Scott Bugie

1
Global Emerging Market BanksThe Russian Banking
SectorComparison of Russian Banks with Turkish
Banks
Banking Analysts ClubMoscow October 8,
2004
Irina Penkina Associate Director, Financial
Services Ratings 7 095 783-4070 irina_penkina_at_sta
ndardandpoors.com

• Scott Bugie
• Managing Director, Financial Services Ratings
• 33 (0)1.44.20.66.80
• scott_bugie_at_standardandpoors.com

2
Overall Creditworthiness of Banking Industries in
EEMEA and Asia Improving
3
FDI, Reduced Corporate Leverage Drive Global
Improvement in Credit Profile of EM Banks

• Foreign Direct Investment
• FDI of European and U.S. banks and investment
  funds accelerated reforms
• Brought much-needed banking know-how and capital
  to banks
• Deepened globalization of the world financial
  sector
• Promoted spread of best practices in banking
  supervision and risk management (although much
  work remains)
• Reduced Coporate Leverage
• Corporate sectors of Asian countries hit by
  crisis in 2nd half of progressively deleveraged
  over the past several years
• Reduced industrial overcapacity (that led to
  crisis)
• Some governments set up SPVs to purchase bad
  assets from troubled banks to facilitate
  restructuring
• Mexico, Turkey, and Brazil having lower levels of
  debt to GDP in 2004 than at the end of the 1990s

4
Global Ranking of Emerging Market Banking Systems
by Industry and Economic Risk
For comparison purposes Standard Poors
classifies Greece and Portugal as mature markets
5
Continuum of Risk

• Systems in the lowest GPA ranges have relatively
  low economic volatility and proven ability to
  maintain manageable levels of problem loans, even
  in recession
• The lowest-risk GPA range includes countries with
  banking systems that suffered severe past
  difficulties, but where participants took
  decisive steps to strengthen the sector
• Systems in the highest ranges show weakness poor
  institutional management less rigorous
  prudential supervision pervasive quasi-fiscal
  lending moral hazard
• Moral hazard can emanate from directed lending
  of public sector financial institutions
  government-connected private sector enterprises
  regulatory forbearance

5-15 GPA Sound infrustructure Low Asset Risk
Continuum of risk levels
50-75 GPA Weak infrustructure High Asset Risk
6
Standard Poors Ranks Banking Sectors by
Industry and Economic Risk, and Estimates the
Potential Level of Problem Assets in a Recession

• The range of gross problematic assets (GPA) is an
  estimate of the potential proportion of bank and
  finance company credit to private and
  nonfinancial public enterprises that could become
  problematic during the full course of a
  recession.
• GPAs include overdue loans, restructured assets
  (where the original terms have been altered),
  foreclosed real estate, other assets recovered in
  loan workouts, and NPAs sold to SPVs.
• The estimated GPA ranges take into account the
  costs and problem asset levels of of the past.
• The GPA range estimates the potential severity of
  financial system stress in a post-boom recession
  scenario, based on the fundamental strengths and
  weaknesses of the economy and financial sector.

7
Domestic Credit to Private Sector to
GDPPotential for Growth in EEMEA and LA
8
Domestic Credit to Private Sector to
GDPPotential for Growth in EEMEA and
LA(different left hand scale)
9
Mortgage Lending in Emerging Markets Remains
Undevelopped
10
Over Past Five Years, Russian Bank
Creditworthiness Lags Sovereign
11
International Scale RatingsRussian financial
institutions
Ratings as of October 6, 2004
12
Banking Turbulence in June - July 2004
Underlying Causes

• Low confidence of households and corporates in
  Russian banks
• Weak, shallow interbank market (highly segmented)
• Concentrations in funding
• Mismatch between long-term assets and short-term
  liabilities
• Downturn in Russian securities markets since
  mid-April
• CBRs increased commitment to clean-up banking
  sector, with policy of withdrawing licenses
• Anticipation of the deposit protection system

13
Bank FailuresMay August 2004
Operations suspended in July, but license not
withdrawn
14
Russian Banking Sector Shows Slower Growth in 2004
Non-annualized nominal ruble growth. Source
Central Bank of Russia.
15
Retail Lending Continues to Boom Now 13 of
Total Loans
At mid-2004, corporate loans totalled
97b retail loans 15b
Source Central Bank of Russia
16
Banking Reform Several key initiatives in process

• Deposit insurance
• Law on credit bureaus (under review by
  parliament)
• Mandatory shadow reporting under IFRS (from 3Q
  2004)
• Legal remedies for mortgage lenders (in
  development)

17
Banking Sector Likely to Consolidate in
Medium-term

• 1,277 banks at mid-year 2004
• No single bank, apart from Sberbank has a market
  share of more than 6)
• Deposit insurance scheme will lead to exit of
  marginal banks 
• Legal procedures for mergers and acquisitions
  likely to be streamlined
• Recent MA is indicative of future activity
  Nikoil/UralSib, Rosbank/OVK, VTB/Guta and
  Promstroi
• Key question will FDI increase?

18
Foreign Direct Investment in Russian Financial
Sector Increasing, but Remains Limited

• Recent investment is in retail banking
• Cetelem to acquire a 50 stake in
  consumer-oriented Russian Standard Bank
• GE Consumer Finance to buy Deltabank (a small
  consumer bank)
• 8 foreign-owned banks rank in top 50 Russian
  banks by total assets
• 41 banks controlled by foreigners (up from 6 in
  2003)
• Foreign-owned banks represent approx. 10 of
  sector, mostly with in corporates and in Moscow
  region

19
Russian Banking IndustryKey challenges to
address

• Dominance of Sberbank and VTB (over 70 market
  share in retail deposits and 40 in corporate
  lending)
• Lack of confidence in private sector banks
• High single-party risk concentrations
• Related party lending
• Abitrary legal environment
• Opaque ownership
• Many marginal banks
• Limited economies of scale
• Over-reliance on trading

20
Restructuring of Turkish Banking SectorPossible
Future Path of Russia?

• At beginning of 2000, Turkish financial sector
  had many similarities with Russian sector of
  2004
• Turkish state banks held important position,
  particularly in retail market
• State banks (particularly Ziraat and Halk) were
  unfair competitors for deposits
• Banks relied on trading profits
• Several large financial-industrial groups (FIGs)
  with strong position in banking market (e.g.
  Sabançi, Cukurova, Dogus, Is, Koç)
• Engrained practice of intragroup lending in FIGs
• Banks profited from large equity holdings
• Low level of publicly-disclosed nonperforming
  loans
• Many marginal banks with weak franchises
• Ineffective banking supervision

21
Restructuring of Turkish Banking SectorPossible
Future Path of Russia?

• But a few key differences of Turkish banks with
  Russian sector at the beginning of 2000 should be
  noted
• Turkish state banks had weak financial profiles,
  in contrast to Sberbank and VTB
• Turkish state banks distributed massive subsidies
  in agricultural, small business, real estate
  sectors
• Many Turkish private sector banks had deeper
  experience, longer track record, better
  franchises than todays Russian private sector
  banks
• Turkey had many fewer banks (79) than Russia

22
Massive Restructuring of Turkish Banking Sector
in Past Four Years

• New regulatory authority created
• Massive supervisory action Regulators took over
  weak banks representing approx. 25 of sector
  (including Pamukbank, Demirbank Iktisat, Esbank,
  Ticaret, Interbank, Imar Bank) using State
  Deposit Insurance Fund
• Special audit for all private banks, with
  stricter rules on reporting problem loans
• Stricter enforcement of limits on intragroup
  loans and single party concentrations
• Number of banks reduced to 50 from 79 (37
  reduction)
• Government guaranteed all retail deposits
  (partially withdrawn this year)
• Loan subsidies were shifted from state banks
  directly to government
• State banks recapitalized and downsized
• State real estate bank Emlak closed, assets
  transferred to Ziraat and Halk
• Total cost of restructuring estimated at 40-50
  billion, or 30 of Turkish GDP.

23
Lessons for Russia

• Clean-up of a banking sector can be costly if
  problems are left to grow over many years.
• Strong regulatory action are required to break
  ingrained habits.
• The level of problem loans during an expansion is
  a poor indicator of the potential extent of
  problems in a recession.
• It is difficult to assess the extent of
  intragroup lending.
• Intragroup exposures can increase massively in a
  downturn.
• A blanket guarantee is sometimes needed to calm
  depositors.

24
Systemwide Nonperforming Loans in Turkey Peaked
at 25 of Total Loans in 2001 Up from 3.5 in 1998
peak of 25 at yearend 2001
Source Central Bank of Turkey