An acute phase of each crisis is followed by an active discussion as what needs to be done in order to mitigate the consequences of the economic slowdown and prevent the crisis from repeating in the future. Petr USHANOV, Management Board Chairman of Russian Credit Bank, has shared with NBJ his ideas about these issues and ways to address them.

NBJ: Petr, what are the major issues and challenges that the Russian banks face today?

P. USHANOV: First of all, we need to understand that this crisis is not something new. In fact, it’s just the second stage of the 2008 crisis. This analogy seems to come to mind: it’s well know that it’s almost impossible to extinguish a peat fire. You can, of course, floods the peat with water, but they will still smolder and as soon as it gets warmer, the fire will inevitably break out again.

NBJ: It’s an interesting comparison.

P. USHANOV: Yes, it is. In this case, individual "peats" were "flooded" with money, but the root causes were not eliminated. The internal factors are of paramount importance in this case. 

NBJ: Can you give some examples of those factors? 

P. USHANOV: When we analyze the internal issues, we need to take into account the economy’s monetization level. The statistics analysis, published by Professors Yakov Mirkin and Mikhail Yershov, clearly shows that the monetization level in Russia in three-four times lower in comparison with developed economies. The second point, which I find important, is a slump in investment into the national economy, to which academician Abel Aganbegyan draws attention.

Both of these factors – low monetization and a deficit in investments (i.e. long term investments) – come together as a powerful force, having a significant impact on the macroeconomic layout, in which out banking sector operates. Financial institutions are similar to water plants that would wither and die off, when their habitat is destroyed. The main issue is insufficient amounts of money in the economy, rather than higher interest rates, as people generally believe. I should specify the following. I am completely convinced that it’s important to work in order to prevent any significant fluctuations in the rates. Continuously changing temperatures – from hot to cold and back – would unfavorably affect any living creature. In the same way, drastic fluctuations in interest rates have had a negative impact on the banking sector. However, the root cause is a low level of monetization of the country’s economy, which fact was rightly highlighted in speeches and the summary report at the XXVI Convention of the Association of Russian Banks.

There is another factor that people quite often forget. In Russia, 25 years ago there was created a completely new banking system that had nothing in common with what we had before. The banking sector that existed before was completely destroyed and we had nothing left – no corporate culture or systemic business processes. A transition from interbranch settlement system (an "umbilical cord" that connected banks right after the USSR collapse) to correspondent accounts was a feat in itself.  The newly emerging system that was being set up in line the latest political campaign, in a rush and during a time, when capital was just starting to accumulate, would get its "birth marks" for years to come. I was working in Bank of Russia at that time and have a firsthand experience of what was going on. I also want to emphasize that it was fortunate that the Bank of Russia, which was to be established on the basis of the Order of the Supreme Soviet of the RSFSR "Concerning State Bank of RSFSR and Banks within the Republic’s Territory", engaged the key specialists, who earlier worked in the USSR’s State Bank, while the Central Bank took in its best practices. This made it possible for the country to ensure a smooth transition for the main banking institution.

NBJ: Yes, 25 years is a very short period of time, in particular, if we look at how long similar processes took to develop in other countries, including global economic leaders.

P. USHANOV: Yes, that’s the point. At the same time, while everybody knows that, we are still trying to implement those standards that were developed in the countries, where the banking sector has been developing – without any major crisis – for 200-300 years, and even more! Financial institutions in those countries have gone through thick and thin. These institutions – if I may say so – seem similar to well-aged folks, who are still quite vigorous and vivacious, and who have rules for any scenario. While, in Russia we have banks that seem like six-year-olds that have just finished pre-school ("perestroika" of the 1990s). I doubt that anyone would ask a kid to study in a college with people, who finished schools a long time ago and had a long life after that.

NBJ: But, to do justice to our banks, they – in spite of their early age – have done well, competing with the "old guys" from the West.

P. USHANOV: Mainly, yes. But, at the same time, it makes no difference – banks in the West and Russia go through completely different stages in their life cycle. The former are "at the sunset", while the latter are "at the dawn". This factor makes it impossible to measure both banking systems, using the same benchmarks, and set the same expectations for the two. It seems as if we metaphorically cut down a cherry orchard and are now trying to figure out why there’s only springs in its place, only starting to grow, and compare them with blossoming orchards all around us. I hope that we are on the same page.

NBJ: Then we might need a different set of benchmarks – the one that helps us find a compromise. After all, our banks have worked with their Western counterparties and they must have developed a way of communicating with each other in order to do that.

P. USHANOV: I totally agree with you. Naturally, this is the task that we need to address and it is closely connected to the issues that I have spoken about. If the banks are water plants, then we need to figure out a way to "water them" so that they receive a sufficient amount of water. The word "sufficient" is key here, as nobody wants to end up with a "flood" (hyperinflation and dollarization).

NBJ: It’s about figuring a right way to "water" them, isn’t it?

P. USHANOV: You are close.  I tend to look at this issue in a broader way – what is the right way not only to "water" them, but also to set up the "drainage system". Unfortunately, we destroyed the old system before we had a time to set up a new one. In this regard, our regulator has a quite logical concern, which was well put by Alexey Simanovsky, First Deputy Chairman of Bank of Russia, at the XXXVI Convention of the Association of Russian Banks: pour too much water in a pot and you might end up up a flood on your hands.In other words, the concern is that banks would channel money to forex, which will lead to a weakening ruble, capital outflow and a leap in inflation. I wouldn’t want to go into the discussion, whether we have had the non-monetary inflation up to now. It’s all the fault of the state monopolistic control of prices for fuel, electricity, railway and airline rates, etc. In this regard, I would also refer to Aganbegyan’s works. However, some people may still say: "It’s the banks that are to blame – the state would support them and then they would turn around and do something bad!" Well, you can just stop watering your plants at home. The issue will still be there. The problem is that the "drainage system" does not work correctly – the system, which should enable an effective distribution of monies, received from the Central Bank, to channel investments into the real sector.

NBJ: It looks like this is a very complicated task, in particular, taking into account that Russia has worked to resolve it for the last 25 years, and, essentially, during every crisis we see the same situation – banks would receive liquidity from the state, channel it to forex, which will result in the events, which you have just described.

P. USHANOV: Yes, this is a serious obstacle for building trust between the state and banks. And the scale of distrust is enormous, which is shown by the information of Bank of Russia, published in RBC, according to which 300 banks effectively provide loans to related borrowers in the amounts, exceeding the ones that are set by the regulator. So, the Russian banks are once again the "bad guys", as 40% of them have unreliable financial statements.

NBJ: Do you have a different opinion on this issue?

P. USHANOV: Russia is not the only country, where this issues is evident. You can recall the scandals, associated with the practices of Lehman Brother and Enron – those were very large corporations that were recognized worldwide and received the best scores from auditors and rating agencies.

The information that became public, when they went bankrupt, was mind-boggling. The scale of fabrication was enormous. The next question that you might ask is like that: might this be just an exception among the top Western companies? In this case, I would ask you, whether you seriously believe that all other companies are that "warm and fuzzy"? It seems to me as if the Western regulators "decided to clean up the attic" and then suddenly found something not that pretty and they would not be very happy with it being discussed in mass media. Thus, this is an issue that is evident all around the world.

NBJ: Anyhow, it’s the Russian regulator and banks that would have to address it. And currently it’s not clear what the best ways to do that might be.

P. USHANOV: Why? We can look at QE policies, driven in US and EU. What is their purpose? This is done in order to get rid of "skeletons in the closet", to dilute toxic assets, found on the balance sheets of banks in those countries. Naturally, the regulators let the market players know that they happy to help now, but subsequently they will roll out new and more stringent standards in order to prevent any "improprieties" down the road.

NBJ: This is the carrot-and-stick policy, isn’t it?

P. USHANOV: Yes, it is. And I think that it will be very effective. And how is the economy developing in Russia? The state says: these are the standards that you have to abide by, while QE is not for you, but we need to start changing the way we live here and now. It’s not as easy as placing a new layer of paint over some graffiti by hooligans...

NBJ: The megaregulator’s representatives refer to the number of 40%, when they speak about unreliability reporting. Of course, there was no doubt as to abuses taking place, but the scale of those turned out to be so enormous...

P. USHANOV: In this very regard I addressed my question to Kseniya Yudaeva, First Deputy Chairman of Bank of Russia, at the IV Financial Stability Forum: «Well, we can assume that 40% of the financial reporting of banks is unreliable. And what about the reporting of other companies?».Commenting on this issue, I can tell you the following: in order for the banks to be able to cheat on their balance sheet, they would need help from other market players, companies, SME and even general public. In case you have any doubts, you can read the newspaper articles about ongoing bankruptcy proceedings, initiated by the Deposits Insurance Agency. Thus, if you agree to use the assumption that such a number of banks have unreliable reporting, this means that, overall, 40% of all companies in Russia have unreliable reporting. We can recall what happened to Lehman Brothers and Enron. Perhaps, we should question all macroeconomic indicators – not only in Russia, but around the world? And this is actually a bigger issue, when compared to the one, which we discussed earlier. You can image a caricature in Charlie Hebdo or another Western newspaper: the governments of different countries are driving the cars, which are their economies. People at the passenger seats are discussing and arguing about some issues, while instead of the windshields the cars have the TV monitors, showing a sci-fi movie about the global economy!

We need to understand the risks that we might face – if the information about the national economy is distorted by nothing short of 40%, it would not be possible to make any precise forecasts. How can we believe that we will be able to overcome a stagnation or recession, when we don’t have any idea as to what the real economic conditions are?

Can you imagine a traveler, going along an unknown path, while his compass has error of margin of 40%? How many patients will have bad treatment, if 40% of their diagnoses are false!

NBJ: But, anyway, there is always a way to resolve any issue.

P. USHANOV: Absolutely, and the solution seems to be on the surface. I will try to tell you about it, using an analogy. Let’s image that you come to the doctor, and he would always ask you about how you feel. Obviously, if you need to get a sick leave, then you will lament about you health, while the situation might not as bad, as you paint it. In the same way corporation all around the world are trying to decrease their taxable profits base in order to retain more profits and get some benefit from the state. Otherwise, if you don’t want to undergo an unpleasant treatment, you would tell your doctor that you are fine, while your condition might leave much to be desired. Similarly, some corporations would try and conceal – in particular, during a crisis – their unstable financial positions, fearing a negative reaction from creditors, regulators, possible bankruptcy, etc. A good doctor, understanding all the intricacies of the situation, would abstain from rash conclusions and ask all the patients to test the blood. We can try and see some parallels.

NBJ: And what can be seen in this case as the "blood system" of the economy? Is it the banking system?

P. USHANOV: I need to clarify. We speak about the national payment system. It is this system that transports "drops of blood" – payment documents, and just like in a living body, it transports "nutrients" – goods and services. If we learn to analyze these "drops of blood", we won’t need any reporting at all.

NBJ: It sounds like a fairy tale.

P. USHANOV: And still I believe that it’s possible. But in order to make this fairy tale come true, we need to improve the process for filling out the payment documents. Any payment document contains the field, which needs to be filled with the text details as to the payment purpose. How is it actually filled it? It seems to me that in this case we may have a similar "attic" as in the case of reporting. If we making this procedure formal, the information and analytics system of the Bank of Russia will enable an analysis in its own interests and interests of other ministries and agencies into all cash flows, split by region and industry, supervision of market participants, primarily, financial institutions, perform tax administration tasks, currency controls and counteract money laundering and achieve various other objectives. 

NBJ: If we assume that it is true, then the question is how we can formalize the process to fill in the respective field?

P. USHANOV: We have to roll out the system of payment purpose codes, which was earlier developed by the Bank of Russia. As I participated in this process, I can tell you that it is possible to identify only 120 codes based on the chart of accounts, which can be written down on singly sheet.

There is a number of additional benefit that we can derive from using this classification system. The bank’s customer, for instance, does not have to fill in the payment documents manually. They can use the improved version of 1C to do that automatically. Then all the electronic documents would be channeled to the information and analytics system to be processed based on the identified algorithms. In this case, it will be possible to analyze the data in any way you wish to: business activities of a particular company, industry or any other sampling you might need to analyze. In this case, neither the regulator, in charge of the banking sector, nor the government or the president’s administration will have to deal with the distorted reporting data, even theoretically.

NBJ: If it is so easy to do, why haven’t this decision been made yet?

P. USHANOV: There are two reasons for that. Firstly, the opponents say that it’s not being done in the West, ergo this is not a good option. However, we shouldn’t follow all the rules that are implemented in the West. It’s a high time that we understand the meaning of what we have just discussed: Russia’s banking system and that in developed economies go through different stages in their life cycle.

NBJ: And what is the second reason?

P. USHANOV: The second reason is that this idea needs to be reported to the people, who are in charge of making decisions, and, most importantly, have a political will. The situation is quite clear: statesmen are overloaded with work, they have enough issues on their hands, the world economy is not stable, while the national economy is in a perilous state... There is virtually no time to do something else. At the same time, if something goes wrong, there will be large-scale distortions on the information in this field due to actions by members of the national payment system. As we know, no good deed goes unpunished, and no one wants to get into trouble! However, there is anther threat. I can imagine, how our children would tell each other a joke, which is well known from the Soviet time about that "there are lies, very big lies and then there’s statistics", explaining by it the popular quotation of Viktor Chernomyrdin: "We wanted the best, but it turned out as always". Then, people would usually lament about the recession, stagnation, sanctions of bad international partners, as well as the fact that the bank have to work in the conditions of a continuous "drought".

For any change to be implemented, all the more so, when we speak about the well-established system, there is a need in political will, and people, who are in charge of making decisions, need to believe that the innovations will bring about significant changes for the better. I would like to say that during various meetings and discussions I have met representatives of both government agencies and businesses, who understand the importance of the new information paradigm and are willing to promote its roll-out.