Market structure and trends
The Russian banking sector awaits fundamental restructuring
following the August 1998 financial crisis and banking collapse. In
his annual address to the Association of Russian Banks in April
2001, Mr Gerashchenko, the chairman of the Bank of Russia, observed
that one of the most important tasks facing the country and central
bank is the reform of the banking system in accordance with a
selected long-term strategy of socio-economic growth, "insofar as
thus far the banking system has not played an active role in
accelerating economic growth." The Joint Address on Economic Policy
of the Government and the Bank of Russia, in late April, confirms
there is no effective procedure in place for the liquidation of
banks whose licences were revoked in the wake of the collapse. The
number of operating banking organizations was reduced by almost one
third, from over 1,700 in mid 1998 to 1,247 in October 2000, and
stood at 1,281 in June 2001. When the task of liquidating failed
banks is done, the government wishes to facilitate a banking sector
which supports the 'real economy' by starting to meet profound
domestic demand for financing.
Capital controls have been in place since 1992 and tightened
predictably in the post-crisis period. The Bank of Russia supports
a dual strategy, on the one hand implementing selected exemptions
from controls, and on the other hand maintaining the mandatory sale
of hard currency export proceeds to ensure high gold and currency
reserves, to inhibit capital flight, and to promote stability in
the exchange market. In public statements this year, the leadership
of the Bank of Russia has defended a cautious approach to
abandonment of mandatory sale of export currency proceeds, while
members of government appear to support a liberalization of capital
flows.
Central Bank consent is required for the acquisition of any
shares in a Russian credit organization by a foreign legal entity,
as summarized below. It is noteworthy that the Joint Address states
outright that by the end of September 2001 legislation permitting
full participation of foreign capital in the Russian banking sector
will be implemented, including free repatriation of profits.
In the Joint Address the government specifically undertook to
ensure strict compliance with legislatively established
anti-monopoly principles for the purposes of promoting competition
on the financial markets. A possible interpretation of the
government's emphasis on this trend is an intent to avoid
concentration of capital and market power in oligarchic groups.
Indeed draft legislation seeks to regulate informal bank groups.
This is expected to be a theme in the government's programme for
development of the banking sector, due out in September 2001.
Main regulatory bodies
The Russian Federation Central Bank, the Bank of Russia, is the
regulatory body with licensing and supervisory authority over the
country's credit organizations. It also regulates monetary policy
and currency and capital controls. As primary regulatory authority
the Bank of Russia derives its powers from three laws: the Law on
Banks and Banking Activity (1996) (the Banking Law), the Law on the
Central Bank (1995), and the Law on Currency Operations and
Currency Control (1992) (the Currency Law). All three have
undergone numerous amendments in recent years. June 2001 amendments
in the Currency Law have liberalized certain transactions
previously requiring a special licence, such as investment by
Russian nationals in securities abroad up to a $75,000 threshold.
The government and Central Bank have promised that proposed
revisions in the Banking Law, the Law on the Central Bank, and the
Law on Restructuring of Credit Organizations will be adopted in
2001 and will in particular require a stricter application of the
requirement to revoke licences for capital inadequacy, will
heighten the responsibility of management and shareholders of
insolvent banks, and will address corporate governance issues.
Types of financial institutions
The Banking Law recognizes several types of financial
institutions: credit organizations, which include 'banks' and
'non-banking credit organizations,' as well as foreign banks, ie
entities recognized as banks by the laws of their jurisdictions of
incorporation. Banks have the exclusive right to carry out a
specific set of 'banking operations' in combination with one
another, while non-banking credit organizations may be granted
licences to carry out separate banking operations. The key cluster
of banking operations normally permitted only to banks consists of:
(i) taking deposits from the public; (ii) lending out or placement
of such funds in the name of and for the account of the bank, on
condition of timely and liquid repayment; and (iii) opening and
managing bank accounts for individuals and legal entities.
Establishing a financial institution
The procedure for establishing a credit organization (banking or
non-banking) is governed by Central Bank Regulation No. 75-I. The
main requirements are:
- if foreign capital is involved, submission by the founders
of an application for preliminary permission to create a bank
with foreign capital;
- if foreign capital is involved, issuance of the preliminary
permission of the Central Bank, Department for the Licensing of
Banking and Auditing Activity;
- submission by the founders of an application for the
registration and licensing of the bank, together with a
business plan corresponding to Central Bank criteria
established in April 2000;
- payment by the founders of the registration fee, equal to
0.1% of the stated charter capital;
- registration of the bank by the local division of the
Central Bank;
- within one month following registration, payment of 100% of
the charter capital; and
- ruling by the Central Bank on whether a licence should be
granted.
Founders must present three years of audited financial
statements and may not have outstanding tax liabilities. Article 11
of the Banking Law states that the promoters of a bank may not
withdraw from the credit organization for three years following its
registration. This would prevent foreign investors from
implementing short term exit strategies, but would not prohibit
partial share transfers.
Under Regulation No. 437 of the Central Bank, where a bank has
elected a management in the form of a general director, and that
director is to be a foreign citizen, at least 50% of the management
board must be composed of Russian citizens. If foreign persons are
nominated as candidates for the chairman of the management board or
the chief accountant, their applications must attach a work permit
issued by the Federal Migration Service, as well as a document
evidencing at least one of these candidates' knowledge of Russian
if all applicants are not Russian. Further, the documents
evidencing these candidates' educational background must be
confirmed by the Russian Ministry of Education. At least 75% of the
total staff employed by a bank formed with foreign capital must be
Russian. These numerical limits were alleviated in June 1999, when
a brief Directive made clear that the Committee for Bank
Supervision is entitled to alter these restrictions.
Interestingly, in mid-1999 Instruction 75-I was revised to
provide that a bank's charter may not allow the board of directors
or its chairman to intervene in the operational activity of the
credit organization, possibly an attempt to cure some of the abuses
in management observed in pre-crisis banks which were de
facto but not de jure controlled by various oligarchic
groups.
It is permissible to make contributions to bank capital in
foreign currency without a special currency licence (while the
nominal value of the shares must be expressed in roubles).
Financial Services online/e-banking
The legislative framework for conducting legal transactions
online is beginning to emerge but is not yet at a level which would
permit widespread use of e-banking services, although a few banks
offer them.
In June 2001, a draft law on electronic signature passed its
first reading in the lower house of the Russian parliament. It
would establish the legal equivalence of an electronic signature
with a hand signature on paper media, the legal concept in the
absence of which e-business will have difficulty evolving.
In mid 2000, the Central Bank implemented a procedure under
which banks may file their periodic reports on activity and
financial condition in electronic media. By concluding a contract
with the relevant branch of the Central Bank, the reporting bank
may establish the agreed use of an e-signature and the regular
electronic submission of reports.
Acquiring financial institutions
Acquisitions of shares in financial institutions are regulated
by both company and banking legislation.
Company legislation
Under the Joint Stock Company Law, a company's charter may
prohibit or restrict acquisitions by one or an affiliated group of
persons of shares in excess of a stated threshold. In addition, the
Joint Stock Company Law recognizes pre-emptive rights of existing
shareholders in closed joint stock companies, which must be
honoured if the legality of any share transfer in such a company is
to be ensured. Mandatory points of the pre-emptive right are given
in the law, such as requiring a 30 to 60 day exercise period, while
others may vary based on the individual financial institution's
charter.
Banking legislation
Banking legislation, in turn, establishes restrictions when an
acquiring entity reaches the threshold of 5% and of 20% of a
financial institution's outstanding share capital. Separately, all
acquisitions of any kind by a foreign person or entity of shares in
a Russian bank are subject to the consent of the Bank of Russia.
Banking legislation also imposes certain restrictions on the manner
in which bank shares may be acquired.
Notification and consent thresholds
Article 11 of the Banking Law requires that the acquisition of
more than 5% of the shares of a Russian bank by a single person or
by a group of persons, bound by contract or in a parent-daughter
relationship as defined by the Civil Code (an 'affiliated group'),
must be notified to the Central Bank. Pursuant to Article 105 of
the Civil Code, a company is deemed the 'daughter' of a 'principal'
company if that principal company has the power to determine the
decisions of the daughter company, whether by virtue of its
majority shareholding, a contract, or another basis. A shareholding
of 20% is deemed to make one company dependent on another as a
matter of law (Article 106). The Central Bank has released no
regulatory clarification on its interpretation of what constitutes
an 'affiliated group' but individual and unofficial views tend in
the direction of concluding that any shareholding ownership
linkages among two or more companies would be sufficient to bring a
group within the provision.
The obligation to notify rests with the purchaser or purchasing
group. When so notified, the territorial division of the Central
Bank is responsible for verifying that the purchaser or purchasing
group is in compliance with regulatory requirements, a process
normally carried out when the Central Bank receives the bank's
report on results of a share issue or when the Central Bank
receives the bank's amended charter for registration. At this
stage, the bank issuing the shares must present to the Central Bank
evidence of compliance.
Article 11 of the Banking Law also provides that acquisition of
more than 20% of the shares of a Russian bank by a single entity or
by an 'affiliated group' is subject to the prior consent of the RF
Central Bank. Proposed amendments would extend this rule to
investments through trust management. Pursuant to paragraph 5.2 of
Instruction 75-I, entities in the affiliated group of persons would
be barred from participating in a purchase of 20% unless they can
demonstrate a stable financial position and have been in existence
for more than three years.
Restrictions on foreign acquisitions
Unlike the restrictions on purchases by any one entity or
affiliated group, which are based on reaching the threshold of 5%
or 20% of the charter capital of a bank, the restrictions on
foreign investment affect any acquisition, regardless of
amount.
A systemic quota on foreign capital. Article 18,
paragraph 1, of the Banking Law provides that a limit or quota on
foreign capital in the Russian banking system must be established
by federal law. Until such a quota is established, the pre-existing
quota of 12% established by the board of directors of the Central
Bank will continue to apply (currently approximately half - 6% - is
used). If and when this is reached, the Central Bank could block
further acquisition by a non-resident of shares in the charter
capital of any authorized Russian bank, regardless of whether 5%
and 20% limits specific to the charter capital of that bank have
been reached or exceeded.
Transaction-specific limits. In order to monitor
compliance with the systemic cap on foreign investment, Article 18,
paragraph 3, of the Banking Law requires any credit organization to
obtain the prior written consent of the Central Bank for: (i) any
increase in charter capital at the expense of foreign investment;
or (ii) alienation (including sale) of its shares for the benefit
of a non-resident, and requires any resident shareholder
(participant) of such credit organization to obtain such prior
consent to any disposition or alienation of shares belonging to it
"for the benefit of a non-resident. An increase in charter capital
at the expense of foreign investment, or an alienation of shares
for the benefit of a non-resident, that has not been sanctioned by
the Central Bank, is null and void. However, under part 5 of
Article 18, if the Central Bank fails to issue its consent or a
reasoned written refusal to an applicant within two months of the
date of filing, the proposed disposition of shares will be
considered permitted.
Funding of acquisitions. A further regulation of
acquisitions of bank shares arises in Article 11 of the Banking Law
in that it prohibits forming the charter capital of a bank (upon
establishment or upon subscription for new shares) with borrowed
funds (privlechennye sredstva). Applicable law and
regulations do not define the term privlechennye sredstva as
such. In order to demonstrate that a purchaser of 20% of a given
bank's shares in using funds which belong to it outright, it is
generally necessary for the purchaser to show that its net assets
are sufficient to make the proposed acquisition.
Competition regulations
Acquisition of more than 20% of the shares of a bank by a single
person (or an affiliated group of persons as defined in the
Antimonopoly Law) requires the preliminary approval of the Ministry
of Antimonopoly Policy and Support of Entrepreneurship (MAP).
Supervision
Bank reporting. The Central Bank Instruction No. 1,
October 1 1997, established what are called 'mandatory economic
standards' (N1-N10) and frequently translated as prudential ratios
for banks. Compliance with these, as well as other types of
performance criteria, is measured and supervised through the system
of periodic reporting. Banks are required to submit to their
territorial division of the Central Bank periodic reports on
operations and financial condition, some every 10 days, some
monthly, some quarterly. The scope, contents, and frequency of
reporting are determined by Directive 7-U and in parallel,
Instruction No. 17. In July 2000, the Central Bank issued
recommendations on liquidity which require banks to adopt liquidity
policies and controls, to monitor concentration of credit risk in
one or an affiliated group of borrowers, and which urge publication
of information on liquidity.
Bank accounting and IAS. Pursuant to Article 5.2 of the
Law on Accounting and Articles 4 and 56 of the Law on the Central
Bank, the rules for accounting and reporting by banks and other
credit organizations are established by the Central Bank and these
are the Rules for Maintenance of Accounting by Credit
Organizations, approved in June 1997.
One issue under debate has been how to bring bank accounting
standards into greater synchronization with international
accounting and financial standards. On the one hand, since early
1998 government representatives have pledged to introduce domestic
standards compatible with international practice. A 1998 decree,
Government Decree 851, referred to a specific schedule for
extending IAS to banks by January 1999. While this did not happen,
Gerashchenko confirmed in February 2000 that the Central Bank has
adopted a plan for bringing bank accounting and reporting into line
with world standards. In the April 2001 Joint Address, the
government again emphasized the importance of transparency in
reporting and the need to improve public confidence in banks. It
referred to a TACIS pilot project on introducing international
standards, and committed to legislative/regulatory reform for
introduction of international accounting standards to the banking
sector by 2004.
Sanctions. Sanctions on non-complying banks, arising
under the Law on the Central Bank (replacing management,
introduction of financial health measures, limitation of or
prohibition on selected banking operations, through full licence
revocation), are enforced under the March 1997 Instruction No.
59.
Disclosure requirements; change of
management/control/cross-border supervision
Central Bank Instruction 75-I regulates both changes in
management and changes in the composition of the shareholders of a
Russian bank, but does not set forth a particular provision on
change in control as such. In the case of a change in the
composition of shareholders, Chapter 18 provides that banks which
are in the form of closed joint stock companies or limited
liability companies must submit for certification by the relevant
territorial division the corporate resolutions approving a change
in the shareholders and a complete list of all shareholders or
participants. Banks in the form of open joint stock companies,
whose shares are traded on the secondary market, need not obtain
consent for changes in shareholdings, but must regularly submit a
list of all shareholders with a position in excess of 5%. Any
shareholding, whether or not above 5%, by foreign persons, must be
specifically reported by all banks. Within 10 days following the
annual general meeting of banks in the form of open joint stock
companies, such banks must electronically provide to the Central
Bank the complete list of its shareholders.
Chapter 22 requires prior submission to the Central Bank in the
event of change in the management of a bank or in the case of
replacement of a bank or a bank branch chief accountant. Persons
nominated to fill these positions must be agreed by the territorial
division Supervisory Department. The Supervisory Department is
required to conduct an inquiry and prepare an analysis of
acceptance or rejection of the candidate within one month, and only
then may the bank appoint the new executive. The new executive's
signature is then accepted within the Central Bank's clearing
system, and the Central Bank's Licensing Department registers the
new executive in the registry of credit organizations.
In April 1998, the Central Bank standardized the procedure for
permitting Russian banks to open subsidiaries outside Russia,
limiting the possibility of consent to investments in which Russian
banks classified for at least six months as "Group 1" banks have
and undertake to maintain control over the subsidiary by
shareholding or contract, and restricting investments in offshore
zones. Such subsidiaries would be able to invest freely abroad,
without Central Bank consent. The application must be reviewed by
bank supervisory and currency control officials, and consent
requires the bank to precisely track and report on currency inflows
and outflows associated with the investment. Investments exceeding
$10 million are ruled on by the board of directors of the Central
Bank.
Bank insolvency
The Russian legal framework for dealing with bank insolvency
appeared in reaction to the August 1998 financial crisis and the
hundreds of bank insolvencies that followed in its wake. Two
specific laws apply, the Bank Insolvency Law of March 1999, and the
Bank Restructuring Law of July 1999, together with the general Law
on Bankruptcy.
The Bank Insolvency Law envisions two categories of measures,
one dealing with rehabilitation measures which the banks are
required to implement themselves, the other with other measures
implemented by a central bank temporary administration. Grounds for
mandating self-rehabilitation include violation of the central bank
minimum ratios for capital adequacy and liquidity, a decrease in
capital assets of more than 20%, as well as a certain degree of
payment failure (three days).
The central bank may (but need not) impose its own temporary
administration, an independent management body, within a failing
bank if any of five grounds are present. These are: violating the
central bank liquidity ratio by more than 20% in the prior month, a
decrease in capital assets of more than 30% together with the
violation of other central bank ratios, failure to carry out
self-implemented rehabilitation, grounds permitting licence
revocation, and again, a specified degree of payment failure. The
obligation to self-rehabilitate, or the power of the central bank
to impose an ordinary temporary administration under the Bank
Insolvency Law, can arise in relation to banks of any size or
relative national and regional importance.
The Restructuring Law of July 1999 introduced a special
state-managed restructuring phase, preceding liquidation, for a
limited class of banks whose banking assets were of overarching
national or regional significance, whose insolvency was
sufficiently deep (such as payment failure of seven days or capital
adequacy of 2%), and whose eligibility was recommended by the
Central Bank. The Agency for Restructuring of Credit Organizations
(ARCO) was charged with implementation.
Whether or not a bank has benefited from an ARCO rehabilitation
plan, if efforts to restructure fail, liquidation may occur only
following discretionary revocation of the banking licence by the
Central Bank. Draft amendments to the Banking Law approved by the
Duma in May would for the first time obligate the Central Bank to
revoke licenses for capital inadequacy and payment failure, the
draft is before the Federation Council.
ARCO is reported to have undertaken the restructuring of 19
banks of which half showed improvement in their financial
condition. Most were small regional financial institutions.
Although ARCO was intended to focus on nationally significant
banks, with the limited funds allocated to it for the task,
restructuring of these national networks could not occur
successfully. ARCO itself had estimated the needed funds as between
R100 billion ($3.5 billion) and R150 billion, compared to the R10
billion it received. With no new funding for ARCO in sight, the
government is considering the future of ARCO with proposals ranging
from its liquidation, its transformation into an agency for
creating deposit guarantees, its conversion to a private bank, or
its conversion to a full state agency charged with the liquidation
of banks not qualifying under the Restructuring Law.
Capital requirements and bank secrecy
The Central Bank announces the minimum charter capital
requirements for banking and non-banking credit organizations, as
well as for credit organizations with foreign capital, on a
quarterly basis. The most recently announced thresholds, for the
second quarter of 2001, were: (i) R25.5 million for newly created
domestic banks; (ii) R2.55 million for newly created domestic
non-banking organizations; and (iii) R255 million for subsidiaries
of foreign banks. A bank which wishes to receive a general licence
for banking must demonstrate the presence of capital assets of at
least R127.5 million. In March 2001, the Central Bank tightened the
rules for revaluation of capital assets due to changes in value of
bank property; these allow a capital increase to be blocked in
cases of distorted valuation.
Under Article 26 of the Law on Banking, tax police previously
had the power to access information classified as 'bank secret', as
did tax supervisory bodies and investigative bodies. Tax code
amendments in 1999 significantly reduced the scope of access,
although reports of tax police exceeding this authority in the
regions continue.
Salans Hertzfeld & Heilbronn HRK
Clements House
14-18 Gresham Street
London EC2V 7NN
UK
Tel: +44-207 509-6000
Fax: +44-207 726-6191
www.salans.com