Ekonomika i zhizn (Moscow), July 19, 2003

Financial flows into stream way of real economy

Bank of Moscow President Andrey Borodin

The International Investment Conference "Russian Economy and Investments: Reality and Outlooks" organized by RBC took place in late June in Vienna. Russian Ambassador to Austria Alexander Golovin, Russian Central Bank Senior Deputy Chairperson Tatiana Paramonova, Russian Economy Minister Mukhamed Tsikanov, Bank of Moscow President Andrey Borodin took part in the opening ceremony. Andrey Borodin made a report at a plenary session. The text of the report with inconsiderable cuts is presented here.

Commercial banks and the investment process in Russia

Currently, there is a period of critical evaluation of the results of Russia's economic development over the past 4 years. It is obvious that the factors that have promoted its gradual development (the effect from the ruble's devaluation and the replacement of imports, the reestablishment of the pre-crisis level of the purchasing demand of households and favorable external economic conjuncture) are about to be depleted.

According to current estimates, it is necessary to increase the share of the gross fixed capital formation in Russia's GDP from the current 15 percent to 25 percent to provide a 7-pecent annual economic growth. The immensity of this task requires immense activities. In the banking sector, this is the creation of conditions for using the sector's potential as a key element in the investment process in the country.

On real role of Russian banks in investment processes

The Russian banking sector has often been criticized for its weak positions in financing investment projects. It is true that the share of long-term banking credits allocated to enterprises was about 5 percent in the structure of the total volume of investments of enterprises and organizations in fixed assets as of the beginning of 2003.

You can say whether it is a lot or a little only if you take into account the peculiarities of Russian investments in fixed assets. Some 58 percent of the total volume of investments in enterprises and organizations (1.36 trillion rubles or $43.9bn) in 2002 were formed from enterprises' own resources and resources of their parent companies. More than 22 percent of the investments were resources of budgets and non-budget funds and only 20 percent were from market sources.

In the structure of these resources, some 25 percent were long-term banking credits, about 20 to 30 percent were funds raised from issuing corporate bonds (some 47.6bn rubles or $1.5bn in bonds were issued in 2002 and the accumulated sum was estimated at about 70bn to 100bn rubles). The underwriters and buyers of these bonds were mainly full service credit organizations.

So, almost half of the total investment resources formed at the cost of market sources belonged to banks.

The role of full service commercial banks as financial mediators in the process of implementing investment projects is very important. They have the necessary organization and technological potential for accumulating and redistributing investment resources.

Investment banks have not been broadly popular in Russia due to legislative restrictions, the shortage of their own funds, high risks and underdevelopment of the stock market.

It should be mentioned that the share of investments in fixed assets financed from issues of shares was only 0.3 percent (!) of the total amount of investments and 1.5 percent of external market investments in 2002. This situation is unlikely to change considerably in the next few years.

The current pension reforms also do not promote the development of investment banks, because the major part of pension resources of citizens is accumulated at state and semi-state enterprises. Non-government pension funds in Russia will not achieve the scale typical for well-developed countries for a long time. The resources of insurance companies and unit investment trusts cannot be considered as a significant source for long-term investments in the real sector of the economy so far.

So, the analysis of the situation shows that full service commercial banks can be the main source for additional investments in the Russian economy over the next 10 to 15 years.

Political stabilization, stable economic growth over the past few years and the increase in Russia's ratings prompted the sharp gain in the flows of foreign money into the country. In the first half of this year, the amount of money coming to Russia increased the outflow of capitals for the first time in the country's new history, $6.3bn against $3.1bn.

Investments in bonds and credits to residents from foreign banks have been booming.

About the role of foreign capital in investment processes

On the whole, the total volume of foreign investments in Russia amounted to about 5 percent of the GDP in 2002, and at least the same amount should be expected in 2003.

There are fears that the Russian banking system will be unable to provide efficient distribution of foreign investments, especially if their amount reaches the potentially possible 10 percent to 15 percent of the GDP.

Such fears are voiced by representatives of international economic organizations who point out that the continuation of this investment and credit boom can lead not to the creation of a new production potential in Russia but to an increase in prices on current assets, the overheating of the economy and a growth in doubtful credits at bank portfolios with a further destabilization of the country's financial sector. One cannot but agree that there is such a threat and it should not be underestimated. The main problem is that more than 43 percent of large and medium-sized businesses in Russia are unprofitable, so they cannot be trustworthy credit takers.

About the same number of enterprises are making low profits. Investments are concentrated in a narrow range of highly profitable enterprises of the fuel, electrical energy and metal sectors (these enterprises received more than 73 percent of all investments in fixed assets of the Russian industry in 2002) and companies of the trade, communications and food sectors. Foreign money is also invested in these enterprises.

Simultaneously with the advance in the trans-border crediting of Russian companies a tendency has appeared of the gradual squeezing of Russian banks from the sector of crediting corporate loan takers with relatively small risks. Russian banks have to increase their credit portfolios by giving credits to "risky" sectors of the economy.

So, the combined risks of the domestic banking sector are increasing. The amount of foreign investments is forecasted to be some 10 to 15 percent of the GDP in the next few years. That is why decisions should be made currently to create conditions for more efficient use of these resources in investment processes.

The first step in this direction is the formation and consistent conduct of the state industrial policy. The diversification of the economy's structure, which has been a necessity for a long time, will remain just a wish, unless domestic and foreign investors are able to see long-term targets of such a policy and can make decisions on investing in sectors of the Russian economy other than the raw materials sector. The second step is to accelerate the development of the country's banking sector, which can become a key element in the development of investment processes.

About the necessity to accelerate growth in capitals and assets in the banking sector Working practices show that trans-border crediting will be limited to a narrow range of exporters. Direct investing is still rather risky for investors.

Moreover, it implies qualitative bank services in regions where usually there are only liaison offices of domestic banks. If this simple truth is recognized, the necessity to change the current approach of state authorities to the domestic banking sector becomes obvious.

Appreciating the Central Bank's activities aimed at raising bank transparency and improving supervision and control over them, one cannot but see that these measures are not enough from the point of view of investment processes in the country, although they are indispensable.

The key element is probably the creation of conditions for accelerated growth in capitals and assets in the banking sector. To achieve this goal it is necessary to broaden financial flows that go through banks. Currently, Russian credit organizations are not allowed to service budget and pension financial flows. The Central Bank's gold and currency reserves exceeded the required minimum ($20bn) for servicing foreign trade long ago. However, even a small part of it is inaccessible for the domestic banking sector and it is not released into the economy.

The system of refinancing commercial banks has not been created so far. There are no sources where banks can take long resources necessary for financing investment projects.

A special problem is the attraction of savings of citizens to banks. Over the past few years, depositors' confidence in banks, which was lost after the 1998 financial crisis, has been restored. Currently, bank resources are growing mainly at the cost of individual deposits that increase by 50 percent annually.

This inflow may become more stable and firm, if the state consistently follows a course aimed at cutting cash circulation.

Such projects are being implemented in some regions so far. In particular, in Moscow the project Social card is being implemented, which is aimed at making social payments to citizens, payments for housing, communal and transportation services cashless. Bank of Moscow is a participant in this project. Mortgage crediting can also promote the coming of public savings to financial markets. At the same time, it is obvious that a large-scale mortgage market will not be formed soon in Russia without state support, the creation of corresponding institutes of such support and active participation of commercial banks in this system.

In this respect, attempts to forbid commercial banks from issuing mortgage securities are absolutely illogical.

A shift in the center of gravity towards processing industries that have a high level of risk requires some measures that could decrease credit risks for banks. World practices include some efficient instruments to reduce credit risks to investors. Taking into account Russian conditions, the following instruments seem to be the most important:
it should be stipulated in legislation that mortgaged property must not be included in bankruptcy assets when an enterprise goes bankrupt; the adoption of legislative norms that promote the broad use of instruments of syndicated crediting by stipulating rights and obligations of participants more clearly and distributing risks;
the broadening of instruments of securing assets stipulated in legislation. It is especially important for the development of the mortgage crediting market;
the real introduction of mechanisms of providing state guarantees for crediting priority projects.

About possible changes in the strategy of full service Russian commercial banks

The increase in trans-border crediting of Russian exporters and the advance in credit and currency risks under conditions when there is no consistent policy of support to the domestic banking sector obviously requires changes in the strategy of development of Russian commercial banks.

Possessions of people have become the main source of bank resources, including long resources. It promotes the emergence of new markets for active operations (consumer and mortgage crediting). So, the potential of investment crediting of Russian banks depends directly on the scale of their activities on the retail market.

We think only full service commercial banks that have well-developed outlet networks will retain and broaden their positions on the markets of investment crediting and investment and banking services. Successful implementation of investment projects in exporting sectors other than the raw materials sector is usually based on those elements of the industrial policy and reduction of credit risks that have been created in regions.

Such conditions are found in Moscow and the Moscow, Novgorod, Rostov and other regions. Bank of Moscow, like other credit organizations, takes this circumstance into account when it finances investment projects.

Another direction of development is the deepening of partnership between Russian and foreign banks that are interested in the decrease in risks for their investments in Russia.

Currently, foreign debts of the Russian corporate sector amount to $43bn and their further increase will result in higher risks for foreign creditors.

The fact that the Russian banking sector has noticeably changed and that Russian banks can be reliable partners for their western counterparts is testified to by a recent stress test conducted by experts of the International Monetary Fund and the World Bank within the framework of the Financial Sector Assessment Program (FSAP). According to its results, the current Russian banking system could withstand a crisis similar to the 1998 crisis.

We believe that the creation of syndicates to finance large investment projects can be one of the most promising forms of such cooperation.

Certainly, the volume of crediting at the cost of resources of foreign financial institutions will continue advancing. Currently these instruments are used mainly to finance companies that export raw materials and energy resources. However, such instruments will be in high demand in sectors other than the raw material sector, in the event of a growth in the pace of the renewal of fixed assets.

We believe that the development of financial leasing is also promising. Cooperation between Russian and foreign financial organizations within the framework of financial leasing would be expedient.