A Good Chance not to Pour Money down the Drain

26 march 2007 года

An idea of establishing a full-fledged Russian Development Bank put forward by Vladimir Putin a year ago is soon to be put into effect. In contrast to the experiments of the 1990s ЁC early 2000s the current attempt to establish a fully functional development institution has a good chance for success.

Alexandr Ivanter, Oleg Solntsev

The Development Bankl should be a unique institution. So we should lay first of all a solid foundation for it. If we build a shaky foundation there will be a wicked witch (Baba Yaga) inside it and weЎЇll never know what she is up to.     

From Russian Prime Minister Mikhail FradkovЎЇs speech at a meeting of the Government on December 14, 2006.

On February 14, the State Duma passed a Bill Ў°On Establishing a Development BankЎ± in the first reading. It will be set up by merging Vnesheconombank, its subsidiary Roseximbank and the State Russian Development Bank. The new BankЎЇs authorized capital will amount to at least 70 billion rubles. The fact that one of the BillЎЇs provision stipulates that the Russian Prime Minister will chair the BankЎЇs supervisory board gives it high political status. The Government favored the idea to replenish the BankЎЇs resource base with the Investment FundЎЇs financial resources and this will boost its financial might.

For the Developmen Bank to operate efficiently, business, regions and the public should be represented in its management bodies. Only in this case, weЎЇll be able to select lines of development the Bank encourages. If we can get this done, the Development Bank could become the third (after the Finance Ministry and the Central Bank) RussiaЎЇs financial authority giving top priority to financing long-term, risky, socially meaningful projects rather than to fiscal exercise and total liquidity sterilization as is the case with the fist two financial authorities.

Parade of Powers

The Development BankЎЇs main objectives are to fund infrastructure projects, support mid and small-size business (through refinancing banks that extend credits to finance it), high-technology production facilities, and Russian exports. According to Deputy Economic Development and Trade Minister Kirill Androsov, who presented the Bill and a plenary session of the State Duma, the Development Bank should be responsible for coordinating all the new development institutions, Special Economic Zones, the Russian Venture Company and the Investment Fund.

Ў°ItЎЇs clear to us that if the Bill Ў°On establishing Development BankЎ± becomes law, we should change the Investment FundЎЇs operating procedures fundamentally, said Vnesheconombak Chairman Vladimir Dmitriev to Expert Business Journal. Ў°We believe that the Development Bank should perform its inherent functions: it should engage in examining and supporting investment projects among other things by way of participating in the capital of companies responsible for carrying out projects.

The amount of all government investments in the 2007 budget exceeded 1 trillion rubles.

Now the Ministry of Economic Development and Trade is solely responsible for distributing government investments through the federal selective investment program, federal target programs, the Investment Fund and the mechanism for supporting exports. The Bill Ў°On Establishing a Development BankЎ± authorizes the Bank to perform agentЎЇs functions to support exports and includes an additional clause providing for the Bank to carry out programs within the framework of federal target programs and the federal selective investment program. Thus, it is most likely that as early as next year (this year will take to get the law passed and establish organizational status of the new institution) the Development Bank will engage in examining, financing, guaranteeing and supporting the lionЎЇs share of projects to be funded through raising government investments.

But this does not mean that the Development Bank would be just a treasury institution responsible for distributing budget funds. Ў°According to conventional wisdom, the Development Bank should be in charge of enforcing government investments, says consulting group Banks. Finances. Investments General Director and former Central Bank Deputy Chairman Alexandr Khandruev. Ў°It is standard international practice that development banks use budget funds only partially. Besides, they tend to issue and place their securities in the market and fund their business using their own capital and profits. This sort of funding scheme is taken to be used for the Russian Development Bank.Ў±

Speaking at the Fourth Krasnoyarsk Economical Forum Vladimir Dmitriev said that over a period of fives years the Development BankЎЇs assets would increase from 8.9 billion to 41.8 billion US dollars. Until the year 2011, the Bank will invest 35 billion dollars in the infrastructure, power engineering industry, housing utility services, agriculture and military industrial complex. Considering that most projects are private public ones, Mr.Dmitriev estimates that for each ruble of government investments there will be three rubles of private investments and in Special Economic Zones and techno parks - 4-5 rubles. The Bank will channel the bulk of financial resources to regions through its authorized banks to be responsible for exercising control over project budgets and project implementation.

Nevertheless, VEBЎЇs Chairman is realistic about the potential and expertise of specialists from the state banks to be merged and is aware that they are not limitless. For example, VEB has unique expertise in examining and funding major industrial projects (DmitrievЎЇs favourate examples are VAZ and KamaZ costruction projects) but it lacks this sort of expertise in insurance business. Ў°Let me remind you that the proposal to get the Bank involved in performing insurance functions and among other things in insuring major export deals was made by the Government in the course of discussing the first version of the Bill Ў°On Establishing a Development Bank,ЎЇ said Vladimir Dmitriev to the Expert Business Journal. These functions are new to both VEB and Roseximbank and we canЎЇt pride ourselves on being competent and experienced enough in this line of business. So, we canЎЇt rule out that a separate institution will be responsible for insuring exports. It will be closely linked to the Development Bank but it wonЎЇt be its organizational subdivision. By the way, in foreign countries these functions are performed by independent institutions such as Hermes in Germany and SACE in Italy.

Nonprofit Nonbank Institution

The Development Bank like VEB will operate without a banking license. It has status as a state-run corporation and this means that its activity is not subject to the Central BankЎЇs regulation and supervision. But the executive government will excise strict control over this institution. In its day-to-day financial and investment business the Development Bank will be guided by the provisions of a memorandum of financial policy worked out and approved by the Government of the Russian Federation annually. Moreover, the countryЎЇs President appoints chairman of the Development Bank on Prime MinisterЎЇs recommendation and Prime Minister himself becomes ex- officio Chairman of the Bank Management Board. It was Mr. Fradkov himself who ordered to include this provision in the Bill at a meeting of the Government causing unfounded rumors: ill wishers got personal at once linking the PremierЎЇs initiative to the fact that his elder son Petr Fradkov heads VEBЎЇs Structural Financing Department. To our mind, all these malicious rumors are misplaced. International practice shows that it is very important for development banks to enjoy massive support of the stateЎЇs ledership.

In terms of law, state corporation status of the new financial institution means that it should engage in nonprofit activity. But there is no doubt that the Development Bank will make financial resources available on a repayable, prompt and paid basis and generate profits from its business (or sustain losses, depending on its performance). Another matter is that the Bank is authorized to engage in entrepreneurial activity ЁC this is stipulated in the Bill (clause 3, point2) - in so far as it seeks to achieve objectives set by this Law (that is to say, is designed to make the Russian economy more competitive, develop infrastructure, innovations, support exports and small and mid-size business).

Profits generated by the Bank are not to be distributed among its founders, as they are assumed to be fully capitalized. Although the procedure for taxing the Development BankЎЇs profits has not been set forth in the Bill, the Ministry of Economic Development and Trade is unlikely to make any exceptions for the Development Bank.  Maybe, this issue will be debated in the future. For example, German KfW, which served as a model for those responsible for formulating the concept of Russian Development Bank, is exempt by law from any taxes, duties and levies.

Ў°Why are they setting up nothing more and nothing less than a bank and an unusual one at that rather than any other establishment, say, a ministry? - asks senior researcher Yakov Pappe from the Institute of National Economy Forecasting. Ў°Because the state is well aware that we should fund only profitable projects. A state bank is not a sack of money with a minister sitting on it but a way to conduct expertЎЇs non-bureaucratic examination of projects. It operates at its own risk but it is the state that determines its lines of business. In this case, it will resemble all major state-run businesses, for example Gazprom which is quite a profit-making company but a decision of whether to purchase the Sakhalin Project or not is to be made by the Kremlin rather than by Gazprom.

LetЎЇs Invest Pensions in Hydropower Stations, Roads and Ports

Under the Bill, during a transitional period (with open-ended date, its time frame is yet to be by set by the Government) the Development Bank will perform VEBЎЇs special functions. It will be responsible for managing Soviet-era foreign debt and a part of Russian debt as well as for trust management of pension savings funds.

Now, VEB manages about 280 billion rubles worth of pension savings funds, with last yearЎЇs yields from managing them amounting to nothing more than 5.67 %. Ў°We achieved very low profitability as we are authorized to invest pension funds only in government securities,Ў± complained Mr. Dmitriev in Krasnoyarsk. He said that a range of instruments in which pension funds can be invested should be expanded. Ў°Specifically, it can include mortgage securities not secured by government guarantees,Ў± said Mr. Dmitriev to Expert Business Journal. Ў°In our opinion, we donЎЇt need these guarantees, as it is standard practice that mortgage securities are secured against collateral as a requirement for obtaining a credit. Besides we think that in terms of risks it would be appropriate to invest pension savings funds in such instruments as foreign corporate issuersЎЇ securities since they have the highest reliability rating. But strategically, we find it more expedient to establish a mechanism for using long pension money inside the country. The money could be invested in special long-term bonds issued to bankroll specific infrastructure projects against the stateЎЇs guarantees. In this respect, western best practices are in place. But we are not sure that yields from such investments would be at least on par with inflation.Ў± Ў°Inflation tends to change dramatically,Ў± says Alexandr Khandruev. Ў°Three years from now, we can reduce inflation to four-six percent. Then, yields from infrastructure investments may well exceed inflation rate and amount to five-eight percent.Ў±

Heavyweight in Full View

According to VnesheconombankЎЇs annual report for the year 2005 (the more updated information about the Bank is closed) as of January 1, 2006, its assets amounted to 3685 billion rubles (128 billion dollars and this amount exceeds SberbankЎЇs assets), and 90% of them as estimated by Expert Business Journal accounts for debt assets of the former Soviet Union and Russia. The total amount of all Russian banksЎЇ assets (minus VEB) amounted to 295 billion dollars as of the same date.

VEBЎЇs own capital amounted to 15.9 billion rubles as of the same date; its balance profit was 6.3 billion rubles in 2005. By capital and profit VEB ranked 10th among Russian commercial banks. By the amount of its loan portfolio (51.8 billion rubles, 40% of credits were extended for more than three years) VEB ranks 15th among commercial banks. By the amount of balances in natural personsЎЇ accounts (4.74 billion rubles) the Bank is behind the fist thirty banks. VEBЎЇs capital profitability rate is 40.8% (with average rate for Russian banks being 21% and for European banks ЁC 12-15%). The information about the number of the BankЎЇs employees has not been made available.

VEBЎЇs foreign borrowings amounted to 2 billion dollars as of the end of the year before last including 500 million worth of the syndicated loan. The BankЎЇs own securities portfolio (minus pension savings funds under trust management) amounts to 52.6 billion rubles. The Bank services 2.5 thousand legal entities - nonfinancial companies. The BankЎЇs largest customers include such foreign economic companies as Atomstroyexport, Zarubezhvodstroy, Mashinmport, Tekhnopromexport and a number of Russian major industrial companies. VEBЎЇs list of strategic industrial priorities includes high-technology industries including aircraft building, shipbuilding nuclear power industry and telecommunications. The total amount of tied credit lines opened for VEB in 2005 was 549 million dollars and 375 million euros. Foreign trade transaction certificates were issued for the total amount of 15.9 billion dollars. VEB funded the largest investment projects such as MASH-3 (§®§Ў§є-3), RRJ and the oil terminal in Ust Luga.

As of the beginning of 2006, VEB had on its balance sheet about 10 billion dollars in Russian companiesЎЇ debts to the state. VEB is responsible for settling these debts and it manages to settle debts worth about 1 billion dollars per year.

Pension portfolio funds under trust management amounted to 176.5 billion rubles as of January1, 2006; yields from managing them amounted to 14.46 billion rubles for the year 2005, the yields were 12.22% per annum and they exceeded inflation rate of 10.9%. As of January 1, 2007, pension savings funds amounted to 276 billion rubles but the yields (5.76%) from managing them were way below inflation.

False Starts

As early as in1992 the Government founded the Russian Bank for Reconstruction and Development with its own capital of 640 million rubles. The Bank was conceived to raise credits from international financial institutions and use them for project financing. Investment funds were intended for implementing structural reforms and developing high-technology industries. But all these daring plans fell through. By 1995 the Bank was transformed into a commercial bank with a small government stake. After a number of conflicts between private shareholders and the 1998 financial crisis the Bank was declared bankrupt and liquidated.

The Russian Development Bank established in 2000 proved to be more viable and effective. It funds small-size business in the regions (through partner banks, its loan portfolio now amounts to about to 8 billion rubles). Long-term loans (in excess of three years) account for the most part of its corporate loan portfolio. The Bank participated in a number of high-profile investment projects aimed at (modernizing AvtoVAZ, financing scientific production association Saturn and acting as a technical consultant upon placing financial resources of the Investment Fund etc.).

But as far as the Russian Development Bank is concerned we canЎЇt say that it lived up to the original objectives. Fist of all, its scope of business is rather limited and there is no doubt that it does not exert any systematic effect o the Russian economy. The BankЎЇs assets are less than 1 billion dollars (0.2% of aggregate assets) and by this indicator it ranks behind fifty largest Russian banks.

Since its foundation the BankЎЇs main lines of business have been almost no different from those of any commercial bank. The Bank invests the bulk of its assets in market instruments on the interbank market. They include government, corporate and foreign securities. Up to 2005, most of resources raised accounted for its own capital accumulated by way of receiving budget contributions. Due to the favorable foreign economic conditions in the past two years, the Bank started to raise funds abroad.

Lost Momentum

Two years ago the Ministry of Economic Development and Trade started a no-joke conflict for the right to set up a Development Bank and determine its scope of responsibility. It banked on the Russian Development Bank. In spring 2005, Herman GrefЎЇs deputy Vitaly Saveljev was appointed as Russian Development Bank Supervisory Council Chairman. And in December that year another GrefЎЇs deputy, a thirty-year old financier Yury Isaev, replaced Tatiana Ryskina, the Bank Board Chairman, Mikhail KasyanovЎЇs protЁ¦gЁ¦, who had been the BankЎЇs Chairman since its foundation.  Within ten years Yury Isaev made a brilliant career advancing from an economic analyst to the Board Chairman of Ў°Rossiisky CreditЎ± and then of its post crisis alter ego, Impex Bank.     

The Russian Development Bank was active in lobbing for a Development Bank concept alternative to that of VEB. The concept provided for establishing a Development Bank incorporating three separate legal entities, namely VEB, the Russian Development Bank and Roseximbank, and it was to be managed by a single company. In this case each of three constituent banks was to retain its legal organizational structure. The idea was that the latter two banks would continue to operate maintaining their existing status as first-tier banks entitled to refinance commercial banks under special programs.

However, the idea of decentralizing government funds to be channeled to a development institution was rejected. In last yearЎЇs summer Yury Isaev left the Bank and stared to work as Dynamo Sports Club Financial Director. Vneshtorgbank Vice President Sergey Kryukov was appointed as Chairman of the Russian Development Bank. Earlier, he worked under Vladimir Dmitriev when the latter was VTB First Deputy Chairman. Thus, the battle between VEB and the Russian Development Bank for ideas and personnel ended with the latter suffering a complete defeat. The bureaucratic squabble resulted in the lost momentum.

The establishment of the state-run corporation declared by President Putin in January 2006 was brought forward to the year 2007.

Transparency, Control, Representation

Basically, we have already formed a solid basis for a major Russian Development Bank to operate effectively. The budgetary Investment Fund is in place and operating. As far as the pension system is concerned, the amount of surplus pension savings funds is on the rise and a relatively small market for government securities canЎЇt absorb it, and this makes it necessary to invest these funds in alternative long-term market instruments with an acceptable level of risks. The current macroeconomic and financial stability of the Russian economy is high as ever. Foreign economic budgetary and debt equilibrium indicator is one of the best among countries with emerging markets.

Business behavior pattern has changed dramatically. We canЎЇt use the Russian Development BankЎЇs funds effectively to finance investment projects in the most effective way without sharing risks with private partners.

It is most important, that in addition to the mentioned basic conditions Russia used a model of second-tier bank, which is not supposed to compete with commercial banks neither in raising, nor in placing financial funds, with this bank operating within a special legal and regulatory network. The idea of establishing such a network is to enable the Development Bank to finance major and risky projects by securing stability through applying preferential capitalization mechanisms. The bulk of the most successful foreign banks are using this model for example, the abovementioned German KfW, Brazilian BNDES, the Japan Development Bank and the Mexican National Financial Corporation and others. For the most part, due to the assistance of this Brazilian Development Bank the worldЎЇs known Brazilian aircraft maker, Embraer, managed to overcome a protracted crisis and build a family of regional jets, ERJ-145/135, making itself a name in the world market.

Foreign best practices show that a development bank is an institution in need of increased public and internal control. Operational risks (that is, risks of making mistakes and committing abuses) are as high as financial ones. To counter these risks we should establish efficient internal control services, conduct independent experts examination and audit, rate managerЎЇs and subdivisionsЎЇ performance and get outside supervisory bodies to assess the BankЎЇs overall performance through benchmarking. In this case, we mean that the BankЎЇs performance and costs should be compared with those of foreign banks seeking to achieve similar objectives under similar conditions.

In our opinion, control mechanisms set forth in the Bill on Establishing a Development Bank should be improved, that is, powers of the internal control service and the procedure for conducting independent expertЎЇs examinations and audits should be defined in a more clear-cut way. Ў°In order to boost the Development BankЎЇs transparency it wouldnЎЇt be bad if corporate governance rating would be assigned to it by leading rating agencies,Ў± ЁC says Alexandr Handruev from Ў°Banks. Finances. Investments.Ў±

Furthermore, we find it very important to establish organizational mechanisms for enabling the public, business and regions to participate in formulating the Development BankЎЇs policy. Today, we canЎЇt identify properly top priorities of industrial policies without maintaining regular direct and feedback ties with those for the sake of whom these policies are pursued.       

We donЎЇt think that this sort of representation (in the BankЎЇs Supervisory Council) should be binding by law. WeЎЇd better establish certain Ў°customs and traditionsЎ±. For example some members of the BankЎЇs Supervisory Council could be appointed on the Presidential State CouncilЎЇs recommendation thus securing the representation of the regions. Other members of the Supervisory Council may be appointed on the recommendation of the National Council for Competitiveness and other representative associations such as the Russian Union of Industrialists and Entrepreneurs, the Russian Chamber of Trade and Industry, OPORy, Delovaya Rossia, the Association of Russian Banks.

Eketerina Shokhina contributed to this article

Expert #8 (549) of February 28, 2007



Principles of Syndication

27 february 2007 года

Vremya Novostey,  February 27, 2007

We have shown that we are in a position to raise considerable funds at record-low rates”

The potential of such financial instruments as syndicated credits is becoming increasingly attractive both to banks and to borrowers. The volumes of the Russian syndicated credit market for financial institutions are on the steady rise: from 2004 to 2006 they more than doubled. The pluses of these financial instruments from the point of view of creditors are easy to understand: they help to reduce risks, diversify loan portfolio and achieve high profitability. But best practices in syndicated banking are just beginning to evolve.

Vnesheconombank is an active market maker in the syndicated market and it acts both as a creditor and a borrower. The fact that the Bank managed to attract syndicated credits twice became highly symbolic for the market: in July 2005, the Bank received a 500-million dollar credit and a year later – an 800-million dollar credit for a three-year period at LIBOR+0.35% per annum. Meanwhile, in 2006, the Bank participated in 8 syndicated credits and the total volume of its participation in these transactions exceeded 30 million US dollars.

Crucial issues relating to the development of syndicated credit market were dealt with at the corporate workshop “Syndicated Lending. Theory and Practice” organized by Vnesheconombank. Together with Vnesheconombank employees the workshop was attended by representatives of 20 Russian and foreign banks and law firms.

Representatives of Dresdner Kleinwort, Bank Austria Creditanstalt, Deutsche Bank, Raiffeisen Zentralbank Osterreich, Vneshtorgbank, as well as such law firms as Bаker&McKenzie and Salans gave master classes. Those who participated in the workshop said that while greater use of syndicated credit transactions is a highly promising and rapidly expanding line of business in Russia it is still hindered by the lack of practical experience in conducting transactions, the absence of special regulation and the limited number of syndicated market makers. Director of Vnesheconombank’s Financial Institutions Department Alexandr Zelenov told Vremya Novostey about the way the Russian syndicated lending sector is developing.

-- What are the special features of conducting syndicated lending transactions in Russia, is there an adequate legal and regulatory framework in this banking sector?

- In fact, there are some special features. There are no separate legislative acts to regulate the syndicated credit market. And in such legislative acts as, for example, the Civil Code these transactions are regulated indirectly as these acts set out only general requirements.

Normative regulation is rather contradictory. Here I mean discrepancies between Bank of Russia regulatory documents and the Loan Market Association’s standard credit documentation applied by foreign credit arrangers. As a consequence, the established standard practice in the Russian syndicated credit market is that agreements made are not fully in line with bank of Russia regulatory standards. And in their reports, foreign lawyers state that regulatory standards themselves are not binding.

In addition to the inadequate regulatory network as a special feature of the Russian syndicated credit market, I would also like to mention the absence of judicial practice, standard credit documentation and generally accepted business principles.

- Judging by the transactions made, Russia banks and companies prefer to attract syndicated credits from foreign syndicates and have foreign credit arrangers. What’s the reason for it? Is it because Russian financial institutions are not experienced enough?

- Nothing of the kind. Although Russian financial institutions haven’t been working in this banking sector for along time, they have acquired appropriate expertise in attracting syndicated credits both for Russian and CIS borrowers. As an example I’d like to mention transactions arranged by VTB, International Moscow Bank and the Bank of Moscow. Lately Vnesheconombank has become an active participant in syndicated credits.

Nevertheless, foreign banks are still in the lead of arranging syndicated credit transactions. The fact is that credit arrangers have the largest share of participation in syndicated credits. Foreign arrangers’ yields are relatively high and this allows them to participate in credits at a rate in excess of traditional ten percent of the credit amount.

Most Russian banks’ yields from participating in syndicated credits are rather low. And syndicated credits’ rates for such banks as Vnesheconombank, VTB (the Russian Bank of Foreign Trade) and Sberbank (the Russian Savings Bank) are so low as to make them unattractive to Russian banks even with commissions for arranging transactions. 

- What are the benefits of syndicated lending now that Russian banks do not have problem attracting credit resources from a single source?

- Application of maximum risk rates for one borrower or a group of tied borrowers as well as limits established by banks do not allow them to extend considerable funds to a single borrower and that was one of the reasons for the syndicated credit market to develop.

What’s more, in principle, it’s easier to attract one credit from 27 banks as Vnesheconombank did it in 2006 despite all the problems associated with this business than 27 separate credits for the same amount and expenses on attracting credits in the second case would be higher. It should be remembered that such a deal is made public. Bilateral credits tend to go unnoticed for a wide range of investors whereas syndicated credits are made public. In the course of syndication, credit arrangers and the borrower involve many creditors who in the end might not participate in the credit but they get to know the borrower better. That is why for many banks a syndicated credit is the first step towards issuing eurobonds and conducting IPO.

- How does Vnesheconombank see its role in promoting syndicated lending in the Russian market?

- In view of the fact that Vnesheconombank is soon to be transformed into a National Development Bank and, in fact, is already acting in this capacity, it sees its role as a chance to attract substantial financial recourses from foreign and maybe Russian banks and at the same time as a chance to make available credit resources to individual economic entities through extending credits to Russian financial institutions in the case that objectives of credits attracted by these banks are in line with Vnesheconombank’s objectives as a development bank.

I would like to emphasize that Vnesheconombank has shown that it is in a position to attract considerable funds at record-low rates. It was the first of Russian financial institutions to attract a syndicated credit with a margin of less than 100 basis points. Making special mention of the debut-syndicated credit, the well-known magazine Global Trade Review said it was the best transaction of the year 2006.

In 2006, Vnesheconombank continued to be successful in borrowing financial funds in the international market: in the agreement on a 800-million dollar syndicated credit signed in July 2006, the LIBOR rate was +0.35% per annum, at that time the rate was the lowest for Russian financial institutions especially taking into account increased risk insurance costs under Russian banks’ debt obligations. I hope that this transaction won’t go unnoticed in leading financial publications.  


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