banks have been battening down the hatches, deferring investments and postponing the changes which are still necessary to create a leading banking industry. They're primarily concentrating on surviving the current crisis conditions. The focus is on cost reduction, risk management, and managing problem loans.

FF Until recently, risk management would not have been a priority at many Russian banks.
AT That's true. But bankers' mentality is gradually changing. Previously, some Russian banks tended to classify risk management, internal control and internal audit as desirable but not essential. Their thinking went roughly as follows: 'It would be nice to have risk management, but if we don't, it won't hurt anyone'. But this attitude is changing around the world, and it's changing gradually here as well. Owners of Russian banks are beginning to realize that it was no accident that Europe chose the difficult path of adopting the first Basel accord, then the second. They're now focusing on these matters with increasing frequency.

FF So some banks really didn't feel the necessity to manage risk in the past?
AT Only rarely. It was a totally natural situation: asset values in the industry were rising by 50-60 percent per year, profitability was off the charts, reaching 19, 22 and even 30 percent at times. With profits like that, no one was thinking about losses - arrears weren't exceeding 1-2 percent². Risk management wasn't a pressing matter. Banks were actively attracting customers. Once they'd secured one, it was somehow awkward to ask questions and draw attention to their somewhat low profitability, high debt burden, and muddled ownership structure.

Risk management wasn't taken seriously. Therefore, risk management people lost motivation, and I don't think the most ambitious or highly qualified people were in such departments two or three years ago: business was growing very rapidly, and the best managers tried to get as close to the action as they could. And I can't say that the situation has completely changed even now. Although the need for risk management is now more widely acknowledged, the quality is not consistently good.

Nevertheless, professional risk managers at least now seem to feel their time has come. A major European banker who directed a risk department recently told me: "I've spent my whole life explaining to people what risk management is and why it's needed. And now things have become so much easier - now I don't have to explain to anyone, not even to my driver. Everyone's grasped it”.

FF A huge amount of pledged property is now passing over to bank ownership from borrowers who have defaulted. How are banks dealing with these non-core assets that have been placed upon them?
AT Having advised banks for many years, I'm now seeing clear changes in bankers' mentality. As late as last fall/winter, at the start of the crisis, many banks were glad to receive things like factories, retail businesses, and unfinished construction in exchange for debts. One came into possession of a meat processing factory, another acquired a Mercedes showroom. People began to make offers to their acquaintances: 'Who wants a Mercedes, who wants an apartment?'. But this nostalgia for the 90s, when everyone was trading with everything under the sun - sausage, marmalade and sugar by the train full - evaporated in a hurry. Everyone understood very quickly that this wasn't some sort of bad luck, but a difficult situation: it was tough to sell assets. It may be now that no asset has a firm price. A real estate property, for example, can be very hard to sell, even discounted below market value. The same is true of packages of shares and companies. Many bankers are now concerned, and they're trying less and less to push a borrower into bankruptcy or seize all kinds of property. These days, I don't see top executives partying because the bank acquired a meat processing factory. If that does happen to someone, then they keep quiet and get rid of it as quickly as possible.

FF Presumably, this means that many bankers now have to focus much more closely on the quality of their core business decisions?
AT Absolutely. Bankers are starting to clean out their Augean stables. For example, a bank may have 70 branches and doesn't know which ones to close and which to leave open. And the important thing isn't simply closing a location, but understanding what's wrong there. What is the problem? How can it be solved systematically? How are other banks doing it?

Before, for example, having a branch with 250m² in floor space didn't bother anyone. The fact that the average size of a large branch with the full range of services in Western Europe didn't exceed 60-70m² seemed to count for nothing. Some Russian banks could easily have branches as large as 800-1,000m². Bankers are gradually beginning to understand that this means a heap of extra expenses on lease, utilities etc.

FF So is the banking industry still attractive?
AT Oddly enough, yes. Some companies and individuals are thinking about how to get into the banking business - although of course not as ambitiously as two to three years ago. A number of banking start-ups are now planned around financial and industrial groups with no banking assets, and around individuals.

A banking license is still valuable, especially if a bank is small and without major problems. KPMG member firms are seeing that the merger and acquisition market is gradually recovering. But whereas before a coefficient of three, four, or five times capital was considered the norm, today the price of transactions will be something rather lower. If a bank is more or less stable, multipliers range from one to two times capital. If an organization has problems, the valuation may be significantly lower. But on the whole, the market will thaw, because systematic changes are taking place. If some banks are heading up in the rankings, and others down, it's obvious that an investor may be interested in rising assets.

Article author

Alexander Tutunnik
Partner
KPMG in Russia and the CIS +7 495 9374 470 Alexander Tutunnik View all articles by this author

1. See 'Frontier spirit: the Russian banking sector', frontiers in finance, KPMG International, March 2006.
2. Central Bank of Russia, http://www.cbr.ru/, June 1, 2009.