The figures behind the figures

If your idea of purgatory is submitting accounts, you’ll sympathize with Russian banks. The central bank requires them to submit reports daily, weekly, monthly, quarterly and yearly. Quantity doesn’t necessarily equate with quality: western investors aren’t particularly impressed with what they see and the Russians know it. “In the international market,” says Igor Komarov, chief accountant at Inkombank, “our balance sheets are as incomprehensible as Chinese grammar.”

At face value there appear to be few problems: all the necessary figures, such as assets, liabilities, shareholder equity and profits, are reported. But the accounts make no attempt to evaluate a bank’s financial situation. Everything is presented in bookkeeping form and follows, with some modifications, the Soviet system of preparing figures as a basis for calculating the tax bill.

International institutional investors, rating agencies and analysts need more information than this. They have been pressing banks to produce additional annual reports prepared according to international accounting standards (IAS).

Revalued figures produced on this basis show lower equity, asset and profit figures throughout the balance sheet. In the case of Inkombank, for example, its 1995 accounts under Russian accounting standards (RAS) report $308 million of shareholders equity; using IAS the figure is $100 million lower. Tokobank’s IAS equity is $110 million lower than its RAS equity of $309 million.

Publishing IAS reports is not a popular option: so far no more than 30 or 40 banks out of some 2,300 do so. Most would rather spend a few million on an impressive building and publish inflated figures rather than commission one of the expensive big-six international accounting firms to reveal their real financial situation. But for those that have extensive foreign dealings, want to open representative offices abroad or get access to international capital markets, IAS accounts are crucial.

But getting hold of IAS accounts isn’t the end of the matter. Finding consolidated accounts is virtually impossible. The few institutions that do present consolidated IAS accounts, such as Mezhcombank, Tokobank and Most Bank, are something of an anomaly in Russia. Consolidation is another concept that’s new to Russian accounting, so those institutions that don’t publish consolidated accounts are not necessarily deliberately avoiding doing so. At present only banking subsidiaries have to be consolidated. But banks such as Imperial, Unexim and ICFI (International Company for Finance and Investments) own or part-own industrial and business concerns that often dwarf their banking operations. Promradtekhbank even owns a hospital and a radio station. In fact some of Russia’s major banks are little more than glorified corporate and state treasuries that bankroll business, industry and government. So they would appear as just single cogs in larger machines if consolidated accounts were presented.

Moves towards greater transparency in Russian accounting are at best described as gradual, and there are more important priorities than producing consolidated accounts. It’s therefore likely to be several years before they are common practice. At present, banks and auditors have more than enough to do preparing IAS accounts for bank business alone.

Onwards and downwards

Where do Russian and international accounting practices differ most? For many banks, adjustments to the role of Taiga bonds in their balance sheets have the most effect on the value of their equity. Taiga bonds worth $8 billion were issued by the finance ministry from 1993 onwards to creditors of the collapsed state-run Vnesheconombank. Those who bought them had to do so at face value and would have incurred further losses had they sold them in the market, where their real value was much lower. So the bonds, which were dollar-denominated, were allowed to be classed as a form of equity, either as part of a bank’s charter fund or to raise additional capital.

The central bank now recognizes that the bonds artificially increase banks’ equity and in February 1995 forbade any new tranches from being used in this way. It also told the banks that they must gradually eliminate the bonds from their equity figures.

Under IAS, bond holdings cannot be registered as equity, and so are eliminated. This is a source of conflict between the banks and the big-six auditing firms since the banks believe the accountants exaggerate the figures relating to the bonds when revaluing equity. “Although we and the auditing firm finally reached a compromise last year,” says one Russian banker, “we know we’re going to have to go through the whole process again.”

Another reason why IAS accounts tend to cut Russian banks down to size springs from the fact that they are calculated on an accrual basis, whereas RAS is based on cash accounts. So RAS figures don’t register a bank’s incoming or outgoing interest payments until they are received or paid out. IAS, by contrast, will add and subtract them as necessary according to the length of the loan. In simple terms of interest owed, the accrual system knocked $2 million off equity and $9 million off profit at Mezhcombank last year.

But by far the largest cut resulting from use of the accrual system is due to loan-loss provisions. According to IAS, provisioning forms part of a bank’s capital but not of its shareholder equity. In RAS there is no notion at all of loan-loss provisions ­ cash-based accounting does not require loans to be declared as lost until they are overdue, and most banks have been in the habit of simply rescheduling loans to avoid this. Recently, however, the central bank has introduced a system for provisioning consisting of five graded categories. According to this, funds of between 2% and 100% of the value of a loan have to be set aside as a loan-loss provision, depending on how risky the loan is.

The banks complain of one major problem with this system: provisioning for the more risky loans (the bottom three tiers) is done before tax whereas for safe loans, provisioned at between 2% and 5% of their value, the funds are not set aside until after tax. This artificially increases a bank’s tax liability and so dents its dividends and profits.

Compared with the western IAS system, the new Russian provisioning system sets aside much less capital, making more available for equity. Taking Mezhcombank as an example, adapting figures to IAS for 1995 required providing for Rb117 billion ($25.23 million) more than its IAS equity total of Rb113 billion.

Loan-loss provisions also mean that IAS-calculated profits are lower than those derived from RAS. At Mezhcombank, a further Rb58.6 billion ($12.6 million) had to be set aside on top of the RAS figures. Profits at the larger Most Bank were hit even harder, with provisioning taking off Rb144 billion.

Despite this the banks that have applied IAS seem to appreciate the importance of provisioning. As Inkombank’s Komarov puts it: “By creating reserves it seems as though we’re missing out on profit, but if this is not done then net profit is unrealistically high. Whereas if the bank has a correct reserve strategy it’s prepared for every eventuality.”

IAS rules on accounting for tax tend to make a further dent in banks’ profit accounts. Under RAS the profit-and-loss account does not include tax payments. Instead all profits are included on the shareholders’ equity account as profit to be distributed ­ Russian legislation, in a hangover from the Soviet era, does not allow for retained earnings; all profits must be distributed, whether through taxes, dividends or by being placed in a reserve fund. Also, expenses such as staff bonuses and salaries are not included in the P&L but are treated as flows of funds and often contribute to shareholder equity figures.

Worst hit in 1995 by the IAS approach to tax was Tokobank, whose RAS-derived profits of Rb114 billion were wiped out under IAS, forcing the bank to report a loss of $11 million.

Asset figures also come out differently in the two accounting systems. Interbranch lending accounts and loans to affiliated companies and individuals (usually shareholders) are included in RAS and so inflate banks’ assets. These flows are said to be used by banks as window-dressing. For example, they may lend money to their own branches or affiliates at the end of a quarter or a year to boost their figures, then have the loan paid back shortly afterwards. Moscow newspaper Isvestia recently published an article accusing Unexim Bank and its sister company ICFI of this. Auditing firms say the practice is widespread. “It happens here just like it happens in the West,” says an accountant. “Only here it’s not done in quite as subtle a manner.”

Increasing authority

The non-specific nature of Russian accounts means that proceeds from some foreign exchange and derivative deals are hidden. Some proceeds are listed in the P&L, but a large amount are subsumed in account number 076, “settlements on other foreign operations”, and found in assets and liabilities. One analyst estimates that between a fifth and a quarter of some banks’ balance-sheets are included in this one account.

The institution responsible for bringing the old Soviet-style Russian accounts up to date is the Central Bank of the Russian Federation. Formed out of the old state-run Gosbank, the central bank has slowly been introducing changes, such as loan-loss provisioning, since 1993. But bankers and consultants reckon it is only in the past 18 months that it has taken on much of a supervisory role. In part this was a result of lack of experience, and the fact that many of the central bank’s best staff left to take up better-paid jobs in the commercial sector. One analyst says the lack of experience at the central bank worsened the interbank loans crisis of August 1995 ­ another rumour, though, has it that the central bank’s approach was a deliberate ploy aimed at weeding out some of the weakest banks.

There is a widespread feeling that the authorities now have more control over the regulatory environment, although there is still room for improvement. As Mike Wharton, banking partner in consultant KPMG’s Moscow office, puts it: “The trouble is that if the Central Bank doesn’t prohibit it, you can do anything. But it is changing, and most of what they’ve done over the last year is very good.”

These changes include the introduction of capital adequacy ratios along BIS lines; 13 norms for banking practice, ranging from minimum start-up funds of Ecu5 million ($4 million) to limiting loans to one borrower to 25% of total loans; and a gradual shift towards improved accountancy standards. In addition to the changes brought in over the past three years there is to be one final push towards internationally accepted accounting standards at the beginning of 1997. How long this will take to effect is unclear.

The Association of Russian Banks believes RAS could be transformed to an internationally acceptable standard within a year but that three to five years would be safer. With scant provisioning and an overreliance on Taiga bonds, too swift a change might bankrupt many of the smaller, weakly capitalized banks.

And whereas some analysts expect Russian standards to change gradually to meet western expectations, others feel that it will be more a question simply of adopting IAS. “Why reinvent the wheel?” says James Kilzer, partner in consultant Price Waterhouse’s Moscow offices. “The Russians have gone straight from cash to electronic banking, bypassing the chequebook, and I expect they’ll do the same with accounting standards.”

If the system is to work well, changes will have to be made to improve consultation and implementation processes. The central bank is often attacked for introducing changes without consulting banks or auditing firms, much to the consternation of those at the receiving end: “If the central bank issues new directives they usually don’t consult us, and so end up having to issue a new directive on how to implement the first one, or suspend the changes altogether,” says a spokesman at the Association of Russian Banks, a view echoed by banks and consultants alike.

Turf warfare is also a problem, particularly where the tax authorities are involved. They still hold great sway in Russia and can block or change new legislation in order to increase revenues. The problem with loan-loss provisioning, for example, has been laid at their door. And when between 50 and 90 often conflicting documents from different government departments turn up at banks every day, it’s time to cut the bureaucracy.

The Russian authorities are not working alone. The big-six accountancy firms, which have been in Moscow since the early 1990s, act as consultants, introducing their clients to what international investors expect of them. Helpful as this is, it doesn’t always have the desired effect. “We’ve started to send bank staff on three-day courses covering the basics of IAS,” said a partner at one of the firms. “The problem is that some of them then think they’re experts, and we have a hard time convincing them otherwise.”

Longer-term advice and support is provided by the World Bank and the European Bank for Reconstruction and Development (EBRD). Their Financial Institutions Development Programme (FIDP) aims to improve Russian banks’ understanding of, and ability to compete in, the international arena by setting up a system of grants and long-term soft loans to be invested in IT and twinning arrangements with western banks (see box).

With 31 banks now on the FIDP programme and establishing relationships with foreign firms and investors, it is only a matter of time before transparent, fully audited accounts become available for most of the top banks ­ although some which do have them, such as Unexim Bank, are wary of releasing them publicly. For the vast majority of banks it will take much longer. With little or no incentive to spend money on IAS accounts, they are likely to stick to whatever the central bank requires at any particular time.

Sources: Euromoney, in cooperation with bank data firm Eurastar, contacted Russian banks by fax. We also used data from western correspondent banks, auditing firms and the rating agency Bank Watch-Bree. Most figures are unconsolidated. Annual data for banks are published in the Russian press, but these are unaudited and unreliable. Where 1995 figures are unavailable we have used 1994 figures. Banks with only 1993 data have been excluded.

Twinning, training and technology

With over 2,000 banks in Russia and only 30-40 places on the Financial Institutions Development Programme (FIDP) it was inevitable that most would miss out. But there are surprises in the list of banks chosen to join the scheme, run jointly by the World Bank and the European Bank for Reconstruction and Development (EBRD) to improve IT and training, and promote links with western banks. Among them are Fes Bank and Dalrybank, which don’t appear on any list of the top 50 banks in Russia. Others, including Conversbank and Petrovsky, have much smaller capital and assets than more obvious candidates such as East-West Investment Bank.

There is, however, a distinct strategy underlying the programme: “Our aim is to strengthen the Russian banking sector as a whole,” says Stephanie Crossley, project administrator at the EBRD’s head office in London. “So we want to support those banks which have the potential for growth and stability, not just those which are large or based in Moscow.”

Some banks are too important to leave out; Unexim and Imperial, with their strong political and business links, fall into this category. Three of the 10 largest banks as measured by Russian accounting standards ­ Sberbank, Vneshtgorbank and Agroprombank ­ are deliberately excluded because they are state-run banks.

The World Bank and the EBRD developed FIDP in 1993 and 1994, setting aside $200 million and $100 million respectively, and retain overall strategic responsibility for the programme. Any bank wanting to join must have minimum shareholder equity of Ecu5 million ($6.2 million) and publish an audit according to international standards before it can be considered. In addition, banks that have not been reviewed before must undergo diagnostic audits, usually lasting a month.

The day-to-day running of the programme rests with the government task force, made up of the Ministry of Finance (MoF), the Russian central bank and the Ministry for Economic Affairs. They have the final say on which banks are admitted to the programme, and the MoF is in charge of distributing the $300 million loan.

It was not until May 1995 that the first six banks were admitted to the scheme, with a further seven joining at the end of the year. All 13 were granted full accreditation, which gained them access to both the twinning and IT aspects of the programme. But the government task force decided that this summer’s 18 new recruits should at first set up coherent twinning arrangements with western banks before receiving loans for IT and training.

The amount distributed to the banks varies, but on average each gets $3 million to help cover the costs of twinning arrangements, of which up to half comes in the form of a grant. Any funds over $1.5 million for twinning, and all funds given out for IT and training, are loans, and can total up to $12 million.

On that basis, the 31 banks accepted onto FIDP have accounted for a large proportion of the initial $300 million. It is unlikely that any more money will be given, and there are no plans for new accreditations to the programme in the near future.

FIDP generally meets with approval. Western firms and consultants praise the two institutions involved for their patience, knowledge and avoidance of bureaucracy, and see it as an essential step towards developing the banking industry as a whole: “The twinning aspect of the World Bank-EBRD programme is easily the best thing for all our clients,” says KPMG’s Mike Wharton. “There’s only so much that consultants can do.”