Negative outlook for Russian banking despite resilience to global crisis

Moody's Investors Service sees negative rating pressure on Russian banks in the near-to-medium-term, reflecting concerns over the credit fundamentals of domestic banks. The first wave of the global financial crisis that struck Russian banks 12 months ago has been contained by timely and adequate actions by the government and the Central Bank of Russia (CBR). However, the risk of further instability in the banking system remains relatively high due to negative pressure on capitalisation and profitability against a background of deteriorating asset quality and liquidity caused by weak depositor confidence and asset-liability mismatches.
As in the past, the dynamics of the Russian banking sector will be largely driven by macroeconomic developments. Strong economic growth in the past eight years had supported banks' lending expansion at or above 40% per year. With Russia now in recession, the operating environment for banks has become hostile. GDP contracted more than 10% in the first half of 2009, and Moody's expects the economy to shrink by 8.5% for the whole year. The rating agency predicts only modest 1.7% economic growth in 2010 — rebounding more strongly in 2011. For many banks, these growth expectations would require at least 12 months of reducing financial leverage, combined with working out problem loans, attracting new capital, repaying foreign debt and reassessing their funding strategies.
"Despite a hostile operating environment, the Russian banking system as a whole has shown adequate resilience to the crisis so far, largely due to state support", said Eugene Tarzimanov, a Moscow-based Moody's analyst. Asset quality and capitalisation represent medium-term risks for Russian banks, and in Moody's opinion they are not likely to materially damage the banking system in the short term.
The state has put in place various anti-crisis mechanisms, ranging from liquidity to capital injections. Moody's notes that the state support package is one of the largest among emerging markets, exceeding 10% of GDP (ca. US$170 bln, mostly through liquidity injections). "The Russian government is committed to supporting the stability of the banking system, as highlighted by numerous bank bailouts and the government is likely to be more selective in channelling its support to banks, providing capital and liquidity to banks of systemic or regional importance. The beneficiaries of this support are state banks, which are taking market share from private sector banks," added Tarzimanov.
As regards asset quality, Moody's estimates that around 11% of loans (US$70 bln) — mostly granted pre-crisis to the corporate sector — were problematic at mid-2009. Additionally, an equally high level of loans had been restructured. The stock of problem loans is likely to exceed US$110 bln by YE2009, which would account for 20% of gross loans. This projected level of asset quality deterioration should be manageable for the banking sector, to be absorbed by available and upcoming capital, as well as reserves. By YE2010, barring any economic shocks, Moody's would expect problem loans to grow to 25% of gross loans, largely driven by impairment in restructured loans and moderate new lending.
Additional pressure on asset quality stems from foreign currency (FX) loans, which comprised around one-third of the total at mid-2009. Moody's estimates that expected losses on FX loans are 70-100% higher compared to rouble-denominated loans. In this context, FX loans expose banks to high credit risk as the rating agency forecasts a 10% depreciation of the rouble against the dollar by YE2009.
Banks' risk positioning remains a historical weakness in Russia. In particular, balance sheets are highly concentrated on selected clients, market risk appetite is high, and related-party deals are omnipresent. With a few exceptions, risk management, corporate governance, as well as transparency and disclosure all remain below international best practices. Moody's therefore notes that improvements in those areas would be key prerequisites for any positive rating actions.