|Dmitry Tulin, head of banking supervision at the Central Bank of Russia|
When two of Russia’s largest private-sector banks had to be nationalized within a month of each other this autumn, at a potential cost to the taxpayer of up to $13 billion, many asked how the central bank could have let it happen.
The fact that both Bank Otkritie and B&N Bank had themselves spent the previous five years buying up troubled lenders with cheap state funding attracted particular attention. Critics accused regulators of creating systemic weakness by encouraging reckless expansion by unsound banks.
Dmitry Tulin, head of banking supervision at the Central Bank of Russia (CBR) and the man behind the bailouts, says such accusations are based on a misunderstanding of the CBR’s capabilities.
Until June this year, the only way that a failing bank in Russia could be saved was if a private-sector buyer – usually, but not necessarily, a bank – agreed to take it over. In return, the investor received ultra-cheap long-term financing from the state, either direct from the CBR or through the Deposit Insurance Agency (DIA).
“The word investor should be in inverted commas,” says Tulin disapprovingly. “They didn’t put at risk much of their own money.”
In theory, this system gave the rescued bank the means to make substantial profits from exploiting the difference between the 0.5% it was now paying on 10- or 15-year emergency financing and the rates it was charging customers. These profits could then be used to build up the bank’s capital base.
As Tulin notes, this “loan-based approach” – originally introduced in 2006 and unique to Russia – had several inherent flaws.
For one thing, it meant that an increasingly large chunk of the sector was exempt from basic regulatory requirements.
“Principles of fair market competition under such conditions are not observed since dozens of banks with no equity capital were allowed to operate,” says Tulin.
More importantly, few reputable banks showed an interest in getting involved in bank rescues.
“These are risky and potentially contagious financial operations,” adds Tulin. “Appropriate volunteers to be investors for large failing banks are not easy to find, even on favourable terms.”
When it comes to an exit, the sooner the better – but it might take us a few years- Dmitry Tulin, CBR
As a result, troubled lenders that could not be shuttered – for systemic or other reasons – were often taken on by unsuitable buyers for the wrong reasons.
“Some banks which followed expansionary strategies agreed to participate in bailouts since they wanted to resolve their own problems with cheap long-term funding provided by the CBR,” says Tulin.
Even when acquirers were themselves in relatively good shape, they may not have had the financial resources and managerial skills needed to turn around failing lenders.
“But all the same, we had to accept them as investors because there were so few volunteers,” adds Tulin.
CBR governor Elvira Nabiullina also noted last year that, not only were rescued banks frequently mismanaged, their new owners tended to use them as depositories for their own bad assets.
“Our analysis shows that investors usually do not invest in capital of banks under resolution, do not develop their business and sometimes use the balance sheet of banks under resolution for bad debts while forwarding a sizeable share of funds for resolution purposes to their own projects,” she told delegates at the International Financial Congress in St Petersburg.
The shortcomings of this system became increasingly apparent after 2014, when the imposition of western sanctions and the collapse of the oil price threw the Russian banking sector into turmoil. Dozens of banks required rescuing, including some that were still digesting failing lenders acquired in the wake of the global financial crisis.
The process created some new banking giants, most notably Otkritie, B&N Bank, Credit Bank of Moscow and Promsvyazbank. Known as the ‘Garden Ring banks’, after the location of their Moscow headquarters, all four have seen massive expansion since the start of the decade.
Promsvyazbank doubled its asset base to R1.2 trillion ($20.2 billion) in the four years to end of 2016, while Credit Bank of Moscow’s balance sheet jumped from R309 billion to R1.7 trillion.
The biggest consolidators, however, were B&N Bank and Otkritie. In 2014 alone, B&N snapped up five lenders in the Rost Bank group, as well as DNB Russia – formerly a subsidiary of Norway’s DnB Bank – and the local arm of Ukraine’s PrivatBank. For the latter, it received R12 billion in funding from the DIA.
The following year, the group added Uralprivatbank and MDM Bank, a large Siberian lender and one of the main consolidators after the 2008 crisis. By the end of 2016, B&N boasted total assets of R1.1 trillion, more than six times the level of four years earlier.
Meanwhile Otkritie, a former brokerage house that only moved into retail banking in 2012 through the $2 billion acquisition of top-10 player Nomos Bank, received R127 billion in state funding in 2014 to take over Trust Bank.
Later that year, the bank doubled its balance sheet again when it helped sanctioned Russian oil firm Rosneft to refinance $7 billion of hard-currency debt. Over the next two years, Otkritie also added several pension funds to its balance sheet and at the end of 2016 agreed to buy insurance company Rosgosstrakh.
As these lenders became larger and more unwieldy, alarm bells began to ring at the central bank. In mid 2016, Nabiullina began calling for changes to the resolution regime to allow the state to take equity stakes in failing banks.
In June, her proposals were finally implemented. Billed as the creation of a Banking Sector Consolidation Fund, in practice the legislation simply meant the CBR was able to nationalize banks in line with standard international practice. It also allowed for the creation of a separate company to manage bailed-out banks. The new regime had barely been in place two weeks before Russian rating agency Acra assigned Otkritie a BBB- rating, one notch below the level required for deposits by state-controlled corporates and private sector pension funds.
The announcement sparked a deposit run. Various attempts to stem the outflows, including by recalling founder Vadim Belyaev as CEO, failed. At the end of August, the bank’s shareholders, which included VTB Bank as well as a clutch of local oligarchs, gave up the struggle and asked the CBR to step in.
Less than four weeks later, the owners of B&N Bank – by this time Russia’s 12th-largest lender – made a similar request after a spate of withdrawals threatened to cause a liquidity crunch. Again, the CBR obliged by taking the bank into temporary administration and then fully nationalizing it.
Hard on the heels
The fact that the bailouts came so hard on the heels of the implementation of the new resolution regime prompted some to suggest that the timing was no coincidence. Tulin says the two things were indeed linked but not in the way that sceptics might suspect.
“We were fully aware of problems with some large institutions and that we needed a tool to address this, which is why we started calling for a new resolution regime last year,” he says. “The timing in the end proved to be close to perfect – one could say that it was a combination of good planning and good luck.”
Initial estimates by the central bank put the cost of the two bailouts at around $6.5 billion apiece, although some sources suggest the final figures could be much higher. The bill for Otkritie’s rescue has already gone up since August after evidence emerged that the bank’s balance sheet had been massaged.
After 2014, Otkritie had used cheap emergency liquidity provided by the CBR to the banking sector to snap up more than $7 billion of Russia’s 2030 Eurobond at depressed levels. This was widely known. What did not become apparent until after nationalization was that the price of the bond had been manipulated to enhance Otkritie’s capital position.
According to people with knowledge of the matter, various different entities in the Otkritie group – including affiliated companies – had created a phantom market in the bond.
“They were constantly trading it among themselves in order to inflate the price on the screens,” says one. “They were then using this price to calculate the bank’s capital ratios.”
I have never been more comfortable in my professional life than I am today, following the introduction of this legislation- Dmitry Tulin
Otkritie’s own subordinated Eurobonds, meanwhile, worth a total of $800 million, have been bailed in. This was not an option for B&N Bank, which had no subordinated debt in circulation. A debut bond issue planned for earlier this year was abandoned after the bank’s financial position deteriorated.
B&N’s former owners have, however, offered to contribute non-financial assets worth R300 billion to plug the bank’s capital hole.
Mikhail Gutseriev and his nephew Mikail Shishkhanov have already transferred shares in oil producer Russneft to the CBR, along with other holdings including a chicken plant, a cement factory, a vegetable warehouse and a nanotechnology firm.
Tulin says the CBR welcomes all contributions “for obvious reasons.”
He adds, however, that it will take time to assess the “real value” of such assets.
According to their former owners, the holdings handed over so far are worth R70 billion. Privately, insiders warn against taking the Gutseriev family’s generosity at face value.
“One should always differentiate between real financial assistance and public shows,” says one. “Some assets can have burdens attached to them. They could turn out to be Trojan horses.”
The CBR has, however, indicated that it will look to recover assets held by Otkritie’s parent group that were bought with loans from the bank. Two of the group’s former minority owners, Alexander Nesis and Alexander Mamut, have already transferred a 7.6% stake in gold miner Polymetal to the central bank.
At present, B&N and Otkritie remain under the supervision of the CBR, which is taking the opportunity to conduct a thorough audit of both banks’ balance sheets. From January, however, management of Otkritie will pass to Mikhail Zadornov, the long-serving and respected head of retail bank VTB24.
How the restructuring of the nationalized banks will proceed has yet to be made public, but the CBR has announced that it will look to combine B&N and Otkritie. Tulin argues that, among other things, a merger will make it easier to find a buyer when the CBR delivers on its promise to reprivatize the banks.
He admits, however, that getting to that point may take a while.
“When it comes to an exit, the sooner the better – but it might take us a few years,” he says. “First, we have to make them financially sound and, secondly, make them attractive to investors.”
In the meantime, the nationalization of B&N and Otkritie has taken the share of the Russian banking sector under state control to close to 70%. Some have speculated this figure could be boosted again over the next year or so as the CBR continues its clean-up of the industry.
Unsurprisingly, Tulin declines to be drawn on whether more bailouts might be required in the near term. He does draw attention, however, to the fact that no cap has been put on equity investments undertaken by the Banking Sector Consolidation Fund.
“The fund is not a legal entity, it’s simply a definition of a set of accounts on the central bank’s balance sheet,” says Tulin. “The capacity of the fund to finance bank rescues is thus equal to the money-issuing capacity of the central bank – so in theory it’s unlimited.”
He also notes that the new legislation gives the CBR a free hand in determining which banks to bail out. Use of the resolution mechanism is not limited to institutions of national systemic importance – it could also be applied to one of Russia’s big regional banks or even a bank that is dominant in a particular sector or segment.
“Size matters, but not only size,” says Tulin. “Whenever we want to prevent some financial instability, then we will tend to use the new bailout mechanism.”
At the same time, he does not rule out the possibility that the loan-based approach might be employed again in future.
“We have deliberately preserved it in the legislation, just in case, because in some situations it could be useful,” he says. “If a financially sound bank wants to absorb a much smaller lender, for example, that approach could be appropriate.”
Tulin also rejects suggestions that, by loading them up with troubled lenders, the old regime played a role in the downfall of B&N and Otkritie.
“Probably such investor banks would have failed all the same, as their business strategies were quite risky,” he says. “It is hard to say whether their participation in bailouts accelerated or postponed their failures.”
Nevertheless, he is clear that he prefers the equity-based approach.
“It is much more transparent and reliable, and it requires much less financing – at least in nominal terms – from the monetary authorities,” he says. “It will give us more freedom in decision-making and also much more confidence in our ability to prevent financial instability on a macro level.
“I have never been more comfortable in my professional life than I am today, following the introduction of this legislation.”
He adds that the new resolution will be a big help in completing the overhaul of the Russian banking sector, launched by Nabiullina in 2014. Much has already been done. In addition to the recent bailouts, more than 300 lenders – out of a total of 900 – have been closed over the past three years.
The pace of closures is now slackening, but insiders say completing the clean-up will likely take another 18 to 24 months.
“The situation in the banking sector is currently well under control, but there are still banks with historical issues that date back to the 2000s and even 1990s,” says Tulin. “However, these problems will be much easier to resolve successfully under the new resolution regime.”
Dmitry Tulin: a determined central banker
When Dmitry Tulin was asked to head up the Central Bank of Russia’s banking supervision department in October last year, people who know him say he jumped at the chance.
“It is a personal mission for him,” says one.
The reason for his commitment dates back to a previous stint in the role more than a decade ago. In February 2006, after less than two years in post, Tulin resigned from the CBR, reportedly due to concerns over the financial soundness of banks being incorporated into Russia’s newly formed Deposit Insurance Agency.
Six months after his departure, his replacement, Andrei Kozlov, was shot dead. An executive of VIP Bank, a lender Kozlov had shut down for money-laundering, was convicted of hiring gunmen to kill him. An acquaintance of Tulin says he took this to heart. “Kozlov was a friend of his,” says the person. “He feels strong responsibility for that and for the sector he abandoned.”
After a six-year stint at Deloitte & Touche and three years in academia, Tulin’s chance to return to the CBR came in January 2015, when governor Elvira Nabiullina invited him to head up the bank’s monetary policy division. Eighteen months later, he was moved to banking supervision, with a remit to continue Nabiullina’s comprehensive clean-up of the sector.
Locals in Moscow say he is pursuing it relentlessly.
“He doesn’t compromise,” says one. “When others at the CBR are arguing for delay or leniency, he will simply say: ‘No’. He is the toughest of the central bank team.”