Why Russia’s Central Bank Will Never Sell Former Zombie Banks Back To Private Interests

Russia’s Central Bank (RCB) might have preferred the private sector be the bigger player in the financial sector than the state after removing the licenses of hundreds of bad banks prior to 2017, bankrupting many private banks in the process. Today, circumstances are such that the private banking sector no longer has the stomach for the political risks, or the funding, to take over the few banks RCB tried to resuscitate.

The strong private banks that remain intact, such as the Alfa Group, are sanctioned by the West. Others have executives that don’t call Russia home anymore and are busy buying mansions in the U.K. where they were once greeted with open arms and are now largely deemed personas non grata.

For the most part, Russia’s financial sector, once riddled with money launderers and corrupt businessmen (one – Andrey Borodin – head of the Bank of Moscow, ran off to London with some $2 billion of depositor cash) is now safe and sound. Most in the financial world will thank Central Bank wonder woman Elvira Nabiullina, once a starlet of the G20 Finance Ministerial of Europe, now out of favor due to her employer. She removed the licenses of hundreds of ill-managed banks. She approved other private banks to take some over, often giving them low-interest loans to take them off her hands.

Nabiullina wanted to turn Russian banking into a Western-looking, privately run operation. Today Russian banks are mostly state-run. The biggest commercial lenders are all state-controlled. The only buyers of the ex-zombie banks today are Sberbank, VTB and Gazprombank at this point, with VTB Bank finally taking over Otkritie (which means Discovery) – once Russia’s largest private bank — in late December after the RCB spent over a trillion and a half rubles to save it. Its primary shareholder Boris Mints failed to manage it under the Basel Accord rules Nabiullina wanted for the entire financial system.

The Basel Accords took place in Switzerland in the 1980s among central bankers and finance ministers and has been upgraded to the Basel III agreement post-Great Recession of 2008-09. It is a series of international banking regulatory rules establishing global banks’ capital requirements and risk measurements. That was the bank foundation Russia did not have until the RCB stripped many banks of their licenses, and Nabiullina turned the system around.

Meanwhile, Mints is now living semi-large in a U.K. mansion, though the British government blocked his access to over $500 million in assets in 2019.

“No one will buy these banks today except the state-owned banks who the Kremlin orders to do so,” says Vladislav Inozemtsev, Director of the Center for Post-Industrial Studies in Moscow and a Special visor to Middle East Media Research Institute’s Russia Media Studies Project in Washington, DC.

“You have two big Russian banks that can be called private – the first is Alfa Group and the other is Moscow Credit Bank which is also quite big, but it was obvious that neither of them would be interested in buying Otkritie or the National Bank Trust which the central bank had on offer. Only the state-controlled banks are buyers of the banks the RCB took over since 2017,” he says. “I think the situation is stable now and Nabiullina can influence people in the Russian government to not change anything. If it is not broke, don’t fix it.”

Nabiullina’s performance in saving the Russian banking system is up for debate. She did save it, but she put it in state control. That was not her stated goal. Now they are stuck with that.

“I think it was a failure,” says Vasily M. Solodkov, Director at the HSE Banking Institute, a research and academic center in Moscow that partners with the CFA Institute in the U.S.

In 2014, there were 923 commercial lenders in Russia. Last year, some 370 remained in business.

“The official explanation why the central bank shut down many small and regional banks is because they were improperly run, were used for money laundering, or were run by criminals. They were seen as a risk to the financial system. But there is another reason, a non-official one. The RCB badly managed the so-called cleaning operation back in 2014. Deposit insurance was not enough for corporate accounts. If a bank was going to lose its license, those corporate accounts had nowhere to go but to pull their money out and put it into big state banks as a safe haven.”

To restore funding, many banks that lost clients offered high deposit interest to keep people banked with them. This became too expensive for banks which sometimes could not honor those payments. Low-interest loans and the usual state support for the state-run banks also allowed them to offer clients low-interest loans, which made them even more attractive.

“The private banks had to do the same, but their funding was much more expensive, so their margins shrunk and their risks rose,” says Solodkov from his office in Moscow. “Many took on riskier operations and got their banking licenses revoked as a result.”

Those banks are gone.

PSB, once a famous private bank, is now state-owned and is supposedly a lender to, or backed by the Ministry of Defense. National Bank Trust is used as bad asset bank that will unlikely be sold. Otkritie is now VTB, like Bank of Moscow is also VTB. There are few banks left the RCB is aiming to sell and even fewer private investors interested in buying.

Read Related Also: Can Delta Air Lines Stock Bounce Back From Recent Slide?

“Nabiullina has completely destroyed the private banking system of the Russian Federation. Due to her activities, it collapsed into one big state banking system, controlled by Nabiullina herself and her people. She has been performing her activities since 2013, consistently closing private banks”, a financial sector source said in Moscow.

RCB data shows over 600 private banks have lost their licenses under Nabiullina’s tenure.

“The most recent example was the controversial case of Otkritie bank. First RCB overestimated Otkritie’s risks and then deprived its credit rating with an affiliated rating agency. Then Nabiullina took Otkritie under the control of the Central Bank, putting Mikhail Zadornov, former Russian finance minister during default in 1998, as the head of it. The cleaning-up process was done by the Central Bank itself.”

This was done under a “bad bank” setup, which became the role of another failed bank, National Bank Trust, which then became the hub of those bad bank assets. Bank Trust got 1 trillion rubles ($16 billion) to buy the full value of the Otkritie loan, for example. “There was no assessment made and no discount of the loan and bank reserves taken into account. As a result, we see billions of losses and a suffering private sector,” this source said.

The deal to sell Otkritie Bank to VTB Bank was a money loser for the RCB. The hope was to sell it to VTB for around 500 billion rubles ($9 billion) after spending around RUR 1.7 trillion ($28 billion) on it. They sold it for RUR 352 billion ($5.6 billion).

For some, the question is that Russia rifled through a lot of taxpayer’s wealth to save a bank they lost hundreds of billions on. But for others, Otkritie was one of the “too big to fail” banks in Russia. RCB had almost no choice.

Vladimir Putin personally approved the sale which was proposed by the charismatic head of VTB Bank Andrey Kostin, who has also been sanctioned since 2020. If VTB was a private bank, given the risks involved, it is unlikely Kostin would have proposed that purchase.

Under sanctions pressure as it is, VTB Bank has its own problems with capital, sources in Russian banking who wished to remain anonymous said this week.

The owners of VTB’s subordinated bonds have already suffered, with the Central Bank allowing VTB temporarily not to make interest payments to investors.

Most of these investors are local, of course, as Russian securities are banned from new American buyers.

Then again, who would buy it?

“The market for Russian assets has disappeared,” says Solodkov about savings and loans, commercial lending, investment banking and asset management. “We have very primitive Russian market now, whose asset values all fell dramatically last year. All the derivatives we had were traded in London; that market is gone. Plus a lot of rich people had their assets frozen, either by foreign governments or Russian government, at least temporarily,” he says, adding that he has bonds in Europe that are frozen and he cannot sell. “It’s a serious problem. The asset management market is also vanishing to a large extent. Sanctions have had a huge effect on the RCBs plans.”

Russia’s finance ecosystem is becoming insular. It had to.

After the first round of Ukraine-related sanctions stemming from the annexation of Crimea in 2014, Nabiullina created what has been likened to a Russian Venmo system, run by the Central Bank. People can transfer money peer to peer or company to company via phone number or QR code. There is no need for a Mastercard
MA
or Visa-run payment infrastructure anymore.

All told, the RCB has spent nearly 2 trillion rubles ($39 billion) saving hundreds of banks between 2011 and 2017 and 1.7 trillion rubles ($28 billion) more to keep Otkritie afloat since 2017. There are no plans to strip the license of any other banks or take over their management. Russian savings deposits are insured, so the “Nabiullina purge” did not lead to any serious run-on banks as consumers were protected.

Last February, the RCB introduced capital controls to reduce people’s capacity to take money out of Russia. These regulations have softened monthly and were later removed in September. Russia’s banking sector is not out of the woods yet. But with hundreds of bad banks gone, Nabiullina has some protection from system failure for what is likely to be another turbulent year for Russia’s business class and financial elites going through some of the most volatile, darkest times of the last thirty years.

For Russians, the good news is that the economy has weathered all of this better than anyone expected.