The last three months of 2010 have seen large-scale discussions of license cancellations of several banks. The unlucky banks include both some of the top 30 (Mezhprombank and its retail subsidiary Mezhprombank Plus) and comparatively small businesses (Slavyansky Bank, Trado-Bank, Monetny Dvor Bank, Uralfinprombank, Donbank and Imperiya Bank). All of these events had something in common: after the licenses were cancelled, the Central Bank has claimed it was due to outflow of assets and significantly invalid reports, i.e. illegal activities of the managers of these banks. After this, the issues of stricter liability for owners and top managers of banks became even more pressing.

BUSINESS AS UNUSUAL

In early October, Mezhprombank was the first bank to get empty by the time the license was cancelled. For half a year (or even longer, according to some sources), Senator Sergey Pugachev, the owner of Mezhprombank, has struggled to keep his bank afloat, together with the regulatory body which has restructured   Mezhprombank's   debt from unsecured auctions, and even VTB had a passive role, having considered refinancing the unstable bank. However, all efforts were in vain, and since the bank was unable to satisfy the creditors, its license cancellation was a natural result.

Still, Mezhprombank's story was not over. The Bank of Russia has sent official letters to the General Prosecutor's Office of Russia, stating that it believes that the management of Mezhprombank might have committed crimes described in Article 195 (unlawful actions during bankruptcy) and Article 196 (deliberate bankruptcy) of the Criminal Code. The regulator's anger is understandable: according to Gennady Melikyan, First Deputy Chairman of the Central Bank, “most loans of this bank have been provided to companies that performed no real business”; the bank has deliberately submitted fraudulent reports, marking bad debt as good debt, and for this reason having no sufficient reserves. Furthermore, over 25 billion rubles received at unsecured auctions of the Bank of Russia were transferred to an account of a non-resident Swiss company controlled by Mezhprombank's owner. Then these funds were transferred to a French aircraft manufacturer via a chain of companies. One of the aircraft produced is now used by Sergey Pugachev, Mezhprombank's ultimate beneficiary, at least as Russian media suggested.

Not long after the Mezhprombank scandalwas over, observers have seen a surge of license cancellations: within less than a month, several banks have lost their businesses - Slavyansky Bank, Trado-Bank, Monetny Dvor Bank, Uralfinprombank and Donbank. Observers note that all of these assets had the same owner, businessman Matvey Urin, who was already infamous for the bankruptcy of Briz-Bank. However, right now he is more known to the public due to the assault on Jorrit Faassen, a Dutch manager of Gazprom. According to the observers, the biggest charge he may face will be the charge of minor disruption of public order, while the circumstances that lead to the license cancellations of the five banks allegedly owned by him could lead to more serious criminal charges. There is one obstacle, however - Matvey Urin is not registered as the real owner of any of these five banks.

While Mezhprombank's crash was quite an expected scandal, however high-profile, the crash of the five banks was viewed as an unprecedented event. On December 8, Chairman of the Central Bank Sergey Ignatyev has stated that “a part” of the assets of Slavyansky Bank and Trado-Bank was stolen, and that the Central Bank was preparing an application to the General Prosecutor's Office in this regard. Several days before a well-informed source told journalists that a significant part of the balance assets of Slavyansky Bank and Trado-Bank consisted of forged securities. “An existing bank would withdraw its assets to buy securities, a new bank would be bought with this money, and the assets of the existing bank would contain forged depositary receipts,” he explained. Observers believe that besides these banks and the depositary, one or more investment companies were involved into the scheme. Thus, it was obviously a deliberate scheme, and at least managers of Slavyansky Bank and Trado-Bank will be held liable for this, judging by the remarks of the Central Bank's head.

Withdrawing assets by purchasing forged securities was not the only allegation. According to the regulator, top managers of the banks allegedly owned by Matvey Urin were also involved in splitting deposits. The Deposit Insurance Agency said that some employees of these banks offered to secure the money by splitting large deposits into amounts covered by 100% indemnity (700 thousand rubles). However, their efforts were pointless, as the Deposit Insurance Agency has enough experience in catching this kind of transactions.

With the exposure of these schemes after the liquidation of Slavyansky Bank and Trado-Bank, the cancellation of licenses of Uralfinprombank, Donbank and Monetny Dvor Bank was less noticeable and has not surprised experts. Observers were expecting that after the scandal around Slavyansky Bank and Trado-Bank, the regulator will carefully verify other bank assets allegedly owned by Matvey Urin. And they were not mistaken.

AGENCY TO BE LIABLE

It was not just the Central Bank who had difficulties due to the license cancellations described above. The Deposit Insurance Agency has even more difficulties, as it will have to pay indemnities to depositors. Neither of the so-called “Urin's assets” was rehabilitated (just like Mezhprombank and Mezhprombank Plus) simply because by the time of license cancellation, most of the assets were already moved out, and the remaining part was too small to attract one or more healthy banks.

In this regard, cases of bank failures during the acute crisis and these recent events should be viewed differently, according to Pavel Samiyev, Deputy General Director of Expert RA rating agency. “They are not similar. In the case of Mezhprombank (and Petroff-Bank as well) it was obvious that it was receiving help from the regulator in the form of unsecured auctions and has used the proceeds to funds the group of companies it was a member of. Another case is Slavyansky Bank and Imperiya Bank - in both cases they used schemes and performed doubtful transactions, to say the least. And a third case is when the bank's policy was too risky and it would become insolvent when there was some failure. This kind of situation was not characteristic of the above banks - it was the case of the credit institutions that failed in the beginning of the last financial crisis, such as Globex, KIT Finance, and Svyaz-Bank. It was evidently due to the deficiencies of their risk management models and mistakes of the management, but there was not deliberate forging of reports and assets were not moved out,” he said.

Pavel Samiyev, however, believes that there is no direct link between the unlawful actions of the managers or owners of these banks whose licenses were cancelled in the last three months and the refusal to rehabilitate their assets. “Banks are rehabilitated when a large share of their liabilities belongs to individuals, for one part. Secondly, it is done when a bank is a market bank, i.e. works in the market in terms of both assets and liabilities, and not with a group of affiliated entities,” he said. Experts believe that Mezhprombank and Petroff-Bank, just like Slavyansky Bank and Imperiya Bank, hardly were market banks.

Still, regardless of whether these banks (as well as Trado-Bank, Monetny Dvor Bank, Uralfinprombank and Donbank) were captive banks or market banks, depositors will be paid indemnities. The amount of these indemnities is impressing: depositors of Slavyansky Bank, Trado-Bank, Monetny Dvor Bank, Uralfinprombank and Don-Bank alone will be paid 11 billion rubles. Mezhprombank Plus will be much cheaper for the government, with the total amount of indemnities a little over 1 billion rubles. Imperiya Bank, as regulators note, is a “small” bank and has few depositors.

ENFORCE AND STRENGTHEN

The funds of the Deposit Insurance Agency will certainly not be exhausted due to the liquidation of a number of banks in the last three months; according to the Deposit Insurance Agency, the amount of accumulated funds as of July 1, 2010 was over 110 billion rubles, including the indemnity reserves from the first half of the year. “Now that all amounts were reserved the fund has 111 billion rubles, or 3.7 billion dollars, and will grow to 4.5 billion dollars after the profits are received in January 2011”, Andrey Melnikov said, Deputy General Director of the DIA.

Nevertheless, there are currently no indications that the banking regulator will leave this situation as is, or at least the statements of the Central Bank's officials give no hope for this.
“The events of the last few weeks have shown that the administrative functions in the area of business reputation of bank managers and owners will be more closely supervised,” said Mikhail Sukhov, Director of the Department for Licensing and Financial Rehabilitation of the Bank of Russia on December 15 in his speech at a parliamentary session in the Federation Council. “We need powers to control the business reputation of bank owners, and evaluate the business reputation of much more people than the nominal bank managers. We see that some of the assets outflow transactions that we have seen in Slavyansky Bank have been made along with other transactions creating risks for the deposit insurance system. The same people not just moved out assets, they also created deposits, which has already been discovered and the figures will be public sooner or later. Illegal financial transactions should be reviewed in criminal court but regardless of this, the regulator should have its leverages,” he said.

Aleksey Simanovsky, Director of the Department for Banking Regulation and Supervision of the Central Bank of Russia, agreed with his colleague, and just like Mikhail Sukhov, he is also concerned that owners, especially real owners, are rarely held liable for the non-transparency of their banks. In Mr. Simanovsky's opinion, no advanced approaches to the banking system will be effective unless this problem is solved and unless strict measures are adopted. Aleksey Guznov, Deputy Director of the Legal Department of the Central Bank has expressed a similar opinion a few days after, saying that measures against bank managers and owners who have “slipped” (or, in simpler terms, created an illegal scheme), will be aimed not at preventing or warning them, but at punishing them. “First of all, officials of credit institutions may be subject to administrative punishment under Article 15.26 of the Code of Administrative Offenses”, Mr. Guznov said. He also noted that that criminal liability of bank managers, e.g. for forger reports, is now being discussed.

The regulator's plans to enforce andstrengthen the liability of top officials and owners have caused different reactions among experts and in the banking community. “Liability of bank management and shareholders is quite a pressing issue, but one has to remember that unlawful actions should be proven. Presumption of innocence is still in effect, and any attempts to ignore it with regard to management and shareholders have not seen any understanding of the banking community and failed as a result”, said Aleksandr Artemyev, Director of BDO in Russia. “The liability of bank management and shareholders may be discussed or strengthened when assets are moved out, i.e. when the bank is already troubled and owners and top managers try to move out the assets that should have been used to cover the liabilities of the bank to creditors, depositors,and so on,” Pavel Samiyev said. “The bank thus becomes unable to continue its business, and the state represented by the Deposit Insurance Agency loses any chances to obtain any assets to settle the liabilities to creditors.” This problem exists indeed and such actions should be definitely punished. On the other hand, when it comes to a not quite correct and excessively risky policy, e.g. loan policy, but the bank has complied with the demands of the Central Bank as the regulator, this should not be subject to criminal or other liability of shareholders or managers.

“Any credit institution inherently takes risks, which is the essence of its business and its added value. If any loan turns into bad debt for any reasons, it makes no sense to have additional liability for this, either criminal or administrative, for managers or owners. This also concerns loans provided to the so-called related borrowers. If the bank does not violate the quotas of the Central Bank for loans to such borrowers, does not forge its reports, and has no false transactions, this is not against the law, and as such, should not cause additional liability except regulatory liability according to current norms and laws”, Pavel Samiyev said.

Aleksandr Gavrilenko, President of the Russian Exchange Union, pointed out that the law currently stipulates some subsidiary liability of bank owners, for instance, when a bank receives an order from the Central Bank to remedy any deficiencies, and owners do nothing to comply with it. If there is indeed no reaction to reasonable comments of the regulator and no measures are taken to correct the situation, the state will be entitled to hold the owners liable.

“As far as I understand, what is now discussed is to have stricter liability of bank owners. In my opinion, it is a very dangerous trend, because implementing it would mean drifting away from the civilized financial market, the rule-of law market. The rest of the world absolutely clearly states the rights and obligations of owners, and closed joint-stock companies are so popular everywhere exactly for this reason - because the liability of owners for business results is limited. If we drift away from these principles, there will be completely different legal circumstances and a completely different business climate in the country. I understand our top officials who aim for this due to the huge volume of not-so-lawful actions of bank owners. But in my opinion, this also occurs because the management of supervisory bodies is insufficiently competent in creating procedures to prevent unlawful actions of bank owners. This is why officials who are unable to cope with it can only think in one way - somehow decrease the number of managed subjects and take more supervision and management powers. In other words, if you cannot play smart, play strong. But applying this strength will clearly reduce the investment attractiveness of the Russian financial sector, and this will have to be taken into account when any decisions are made”, Aleksandr Gavrilenko said.

Unlike the President of the Russian Exchange Union, Director of the Center for Economic Analysis of the Moscow Academy for Finance and Industry Sergey Moiseev believes that the regulator's intentions to strengthen the liability of top bank officials and bank owners is, on the contrary, aligned with the modern global practice. “The system of penalties abroad is quite developed; take the USA, for instance, where reforms have been made and criminal liability was instituted for some actions, as well as banning to work in the financial industry, or even repayment of bonuses received by managers and owners in the last three to five years. And if there are indications that the bank or a financial organization was deliberately stripped of assets, there are no limits as to the earnings that should be returned,” he says. According to him, Russia's situation is different. “The Criminal Code lists deliberate bankruptcy of an enterprise as an offence, but in practice, this is difficult to prove. Very often the suspects disappear before the investigation ends, or all documented proofs, such as financial reports, are destroyed, or the assets that have been moved out cannot be returned”, Sergey Moiseev pointed out.

THEY ARE NOT RESPONSIBLE FOR EVERYTHING

Valery Miroshnikov, Deputy General Director of the Deposit Insurance Agency, confirms the words of Mr. Moiseev. “Russian laws stipulate liability for bankrupting a bank, but there is a small problem: this provision is hard to implement. As a result, the Deposit Insurance Agency submits applications to law enforcement bodies, but it often yields no special results,” he told NBJ in the interview.

“In my opinion, it is reasonable to speak not of the abstract issue of more liability for bank owners, but review the efficiency of current regulations about the liability of bank managers and real owners. There have been many examples of criminal cases against fraudulent persons guilty of deliberate bankruptcy of credit institutions.   The   examples   include Vneshagrobank, Sodbiznesbank, and the well-known case of VEFK Bank. However, there is a number of other examples where our Agency sent appropriate requests, but criminal investigations against bank owners were not started for inexplicable reasons. In this sense, our practice is contrary to the practice of developed countries, where similar crimes are punished very strictly, and those found guilty receive severe sentences, up to 150 years in prison. In Russia, unfortunately, you can deliberately bankrupt a bank and get away with it,” he said.

Among the cases of criminal investigations against “bank crashers”, Valery Miroshnikov has mentioned the infamous VEFK Bank. “The VEFK's issue was, according to the DIA employees, one of the most difficult among other rehabilitated banks. The former owner of this bank, businessman Aleksandr Gitelson, was charged with embezzling as much as 900 million rubles. A criminal investigation has been started against him, and he even spent some time in jail; however, later he was released on bail and disappeared, so he had to be put on the federal wanted list. Still, according to the Kommersant newspaper, Mr. Gitelson is still able to take part in the Russian banking business via three banks controlled by him.

Observers say that Gitelson's case is difficult, but not hopeless: he was the real owner of VEFK, so it was not difficult to determine that he was involved in the schemes that were used by the bank to move out its funds. The matters are much worse when the real owners of the bank are well-camouflaged, as in the case of Slavyansky Bank, Trado-Bank, Monetny Dvor Bank, Uralfinprombank and Donbank, where the name of Matvey Urin as the owner or beneficiary is not mentioned in any documents.

“Returning to the issue of increasing the liability of owners, the actions here should be very careful. First, it should be proven that the person is indeed the owner of the bank, its ultimate beneficiary. The issue of disclosure of real bank owners thus gets even more topical. But even real owners may not always be aware of the actions of managers,” he said.

According to Lidiya Gorshkova, head of Pepeliaev Group law firm, “changes have been made in summer 2009 to the bankruptcy law, giving rise to the notion of the person controlling the borrower.” She said that this person does not have to be officially registered as the owner or beneficiary of the company. If it is proven that this person has determined the strategy of the bank and forced the management to perform illegal actions, such person may also be subject to liability. Observers, however, admit that this will be difficult in the specific Russian conditions.

So, what remains in the end? Experts state that it is currently easier to hold liable top bank managers , and according to Valery Miroshnikov, there are often good reasons to hold them liable. Still, not all of their sins may be punished. “In my opinion, what our laws are really missing is the liability for forging reports. We have prepared the draft of such law together with other governmental agencies, and it is currently reviewed by the Ministry of Economic Development. Of course, the Bank of Russia is entitled to cancel a bank's license for submitting significantly false reports, but those who directly forged the reports have no liability. Unfortunately, the Criminal Code currently lists no such offense,” Valery Miroshnikov pointed out.

“There is certainly such penalty as blacklisting, but only those who claim the posts requiring the approval of the Central Bank may be affected. These include chairmen of boards, and deputy chairmen of boards. The regulator may consider expanding this list of posts by including other positions. But it seems to me that this is not sufficient to solve the problem”, Deputy General Director of the Deposit Insurance Agency said.