Author: | Published: 9 Jul 2001
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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).


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.

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