When 35-year-old Russian financier Alexei Frenkel was arrested in January for ordering the murder of deputy central bank governor Andrei Kozlov, many commentators were happy to see at least one of Russia’s many contract killings apparently solved.

However, since his arrest, the situation has only got murkier.  

Frenkel, who was CEO of VIP-Bank, which had its license removed on suspicion of money-laundering in 2006, had written a series of letters to the press three months before his arrest, just after his bank had been closed down, in which he made a litany of complaints against what he saw as the arbitrary and corrupt way in which the Central Bank withdrew licenses. The Central Bank, he suggested, “come to you and make a proposal…You refuse, they’ll close you down.”

At first, the Central Bank and the government angrily dismissed the allegations as the ravings of a murderer. Central Bank governor Sergei Ignatyev said there was no hard evidence in the allegations, and that they emanated “from those whose work in fictional banking operations is being hampered by the Bank of Russia”.

But other senior figures in the banking sector were more hesitant in their defence of the Central Bank. Thus Andrei Yemelin, vice-president of the Association of Russian Banks, told the Russian press that “imperfections in banking legislation” had “led to the appearance of evidence that has allowed someone to draw conclusions about corruption in the Central Bank”. Vladislav Resnik, chairman of the Duma’s banking committee, said the Central Bank often found “artificial grounds” for removing licenses.

Now, three months after Frenkel’s arrest, there has been an unprecedented call for reform of the Central Bank’s regulatory functions. The National Banking Council met in March for a series of meetings, at which a wide range of reforms were proposed, including stripping the Central Bank of its powers to revoke licenses, and setting up a new mega-regulator along the lines of the UK’s FSA. The Kremlin is likely to decide on one of these variants in the next month.  

The controversy shows that nothing is ever simple or straightforward in Russian politics, least of all banking reform. The Central Bank has always played an unusual role in the sector, particularly because it is also the biggest shareholder in the country’s biggest bank, Sberbank, which is one of the most powerful institutions in the Russian economy with a market share in banking deposits of over 50%. This gives the Central Bank substantial financial and political leverage.  

“Of course, it’s not ideal that the Central Bank is the largest shareholder in the sector’s largest bank”, says Alexander Murychev, president of the Association of Regional Banks. “But what is the alternative? To whom should the government sell such a large and influential bank?” 

While the private sector complains about the quality of the Central Bank’s regulation, the state-owned banking sector gets ever bigger. Vneshtorgbank (VTB) in particular is expanding at a mighty rate, opening branches in Shanghai and Angola, buying up uranium mines in Namibia, signing partnership agreements with airlines in Argentina. It’s looking to expand in the investment banking market too, and recently bid around $2.5 billion for Troika Dialog, whose main shareholder, Ruben Vardanian refused the bid, much to the surprise of the market.

As with the expansion of other state giants such as Gazprom, sometimes it’s hard to discern the overall strategy of VTB’s expansion plan, other than ‘get bigger quickly’. Elena Titova, head of Morgan Stanley’s Moscow office, says: “VTB haven’t quite decided which business segments they want to be strong in yet.”  

VTB has started to nip at the heels of Sberbank – VTB’s head of international strategy, Julia Chupina, told me: “We want to be bigger than Sberbank, to be number one.” The rivalry between the two banks reveals the nature of Russian bureaucratic capitalism – different parts of the state structure compete very actively, though not in traditional market ways but through Byzantine behind-the-scenes bureaucratic intrigues.

Thus Sberbank and VTB likewise compete through their respective government representatives – Sergei Ignatiev, governor of the Central Bank; and Alexei Kudrin, minister of finance. A Cold War is being waged by these two officials, with Kudrin having recently ordered an audit of the Central Bank’s behaviour by the General Prosecutor’s office. The dispute is as much about VTB competing with Sberbank, as it is about the legality or illegality of the Central Bank’s actions.

Other state-owned banks are also increasing their share of the market. Akbars Bank, for example, is a regional bank owned by the republic of Tatarstan. It received a $400 million capital injection from the regional administration last year, which its using to set up filial branches across Russia. “The capital injection was absolutely necessary to our strategy of regional expansion” says Akbars deputy chairman Zufar Garaev. “We want to be a top five bank in most Russian regions within five years.”

Another big banking player in the process of being created by bureaucratic diktat is the new Russian Bank of Development, which will incorporate Vnesheconombank, the Russian Bank for Development, and Eximbank, and will have capital of at least $500 million. Again, there’s a lot of bureaucratic infighting over who will control the bank. Prime minister Fradkov is making a bid to bring it under the control of his office, while minister Gref of the ministry of economic trade and development, who does not get on with Fradkov, wants it to be more independent.  

The bank is likely to be mainly involved in public-private partnerships throughout the Russian regions, such as the $5 billion construction of the Boguchanskaya hydro-electric dam in central Siberia.

Thus we can see bureaucratic intrigues playing an ever-larger role in determining the winners and losers of the Russian banking sector. Murychev of the Association of Regional Banks says: “It’s true the state seems to be taking a leading role in developing the sector, with the creation of new state banks like the development bank and by giving capital injections from the state budget to banks like VTB. But maybe that’s not a bad thing. Private banks find it hard to get long-term financing, to get cheap financing, to find capital. So, maybe state banks need to take the lead in the development of markets like the mortgage or SME-lending market.”

At the same time, there’s still a clear role for private and foreign capital. Even the state-owned banks are looking for it. Both Sberbank and VTB considered getting further capital injections from the state, but both decided instead to go for share offerings. Sberbank went first, issuing $8 billion in shares. The issue should have been a big success, considering how well Sberbank shares have performed over the last five years, but Sberbank managed to screw it up, paying its lead-managers a pittance (0.8% fees), not doing a road-show, making the process very difficult for foreign investors to participate in, and giving the market conflicting statements about valuation.  

In the end, the deal was mainly supported by large orders from Russian oligarchs close to the bank’s management, such as Elena Baturina, wife of Moscow mayor Yuri Luzhkov; and Suleiman Kerimov, billionaire owner of Nafta Moskva. Elena Titova of Morgan Stanley says: “Sberbank was basically an off-market deal. But that may be good for future deals, because it didn’t saturate demand.”

VTB is now preparing its IPO for the next few weeks, which will likely raise around $2 billion. It should be a success, simply because the banking sector is growing very quickly but only Sberbank shares are readily available from the sector so far. Other state-owned banks, such as Akbars Bank, are also preparing IPOs.

Meanwhile, private banks are still performing well, particularly in areas where customer service makes a real difference, such as in retail and SME lending. Some private banks are making the first step towards getting western strategic partners – PromSvyazBank is completing a deal to sell a minority stake to Commerzbank, while Rosbank sold a 10% stake to Societe Generale towards the end of last year, for four times book value, and is likely to sell more of the bank to SG if it is satisfied with the quality of Rosbank’s loan portfolio.

The foreign investor really taking the lead in investment into the sector is East Capital, which raised a $350 million CIS financial institutions fund last year, which it has since invested around 70% of in 10 acquisitions, including several throughout the Russian regions, buying minority stakes in banks like Bank Kedr, a leader in Krasnoyarsk; Akibank, the fourth biggest bank in Tatarstan; and Kolyma Bank and Asia Pacific Bank, two banks in the far east of Russia which are majority-owned by Expobank. Renaissance Capital has since followed suit, raising a $200 million financial institutions fund. 

Kestutis Sasnauskas, partner at East Capital, says: “The banking sector has enormous potential. Last year, the total assets of the sector were the equivalent of Svenska Handelsbanken, which is not that big a bank. The total mortgage market was the same size as Estonia’s. There’s a lot of room for growth. A lot of banks are growing at rates of 100% or more, so they need capital.”  

However, Sasnauskas says Central Bank regulations make it hard for some foreign investors to invest in Russian bank equity, so East Capital set up a special purpose vehicle just for the fund. Sources suggest it is a stalking horse for Svensa Handelsbanken, one of the fund’s main investors, which gets the first right to buy out East Capital from its banking investments.

Jules Evans, a British freelance journalist based in Moscow.

March 27, 2007