How do regulatory changes affect - or should affect - the risk management strategies in Russian banks? Why does Russia need to create a meta- or mega-regulator? Why people in Russia do not transform savings into development capital and, consequently, there is a deficit of long-term money? Viktor PLESKACHEVSKY, head of the Property Committee of the State Duma answered these and other topical questions in an interview to the NBJ.

“THE STATE DOES NOT INCENTIVIZE PEOPLE TO CREATE THEIR OWN STABILIZATION FUNDS”

NBJ: Mr. Pleskachevsky, there are still ongoing discussions about why the Russian economy suffered so much in the last global financial crisis and why it is so slow in recovering. What do you think are the main reasons for this?

V. PLESKACHEVSKY: In fact, there are many reasons, and I will name only those that I believe are the most important. First of all, all economically developed countries, the “open economies”, have a lot of financial instruments that allow overcoming acute volatility periods, such as changes in oil or property prices, without dramatic shocks. By the time of the 2007-2009 global financial crisis, Russia has become an “open economy”, but has not acquired such instruments.

Another point is the diversification of the economy. The countries that have chosen this way have put tremendous effort into eliminating the dependency of their economy on a single product. One of the examples is South Korea that used “chaebolization” - creating monopolies basing on joint private and national capital. However, after some time the South Korean authorities realized that without small and medium business the economy will just die out: it will not be stable and any crisis will result in grave consequences. This is why they took measures to develop small and medium business.

NBJ: Russia also takes such measures.

V. PLESKACHEVSKY: In Russia, rather, this is widely discussed, but I cannot say that there is any significant success in this respect.

So, it's the absence of financial instruments, big business - small business, and diversification of the economy. Another important issue is taxes. Taxes have not been discussed much recently, but earlier the authorities insisted that taxes have no regulatory function and only have a fiscal function. In fact, developed countries have a completely different approach to that. If the tax for some industry is higher, it means that this industry is being depressed, and if it is lower, the industry is developing. Smaller taxes apply to financial organizations and small businesses. Moreover, in all developed countries, the VAT is reimbursed to financial organizations, while in Russia it is included into the prime cost, although it is obvious that the income structure of banks and financial companies contains no VAT while their expenses do include it. The result is that financial organizations are subject to the same taxation as exporters or construction companies.

Finally, one more reason for the acuteness of the crisis in Russia. Everyone says we have the mining industry and the processing industry. All economists realize that the share of labour in the processing industry is higher than in mining. Well, then do you think it is fair that the social tax is the same for both of these industries? Of course not. By keeping this approach, we basically punish the processing industry, although the whole world believes that processing is more important than mining and the more the processing industry is developed, the more developed is the economy of the country.

NBJ: You have described the factors that have caused the acute and prolonged crisis in Russia. Can they also serve as lessons that the economic and financial authorities of the country should learn from the crisis?

V. PLESKACHEVSKY: They should, but do they? Let me give you another example: the stabilization fund. All developed countries create national stabilization funds, but they also incentivize individual-level stabilization funds. For example, in the UK, 7000 pounds are excluded from the taxable base if the person invests this money into pen sion, insurance or investment funds. Thus, the person creates their own stabilization fund that covers four key risks: loss of ability to work, loss of employment, expenses on education for children and pension. This certainly removes some of the social burden from the state.

NBJ: What are the consequences for the banking industry, if any?

V. PLESKACHEVSKY: There consequences are important. Remember how four years ago banks started actively developing consumer credits, and young people who have just got their $2000 salary started buying mortgages. With smallest market fluctuations, this would turn into a tragedy, because people had no financial reserves.

The average savings in Russia are the same as in Singapore or Taiwan when they were in the process of an economic leap forward. Unlike these countries, Russia has no instruments and mechanisms that would transform savings into accumulations.

NBJ: But we have bank deposits, doesn't this mechanism transform savings into accumulations?

V. PLESKACHEVSKY: In my opinion, this is absolutely ridiculous. One famous economist, after long discussions, abandoned the idea that the main function of banks is to give loans to the economy. In the whole world, banks are for short-term money, while funds, such as mutual funds, insurance or pension funds are for long-term money. In the US, the total capital of mutual funds only is four times the total capital of banks! US citizens may open deposits or invest money into various types of funds depending on their goals and the duration of investment. This is why banks and funds have to compete.

NBJ: Russia obviously has no such competition, does it?

V. PLESKACHEVSKY: That's the problem. The banking industry in Russia is the most developed segment of the financial market, while in developed countries it occupies only a part of the financial market. Meanwhile, the capacity of our banking market as related to the GDP is two times smaller than the same value in developing countries.

NBJ: In developing countries? What about developed countries?

V. PLESKACHEVSKY: It's 6 times smaller. That means that our whole financial sector is basically just a model of a usable financial sector.

NBJ: What comes first here - the savings are not transformed into pension, insurance and other funds because these funds are underdeveloped or these funds are underdeveloped because the savings are not being transformed for some reason?

V. PLESKACHEVSKY: The main problem is that Russia has no adequate mechanisms for such transformation and no incentives for people to use them. Thus, it's not the peoples' fault - it's the government's fault. All the problems can be boiled down to one -the problem of single regulation: single regulation principles or a single regulator.

NBJ: Is it that bad to have a single regulator?

V. PLESKACHEVSKY: Not bad at all, but this will not eliminate all obstacles to transforming savings into accumulations. One has to realize that our whole financial system is too costly. Partly because of the taxation which is the same for everyone. Anywhere in the world people can invest money through a broker by buying shares or using collective investment funds, such as insurance or pension funds. Regardless of the type, the important thing is that they accumulate the money of individuals and then turn this money into development capital. The taxes are adjusted so as buying shares via brokers is less effective an investment than investing in insurance or pension funds. Taxation in Russia is such that only an idiot would invest into insurance or pension funds. As a result, the person does not enter the money market at all. What do they do then?

NBJ: They open a deposit.

V. PLESKACHEVSKY: No, they buy an apartment. They open a deposit when their savings are tiny, and if they have more, they invest into property. This is why estimates show that 30% to 50% of residential property in Moscow was purchased for investment purposes rather than for living, which results in excessive prices per square meter. And this is not surprising, taking into account that securities in Russia are categorized so that if I buy securities now and sell them the next year, I can be subject to taxes regardless of whether I earned profit or lost money on these securities.

This is why - because of the lack of mechanisms for transforming savings into accumulations - the small-scale crisis (and it did reach us as a small-scale one) hit our economy and financial system so hard.

NBJ: Even though the financial system and the banking sector in particular received significant support from the state?

V. PLESKACHEVSKY: State support of banks is normal, because whether we like the banking system or not, it's the key pillar of the economy.

NBJ: You said that banks by definition deal with short-term money. Meanwhile, credit institutions in Russia complain about lack of long-term money. Do they complain about what they actually shouldn't have?

V. PLESKACHEVSKY: Yes. Obviously the banks are protecting their own interests, and if they were to decide, they would forbid any funds at all. This is what we have the government for - to align the interests of market players fairly and to ensure adequate development of the country's economy in general.

“CREATING A MEGA-REGULATOR WILL REMOVE THE DIVIDING WALLS ON THE MARKET”

NBJ: We have touched upon the issue of a single regulator. According to your
speech at one conference, we may conclude that you are a proponent of creating a mega-regulator of the financial market in Russia.

V. PLESKACHEVSKY: Moreover, I am convinced that over time, creating such institution will be even more critical. According to the logic of financial engineering (this term has been coined by Anatoly Levenchuk in early 90s), we have to pay attention to the following. In early 90s, we had no financial market, none whatsoever, so there could have been no principles or skills in regulating it.

NBJ: But there was a banking market already, even though undeveloped.

V. PLESKACHEVSKY: And what was it doing? It provided but a few financial services - opened and maintained deposits, settlements and a little bit of insurance. Securities or notes? None of the kind. Stock markets? Never. Capital markets? There couldn't have been any in a state economy. It all started to appear gradually, and the government started distributing the regulatory functions, or, to be more precise, the functions of creating regulations. State Construction Committee was in charge of mortgages, the Ministry of Industry and Science was in charge of leasing, antitrust authorities were in charge of the goods market, the Federal Securities Commission was in charge of the money market, the Central Bank was in charge of currency markets and the banking sector, the Ministry of Finance was in charge of insurance, and the Ministry of Labour was in charge of pensions. No wonder the basic principle of institutional investors is violated now - don't invest money of the pension fund into the shares of the founder of such fund. All over the world, this is punished by a prison sentence. No wonder mortgage in Russia is an instrument of the housing policy while elsewhere it is an instrument of the financial policy. No wonder that the Central Bank and the Federal Securities Committee used to argue who should regulate the money market. Elsewhere in the world, this issue has been solved long time ago: whatever institution takes part in the money market, it should be regulated by those who regulate this segment of the financial market. The situation in Russia is absurd: the Central Bank appropriated all powers to regulate any business of banks, even if they would sell cucumbers.

I can cite countless examples of such illogical situations, but let us draw a conclusion: because of this chaos, the government now speaks of a separate development strategies for the banking sector, the insurance segment and so on. Stock exchanges are still not united, currency exchanges are not mentioned in a single law and are regulated by guidelines of the Central Bank. As a result, our financial system bears tremendous internal expenses, partly because of inadequate taxes, and partly because of inadequate regulations. Nevertheless, the government never discusses the financial market as a whole; the single exception is the governmental meeting in 2005 - the first and the last one.

NBJ: Well, the idea of a mega-regulator is actually discussed. But it is more like a phantom - it disappears as soon as it appears on the horizon.

V. PLESKACHEVSKY: This is easily explained. In the US, for example, there are two commissions regulating the same segment of the financial market. Everyone understands that they have to be united, but in practice, this is difficult, because these commissions have been created by two committee of the Congress. These committees will never agree unless there is political decision for this.

NBJ: You mean an order “from the top”?

V. PLESKACHEVSKY: Yes, is there anything surprising? This is how the single regulator of the financial market appeared in the UK. The egoism of various authorities means that this problem may only be solved by clear and distinct political decisions. There are people in Russia who can make such decisions, so any discussions about that should be stopped and a commissions should be created that will work out the law.

NBJ: But the mega-regulator is likely to be created on the basis of an existing state institution. Who can get such functions and from what other authorities?

V. PLESKACHEVSKY: This is not relevant. We know the history of single regulators in other countries of the world. At first, a meta-regulator may be created - a coordination body that forces all existing regulators to agree on every step between each other. For instance, the US has such meta-regulator - the President's Working Group for Financial Markets. It is not permanent, and has convened only several times in its history - when existing regulators could not resolve their contradictions without it.

NBJ: This was in the USA - but is there a risk in Russia that it will be a kind of superstructure that will only make the regulation process seven more complicated?

V. PLESKACHEVSKY: I think this risk can be avoided if it does not take the form of an instant revolution, like “let's start from the next Monday” - it should take the form of evolution. We have experts, and we have the idea of a meta-regulator that should develop a plan of how to create a mega-regulator within, say, two or three years.

“BANKS READJUST, BUT VERY SLOWLY. SBERBANK IS AN EXCEPTION”

NBJ: So creating a meta-regulator first and a mega-regulator later would remove the barriers between segments of the financial market?

V. PLESKACHEVSKY: Of course. This would help realize the meaning of each segment in the structure of demand of individuals, enterprises and the economy in general. Unfortunately, bankers often think that they are on the top of the financial market. But as I have already said, the banking segment in developed countries is only a small part of the financial market. I would like to hear an answer from Russian bankers who believe they are on the top - why their current margin is not enough to increase their capital and to develop their business? Why the same or even smaller margin is enough for foreign banks?

NBJ: Costs in Russia are higher.

V. PLESKACHEVSKY: This is not the only reason. Russian bankers have mainly arisen in the 90s, when the rates were at 160-200% p.a. This is why they have created the expenditure mechanisms of their banks basing on these values. Who would pay attention to minor issues when the rates are at 160-200%?

NBJ: But the banks seem to readjust now.

V. PLESKACHEVSKY: They readjust slowly. Let us ask them another question: what happens if the average weighted market rate is down 6-7% compared to the current levels? Half of the banks will collapse, because they are not able to sustain such profitability, since only a few banks have efficient and economical mechanisms. Banks have hardly survived when the rate fell from 20% to 15%, and hardly survive when they have to explore new markets, look for new segments and calculate their risks more precisely. What's surprising, Sberbank thinks about it more than other market players, even though until recently it wasn't even a bank -rather a huge payment service organization. But it changes for the better so fast that other banks will have a hard time if they don't start changing, too.

NBJ: So now Sberbank that wasn't even a full-fledged bank before has become one, while many banks may cease being banks?

V. PLESKACHEVSKY: Let us remember the key idea of German Gref: a bank is a service company. This means it has to be customer-oriented, save on costs, and provide the full range of banking products. What banker would have thought about that? Who in the banking system thought that all financial markets are built on the principle of a pyramid, with small customers in the bottom and large transactions on the top? Who realized that the amount of large transactions is incomparable with the total amount of transactions of small customers? Who would have thought that the latter is much larger than the former? As recently as four or five years ago Sberbank did not think so, otherwise the par value of its shares at the people's IPO would not have been 100,000 rubles.

NBJ: Everyone used to think and still think that the bank is a service company, but are these mere words?

V. PLESKACHEVSKY: I would agree with you, with just one reservation: they didn't think so before, but now they do start thinking that they have to go to the lower segment of the pyramid and build their relationships with small customers. The advantage of Sberbank is that Mr. Gref started thinking about it earlier than anyone else. They launched the “Credit Factory” - a very interesting mechanism. Instead of the people who decide whether to give a loan or not, Sberbank now uses software. What's interesting, any expenses on developing such software are reasonable: the number of approved loans and the average loan amount have quickly increased, while the share of uncollectible loans decreased by several times! The Credit Factory shows that processing of loan applications and disbursement of loans may be done without human participation at all.

NBJ: Maybe this only applies to loans to individuals?

V. PLESKACHEVSKY: Sberbank does the same for small and medium business. Of course, the mechanism has to be developed and improved, but these issues can be solved. In providing credits to small and medium businesses, the bank has to keep its costs small, otherwise its small loans business will be inefficient, and that's what Mr. Gref understands. He also understands another thing, unlike many other bankers: the prime cost for processing a payment order is currently about 20-30 rubles, which basically makes it impossible to use it for small amounts. I recently took part in a discussion on improving the forms and procedures organized by the Central Bank, and I seem to be able to prove that the payment orders as they are should be eliminated. It is a useless document containing about 100 blanks to fill out. One hundred is googol, 10 raised to the 100th power, while the number of molecules in the universe is only 10 raised to the 80th power. On the other hand, any person in the world may only be described with 11 characters. Question: why does the payment order has to contain 100 blanks? To make an old granny who makes a mistake in just one item start all over again? I proved to German Gref that the 20 rubles prime cost of a payment order when it was submitted for processing is incomparable with the prime cost of filling it out. Why not just assign a code to the individual, a code to the payee and so on? Why cannot the payment order be filled out within several seconds, or, in the IT speak, in several clicks - by introducing a code or several code? We are living in an electronic world, and the bank-client software already allows electronic payment orders. Why cannot we install terminals in offices similar to self-check-in counters in European airports?

NBJ: Some might object - installing a terminal in each office is unplanned expenses…

V. PLESKACHEVSKY: Those who say that simply should learn to count. Installing the terminals will allow reducing the number of tellers. Labour is the most inefficient and the most costly part of any service or product. Certainly there will be some problems in transitioning to electronic payment orders. However, only those who look for short-term profit rather than a development strategy may cite these costs as a reason for abandoning the idea.

“THERE ARE NO BIG OR SMALL RISKS -THERE ARE MANAGEABLE AND UNMANAGEABLE RISKS”

NBJ: We have briefly touched upon the issue of evaluation of risks. It's not a secret that the recent crisis was so acute partly because banks underestimated their credit risks. As far as I know, you used to read a lecture on this topic. What is your opinion about the current approach of banks to risks evaluation?

V. PLESKACHEVSKY: At my lectures, I have asked the audience: do bankers take into account changes in laws that have already occurred or may occur in creating their risk management policy? The answer is simple - no. Just a simple example: the individual bankruptcy law will be passed soon, and as a result, the risks for banks will either increase or decrease. If the individual is bankrupt, banks will not be able to hire debt collection agencies, foreclose on any assets of the debtor, call the debtor at night and harass their relatives. This means that the share of unpaid debts will increase and the credit risks will increase, doesn't it? How do you account this in your risk management or loan granting system?

I should say that the audience understood me instantly, because they were not the top officials but decision-makers -heads of specific departments. They realized that every bit of the legislation concerning pledges or bankruptcies and so on changes the bank's abilities to claim its money back. It is an axiom in risk management: there are no risks that are too big or too small - they can be manageable or unmanageable. If the individual bankruptcy law is passed, will the predictability and manageability of the risk improve? Certainly. Sadly, our banking community has a 20-year history but still remains immature - despite several almost genial people working in banking. But unfortunately, they do not make decisions.

NВJ: Maybe bankers are waiting for draft laws to be turned into laws and only after that they start calculating the risks.

V. PLESKACHEVSKY: Too bad. I remember how two years ago banks demanded from me to create a procedure of out-of-court foreclosure on pledges. This was discussed at all levels in the government, and I described and explained that this mechanism will not work, just because it doesn't work in any civilized legal system. This is a very controversial law: the person whose property you foreclosed on may at any time launch the property attachment procedure against you.

A more complex option comparing to the out-of-court procedure of foreclosure was suggested, which was more realistic from the point of view of outcome of court proceedings. The essence was not to drag the court proceedings for years but to receive the so-called simple resolution of the court on such issues. That is, it is still a court procedure, but a simplified one. Two years have passed - ask the bankers if the mechanism of out-of-court foreclosure on pledges helped them. No results at all! And the reasons are simple: they had to listen to experts and consider the results.

NBJ: Two years ago banks were busy with other things - it was the crisis time.

V. PLESKACHEVSKY: Yes, the situation was difficult. Borrowers started, softly speaking, acting in their own interests, if not abusing their powers. Banks did the same. At that time, the opinion of banks was paid more attention than ours, and as a result, two years have been lost. If these losses could be converted into money, I think the developers of the idea of out-of-court foreclosure on pledges would lose their jobs or would be at least demoted.

NBJ: Speaking of the individual bankruptcy law, it should be noted that the banking community has many objections against it. There is an opinion that the law only protects the interests of the debtor - “call yourself a bankrupt and spare yourself the trouble”.

V. PLESKACHEVSKY: I would doubt the education of those who claim it. In the whole world the bankruptcy procedure is initiated in the interests of the debtor. 98% of bankruptcies are initiated as a measure against dishonest creditors. In this case it is more fair than satisfying a bank than grants loans to random borrowers and then wants to take all of their property.

The whole banking community will certainly resist the individual bankruptcy law, instead of seeing it as a mechanism of better predictability. But in the end of the day, banks will live with it and will configure their risk management system according to changes in the legislation. Maybe then they will stop posting ads like “come and get a loan with only two documents within one hour”.

NBJ: Banks explain that they have large liquidity and have to earn on investing it.

V. PLESKACHEVSKY: Yes, sure. But they should better remember: the recent crisis that has begun in the USA was, according to some experts, caused by two problems: bad regulation and bad bonus policy. Bad regulation - because in Canada, for instance, the share of risky transactions in credit portfolios of banks should not exceed 5%, while in the US the permitted share of such transactions was 22%. Bad bonus policy - because bankers received bonuses depending on the volume, not on the quality of assets. Your argument may only be cited by those bankers who are convinced: big volume is the key, they will insure via securitization and everything will be great. But they do not take into account one thing: the Americans, besides securitization, also use credit default swaps. Only a couple hundred people knows what this is in Russia, or a little bit more after the crisis. Alan Greenspan, former head of the Federal Reserve System, used to say that the country survived the Enron crisis only due to the CDS, because the risks were distributed among the whole country, and the financial system did not collapse. Who among Russian bankers thinks the same? I know some people, but again, they are not strategic decision-makers in banks.