Crisis, What Crisis? The Banking Sector Weathers a Panicky Public

The Russian banking sector successfully weathered what might be described as a “pseudo-crisis” in early July, providing further evidence that the economy and financial system had developed to a point that the kind of full-blown meltdown that occurred in 1998 was a virtual impossibility. But the events also showed both that the need for further banking reform is still pressing and that the job of effectively regulating the sector is far from simple.

As most analysts had predicted all along, the road bump that the banking system hit did not bring it screeching to a halt or develop into a systemic crisis threatening a total collapse. But the runs on banks by depositors fearing the loss of their savings and liquidity problems on the inter-bank market as banks themselves were spooked into curtailing loans to each other did highlight the central role of confidence and communication in any banking system – not just in Russia – and the important place the Central Bank occupies in supporting these.

As so often in Russia, the rumour mill was in full swing during the “crisis” and conspiracy theories abounded as people asked who was responsible and whose interests were being served? Blame was sprinkled liberally in all directions, with mutual recriminations and accusations of dirty and manipulative press campaigns thrown in for good measure.

High on the list of the usual suspects were commercial banks allegedly seeking to weaken their competitors by floating rumours about their financial solidity through journalists who were paid to write stories to order. Alfa Bank, for instance, accused Kommersant of discrediting it at the behest of Boris Berezovsky, who owns the daily newspaper, while Boris Fyodorov, an outspoken former finance minister, Duma deputy and head of the investment bank United Financial Group, said on Ekho Moskvy radio that the insiders responsible for such actions should be locked up.

Alfa Bank was one of the worst hit by the bank runs and suffered through a week of lineups of depositors looking to clean out their accounts. Only on July 14 was it finally able to announce that deposits from individual clients had once again nosed above withdrawals.

Another intstitution, Guta Bank, was in effect bailed out after state-owned Vneshtorgbank acquired it using funds borrowed from the Central Bank, enabling Guta to process claims from customers wanting their money back.

The liquidity crunch was not eased any by comments from an official at the commission for investigating money laundering to the effect that the Central Bank had a “black list” of ten doubtful banks, rumours which persisted despite repeated denials by the Central Bank itself.

The Ruble Stops Here

Despite the Central Bank’s moves to limit the damage, which included cutting reserve requirements to provide more liquidity, market participants, observers and politicians, blamed the Central Bank itself for triggering the crisis.

The fears that rippled through the system began when the Central Bank withdrew the licenses from Sodbizbank and KreditTrust for alleged money-laundering activities, but were exacerbated, according to critics, by its failure to act decisively enough to restore confidence.

Andrei Illarionov, the economic advisor to President Vladimir Putin, slammed the Central Bank for what he said was poor regulation of the sector. He also listed a raft of what he called the bank’s “socialist” policies, including reserve requirements and capital controls, a reaction that appeared to be a bit overwrought, considering that reserve requirements are standard in the banking sectors of all of the world’s developed economies.

Criticism of the situation was widespread, and some other comments seemed closer to the mark. Prime Minister Mikahil Fradkov said that the Central Bank had handled the crisis well, but that its actions should have been more “transparent and consistent,” while former prime minister Mikhail Kasyanov called the bank run “a crisis of confidence … that arose in the absence of clear information on the actions of the authorities and their intentions.”

But not everyone was as critical.

“The line that it was the Central Bank that triggered the crisis is one being promoted by those who got caught up by the hysteria,” says Richard Hainsworth, general director at Rus Rating, an independent bank rating agency covering some 40 banks in Russia. “They don’t want to admit they over-reacted, and hence it was the Central Bank that was wrong. But what exactly did the Central Bank do wrong?

Hainsworth added that criticism that the Central Bank didn’t support the smaller banks was unfair, as it did ultimately step in to help. Perhaps the help came later than it should have, but he doesn’t think that it is fair to lay the blame for this at the feet of the Central Bank.

“I think with hindsight that it would be consistent for the Central Bank to argue that it could not have acted faster for technical reasons,” Hainsworth said. “But it acted firmly and resourcefully, and when it comes down to it, in time. That is the very best one could expect from a regulator.”

Individual banks themselves couldn’t be absolved from some responsibility for the pseudo crisis. Nobody argued that the initial move against Sodbiznessbank and KreditTrust was a mistake, but the actions of other banks ultimately determined how they came out of the fray. According to Ralf-Dieter Montag-Girmes, chairman of the board at Investment-Credit Bank ARQ, the difference in the outcomes for Alfa Bank and Guta Bank illustrates the point.

“The Central Bank made a number of statements that Alfa Bank was fine. And, of course, Alfa’s shareholders were both able and willing to put up their own money, to the tune of some $700 million, fully justifying the Central Bank’s confidence,” Montag-Girmes said. “But that contrasts with Guta Bank, which basically did have the assets on which to borrow enough to see them through the crisis, but no one lent to them and the shareholders pretty much gave up without a fight and let the Bank be nationalized, and on rather disadvantageous terms.”

The “bail-out” deal that the Central Bank worked out involved Vneshtorgbank, which is also state owned, buying 85.8 percent of the shares in Guta-Bank’s shares for the nominal sum of 1 million rubles (about $33,000).

A Bewildered Public

The Central Bank’s involvement aside, the biggest factor behind the “crisis of confidence” was likely a generally poor understanding on the part of the press, analysts and the wider public of how banks and regulation actually work, which, combined with memory of earlier crises, in 1998 and 1995, led to overreaction. The comparisons with earlier crises overlooked the current positive macro-economic indicators and improvements in the banking system, which were not present then.

None of the observers explained how or why Russia could default when it was running budgetary and trade-account surpluses, when its gold and foreign currency reserves stood at record levels, and its external debt situation was immeasurably better than in 1998. The pyramid scheme dynamics of the GKO market and the “Asian contagion” were also missing this time around.

But no central bank can prevail if confidence in the system is eroded. There is always a danger that such panics become self-fulfilling, leading to bank runs, failures and, thus, to a systemic crisis.

It also seems likely that part of the Central Bank’s reticence to step in quickly was to avoid a moral hazard faced by all central banks: If they bail out banks that have gotten into difficulty of their own accord, central banks are likely to encourage irresponsible behaviour and increased risk-taking further down the line, since private banks think they will be rescued. On the other hand, if central banks let bad banks fail, they run the risk of creating a systemic crisis, as confidence in the whole system collapses and depositors and creditors cannot differentiate between good and bad banks. This is what happened in this case in Russia.

This lack of accurate information can all too easily result in the failure of good banks as well as bad, which would clearly be a disaster with devastating effects for Russia at a time when confidence in the banking system had just begun to increase. Just as important, banks were beginning to operate more like true banks and had finally begun channelling funds into economic growth.

Given that the Central Bank of Russia is still “young” and does not have the institutional memory of some of its counterparts in the West, its recent performance was not as bad as many made out. It did, ultimately avert a real crisis.

The question now is: What did the Central Bank learn from the process?

“The real test will come when the next round of licence withdrawals, from several obvious candidates starts, and this looks set for August,” said Montag-Girmes. “We should then see the CBR better coordinated and prepared as it continues to clean up the banking system.”

Special to Russia Profile, an online and monthly print magazine dedicated to Russia and published jointly by RIA-Novosti and Independent Media, Moscow.

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