Interview of Mikhail Sukhov, Bank of Russia Deputy Governor, to on 12 February 2014

‘For us, bank resolution is not something inadmissible’

In his interview with, Mikhail Sukhov, Deputy Governor of the Bank of Russia, spoke about how many banks will be considered as systemically important and supported by the central bank, what percentage of their deposited funds depositors will receive after the revocation of a banking licence and which credit institutions may be subject to bank resolution.

-  The Bank of Russia Regulation on the criteria for inclusion in the list of systemically important banks became effective on 2 February 2014. At what stage is the formation of this list? How many banks are included in it?

-  Indeed, the Regulation on the criteria for determining systemically important banks came into force in early February. We are now working on the assessment of the conformity of banks with not only quantitative but also qualitative criteria which are set out in this Regulation of the Bank of Russia. Based on the analysis, we will send the information directly to banks. Some of them will be transferred for supervision to the Systemically Important Banks Supervision Department, while the other part will remain under the supervision of Bank of Russia regional branches.

Depending on the assessment of qualitative parameters associated with bank activities, the list of systemically important banks may include 50-60 banks.

-  The Bank of Russia will impose tighter requirements on them. May systemically important banks have their licences revoked? Or may they expect bank resolution as their importance to the financial system is too high? Earlier, analysts argued that the banks included in the list would also be able to count on government assistance. Is it true?

-  Without doubts, not only the Bank of Russia, but the public at large should require that these banks comply with tighter standards related to ensuring financial stability and transparency. There is an understanding that all systemically important banks must regularly assess the scenarios related to the impact of various external factors on their potential needs for liquidity and capital. The results of this work specifying the sources for overcoming potential difficulties must be known to the Bank of Russia in the form of action plans for ensuring business continuity. On their basis, the Bank of Russia, as a supervisory body, will work out in advance the options for acting in specific situations.

-  That is, a troubled bank will in fact obtain support?

The key principle in this situation is that banks must rely on their own resources, the resources of their shareholders and creditors. Therefore, the main requirement for these banks is to have ways out of difficult situations without government involvement. For us, bank resolution involving public funds in accordance with applicable law is not something inadmissible, but it may be considered as the last, rather than the first resort for solving problems.

-  Are there any systemically important banks whose condition is a matter of concern for the Bank of Russia or whose position may substantially deteriorate in case of market stress?

-  All banks, both the systemically important ones and others, are under the Bank of Russia’s supervision. All of them are market players and, theoretically, may incur financial losses, the amount of which depends on the degree of diligence and foresight of their managers and owners. Our task, together with bank owners and managers, is to ensure early detection of potential financial problems in their activities. Based on the scenarios that we published in December 2012, all major banks have internal resources to manage their liquidity and capital adequacy parameters. Therefore, such variables as changes in oil prices, exchange rates, or a fall in GDP, have been analysed by our banks, and they see nothing critical there. We have no reason to disagree with these calculations.

-  After the revocation of licences from large regional banks, such as Investbank, First Express Bank, etc., the situation in the regions has been strained. Regional budgets’ funds were deposited with these banks. This raises the question of why the central bank did not proceed with bank resolution but chose to revoke the licences. Could you explain what guided the regulator in this case? And what can the regions do when faced with the most difficult economic situation?

-  As an alternative to revoking licences, a bank resolution has a number of prerequisites. These include the simultaneous impact of both socio-economic factors and economic grounds for implementing rehabilitation procedures in terms of the financial condition of the bank and the specifics of its business. We do not consider it possible, for example, to continue the activities of banks, whose main business is associated with the so-called dubious transactions involving a corresponding customer base. We also compare the amount of funds required for financial rehabilitation with the bank liabilities. In those cases where continuation of the bank's operations requires the provision of more funds than the bank owes to its customers, such financial rehabilitation goes beyond the conventional market-based approaches. Of course, the sources of possible losses in the event of stopping the bank’s operations should be assessed taking into account possible indirect adverse effects. This happens, for example, when the erosion of trust in one financial institution may deteriorate the attitude towards a wide range of other banks, which is especially noticeable in certain regions. Therefore, in each specific case we observe one or another combination of these three conditions, which is sometimes associated with absolute performance indicators of the bank but is not always limited to them.

In the case of Investbank, First Express and Pushkino, the scale of losses or low-quality assets was such that to compensate the losses of the bank on a repayment basis would require funds close to the total size of its liabilities.

There is a matter of economic feasibility in all implemented projects related to financial rehabilitation.

-  How do you rate the chances of affected depositors, who held more than 700,000 roubles on their deposits with the banks that had their licences revoked in the second half of last year (Investbank, Project Financing Bank, Master Bank), of getting their money back? According to a standard practice, they receive no more than 10% of what they held on their bank accounts.

-  The information that large depositors receive no more than 10% of the amount in their accounts is incorrect. It all depends on the availability and condition of the assets in each bank, as well as on the ability of the Deposit Insurance Agency to sell them and monetise the assets in the bankruptcy estate. While working as a receiver, the Deposit Insurance Agency has already liquidated 159 banks, and the claims of all priorities submitted by the creditors have been satisfied by 30.5%, while the claims of first-priority creditors, which include depositors with deposits in excess of the insured amount (received by them under the deposit insurance system) and also the Deposit Insurance Agency for paid insurance amounts, by 55.5%. Taking into account the insurance compensation, the average percentage of satisfying depositors’ claims amounted to 81.1%.

Among the total number of credit institutions liquidated by the Deposit Insurance Agency, in 68 credit institutions, the claims of first-priority creditors have been satisfied in full.

In our view, to ensure the necessary transparency of liquidation, it is important that creditors participate in the committees and meetings of creditors.

-  During the latest crisis, one of the major weaknesses in banks was the revealed high percentage of bank lending to businesses affiliated with the owners of banks. How important is this problem now for the banking sector? For example, if we talk about systemically important banks, could there be the same problems as those detected in the Bank of Moscow or International Industrial Bank?

-  According to our estimates, lending to businesses affiliated with the owners of banks is more typical of the banks that are not systemically important. The reason is that if the owner of a major Russian bank has another business, very often his business reaches such scale and degree of trust among investors and lenders that it can raise funds in the debt market and also by placing the securities at less cost than it can raise from its own bank given the profitability considerations.

Therefore, in our view, the measures to limit the investments of a bank in the business of persons who control its activities will affect primarily the banks that are outside the scope of systemically important with a corresponding quantitative and qualitative impact on the banking sector in general. As for the problems of the Bank of Moscow and International Industrial Bank, as well as certain other banks, the reasons for their financial losses are currently being investigated with the involvement of law-enforcement agencies, and these reasons are far from being economic. With regard to the affiliation of borrowers and shareholders, from 1 January 2015, the Bank of Russia will begin to implement new practices set forth by legislation, including the application of the informed judgment.

We also believe that the Bank of Russia’s measures to increase the transparency of the financial condition of banks, based on the approaches of the Basel Committee on Banking Supervision, will help expand the opportunities for external experts to evaluate independently the financial indicators of banks, which, in turn, will increase the responsibility of the owners and management of banks and lead to improved business decisions.

-  Do Russian banks have any weaknesses that are of particular concern to the central bank now, in the course of the transition to new business standards?

-  A bottleneck in the banking business economics is the underdevelopment of market tools for managing liquidity, interest rate, exchange rate and other types of financial risks.

Therefore, more often than in many other countries, banks are counting, from an operational point of view, on the Bank of Russia as a lender of last resort.

It is clear that the market may create far more opportunities for managing banks’ finances than any central bank, which uses its instruments to achieve monetary policy goals rather than support the banking sector. Therefore, the measures aimed at boosting the interbank lending market, forward transactions and asset securitisation should ensure the systemic stability among banks of different sizes. The scope of these measures depends on the investor confidence not only in banks but also in non-bank financial institutions. Thus, the measures to develop the functions of the Bank of Russia as a mega-regulator are also needed in order to provide banks with additional opportunities of conducting operations in the financial markets. However, it is obvious that the characteristics of the banking sector development are determined by the pace and quality of economic growth.

-  Do you think that a tighter policy of the Bank of Russia towards banks may stir up mergers and acquisitions in the banking market?

-  Mergers and acquisitions in the banking market represent an independent process that is going on among economically sustainable and profitable entities. These clearly do not include the banks, from which we revoke the licences. Moreover, some customers of these banks, such as those who place their money to gain extra-high income, are of no interest to the banks that implement a reasonably conservative commercial policy in the market. This largely explains the fact that at the moment big banks are not particularly interested in financial rehabilitation and business consolidation of troubled institutions. We are witnessing the withdrawal from the market of institutions whose business, in essence, cannot be regarded as banking, and this is rather useful for the soundness of our banking system. Therefore, we believe that mergers and acquisitions in the banking system will continue for reasons that are not directly related to supervisory policy.

-  The discussion of the idea to introduce differentiated contributions of banks to the Deposit Insurance Agency is currently underway. To what extent is this necessary, and what are the criteria for differentiation of banks’ contributions to the Deposit Insurance Agency?

-  The differentiation of banks’ contributions to the Deposit Insurance Fund is fairer than the current flat rate. The amount of banks’ contributions to the Fund should be linked to the risk exposure of a bank, which, in its turn, must be assessed based on the criteria that are clear and well-known to the market. We have to solve several difficult problems.

One of them is to ensure that the concept of "high risk exposure" is not limited to the assessment of banks’ current financial condition. Therefore, the system for determining the risk exposure of a bank must take into account its business model and its viability in the medium term (3-5 years).

Another, no less obvious difficulty is banks’ reporting quality, because the best falsifier of financial statements should not be making the lowest payments. Therefore, the establishment of appropriate criteria is a complicated task, which we need to carry out this year together with the Deposit Insurance Agency and market participants. At the first stage, we consider it appropriate to apply a more easily administrated method of calculating the contributions to the Deposit Insurance Fund based on the deposit interest rate.

There are fears that this will lead to a reduction of deposit interest rates. This will, accordingly, have an adverse impact on banks, given that many of them are already experiencing difficulties in raising funds.

-  The level of deposit interest rates is to a greater extent influenced by macroeconomic factors than by the costs of raising funds. We should not fear a certain reduction in deposit interest rates at high-risk banks, because the current flat payment rate system is unfair to the banks with lower business risks. If the owners of a bank want to carry out a high-margin business, they can do so by raising funds from other creditors, qualified investors, who will assess their risks without relying on government guarantees. As a result, the banking sector will gain trust by improving the competitive positions of banks that place funds on reasonable economic terms.

-  There are also discussions on increasing the amount of insurance compensation from 700,000 roubles to 1 million roubles and expanding the list of insured parties. The list currently includes private individuals and entrepreneurs and it is proposed to include in it all small businesses. To what extent is this necessary? Do you think it is appropriate to insure the accounts of charities? For example, after the revocation of the licence from Master Bank, Doctor Lisa Charitable Foundation lost its funds intended for a hospice.

-  Since the beginning of 2014, the insurance base for payments has included not only private individuals but also entrepreneurs, which is an additional instrument to boost confidence in the banking sector. Any further measures to define the range of persons who may benefit from insurance compensation require several conditions. One of them, obviously, is the burden on banks to accumulate funds in the Deposit Insurance Fund. We should bear in mind that the ultimate contributors to the Fund are bank customers: depending on the level of competition these are either depositors or borrowers. In addition, the range of insured persons must be defined in such a way as to prevent the erosion of the insurance liability limit from splitting the obligations.

Undoubtedly, charitable, religious and other public organisations may be considered as the most obvious candidates for the additional attention on the part of the deposit insurance system.

-  A draft law is currently being discussed that will ban the spread of unreliable information on bank activities. What is the need in this document? The central bank makes comments on the information on banks’ condition rather seldom. How, then, can ordinary bank depositors, for example, monitor the condition of a bank? And what is "unreliable information"? Who is going to determine whether information is unreliable? The Prosecutor's Office?

-  Unreliable information on bank activities may cause damage not only to a particular bank but also to other banks. Solving the financial problems of banks is a rather expensive process, which is burdensome either for creditors who lose their money in the bank, or for the society that invests public funds in its financial rehabilitation. The inevitable feature of unreliable information is its anonymity.

Therefore, we believe it is important to disseminate information about banks only through identifiable information sources, including the media.

This will allow individuals having their own opinion to retain the ability to express it in accordance with the accepted principles of publicly disclosed information. As a main tool we consider the possibility of using the prosecutor’s intervention to block websites or other channels used for disseminating false information.

Prepared by: Natalia Yeremina, Yana Milyukova and Olga Adamchuk

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