The Graphs Are Not Included Here; Source: Russian Economic Trends

The graphs are not included here; source: Russian Economic Trends (excellent source of information on Russia in general).

What went wrong?

Asian Contagion: reppraisal of risk, liquidity problems in investment funds trading on international level, fall in world commodities prices.

Commodities make up about 80% of Russians export. Commercial deficit exacerbated by the adverse price movements in the world commodity markets at the end of 1997 and into 1998. (Current account balance: Q1 1997 + $3.9 bn vs. Q1 1998 -$1.5 bn.)

At the beginning of the 1990s there is shift form direct Central Bank financing of the government spending to privet sector loans in the form of government short-term obligations (GKOs).

Possibility of major fly into dollars by the local population. (Hyperinflation recent past.)

GKOs were indirectly used as a subsidy to the banking system (negative real interest rates; $55 bn transferred in interests).

Political instability. March 1998: major changes in the government (“young, radical reformers”). June 1998: large companies ignored demands to pay their taxes; the Duma rejected many points of the government’s agreement with the IMF; and once again, the banks managed to convince the president to sack the government, rather than allowing it to take radical measures to address their insolvency. (The health problems of the president are not helping either.)

June 1998, total household deposits stood at R165 bn (including R35 bn of foreign currency deposits). ¾ are held in Sberbank, the majority of the rest is held in 5 privet banks).

Russian banks entered the critical month of August 1998 with the following flaws in their books:

Large number of non-performing enterprise loans. Official numbers indicate 7% of total loans.

Concentration of bad loans. 50% of the bad loans are on the books of 5 largest banks, which account for 1/3 of total lending to the economy. Bad debts if banks lending to agriculture are estimated at 60% of their total loans.

Concentration of risk. Large amounts of loans given to one borrower, including the government of Russia. In July, Sberbank held about 50% of its assets in GKOs, and the rest of the banking system in total held 10% of its assets in government bonds. In total approximately $15 bn.

Large amount of unhedged off-balance sheet forward contract: aprox. $2 billion outstanding in non-deliverable forward contracts, taken out by investors in short-term ruble debt in order to hedge their currency risk.

Rapidly increasing foreign currency liabilities, unmatched by foreign currency assts. In July, foreign liabilities of commercial banks, including deposits, exceeded their foreign assets by R115 bn and accounted for 30% of all liabilities.

First three weeks of August:

Central Bank is faced with two conflicting interests: bailing out the banking system and defending the currency.

Central Bank started to issue large amounts of credit. Official numbers indicate aprox. R23 bn worth of credits to commercial banks. Monthly average Jan-Jul 1998 was R7bn.

The amount of savings withdrawn form 30 largest banks rose to R17 bn (10% of total retail deposits in these banks) vs. R2 bn of the previous month.

In total Russian citizens managed to withdraw 18% or R30bn of ruble deposits. At the same time, $1bn was withdrawn from dollar accounts.

The Central Bank allowed depositor of banks which hold over R300 mn in retail accounts (32 banks), to transfer their savings to Sberbank. That made liabilities of Sberbank towards population amount to R124bn, while its assets total was R200bn, half of which is frozen government debt.

On August 1, 1998 R0.001bn worth if stalled payments was registered. In the third week of September 30 largest banks were having R7 bn of stalled payments.

Changes in monetary policy (August 17):

An effective float of exchange rate. This replaces the old system of pre-announced narrow daily trading corridor.

An indefinite imposition of controls on capital accounts transactions. Specially, non residents will not be allowed to invest into ruble assets with the maturity of less than one year.

The moratorium does not include payments on the external debt of Russian Federation (There are no sovereign debt payments due in the period!).

A lengthening of the maturity of all GKP and OFZ instruments (rouble denominated short and long term government bond). The trading on the GKO/OFZ markets are to be suspended.

For the purposes of financial analysis and before a restructuring program, Central Bank of Russia divided all banks in four groups:

(862 banks): banks with sufficient capital which are not experiencing difficulties with liquidity management;

(Alarming number! Lobbying?)

(15 banks): banks which experienced problems mainly due to reasons other than financial crisis;

(275 banks): insolvent banks with insufficient capital, liquidity problems and lack of potential; (Liquidated by July 1999, deposits transferred to Sberbank)

(*That adds to 1550)

Ironic Facts:

Devaluation would leave only 30 of the country 1500 banks standing (Russia Finance Minister, June 1998)

Closing these 12 banks enables the government to impress its creditors without shouldering any real financial burden (…) By one estimate more than 100 banks are now technically insolvent, and more bankruptcies must surely follow, not just to improve the health of the banking system, but also to boost tax collection. (The Economist, May 20th 1999).

Up to date not a single banker was tried for fraud or asset-stripping. “Russia’s cozy accounting practices have made life after death relatively easy”.

The main problems stated by foreign investors and importers are:

Unclear and over-bureaucratic system of standards, licensing, and certification;

…We are talking about Russian financial crisis (1998)