Financial stability of Russian banks: size or specialty?

The Russian bank market is affected by ups and downs at the international markets, liquidity problems, political instability and poor institutional regulation (usually noted by Western analysts). American rating agencies in their recent reports gave very low assessment of the Russian banking system regulation and stability level – not just below advanced economies, but next to the least developed countries of the world. We do not find the situation so dramatic. Recently domestic banks have demonstrated reasonable success in developing risk-management systems, often showing financial and profit indicators higher then in the West. Quality regulation has been progressing even more speedily and efficiently than might be expected. Besides, the liquidity crisis demonstrated the CB readiness to properly use re-financing mechanism and block negative tendencies.

Presently the Russian banking system is internally shock-proved. It may be seriously shaken by a strong outside shock (like a great drop in oil prices), but the risk relates to macro-risks in all branches of economy.

Still, risk susceptibility and stability of different banks vary quite significantly. The Expert RA rating agency ranked banks by their financial stability on the basis of their activity in the first half of 2007. Our cluster analysis allowed dividing 40 banks into 6 groups by levels of their financial stability.

According to our classification, the bank size is presently not the main indicator of its financial stability: too big to fail effect, implying financial stability of a credit institution depending on its size, was not manifest in our study.

Another trend made itself clear: if a bank is active in developing retail operations, its chances to break its financial stability are higher. The market is tough and demands sacrifices. At a short haul you question your capital adequacy and profitability, at a longer one – quality of bank assets.

The first group of financial stability is not necessarily compiled by the largest banks (Vozrozhdenie, Credit Ural Bank etc.). These are the banks with high capital adequacy, good asset quality, high profitability, efficient management and acceptable liquidity level (not too high – to avoid losing profit, and not too low – to avoid taking risks).

The second group is composed by the key market players (Alpha-Bank, MDM-Bank, HOMOS-Bank etc.). Capital adequacy and lower asset profitability prevented almost all of them from moving one step higher. Even lower overdue debts and softer liquidity cushion failed to allow the banks catching up with the leaders. After all, the indicators were secured by low maneuverability and not by efficient risk-management.

The third group is formed by banks with retail dynamics one step ahead of their colleagues; but they have to pay for it by even lower level of own funds, even higher payment delays and smaller liquidity reserves (Trust, Gazenergoprombank etc.)

The group four consists of retail leaders – banks Russian Standard and Home Credit. Good capital reserves and high profitability did not prevent them from occupying the fourth place. Financial stability is inevitably disrupted by very high share of overdue payments and big expenses-earnings ratio. When the two banks would relieve themselves from their «bad debts» portfolios, they may easily climb a couple of steps higher.

Banks of groups five and six are definitely behind other participants of the analysis in asset size. They also feature relatively high (comparing with the others) level of overdue payments and worse results in profit and efficiency.

Banking classification by groups of financial stability

The 41 banks cluster analysis (Russian banks out of the 150-top list, by assets) singled out 6 groups with distinct financial stability indicators.

The first group of financial stability

Russian bank of development, ING-Bank Eurasia, Vozrozhdenie Bank, Credit Ural Bank, BTA-Kazan
Banks in the group feature the best indicators of financial stability, although they are not leaders in asset volumes. Capital adequacy indicators are very high: average H1 norm in the group is 19.7%. At the same time the group banks showed the best combination of expenses-earnings ratio (85.5%), asset profitability (2.0%) and overdue payments share (1.1%).

Presence of Credit Ural Bank and BTA-Kazan in the group may seem strange at first sight, since the amount of their business notably differs from that of three other banks in the group. But they have the best expenses-earnings ratio and very high ROA, therefore they were placed in the lead of financial stability.

The second group of financial stability

Rosselkhozbank, Raiffeisenbank Austria, MDM-Bank, NOMOS-Bank, Alpha-Bank, Promsviazbank
The second group is composed by the top-10 largest asset banks. These are the largest and most reliable credit organizations, confirmed by the indicator analysis: the largest share of liabilities and own funds, good current liquidity (group average 77%) and low share of overdue debts (0.6%). Presence of the banks in the second group relates to relatively low capital adequacy (average 12%) and a bit less profitable business comparing to the first group (ROA equals 1.8%, expenses-earnings ratio – 93.7%).

The third group of financial stability

National bank TRUST, SDM-BANK, Gazenergoprombank, AKIBank, First United Bank, Moscow Industrial Bank, Far-East Bank, Saint-Petersburg Bank, Transcreditbank.
The group banks have consistent market positions and feature good indicators of financial stability: capital adequacy (11.7%) and current liquidity (64.4%) are a bit over the threshold value, low overdue payments (1.0%), profitable business (ROA – 1.9%). Outside our cluster analysis we may single out good own funds profitability (24.9%) and low dependence on the inter-bank credit market (2.7%).

The fourth group of financial stability

Russian Credit and Home Credit and Finance Bank
The group is small, but the two banks have specific features distinguishing them from other Russian banks. Quite large and broadly resourced banks (Н1 averages to 17.5%) are leaders of the retail financial market, taking quite serious risks. As a result, on the one hand the banks boast the highest profitability indicators (ROA – 3.9%, ROE – 32.0%), high capital adequacy (17.5%) and current liquidity (86.8%), on the other hand – the largest share of overdue payments (about 15.0%).

The fifth group of financial stability

Expobank, Credit Agroprobank, My Bank (former Gubernsky), Avanguard, LOKO-Bank, KMB-Bank, Natstorgbank, SKB-Bank, Moscommertsbank, Moscow Capital, Avtovazbank, Severnaya Kazna
The most numerous group consists of relatively small banks featuring acceptable level of financial stability, which is a bit lower than in previous groups. The group as a whole is not in the lead in any considered indicators, but not among outsiders, too. The group is characterized by capital adequacy and current liquidity a bit above normative parameters (12.1% and 67.9%), low profitability indicators (ROA – 1.0%, ROE – 11.6%), average indicators of overdue debts (1.2%) and good expenses-earnings ratio (average 95.7%).

The sixth group of financial stability

AKB CentroCredit, AKB Metallinvestbank, International Industrial Bank, Rus-Bank, AKB Russian Capital, IMPEKSBANK
The last group of financial stability consists of large banks, lagging behind the rest of the banks in our list by a number of parameters. Despite high adequacy of capital (group average 20.5%), we see here the highest expenses-earnings ratio (97.9%), low profitability (ROA – 0.9%, ROE – 4.4%) and current liquidity (58.7%), and high share of overdue debts (1.7%). As a result the group turned out to be in the end of our financial stability hierarchy.

DeltaCreditBank found itself outside of all the financial stability groups and needs an individual comment. Its indicators are notably distinct from the general picture and disallow considering it in the group context. DeltaCreditBank features high liquidity (norm of instant liquidity – 411.6%, current liquidity – 750.1%) and practical absence of overdue payments, at the same time capital adequacy, expenses-earnings ratio and profitability indicators are at the medium level. But for excessive liquidity, the bank might find itself in the second group of financial stability.

Classification methodology

Financial stability of a bank implies ability of a bank to uphold an acceptable creditworthiness level for a long time. Creditworthiness implies ability of a bank to perform its obligations fully and on time.

Banks were divided into financial stability groups on the basis of the CAMEL classic methodology, providing for consideration of five chief aspects of banking activity: capital adequacy, asset quality, management efficiency, profitability and liquidity.

Size of a bank was also taken into consideration. The provision is as follows: a larger bank has larger capacities to perform its functions in full and on time.

The classification used data forms 101 and 102 and was also based on voluntary information presented by banks to Expert RA. We presume that the agreement itself to participate in our analysis testifies to a certain level of bank information openness and may mean a better selection (only most stable banks decide to participate in the study).

We present a brief classification methodology and decipher ratios in table 1.

Methodology

Financial stability groups were formed by hierarchy cluster analysis method (Ward’s method, Euclidian space). In the cluster analysis process all observations (banks) are considered as points in multidimensional space of characteristics. The classification procedure permits specifying points close to each other and group them on the basis of similar characteristics. Thus, the analysis procedure is remindful of a mathematically arranged work of an astronomer, singling out star clusters in the sky.

Many analysts relate «cluster analysis» to intuitively built classifications, with non-orderly characteristics and absence of mathematic grounding. Our analysis is based on classic procedures, used by economy statistics.

5 variables of strong influence on bank financial stability were taken into consideration:

• Capital adequacy ratio (Н1), %;
• Share of overdue debts, %;
• Bank expenses-earnings ratio, %;
• Asset profitability, %;
• Current liquidity ratio (Н3), %;
• Total bank assets, thousand rubles.

Initial data was standardized in advance to exclude any domination of cost indicator (total bank assets, measured in thousand rubles, notably differ from other 5 ratios).

Ratio description

Capital adequacy

Capital adequacy ratio – ratio, determined according to set calculation of mandatory norm Н1 («Norm of adequacy of bank own funds»), and equals to ratio between bank own funds and risk-weighted assets. Minimal ratio norm, in line with incumbent Instruction 110-И («On mandatory bank norms»), is 10% for banks with own funds over 5 mln euro and 11% for other banks.

Capital quality ratio – ratio between bank fixed capital and total amount of own funds; it shows a share of first level capital in bank own funds. Own funds are calculated in line with Basel-1 approach (Instruction №215-П «On methods of determining own funds of credit organizations»).

Financial leverage ratio – ratio between bank liabilities and total assets; it shows a share of bank borrowed funds (liabilities) in total volume of attracted resources, both borrowed and one’s own.

Asset quality

Asset quality ratio – ratio between risk-weighted assets and total bank assets, characterizing risk level of bank operations. Higher ratio means higher risk level.

Overdue payment ratio – share of overdue loans in total loans.

Loan reserves ratio – ratio between reserves for possible loan losses, formed in line with Instruction № 254-П («On forming reserves by crediting organizations for possible loan and debt losses») and total loans; it shows average norm of allocation to reserves.

Management efficiency

Profit quality ratio – ratio between net revenues from single operations and net bank profits; it shows structural stability of bank net profit.

Growth quality ratio – ratio between difference in current and former (for the same period of time) asset profitability and percentage asset increment; it shows what percentage is sacrificed by a bank for 1% of its growth.

Expenses-earnings ratio – ratio between total bank expenses and total bank earnings in line with form 102; it shows bank loss level.

Profitability

Asset profitability ratio – ratio between profit before tax and average bank assets (for a certain period); it shows percentage of profit per 1 ruble of bank assets.

Bank own funds profitability ratio – ratio between profit before tax and average bank own funds (for a certain period); it shows percentage of profit per 1 ruble of bank own funds.

Net interest margin ratio – ratio between net interest and similar revenues and average bank assets (for a certain period); it shows percentage of net interest revenues per 1 ruble of bank assets.

Liquidity

Instant liquidity ratio – ratio, determined according to set calculations for mandatory norm Н2 («Norm of instant liquidity»), and equal to ratio between highly liquid bank assets and demand obligations. Minimal ratio norm, in line with the incumbent Instruction 110-И («On mandatory bank norms»), is 15%.

Current liquidity ratio – ratio, determined according to set calculations for mandatory norm Н3 («Norm of current bank liquidity»), and equal to ratio between bank liquid assets and demand obligations. Minimal ratio norm, in line with the incumbent Instruction 110-И («On mandatory bank norms»), is 50%.

Inter-bank credit market dependence ratio – ratio between difference in attracted and placed inter-bank credits (deposits) and total volume of bank borrowed assets.

Creditworthiness – ability of a bank to fulfill its functions fully and on time.

Bank financial stability – ability of a bank to uphold acceptable creditworthiness level for a long time.