Banking: Russia’s sub-debt boom

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A wave of lower tier 2 issuance will not deal with Russian banks’ strained capital levels.

As in Turkey, banks in Russia are grappling less with the fallout from a sovereign debt crisis than with how to continue financing a booming consumer economy.

Russian banks entered the post-crisis era with strong capital levels. But lending has increased at annual rates of 30% and upward since 2009, and unsecured retail and trade lending has predominated. As a result, the sector’s average capital level is at a seven-year low.

Last month, the central bank said it was increasing reserve requirements for overdue unsecured retail loans, reportedly to double the existing minimum. Nevertheless, as competition heats up in retail lending – partly thanks to the rise of specialized outfits such as Tinkoff Credit Systems – Russian banks appear to have little intention of slowing down and deleveraging.

Meanwhile, the cancellation of Promsvyazbank’s hoped-for London IPO last month shows just how unaccommodating equity investors will remain, especially to the smaller Russian banks. Now Russian banks, including Promsvyazbank, are trying to plug their flagging capital levels via lower tier 2 issuance.

Last month, Bank St Petersburg, Home Credit and Finance Bank and retail specialist Russian Standard Bank all issued lower tier 2 bonds. Sberbank and VTB also issued lower tier 2 bonds of $2 billion and $1.5 billion, respectively.

But even if there is no retail lending bubble in Russia, lower tier 2 issuance will still be only a short-term solution. Mindful of the growing risk in the sector – much of which central bank funding has fuelled – the central bank announced this autumn that it is considering moving to Basle III rules far more closely than previously expected to the timescale for Basle III’s adoption in western Europe.

One problem is that some Russian banks still have big holdings of non-core assets on their balance sheets: frequently illiquid equity gathered as collateral from crisis-era debts. Under Basle III rules, this could mean potentially life-threatening capital deductions for some lenders.

The central bank, perhaps giving banks some space to prepare themselves, has indicated that it is considering allowing sub-debt issued before 2013 to count as regulatory capital under the old rules, even after the new rules come into effect. This, along with a receptive global investor base, has triggered the rush to issue lower tier 2 paper.

But only the biggest banks, mostly state-owned, will be in a position to sell Basle III-compliant hybrid capital. For the smaller and more specialized players, unless investor appetite for bank equity somehow recovers in the next two years, a more realistic solution after that period might be to sell up to the bigger banks – most likely the state-owned or state-linked ones.