Trade and Project Financing in Russia

A Hot Tip about Banking and Finance in Russia

Posted on: 4 Jan 2010

How Do I Get Paid (Methods of Payment)

As in other markets, payment methods and terms vary depending upon the U.S. Company’s business model and relationship with Russian trading partners. For new to market companies, requesting advance payment for goods and services from a Russian customer may be a prudent course to follow until both parties establish a positive record of payment. Currently, there are a limited number of U.S. banks that accept Russian letters of credit from some of the largest Russian banks, specifically those that have been approved by the U.S. Export Import Bank. Once a U.S. firm has established a strong relationship with a Russian trading partner, it may consider extending short, and eventually longer-term credit as a way to bolster sales volume. This should be done with caution and only after careful evaluation and establishment of successful payments. The U.S. exporter might also consider insuring such credits with one of the larger Russian insurance companies that offer export credit insurance to foreign firms. Such insurance can be reinsured through a large international insurance company.

 

For some large transactions, advance payment from a Russian buyer may be impractical. In such cases, financing may be provided by a bank, export credit agency or venture fund. Exporters risk can be minimized with a bank or insurance guarantee from a Russian bank that would be acceptable to a U.S. bank. In leasing deals, exporters should insist on an upfront payment of three to fourth months upon delivery as a way to mitigate some of the risk.

 

Many Russian banks now offer factoring services. However, the volume and value of transactions using this technique have yet to achieve levels that are either profitable or self-sustaining.

 

Leasing has become increasingly attractive to both lessees and lessors because of its economic effectiveness, flexibility and accessibility in comparison to bank finance. Most large Russian banks have leasing programs that they offer their clients in such cases, and there is a growing list of foreign leasing companies operating in Russia that can offer Russian clients leasing terms for imported equipment. Aviation, energy, mining, construction, transportation, pharmaceutical, forestry and fishing industries equipment, which may be too expensive for Russian customers to purchase, are often leased.

 

The use of barter, estimated to account for 70-80% of foreign transactions in the USSR, has declined to 1%-2%, because liquidity has generally improved in the banking sector as the economy has grown. Despite the decline in barter, financial intermediation in the banking sector remains generally weak. While barter transactions can be more complex than cash transactions, U.S. firms should not dismiss them, for they can be profitable and help a company win market share. As in cash transactions, companies are advised to stay engaged in all aspects of the deal, demand that commitments be met on schedule, and ensure contracts are in accordance with Russian law to avoid tax and other problems

 

How Does the Banking System Operate

Macroeconomic stability and economic growth have contributed to the rapid development of the banking sector in the last several years. The rehabilitation of bank payment settlement systems, an increase in income and savings, and the growth of demand for investment resources are driving improvements in the financial services sector. In the last several years, the Central Bank of Russia has achieved visible results in banking sector reform, which is being carried out in order to increase sustainability, functionality, transparency and reliability of the banking system.

 

In November 2006, Russia and the U.S. signed their WTO (World Trade Organization) Bilateral Agreement, a major step in Russia’s accession to the WTO. As part of this Agreement, Russia pledged to allow foreign ownership to account for as much as 70% of the country’s total banking sector equity. Previously, Russia had the prerogative to legislate the limit on foreign capital to 50% of total equity. However, at the time the bilateral agreement was signed, foreign equity accounted for 20% of the total. Russia’s pledge essentially “grandfathered” in that 20% and provided new foreign equity the potential to absorb/account for an additional 50% of total banking sector equity.

 

It is expected that as U.S. banks increase their presence in the country, they will bring more of their services to the Russian market.

 

Under the current legislation, foreign banks, e.g., Citibank and Raiffeisenbank, can operate in Russia only as subsidiaries. They are subject to all Central Bank regulations -- for instance, on capital and lending -- that apply to the banking sector. Branch banking by foreign banks is limited to their Russian subsidiaries.

 

U.S. banks have increased their share of the Russian banking market. Citibank has been present in the Russian market for many years, but has recently increased its presence via aggressive expansion into retail banking. GE Capital has also entered the retail banking sector. Morgan Stanley (which has been involved in investment counseling via a representative office) has a subsidiary bank involved in investment banking.

 

Russian banks are also playing a more effective and normal role in the economy by collecting savings from an increasing number of depositors and distributing them through loans and other types of financing to more productive uses. While the self-serving “pocket banks” of major financial and industrial groups that in the past served their respective major clients are still common, the financial system is becoming more populated with normally functioning, financially stable banks.

 

Evidence of the growing capacity of Russian banks is the boom in consumer credit. While only 51% of Russian citizens are estimated to have bank accounts, the market for consumer and car credits, as well as the number of credit cards, was estimated to have grown between 56% and 70% in 2006, by 50% again 2007, and 40% in 2008. In absolute terms the consumer credit market stood at about US $110 billion, car credits at US $20 billion and credit cards at US $10 billion in 2008.

 

Despite these recent improvements, the Russian banking system is still evolving in terms of being able to meet the capital and credit needs of a rapidly growing and dynamic market economy. However, a company doing business in Russia can easily access an expanding range of basic banking services offered by the larger commercial banks. A functioning banking sector is slowly emerging in Russia.

 

During the early 1990s a large number of small, poorly regulated and poorly managed banks appeared in Russia, and by 1995 the country had over 2,600 banks. Near the end of 2007, there were approximately 1,250 banks in Russia, down from 1,300 at the end of 2006. Approximately 60 banks are 100% foreign-owned. The number of small banks is gradually decreasing due to insolvency and consolidation.

 

The Central Bank of Russia’s priorities include the strengthening of bank supervision, adopting International Accounting Standards, and expanding the scope of the deposit insurance system. The Deposit Insurance Agency similar to the U.S. Federal Deposit Insurance Corporation was introduced starting in the first half of 2004. All Russian banks, which hold private deposits, are required to apply for certification in order to participate in this system. Most applicants are expected to gain entry into the system eventually. While the level of insurance is still small per depositor, this is an important step towards increasing public confidence in the system.

 

Private deposits held in banks in Russia reached RR 5.5 trillion ($207 billion) at the end of October 2008 (latest data available at this writing) compared to RR 5.2 trillion ($211 billion) at the end of 2007. High-profile defaults on the interbank market in September 2008 generated widespread uncertainty across the banking sector. Until that point, however, deposits had been growing approximately RR100 billion per month, reflecting confidence in the banking sector and in what had been a strengthening ruble. The onset of the economic crisis has, again, underscored the dominance of state banks in the sector. State-owned Sberbank remains the country’s largest bank by assets, while state-owned VTB and Gazprombank are the second- and third-largest, respectively. Commercial lending dominates, but loans to households are beginning to grow. Limited choices and tradeoffs confront companies choosing a bank in Russia. There are three main types of bank: a foreign-owned subsidiary, a state-owned Russian bank, or an array of Russian private commercial banks.

 

Foreign-Exchange Controls

On July 1, 2006, the Government of the Russian Federation liberalized its capital account, thereby lifting the remaining restrictions on capital inflows and outflows. The move capped a period of gradual steps toward allowing the free flow of capital into and out of the country. Mandatory reserves, preliminary registration, and special accounts are no longer required. The Central Bank, however, maintains certain procedural requirements that resident and non-resident parties to a transaction must observe.

 

U.S. Banks and Local Correspondent Banks

Most foreign businesses prefer to deal with foreign-owned banks, as they are more stable, more experienced and generally offer higher levels of service. Until recently, these banks concentrated their activity in highly profitable financial markets and were not interested in commercial banking. However, strong demand has drawn them into diversifying their services to include foreign trade transactions and commercial banking. Many foreign banks now provide regular commercial services including accounts, transfers, currency exchange, credit, documentary operations, letters of credit, and trade financing. Some of these banks will establish individual accounts for non-residents and employees of their institutional clientele.

 

Unfortunately, the lack of nationwide branches makes these services largely unavailable to customers operating outside the major metropolitan centers of Moscow and St. Petersburg. U.S. banks have increased their share of the Russian banking market. As mentioned earlier, Citibank has been present in the Russian market for many years, but has recently increased its presence via aggressive expansion into retail banking. GE Money Bank has also made inroads in the sector.

 

State Owned Banks

Two state-controlled banks, Sberbank and Vneshtorgbank (VTB), continue to dominate the corporate and retail banking sectors in Russia. The state also controls a number of smaller banks. The Russian government has repeatedly urged Russia's state-controlled banks to modernize in order to play a more active role in the economy. These public criticisms aside, state banks have been the primary beneficiaries of the government’s efforts to supply short- and long-term liquidity to the economy to mitigate the economic crisis.

 

Russian Private Commercial Banks

Other viable Russian banks include emerging service-oriented banks and large banks owned by financial-industrial groups. The 1998 crisis severely impacted the major Russian banks, closing about 15 of the largest and leaving others in a weakened state and needing reorganization.

 

The most aggressive component of the Russian banking system is a group of new banks that grew larger following the 1998 crisis. They are competitive and likely to remain customer oriented and to find creative solutions to Russia's business complexities. A potential weakness is their limited capacity to provide services comparable to those of large international banks. Furthermore, they lack nationwide coverage.

 

The top Russian banks, ranked by net assets as of early 2009 are:

• Sberbank

• Gazprombank

• Russian Agricultural Bank

• Bank of Moscow

• Alfa-Bank

• Raiffeisenbank

• UniCredit Bank

• VTB

• Rosbank

• Uralsib

• Promsvyazbank

• MDM Bank

• NOMOS-BANK

• Citibank

• Petrocommerce

 

Project Financing

The Russian banking sector has largely recovered from the August 1998 economic crisis, although the situation in 2008 has uncovered some weaknesses, such as liquidity management and poor asset quality, which the Central Bank and Deposit Insurance Agency are striving to remedy. A mini-banking crisis during the first half of 2004 was handled fairly quickly. The rate of increase in the volume of loans provided by banks exceeds GDP growth. A number of western investment banks and venture funds have steadily increased the size of their project finance portfolios. Additionally, a number of bilateral and multilateral financial institutions continue to facilitate trade and investment in both the public infrastructure and private sectors. However, the use of long-term, limited recourse project financing remains hampered by several difficulties. These factors include the immaturity of commercial legislation, poor contract enforcement, a lack of transparency in beneficial ownership, the inefficient process and high cost of collateralizing project assets, limited rights of debt and equity holders, and weak contractor performance requirements.

 

Since the U.S. Export-Import Bank (Ex-Im Bank) began lending to support U.S. exports to Russia in 1991, total authorizations have been US $4.8 billion (total exposure in Russia is currently over $750 million). Over the past several years, authorizations for Russia have averaged approximately US $240 million per year. Today, Ex-Im Bank's outstanding portfolio is in such sectors as oil & gas, mining, agriculture, and financial services.

 

In fiscal year 2008 (from October 2007 to September 2008), Ex-Im Bank authorized approximately $374 million worth of exports to Russia. Ex-Im Bank's business in Russia during this time remained concentrated in supporting sales of agricultural and manufacturing equipment.

 

Over the 75 years of its existence, the Bank has provided financing for an estimated US $500 billion in U.S. exports. In FY 2008 alone, Ex-Im Bank supported over US $14.4 billion in U.S. exports of which US $3.2 billion went to directly supporting small business transactions.

 

 

Read the full market research report


Posted: 04 January 2010

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