Russian Banks: Overgrown and Underfinanced

Banking has changed faster than anything else in the former Soviet Union. In 1987 there were four banks, all completely subordinated to the central bank. The financial system simply implemented the five-year plan. If the plan required shoes, and a shoe factory required money, credit appeared overnight. Since then the plan has vanished and more than 2,000 commercial banks have sprung up. Russia alone has 1,500 of them, and Moscow 500. Total commercial-banking capital doubled from 43 billion roubles ($330m, at today's rate) on January 1st to 76 billion on May 1st.

Yet for all the apparent change, the development of an efficient modem banking system is still hopelessly hindered by legacies of the old regime. Start with who runs the new banks. Critics complain that it is the old communist elites, who have found a new way to exercise power.

Although a few banks are genuinely private (like one owned by Roland Bykov, an actor), many are not. The largest, Rosselkhoz Bank, the Russian collective-farm bank, is the former state agricultural bank under a new name. Most ministries have set up their own banks. One of the most active of the new financial groups, Menatep, was established by members of the Young Communist League. The All-Russia -change Bank has a former Soviet parliamentary spokesman on its board and holds meetings in the country house that belonged to Stalin's police chief.

Whatever their political connections, these banks are closely tied to state enterprises. Four-fifths were set up by one or more state enterprises, which typically subscribe a bank's founding capital and hold its shares. The third largest, AvtoVAZ Bank, was by the company that makes Lada cars for example. These banks do not strenghten enterprises, as do German or Japanese banks with close links to companies. They just provide cheap money.

The most thorough study of commercial banks in the former Soviet Union looked at Ukraine.(1) It concluded that the close links between banks and business have arisen less because of a nomenklatura plot, or the need for cheap credit, than because the costs of allocating credit are enormous. Enterprises have track records that show their creditworthiness, so it is hard for lenders to them as borrowers. It is difficult, too, for lenders to monitor performance once a loan is made. Laws on collateral and bankruptcy exist, but are so new that it is difficult to arrange collateral or sue defaulters.

Bankers get round these problems by knowing the people they lend to. Banks lend mainly to the enterprises that own screen them, or to others in related businesses. But as banks expand they are beginning to lend to enterprises they do not know. In a recent survey of 230 banks, the 40 fastest-growing ones said that the number of their industrial customers had risen. So is Russia beginning to develop a banking system in which banks are closely involved in the running of companies? Nothing so sensible.

BORROW LONG, LEND SHORT

In capitalist economies, whether America and Britain or Germany and Japan, most banks obtain money through short-term deposits and lend it long-term. Not so in Russia. Long-term capital (equity and official loans) is a large proportion of the new banks' liabilities. Loans that mature in six months or less accounted for more than half of their total assets on May 1st, and long-term loans for only 3% (see table). (table omitted)

Commercial banks lend short-term partly because that reduces the risks of poor information about borrowers. The scarcity of deposits has more complicated origins. One explanation is that the interest rates banks offer are sharply negative in real terms. But there are structural reasons too.

Households prefer to keep their money at Sberbank, the old state savings bank. Sberbank held 431 billion roubles of household deposits as of July 1st, other commercial banks a mere 8.2 billion roubles. True, the newer banks built their share from nothing at the start of the year, while Sberbank's deposits increased by only 15% in nominal terms. But on present form the new banks seem unlikely to increase their share significantly.

Many do not accept household deposits. Those that do often say they do not make loans to individuals. On the corporate side, commercial banks are stymied by another Soviet legacy. Cash is not legal tender for all transactions in Russia; the banking system cannot freely convert notes and coin into bank money, and vice versa. The money used by enterprises circulates in two legally separate circuits. Enterprises hold deposits at commercial banks. When one wants to buy something from another, it credits the bank account of the seller and debits its own account. When they need cash--for instance, to payworkers--enterprises are supposed to get it from an official pool.

This separation of cash and credit, the product of central planning, more or less worked when there were only a few banks, and workers spent cash at state-owned shops. Now it is a mess. Banks cannot give company the cash they need; companies resort even to barter. What is more, the two circuits create an exceptionally cumbersome payments system. Every banking transaction passes through the central bank, and delays are enormous.

Combined with loose monetary policy, the dichotomy between cash and credit is especially pernicious. Banks do not really allocate credit as they think best; they have become conduits for cheap loans from the state, and depend on cheap credits themselves for capital.

The problem arose when prices were freed and companies in monopoly positions set their prices high. Consumers bought less. Businesses blithely maintained their output, running up trade debts approaching 2 trillion roubles to do so.

In response, the central bank (and Sberbank) started offering cheap credits to commercial banks, and through them to enterprises. These credits are now a sizeable part of commercial banks' liabilities. The interest charged on them has risen, from 20% to 80%, but is still far below inflation. In addition, part of the deposits from enterprises, which make up another chunk of bank liabilities, were financed by earlier quasi-official credits. Commercial banks are tied ever more closely to the hugely indebted enterprises that own them. Many are surviving only because of cheap government credit. This cannot last.

Reform of Russia's financial system is urgent. Jeffrey Sachs, an American adviser to the Russian government, argues that it must not only raise interest rates and cut new credit but also simplify the payments system and unify cash and credit(2). Banks, he says, must be able to guarantee that deposits can be withdrawn as cash. This would be painful, for commercial banks have little liquidity. The central bank also opposes what it sees, rightly, as a weakening of its control over banking, But such changes are essential if efficient, modern commercial banking is ever to emerge. And if it does not, Russia's economic reforms will have been in vain.

* "New Banks in the Former Soviet Union: How do they 0perate?" by Simon Johnson, Heidi Kroll and Mark Horton.

* "Remaining steps to Achieving a Market-Based Monetary System" by Jeffrey Sachs and David Lipton.

Both studies in "Changing the Economic system in Russia", edited by Anders Aslund and Richard Layard. To be published by Printer Publishers in Britain and St Martin's Press in America.