Foreign banks entry into the Russian market: motivation, entry modes and strategies

Victor GorshkovPhD candidate, Graduate School of Economics, Kyoto University

(Kyoto, Japan)August 3d , 2011

International Young Shcolars WorkshopKyoto University

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Background and motivation

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o Liberalization of policy measures in the 90th, financial sector as the priorityo 2003-2007 period of high economic growth in Russiao Does globalization(liberalization) of financial markets bring positive results for

the economic growth?o Analysis of financial liberalization with an accent on activity of foreign bankso Behavior of foreign banks on the Russian market

Outline of the presentation

1. General overview of the Russian banking sector and activity of foreign banks on the Russian market

2. Motivation of foreign banks

3. Entry modes and strategies of foreign banks in Russia

4. Conclusion & future research plan

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1.General overview of the Russian banking sector and activity of foreign banks

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Specific features of the Russian banking sector

o Strong government participation( government is a shareholder of approximately 200 banks)

o Some banks are strongly connected to financial industrial groups (Gazprom)

o The function of converting deposits into investments is not effectively working (companies tend to issue bonds or attract capital from foreign markets)

o Concentration towards large banks with the existence of many small banks

o Difficulties with attracting long-term borrowingso Revenue structure of banks is unbalanced (huge percentage of foreign

exchange profits)o Presence of foreign banks is increasing

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Russia positioned modernization as the priority goal for its development. For reaching this goal huge capital injections are needed for the economy. Despite the fact that during 2000-2008 financing of investment projects

increased up to 24%, in 2009 loans from banks amounted to only 7% in the whole structure of financing. Companies still tend to use government, equity and other kinds of financing

Structure of the banking sector(1)

o Activity of banks is licensed

o The number of banks is excessive

o Structure of the banking sector: 1) state-owned banks, 2)Russian-capital large banks, 3)Russian-capital medium and small banks, 4) foreign banks

Structure of the banking sector(2)

When compared to other countries, the number of banks in Russia is very excessive.

Number of banks in the world(2006) : USA - 7475, Germany – 2400, Russia – 1299, Australia – 882, France – 880, Andorra – 7, Estonia – 9, Turkmenistan – 11, Tajikistan – 11, Lithuania – 12, Canada – 70(2000), Singapore – 25(2000)

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o Following high economic growth, a lot of changes have been made in the banking sector

o Russian banking sector was formed on the base of the Soviet one (1990s- 5 sectorial banks – Sberbank, Foreign trade bank, Agricultural bank, Industrial bank, Housing and social welfare bank)

o During Soviet times these 5 banks were regulated and coordinated by Gozbank(state bank)

o December 2d, 1991 Federal Law “About banks and banking activity”

o 2011 – 1012 banks, 2926 branches, regional differences

Foreign investments into the banking sector

o Foreign share in banking assets is increasing, but the total level of foreign investments to financial sector is still very low and is amounted to 3-4 ％

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What is a foreign bank?

1. Definition given in the Russian Law. Some other countries use the same approach. Number of branches is not considered

2. When analyzing foreign banks’ motivation, modes of entry, etc. representative offices should be considered

3. Quantitative definition is used to define the share of foreign capital in the banking system of a particular country

4. Domestic banks with foreign capital participation of more than 50%

5. Domestic banks with foreign capital participation of less than 50%

Indicators for the evaluation of the foreign banks` activity

① Number of banks with foreign capital participation officially registered

② Sum of investments by non-residents to charter capital of the banking

sector

③ Share of non-residents in charter capital of the banking sector

④ Share of banks controlled by foreigners （ more than 50 ％） in total

assets of the banking sector

⑤ Share of banks controlled by foreigners （ more than 50 ％） in total

liabilities (capital) of the banking sector

⑥ Share of assets of banks with foreign participation in GDP

⑦ Share of capital (equity) of banks with foreign participation in GDP

⑧ Share of banks controlled by foreigners in different market segments

(loans, deposits, etc.)• 3 番目の指標は、ロシアにおける外資の参入制限に用いられて

いる• クロスボーダー融資のダイナミックスも外国銀行の活動を表

す

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Foreign banks entry: historical background

90s - capital liberalization, cross-border transactions are permitted at present (final stage of capital liberalization) , political confrontation towards activity of foreign banks

Strong intention of domestic protectionism of banking sector

Main restrictions ：¢ President act № 1924 dated by 17.11.1993 “About

prohibition of foreign banks` transactions with Russian companies and households “ ＝＞ abolished

¢ Limits of participation （ 90s-12 ％、ＷＴＯ negotiations – 50 ％）

¢ Factual prohibition of establishment of foreign banks’ branches

¢ Licensing system by CB Most foreign banks entering Russia established

subsidiaries and developed their branch networks through them

Representative offices of foreign banks Transactions like increase of equity, transfer/sale of

shares are subject to approval by CB

Merits and demerits of foreign capital participation in the Russian

banking sector

Merits

Import of new banking technologies

Management efficiency New banking products Competition between

banks 金融機関の競争銀行取引の透明性

Demerits

Low competition and efficiency level of Russian banks

Unfair competition External shocks and

capital flight

From conservatism to relative liberalism

Number of foreign banks and investment of non-residents into the banking sector(1)

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Investments to charter capital made by non-residents (million rubles)

Number of banks with foreign capital participation

Commercial banks with foreign capital share of more than 51%

Commercial banks with 100% foreign capital participation

Share of non-residents in charter capital of the banking sector

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Indicator 2005 2006 2007 2008 2009 2010 2011

Number of banks with foreign participation

131 136 153 202 221 226 220Equity(capital) investments made by non-residents （ million rubles ） 23 553.0 49 554.5 90 092.8 183 506.3 251 073.3 305 195.6 333 285,7Total capital of the banking sector 380 468 444 377 566 513 731 736 881 350 1 244 364 1 186 179Share of non-residents in total capital of the banking sector （％）　 6.19 11.15 15.90 25.08 28.49 24.53 28.10

Number of foreign banks and investment of non-residents into the banking sector (2)

Number of foreign banks and investment of non-residents into the banking sector (3)

Increase rate of foreign share in total charter capital of the banking sector (in comparison to 2005), %

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Share of foreign banks in major indicators of the banking sector

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2003 2004 2005 2006 2007 2008

2009

2010

2011

Number of banks with FPincl 、 share of more than 5

1 ％100% foreign share

123--

128--

131--

136--

1531352

2022363

2212676

2262682

2203180

Commercial banks with foreign participation of more than 51 ％Assets 8 ．

17.4 7.6 8.3 12.1 17.2 18.7 18.3 18.0

Equity （ Capital ） 7.1 6.6 7.8 9.3 12.7 15.7 17.3 17.0 19.1

Corporate loans (companies) 7.1 6.1 6.2 7.4 10.0 15.5 16.6 14.8 15.1

Private loans (households) 2.3 2.3 3.0 3.4 6.2 8.9 10.3 12.0 11.5

Commercial banks with 100% foreign participation

Assets 5.6 5.6 5.9 8.0 9.0 11.6 13.0 11.3 11.0

Equity （ Capital ） 5.4 5.4 6.3 9.0 10.1 11.1 12.2 11.0 12.1

Corporate loans (companies) 5.5 4.6 4.6 7.3 7.9 10.7 11.6 9.0 9.2

Private loans (households) 1.5 1.5 2.4 3.3 4.1 5.0 5.4 6.2 5.3

Foreign share in banking sector of selected economies: Estonia – 99%, Czech Republic – 97%, Lithuania – 77%, Poland – 70%, USA – 20%, Italy – 15%

ROE of Russian banks (3 years period, %)

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Russian banks ROE Foreign banks operating in Russia

ROE

Sberbank 30.1 Citybank 37.6

Vneshtorgbank 23.1 International Moscow Bank 39.5

Gazprombank 15.2 Raiffaisen 49.7

Alfa-bank 1.6 Eurofinance – Moskovsky Narodnij Bank

21.9

International Industrial Bank 1.9 Commerzbank 39.6

Rosbank 15.5 ABN AMRO 44.0

МDМ-bank 4.7 Deutsche Bank 35.5

Moscow bank 14.2 CFSB 31.1

ロシアの銀行と上手く競争できている

Revenue structure of the Russian banks (incl. FB)

Revenues from intermediary services are very low. Russian banking sector is not fulfilling the function of collecting deposits and converting them into investments. Most banking profits are

from foreign exchange operations17

18Raiffeisen bank (Austria)– “healthiness’ №1 　（ June, 2010 ）（ Source ） Expert 、 www.bankir.ru

Ratings of Russian banks(01.02.2011)

Assets Capital C. loans Private loans Deposits

2. Motivation of foreign banks

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Business strategy analysis of foreign banksBusiness strategy analysis of foreign banks

MotivationMotivation StrategyStrategy

Representative office Subsidiary Branch Joint-venture with the

Russian bank Minor shareholder

participation

Representative office Subsidiary Branch Joint-venture with the

Russian bank Minor shareholder

participation

Main aims of the paper ：o Quantitate and qualitative analyses of foreign banks on the Russian marketoExamination of motivation, forms of entry and strategies of foreign banks in Russia

Main aims of the paper ：o Quantitate and qualitative analyses of foreign banks on the Russian marketoExamination of motivation, forms of entry and strategies of foreign banks in Russia

Form of entryForm of entry

Organic growth Cherry-picking M&A

Organic growth Cherry-picking M&A

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Motivation of foreign banks’ entry into the Russian market （ 1 ）

o Motivation of entry into the Russian market is similar to the one in other developing and transition economy (push)

o Both PUSH and PULL reasons were justified o Multiple reasons for entry o Non-economic reasons for entry(? ）

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€21.0bn

€32.0bn

NET PROFITSBefore tax / extr items

€16.5bn

€28.4bn

€25.4bn

Sources: Central Banks and Unicredit-NE Research Network(1)Net Profit for the Banking Sector is before tax and extraordinary items.

CAGR ’05-’08

(local currency)

Net InterestIncome

Net non-interest income

Net revenues

Net profit(1)

Poland 10% 9% 9% 10%

Turkey 5% 10% 7% 14%

Croatia 4% 9% 6% 10%

Russia 24% 24% 24% 21%

Bulgaria 12% 14% 12% 13%

Czech R. 5% 9% 7% 7%

Hungary 7% 12% 9% 8%

Romania 10% 19% 15% 11%

Slovakia 1% 16% 7% 9%

CEE-9 13% 14% 13% 15%

Bulgaria2%

Czech R.7%

Poland13%

Romania3%Hungary

7%

Russia35%

Croatia3%

Turkey26%

Slovakia3%

% country over CEE-9 NetProfit(1) (2005)

€ bn

Motivation of foreign banks’ entry into the Russian market （ 2 ）

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3. Entry modes and strategies of foreign banks in Russia

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Forms of entry and strategy of foreign banks

Forms of entry Business strategy

Representative office organic growth

Subsidiary (Russian juridical company)

（ 100 ％ foreign capital participation banks are mostly common ）

Branch (allowed under the terms of current legislation, but “politically” not welcomed and there are no cases at

present)

Minor shareholder participation in 2010 – 118 banks （ more than 5

0% ）

M&A

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M&A in financial sector: recent trends

o 　 M&A in banking sector happen more and more often. M&A as the way to solve current problems of the Russian banking sector （ not sufficient capitalization, obsolete technology)

o 　 90s - restrictions on foreign capital participation, M&A were not common o 　 2000s – increase of M&A, investments to the real sector of the economy; share of M&A in

the financial sector （ 2004 － 3 ％、 2005 － 3 ％、 2006 － 7.1 ％、 2007 － 2.5 ％、 2008－ 9 ％、 2009 － 4 ％）

o 　２ 003-2004 　 - good economic performance, but latent period of M&A (Rybin), acquisition of medium banks

o 2005-2006 - open period of M&A, big banks acquisitions, retail banks, tiny banks o 　 2007 － 2008 - 　 positive dynamics 、 M&A by investment funds, foreign financial

institutionso 　 M&A between Russian banks

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Specific features of M&A in the Russian banking sector

A)The objects of M&A transactions are usually regional banks with strong regional

retail network (organic strategy growth is very expensive)

B)M&A of medium-sized banks is gradually changing to acquiring regional banks

C)Friendly M&A, hostile M&A are not common due to low transparency of Russian

banks and complicated legislative procedure

D)Domestic M&A are very strong

E)Outbound M&A by Russian banks (post-Soviet countries)

＝＞　 foreign banks having access to the wide capital network of their parent banks

can increase M&A in the near future. Negotiations for entering WTO can facilitate

this process

Government plans to privatize some banks until 2015 (27.10.2010 Nikkei Shimbun) Sberbank, Vneshtorgbank, Agricultural Bank

Activity of foreign banks in Russia (summary 1)

Integration of banking system into the world financial market is a very important step of the development of the national banking system; foreign banks can positively effect on this process. Particularly in case of Russia there is a problem of undercapitalization, foreign banks have all the capabilities to solve it.

Russian market is very attractive and potentially profitable for foreign banks

Integration into the world financial markets is obvious, but the state still has a dominating position in the industry

Entry motivation ： from “follower”startegy based on political and non-economic reasoning of entry to the “leadership”approach, PUSH/PULL

Entry mode ：　 subsidiary, from organic growth to

　　 M&A

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Recent trends in activity of foreign banks in Russia ：① increase of foreign share in assets and liabilities (capital) ②100 ％　 foreign share banks are more common (ownership problem) ③universalization of banking services (from supporting foreign customers to corporate lending, development of retail banking, individual transactions, consulting, credit card business) ④ world economic crisis didn’t influence considerably on the strategies of foreign banks in Russia ⑤ form “venture business”, “high risk-high return” concepts to “same market as the others” way of thinking (some banks still being observers though) 、⑥　 increasing competition with Russian banks, problems with efficiency ＝＞ positive trend ＝＞ further increase of foreign share??

Problems of foreign banks in Russia ：　① offshore capital procurement by Russian companies ② restrictions (branches, limit of foreign participation share) ③ non-transparency of the Russian banking system, problem of trust towards investors 　 ④　 traditional/non-traditional banking activity – most FB are making profits from foreign exchange!

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Activity of foreign banks in Russia (summary 2)

4. Conclusion and future research plans

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MORE THAN 1,000 € BLN MARKET IN TERMS OF TOTAL ASSETS, WITH LARGELY INTERNATIONAL BANKS AND STILL IMPORTANT GROWTH OPPORTUNITIES

2005i

No. of banks(1)Market share Total Assets(3) Total Gross Loans Total Deposits

Foreign banks TOP 3(2) € bln % of GDP € bln % of GDP € bln % of GDP

EU Members

Poland 61(4) 70%(4) 37%(4) 152 60% 77 30% 99 39%

Hungary 34 84%(5) 38% 75 87% 46 53% 37 43%

Czech Republic 36 85%(6) 56% 102 99% 40 39% 65 63%

Slovakia 23 98% 47% 37 96% 14 36% 21 55%

Slovenia 22(6) 19%(6) 50% 29 107% 15 56% 16 57%

Estonia 13 99% 88% 12 112% 6 56% 5 47%

Latvia 23 58% 54% 16(7) 123% 7 55% 4 31%

Lithuania 12 86%(8) 67% 13 63% 7 32% 6 28%

EU Candidates

Croatia 34 91% 54% 35 114% 21 68% 19 61%

Bulgaria 34 76% 34%(9) 17 78% 9 43% 10 49%

Romania 39 88%(10) 50%(11) 35(7) 45% 17 22% 22 28%

Turkey 31 19% 45% 249 81% 96(16) 31% 152 50%

Others

Russia 1,205(15) 9% 39% 285(7) 45% 159 25% 156 25%

Serbia 40(12) 66% 36% 9 48% 5 27% 5 25%

Bosnia-Herzegovina 33 89%/98%(13) 54%(14) 6(7) 81% 4 51% 4 47%

Ukraine 165 n.a. n.a. 36 50% 23 32% 18 25%

Total CEE 17 1,805 46%(17) 50%(18) 1,108 66% 545 33% 638 38%

Euro Area 6,403(6) 25%(6) - 17,895 224% 9,141(16

)

115% 7,395 93%

Future trends of foreign banks in Russia (1)

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Restrictions on capital transactions are the same as in some developed countries

Relatively liberalized banking system , no hindrance in terms of legislation for foreign banks. But reality is a bit different ！

Foreign banks have already entered and been operating on the Russian market ＝＞what are the benefits for the Russian banking sector? Is there a need to restrict foreign investments into the banking sector?

After crisis(1998) Russian companies were mostly saved by state-owned banks and foreign banks, therefore it is possible to assume that further development of the banking sector will be strongly connected with state and foreign banks

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Future trends of foreign banks in Russia (2)

Changes in banking sector ：　① East Europe scenario （ Privatization ）② Dominance of state banks ③Development of private domestic banks

Cross-border investments?

o Cross-border lending as an indicator of

liberalization of capital markets

o Direct foreign lending vs. foreign lending

through domestic subsidiaries (offshore vs.

onshore lending)

o Russian public sector and offshore lending

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Concluding remarks Some positive results of financial globalization on Russian banking

sector are obvious At present globalization in financial sphere and development of the

banking sector do not stipulate conditions for the higher economic growth

Foreign bank entry and banking regulatory reform go well side by side Bank privatization and foreign bank entry Foreign bank entry in Russia: surprisingly rapid or surprisingly late? Foreign banks in Russia: lenders of last resort???

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Russian banking system as a whole is not engaged in fulfilling traditional banking functions (deposits, lending), neither in developing new so called

non-traditional banking functions (securitization, investment banking). Banks operating in Russia, including the foreign ones, make revenues from the foreign exchange operations. Thus, in a sense the system is

abnormal and FB entering Russia are made to operate in these conditions

Furture research plans

Japanese banks’ entry into the Russian market

Foreign banks’ activity in Japan

Foreign banks in Japan and Russia: comparative

analysis

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Thank you for your attention!

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