The radical market reforms that began in Russia in the 90s inevitably involved the creation of one of capitalism’s key institutions, a banking system – a process equally traumatic for the bankers themselves and their clients. Moreover, many of the problems of that time are still with us today, since the liberalisation of this sector has not been systematic and has erred on the side of, if not populism, then certainly the bankers’ lobby and vested interests. The reforms are still not complete, which limits their effectiveness.

'In Soviet times the role of the banks was practically speaking limited to financing central government’s economic plans; sectoral banks and savings banks existed but did not function in market-led conditions.'

The transition to a two-tier banking system

In Soviet times the role of the banks was practically speaking limited to financing central government’s economic plans; sectoral banks and savings banks existed but did not function in market-led conditions. So sectoral banks would, for example, provide financial assistance to Soviet enterprises with cash flow problems. However, the provision of credit often depended less on the creditworthiness of the borrower than on its priority for the planning policy makers and government departments. So banks were obliged to give money to enterprises that were planned to run at a loss, producing goods important to the government but for which there may have been no demand. Banks also provided finance for massive government projects (the construction of large industrial plants, railway lines or military installations), without regard for the wants of the Russian population. In this environment there could be no question of effective use of resources, and it was precisely the ineffectiveness of the planned economy that pushed Russia towards reform, including reform of the banking sector.

In the early 90s laws were introduced regulating banking on market principles, and the Central Bank of Russia was created as the upper tier of the banking system, with all the commercial banks forming a second tier.

Vladimir Putin visiting Russia’s Central Bank Depository where two thirds of the country’s reserves of gold and foreign exchange are kept. The Central Bank was created in the 90s as the upper tier of the banking system.

The Central Bank was to take charge of the issue of money, while the commercial banks were to deal with businesses and individuals. However, the way the transition was managed led to the majority of the commercial banks remaining in the hands of the state. Populism in economic policy also led the Central Bank to pump money into the economy, causing inflation to soar to more than two thousand percent. During the period when Viktor Geraschenko was president of the Central Bank (1992-1994), the money supply rose by 20% per month, and his reforms, which involved devaluation of the rouble and the replacement of old Soviet roubles with new (1993), are remembered by the population as daylight robbery.

Immediately after the introduction of market reforms the Russian banking system was extremely small and unstable: the total capitalisation of all Russia’s banks was less than a third of the share capital of a large American commercial bank, although in terms of numbers of banks Russia ranked third in the world, after the USA and Germany. A large number of banks were involved in less than honourable dealings, including active participation in financial pyramid schemes, some of them run by the government. The GKO (State Short-term Bonds) pyramid accumulated enormous funds before its crash in 1998, attracting almost the entire spare money stocks of the banking system – after all, it yielded up to 300%!  

'Immediately after the introduction of market reforms the Russian banking system was extremely small and unstable: the total capitalisation of all Russia’s banks was less than a third of the share capital of a large American commercial bank, although in terms of numbers of banks Russia ranked third in the world, after the USA and Germany.'

The 1998 Crisis

The 1998 crisis brought about a stream of bankruptcies, including some major banks, and set off a drain of capital that led to much of the population losing all confidence in banks and refusing to use them. But this period of mistrust was short lived: when oil prices began to hit new heights in 2000, and people started to see a steady rise in their real earnings, mistrust gave way to euphoria and Russians began to make active use of bank credit facilities with interest rates of up to 100%, although the adverts presented them as 0%. Optimism reigned everywhere, and people happily borrowed money from banks for mortgages, car loans and other outgoings. Everyone was convinced that the crises were over and that the future held only ever increasing dividends. It was not just the government that saw itself as a safe haven in the world of finance; the population, up to their necks in debt, evidently saw themselves as safely moored there as well.

The 2008 – 2010 crisis and its aftermath

The reality was very different, and the 2008-2010 crisis brought problems for many borrowers. Moreover, during the crisis period the government poured money into the economy and in the first place directed help at the state banks, leading to a centralisation of the banking system: today 60% of capital and shares are in the hands of the state banks. During the crisis period 200 billion dollars of gold and currency reserves went on supporting the rouble exchange rate.

The Russian banking system’s problems are not over, and this is particularly evident in two areas, if one compares it with Western countries: inflation, for which the Central Bank is responsible, and interest levels on the credit market. Despite the rapid growth of the economy during Putin’s presidency, inflation in Russia remains very high, at 9-10% - about five times the rate in Europe and the USA. In other words, on this scale Russia is clearly lagging behind the leaders in the world economy. But this does not appear to have happened by chance, since during Putin’s presidency the money supply increased by a factor of 28.

Consumer credit and mortgages gained popularity in Russia on the wave of the 00s oil boom. Customers were prepared to borrow money at interest rates much higher than in Western countries.

To some extent it can be explained by the populist politics of those years: the growth in spending on social welfare and government projects has required ever more cash, and as Russia’s Central Bank is heavily dependent on the government its issues are determined by the latter’s needs. It is no surprise that inflation does not want to fall (inflation cannot want anything), despite all the vocal interventions of governmental organisations.

As a result of this high inflation rate, Russia has a higher interest rate, which makes some investment projects uneconomic. Here too it lags behind Europe by a factor of 4-5, which incidentally makes it worthwhile to attract money from foreign banks. The last few years have seen a trend towards foreign banks entering the Russian market, which has improved services and brought down interest rates. Russia’s wish to join the World Trade Organisation has forced her to reconsider her attitude to foreign banks, which until now were bound by a limit of 25% of the market sector.  

At present Russian banks are actively seeking capital investment on the international markets, but during the crisis period there was a significant decline in the number of reliable borrowers, leading to the current drop in interest rates. However, ordinary Russians have lost some of their financial optimism and are less happy about building up debts to the same extent as before the crisis.

'The Russian banking system is very young in international terms, so it is not surprising that after 20 years of reform it is still not perfect.'

The Russian banking system is very young in international terms, so it is not surprising that after 20 years of reform it is still not perfect. But as the Russian population becomes more finance-literate and gains more experience in the world of credit, competition in the market will gradually become healthier – provided, of course, that the government does not throw a spanner in the works.