Russian banks to adopt stricter reserve rules than West

In an announcement earlier today, the head of Russia's Central Bank, Elvira Nabiullina, stated that Russia's banks will be forced to comply with the new Basel III requirements starting on January 1, 2014. Basel III is the newest in a series of financial controls designed to strengthen the balance sheets of banks, in order to hopefully prevent any serious or systemic financial crises arising from a lack of an adequate reserve ratio. (For more detail on the Basel III rules themselves, see this downloadable report from KPMG from 2011, and for more recent news visit this section of the WSJ website).

While this many in America feel the new reserve requirements of Basel III are too stringent, and will harm not the U.S. economy, in particular the financial and housing sectors, in Russia the Basel III rules will actually be more severe than in the West. Ms. Nabiullina announced that the new Central Bank requirements for common equity will be 5 percent, capital assets at 5.5 percent (with an increase to 6 percent beginning January 1, 2015), and aggregate capital at 10 percent, according to an article from Russia Beyond the Headlines (RBTH). RBTH noted that "these requirements will be stricter than the Western ones, which provide for the adequacy of common equity at the level of 4.5 percent."

Basel III to be implemented in Russia - and then some. Image http://goldenageofgaia.com/wp-content/uploads/2013/06/basel-III.jpg

One analyst at VTB Bank, one of the largest banks in Russia, doesn't think that the Russian banking system will have much trouble meeting the tougher rules--mainly because the financial system in Russia is very different, in general, than in Europe or the United States,and credit rules are already tighter. Asset structure in Russian banks is still relatively basic and static, and there is a less favorable attitude towards highly leveraged bank balance sheets. Thus, the medicine of Basel III will be somewhat easier for Russian banks to swallow than their Western counterparts. In combination with the monetary policy of the Russian (and Ukrainian) central bank, and the general aversion to inflation, banks' more rigid credit policies are seen by some as limiting the potential growth of the Russian economy. At the moment, though, the priority throughout Europe, the US, and Russia seems to be stability rather than growth or profits.

However, it is important to note that the new effective date of January 1, 2014 for the Basel III rules is later than the original date, set in October of 2013. Svetlana Pavlova, assistant vice president and analyst at Moody’s, thinks that shifting the dates of Basel III’s implementation in Russia bodes ill for the country's financial sector. Also, the lowering of the capital assets level from the original 7.5% to the new 5.5%, while still strict, is seen by some as a matter of concern.

On the whole, the announcement about the Basel III “In general, capitalization is higher in our banks than in European ones. And this is correct: Considering the higher volatility of the Russian economy and tempo of growth of the banking sector, our banks need to be stronger to match the level of risk,” said Pavlova.

Basel III: rebuilding the capital of the global financial system. Image http://www.eamcap.com/wp-content/uploads/2010/09/Basel-III-capital.jpg

For more on this story, read the full article from RBTH here: http://rbth.ru/business/2013/07/22/banks_to_adopt_basel_iii_standards_in_2014_28277.html

A Day in the Life of a Russian Oligarch

If you follow business news about Russia, Ukraine, or post-Communist Eastern Europe in general, you've no doubt read a lot about oligarchs. But who are they, really, and what do they do besides amass wealth using government support and/or corruption?

Business Insider has picked up and shared an interesting interview with Sergei Veremeenko, one of Russia's most famous and successful oligarchs (net worth estimated at $1.4bln, and he's also married to Miss World 2006). Like the majority of oligarchs, Veremeenko made most of his millions from...you guessed it, natural resources (read: oil) and finance. He was born in the oil-rich Ufa area and thus had a natural career path into energy, but then diversified in 1992 when he partnered with fellow billionaire (and fellow Sergei) Sergei Pugachev to found the International Industrial Bank.

Check out the 8+ minute-long video interview by VICE at this link: http://www.forbes.com/fdc/welcome_mjx.shtml

Goldman Sachs to Overhaul Russian Business Image

Russia, despite all of the improvements that have taken place since the collapse of communism, is not exactly considered an outstanding place to do business. Growing socio-political unrest, excessive government involvement in the markets, and an economic over-reliance on commodities--particularly oil--have caused international investors to be wary. On a broader scale, slowing growth and disappointing performances by all of the BRICS countries have led to deflated expectations for emerging markets in general. All of these financial and economic trends have been combined with an overwhelmingly negative perception of Russian international relations, especially Putin's continued support for Bashar-al-Assad's regime in the Syrian civil war, and the recent fiasco surrounding alleged CIA spy Ryan Fogle, who was outed by the Russian FSB (Федеральная служба безопасности Российской Федерации, successor to the KGB).

Image from Bloomberg.

Yet many Russians have continually insisted that perceptions of the Russian business environment do not reflect reality. German Gref, current head of Sberbank, Russia's largest bank, responded to a recent international business ranking that placed Russia behind Albania by stating, “We have to improve our image because we are really better than what people think of us.” (Video and full text of his comments available here in Russian; I have yet to translate all of it myself).

Enter Wall Street--more specifically, Goldman Sachs, arguably the leading American investment bank. Earlier this spring, it was announced that Goldman Sachs has been tasked with improving Russia's international business image. According to The Wild East, Goldman has been hired by a special working group formed by the Ministry for Economic Development, and composed of Sberbank, VTB, and, most importantly, the Russia Direct Investment Fund--headed by Kyrill Dmitriev, a former Goldman Sachs man.

The re-entry of Goldman Sachs into the Russian market is an important international move for the firm, considering they left Russia twice during the 1990s and only returned in 2006. While many Western firms have left Russia indefinitely due to the uncompetitive and government-dominated banking environment there, Goldman has been able to grow profits at its Moscow operation and remain an active player in the deal-making and advisory scene. Goldman Sachs assisted Russian giant VTB with its 2011 secondary debt placement of $5.2 billion, and has advised on the listing for Russia's national MICEX exchange.

One of the biggest challenges Goldman will face moving forward is how to help Russia in its efforts to improve its current credit rating of BBB, the second-lowest investment grade. Goldman certainly has the firepower and clout to make an impact, but it will have to contend not only with the specific challenges facing Russia's national economy, but also with the broader economic currents outlined above. Goldman has also already been attacked by some activist groups such as Human Rights Foundation, which has argued the bank shouldn't work for Russia due to the country's alleged human rights abuses. However, given Goldman's signature resilience and continued rebound following the 2007-2008 American financial crisis--and the current dearth of Western bulge-bracket finance in Russia--expanding its international involvement and deepening its presence in the "Wild East" of Russia might prove a very profitable move.

Image from Fox Business.

International Banking: Regulation, A Capital Idea?

As soon as I saw the cover of last week's print edition of The Economist, I knew it was going to be an especially interesting read (moreso than usual). The special focus of the May 11th issue is on the current state of international banking--in particular the future of investment banking in the wake of the 2007-2008 collapse and the ongoing recovery.

While the "Leaders" piece on the resurgence of American investment banks vis-a-vis their European cousins/competitors is fascinating, as is this "Twilight of the Gods" piece on the leaner future of investment banking, it is the article on new banking regulations and their impact on the dynamics of international finance that has most intrigued me.

Entitled "Regulation: The bite is worse than the bark," the article starts by summarizing the atmosphere surrounding new and proposed banking regulations, using a quote from the current chairman of UBS, Axel Weber. In an interview, Mr. Weber stated, "The mood among investment banks that I talk to...is such that they expect that the regulation is over, they expect that they will be able to keep growing their balance-sheets, that they will be growing bigger than ever. The mood among the regulators I talk with is more like 'we haven’t even started.'"

While Swiss banks such as UBS and Credit Suisse have been hit particularly hard by newer, stricter regulations, Mr. Weber is uniquely qualified to comment upon the sentiment on both sides of the regulatory divide. And his comments are particularly troubling for international banks operating in America--not just the Swiss, but British and Germany firms as well.

But first, an overview of the three primary options available to regulators:
1) Higher capital and liquidity requirements;
2) Restrictions on bank activities such as trading for their own profit;
3) Structural changes such as forcing banks to “ring-fence” their retail banks from their trading businesses or to reorganise global businesses into national subsidiaries.

All banks are set to be subject to at least one of the three forms of corrective medicine, but the bigger and more complex banks likely face at least two if not all three forms of regulations in the near future.
I'll save the technicalities and complexities of Basel 3 and the Volcker Rule for a future blog post; but suffice it to say that while the new rules will likely create a more stable financial system, they are also having unintended consequences for international investment banks.

While none of the above regulations pose a deep, mortal threat to the future of America's biggest investment banking firms, The Economist reports that two further sets of rules being discussed "could dash the hopes of Europe’s remaining big investment-banking contenders, Barclays and Deutsche Bank, of being able to go on challenging the dominance of America’s biggest banks."

The first is "a proposal to separate investment banking from retail banking," which in Britain could mean the construction of a Chinese Wall of sorts between the retail-banking arm and the investment-banking division of a bank. Continental Europe, meanwhile, "is debating variations of a plan by Erkki Liikanen, the governor of Finland’s central bank, to separate banks’ trading operations." Both potential rules would mean an increase in funding and operation costs for Europe's banks, and would deter big global banks from operating in Britain or Europe.

America, meanwhile "has made it clear it wants to be in the game," and it has been American banks that have led the aggressive resurgence of Wall Street and fueled overall banking sector recovery. But in Washington, DC, a second set of regulations is on the drawing board that could deal a severe blow to the American operations of European-based global banks, by forcing big foreign firms to establish local holding companies for their American subsidiary operations. This would most obviously and immediately impact Deutsche Bank and Barclays, two of the leading European banks which have both avoided the new capital requirements by moving assets and deregistering their American holding companies.

As The Economist explains, the proposed regulations on foreign banks make perfect sense to American regulators: "if a big European bank collapses on their doorstep, they do not want to have to ask its home country for money." However, an executive at Morgan Stanley has estimated that Deutsche Bank has a hidden capital deficit of $20 billion in its American business that would be exposed by the new regulations. Barclays is in a similar situation.

Image taken from blog Special FX for Wizards

The bottom line? "If other regulators were to follow its [America's] lead and force all foreign banks to hold capital and liquidity locally, the era of financial globalisation would be over." And the end of global finance is something I don't think even the most gung-ho regulator truly wants. Personally, as someone interested in a career in international finance and who is considering working at a firm such as Barclays or DB after graduation, financial globalization is certainly something I hope continues for a long, long time.


You can read the article in full at this link: Regulation: The bite is worse than the bark. Feel free to leave your thoughts and comments below.