Russia Private-Bank Experiment Implodes With Otkritie Rescue

(Bloomberg) -- The bailout of one of Russia’s biggest banks may spell the end of a short-lived effort by ambitious private lenders to both compete with the state giants that dominate the industry and help them navigate sanctions.

The central bank’s takeover of Bank Otkritie FC this week signals the failure of a strategy conceived three years ago, when tumbling oil prices and international penalties created an opportunity for a new generation of banks not directly tied to the Kremlin. With companies including Sberbank PSJC, which holds about half of Russia’s savings, constrained by financial curbs, a clutch of private lenders favored with cheap state funding emerged to fill the gap.

Russia Private-Bank Experiment Implodes With Otkritie Rescue

But Otkritie -- a hard-charging upstart backed by four billionaires -- ravaged its own finances with lax lending policies and unchecked expansion: the bank bought a diamond mine from its own shareholders for $1.45 billion at the same time it was absorbing Russia’s biggest insurer. An unexpectedly low credit rating because of the bank’s loan portfolio and the failure of a rival triggered its downfall, leading to a run on deposits that drained 527 billion rubles ($9.1 billion) in the two months before the central bank was forced to step in.

“It’s no secret that many Russian private banks are ill-prepared to meet international standards of accounting, risk control and even simple business strategy,” Anastasia Nesvetailova, head of City University’s Political Economy Research Centre in London, said by email. “Some of Otkritie’s problems appear to be linked to the bank’s own strategy of acquiring a series of competitors, but they are merely a reflection of the wider financial culture in the country.”

Black December

Otkritie’s breakthrough came at the end of 2014, during what Sberbank later called Black December, when plunging oil prices and political tensions sent the ruble spiraling to record lows. The bank’s co-founder, Vadim Belyaev, and VTB Group, a minority shareholder, put together a novel transaction that would catapult Otkritie into the big leagues overnight while helping Russia’s biggest oil company Rosneft PJSC avoid default.

The trade involved Otkritie using 1 trillion rubles in bonds issued by Rosneft as collateral for a central bank loan of up to $15 billion, which Otkritie then loaned back to the sanctioned oil company to service debt, according to a person familiar with the deals. Andrey Kostin, the head of VTB, told the Financial Times that his bank couldn’t do the deal because of sanctions, so Otkritie took the high-risk, high-reward transaction. They kept the pact a secret, apparently to avoid retaliatory U.S. penalties.

The deal caused a fresh dive in the ruble and another run on banks, prompting monetary authorities to jack up interest rates in a bid to calm the markets. The ruble turmoil angered President Vladimir Putin, who prizes financial stability, leading to a rare public rebuke of Rosneft chief Igor Sechin, his longtime ally.

But the gambit was a boon for Otkritie, which doubled its assets and won the envy of the industry. After that, Belyaev pursued growth aggressively, receiving 127 billion rubles in funding from the central bank to rescue National Bank Trust, the biggest victim of the crisis at the time. 

‘Going Crazy’

“Otkritie was a key player when things were going crazy in late 2014 and it was very cooperative post-crisis,” said Tom Adshead, chief operating officer at Macro Advisory in Moscow. “But clearly it was a bit too aggressive.”

The deals continued to pile up as Belyaev pursued his goal of turning Otkritie, once called Shchit Bank, or Shield Bank, into Russia’s largest private financial company. He’d already shelled out about $40 million for the naming rights to a Moscow premiere-league soccer stadium that will host the 2018 World Cup. In 2015, Otkritie was named one of 10 lenders the central bank deemed “systemically important,” or too big to fail, cementing its reputation as a major player.

One of Otkritie’s hallmarks was its complex ownership structure, with about two-thirds of its stock owned by a company, Otkritie Holding, that doesn’t have a controlling shareholder. Two Lukoil PJSC billionaires, Vagit Alekperov and Leonid Fedun, precious metals magnate Alexander Nesis and Internet entrepreneur Alexander Mamut own a combined 36 percent of the group, while VTB and Belyaev also have stakes.

The bank needed to either raise capital or cut its assets, but both options turned out to be “too difficult” and Otkritie’s owners instead appealed to the central bank for a rescue, First Deputy Governor Dmitry Tulin said Tuesday.

Outflows have slowed significantly after the central bank takeover, and Otkritie is considering lowering the interest it pays on deposits as clients are attracted to its new quasi-sovereign status, according to Otkritie’s press service.

Otkritie wasn’t the only private lender to grow rapidly with central bank help, even as Governor Elvira Nabiullina embarked on an industry-wide culling that’s eliminated hundreds of lenders since 2014, more than a third of the total. Two of the largest, Promsvyazbank and B&N Bank, both expanded through acquisitions and received state money to rescue smaller competitors. Promsvyazbank’s assets have about doubled, while B&N’s have jumped fivefold.

Still, such torrid growth hasn’t been enough to reduce the government’s dominant role in the industry. Before Otkritie’s rescue, 60 percent of the sector’s assets were held by state banks and the ongoing consolidation is accelerating a flight to quality that will only boost their market share further.

Reversal of Fortune

Now Otkritie, which became a kind of guinea pig for an experiment in government-backed private banking, is the first lender to be taken over by a special fund the central bank created so it doesn’t have to outsource bailouts to the private sector -- just like it turned to Otkritie after National Bank Trust collapsed.  

Russia Private-Bank Experiment Implodes With Otkritie Rescue

This new strategy for dealing with struggling banks will only lead to greater state control over the country’s financial system. In the event of a successful rescue, the equity will remain with authorities unless a buyer can be found.

In the meantime, officials are doing everything they can to calm an increasingly nervous public and banking industry.

Two weeks ago, regulators chastised an investment adviser at Alfa Capital for warning in a note to clients that Otkritie, Promsvyazbank, B&N Bank and Credit Bank of Moscow were possible targets for a central bank-mandated cleanup, a prediction that’s being taken more seriously now that one’s been nationalized.

“The central bank gave a signal that high-risk behavior needs a lot of capital,” said Kirill Lukashuk, the head of bank ratings at ACRA, which stoked the outflows when it rated Otkritie below investment grade for pension funds. “Now it’s turning the screws about provisioning, and soon business strategy and capital reserves will become a key issue for all large banks.”