Breakthrough for an hour

The Financial sector in 2005 has definitely moved on. But the progressive movement may be easily cut short, if Russia fails to protect interests of national bankers and insurers when entering WTO.

By Irina Velieva and Andrey Zemtsov

In 2005 the financial sector of the Russian economy showed much better dynamic growth than the real sector. Revenues of banks and insurance companies in "Expert-400" rating grew up by 52 and 43% accordingly, while average proceeds of 400 leading Russian companies increased by 33%. Expanded retail financial services were mostly responsible for the growth. Russian citizens, quite recently rebuked for "low financial literacy", secured fast-pacing development of bank crediting, establishment of a market of collective investments, increased activity in insurance. According to our assessments, demand for financial services on the side of individuals is far from saturation, and the MSE business has not been covered at all. The market is highly promising, but the balance of power in the financial sector may be strongly influenced by our regulators and conditions of joining WTO.

Retail as a means of rescue

Bank services to private clients (first of all, crediting of individuals) proved to be the fastest growing segment in 2005. Last year total crediting of individuals increased by 1.9 times. Within the last couple of years 39% of Russians used consumption credits. In 2006-2007 bankers have placed their stakes on mortgage. Enormous housing demand is accompanied by increased trust of population to banks, and banks with their chronic problem of liquidity surplus are in need of long-term money. In 2005 volumes of mortgage loans grew up by 2.3 times and amounted to 125.7 billion rubles. In 2006 banks expect the mortgage figures to double.

Last year property insurance (mostly, autocasco) was the insurance market prime mover. Increase of this type of insurance may be attributed to growing revenues and insurance culture of the population. Compulsory medical insurance (CMI) contributions increased by 50% within a year, probably, due to putting "grey" salaries to light. In the near future we expect landslide development of voluntary medical insurance (VMI). The reason is simple: VMI will be included in a social package of SME (20-40 personnel).

Refinancing financiers

The growth of active operations is contained by thin capitalization of Russian banks

Banks develop dynamically, and insurers get rid of their schemes

In 2005 aggregated banks’ assets increased by 36.6% and amounted to 9750.3 billion rubles. By the end of the year banks’ own funds reached 1241.8 billion rubles (increase 31.1%).

Advanced rate of banking assets’ growth aggravated the problem of low level own capital, which hinders banking operations development (diagram 1). Internal sources of building up own funds (augmentation of authorized fund at the expense of existing shareholders, profit capitalization) are no longer able to secure desired up-growth. In search of financing many banks have to turn to foreign markets: to attract subordinated loans or reflect on preparing IPO. In 2005 banks utilized subordinated loans actively enough (34.2% of total own funds increment), but they were not in a hurry to go to stock exchanges. Experts were too quick to name 2006 "a year of banking IPO": not a single public bank placement happened within the first nine months.

It seems that not too many banks will reach foreign stock exchanges next year, as well. The interest of foreigners to the Russian banking sector is extremely considerable – private deals to sell large stock of shares are quite possible. Sometimes selling to strategic investors brings more profit than public placement. First, foreigners are ready to pay more to control a bank. Second, IPO is a tedious and quite expensive procedure (the placement cost may reach 10% of the sum). Within the last eighteen months several such deals took place: French Societe Generale acquired 100% of Deltacredit mortgage bank and 20% of shares of Rosbank (position seven in the list of largest assets) with an option for another 30% of shares. Raiffeisen International totally absorbed Impexbank, and GE Consumer Finance (USA) bought 100% of Deltabank shares (consumer crediting specialty). Italian Banca Intesa purchased 75% of KMB-Bank (SME crediting), and German Commerzbank has plans to acquire 15.3% in Promsviazbank capital.

Judging by formal indicators, the insurance sector in 2005 developed much slower than the banking one. Comparing with the previous year, the amount of insurance premium increased by mere 4% and reached 490.5 billion rubles. First of all, slow rates of insurers may be explained by wrapping up optimization schemes in life insurance (diagram 2). Collections in this type of insurance in 2005 reduced four times — down to 25.3 billion rubles (102 billion rubles in 2004). Life insurance share of collected premium was only 5% of total collection, but in 2004 it was 22%. The tendency should undoubtedly be considered as an indicator of the market stabilization. In many ways the result was brought about by joint actions of the state regulation bodies to fight scheming activity.

Financial state of the insurance sector also improved. In 2005 the circle of the insurance market players narrowed (it was left by 210 companies and joined by another 154), but the insurers’ aggregated revenues grew up by 8.6 billion rubles and reached 143.1 billion rubles.

Regulators are awake

Expanded list of measures to increase transparency and stability of bank and insurance companies proved to be the main tendency in regulating the banking and insurance sectors in 2005-2006. Last year the law "On insurance of individuals" started running at full capacity. The insurance coverage sum increased from initial 100 000 rubles to 190 000 rubles. Deposit insurance system (DIS) has acted as a filter to sift away less reliable banks. By September 1, 2006 only 930 banks out of 1163 Russian banks joined DIS. Despite quite rigorous selection, certain banks already lost their licenses and went bankrupt. DIS demonstrated its viability – majority of depositors got their money back.

Supervision of banks and insurance companies involved in questionable operations has become more severe. Number of banks that lost license due to poor financial state went down. On the other hand, the number of revoked licenses due to inobservance of a law "On combating laundering of criminal proceeds and financing terrorism", notably grew up. According to our assessments, clean-up of banks would continue, and after a while the financial sector would step out of the shade completely.

Federal service of insurance supervision, in its turn, intensified efforts to relieve the market from "scheme designers". So far the most "scheme contagious" segment of the market was life insurance. The situation in the sphere was rectified pretty quickly, but it is too early to report a complete victory over "scheme designers". Now companies moved their "scheming" activity from life insurance to reinsurance and property insurance areas. But, anyway, gradually the market would get rid of "scheming" insurers.

Mass deficiency

Despite speedy development of Russian banks and insurance companies, the financial sector share in the Russian economy is still insufficient.

Ratio of the Russian banks own capital to GDP was 5.7% by the end of 2005. To compare: in Germany the similar indicator is equal to 14%, in France — 22%, in Great Britain — 18%. If you take ratio of assets to GDP, our lagging behind would be even more significant. In Russia "assets of banks to GDP" was 45% by the end of 2005. In the USA it is 74%, in France — 281%, in Germany - 317%, in Great Britain — 398%.

The insurance segment is also undersized comparing with insurance markets of developed countries. Insurance contributions per capita in Russia are less than 150 dollars, but in Western Europe they exceed 2500 dollars, in the USA - over 3700 dollars, in Japan — over 7000 dollars. Insurance premium in 2005 constituted 2.3% of GDP (in East European countries — 3.3%, in Western Europe — 7.9%). Besides, the insurance market indicators have had negative dynamics. We think the reason is "clearing" the market of insurance schemes.

On the verge of entering WTO

Russia joining WTO may seriously change activities of the financial market participants. A lot would depend on entry conditions. It is too early to discuss them, since negotiations would not be completed by the end of this, or may be, next year. A possible topic of discussion is the issue of foreign quota in the banking sector of Russia. 12 percent quota, operational for a long while, (capital controlled by non-residents), proved to be inefficient. In July 2005 the foreign capital share was below 7%, but in April 2006 it reached 11.98%. The Russian side intends to introduce quota for foreign capital involvement at the level of 50%. Evidently, branches of foreign banks would not be allowed to enter the market.

In case of insurers, their government lobby is less powerful than that of bankers, therefore a threat of foreign appearance at the insurance market is quite tangible. The issue of principle is whether direct branches of foreign insurers would be controlled by the Russian insurance supervision. If the answer is "no", the national insurance market is in for serious turmoil.