Financial liberalization in the Russian Federation involved the abolition of State controls on credit allocation and interest rates, privat...
Financial liberalization in the Russian Federation involved the abolition of State controls on credit allocation and interest rates, privatization of financial institutions, elimination of restrictions on the flow of capital into and out of the country, development of securities and money markets as alternative sources and depositories for funds. It was expected that liberalization would promote investments contributing to economic development. However, it became apparent that the failure to install the supporting monetary and legal infrastructure in tandem with these changes exposed the economy to the flow of illicit wealth. It revealed the weaknesses of the system, exposing it to many risks and increasing its dependence on foreign sources of financing in general and, in all likelihood, sources of dubious origin.34 The development of commercial banking—
regarded as a symbol of success of reform in the financial sector—has been spectacular, at least from the quantitative perspective. Following the 1988 banking reform, commercial banks mushroomed all over the country. There were 225 registered banks in 1989, 1,360 in 1991, 2,019 at the end of 1993 and 2,605 in June 1996.35 It appears that much of the growth was due to existing legal gaps and lack of supervision. For example, some of the entities registered as banks were simply exchange points or branches of a few State banks. Much of the commercial banks’ profits in the early 1990s came from investing cheap funds, obtained from enterprise deposits that were paid negative real interest rates. Moreover, to a great extent their methods of earning profits could be considered illegal, as many came from the deliberate delays in executing transactions—payments between enterprises and social security payments to beneficiaries. By 1997, the Russian banking system became significantly exposed to external and foreign currency risks. Data from early 1998 indicates that the maturity structure of foreign assets and liabilities was mismatched, with liabilities to non-residents denominated in foreign exchange of under $11.8 billion offset by similar assets of only $5.9 billion. Although balance-sheets assets of the commercial banking sector denominated in foreign currency exceeded liabilities, the quality of the assets was extremely poor due to large loans of dubious quality extended in foreign currency to domestic enterprises. Furthermore, the gross foreign currency exposure of the banking system as a whole was substantial, with assets and liabilities denominated in foreign currency exceeding $40 billion. About 26 per cent of foreign currency liabilities had maturities of less than one month.36 Exposed to foreign exchange and interest rate risks, highly dependent on government securities, a large number of banks, particularly Moscow-based banks, became insolvent during the financial crisis of 1998. Following the crisis of 1998, by the end of 1999 the number of operating banks had fallen to 1,400, the Central Bank having withdrawn over 1,000 bank licences since the beginning of 1995. Additionally, the crisis and after-crisis actions by the Government and the banking sector seemed to contribute to the concentration of the banking sector. At the end of 1997, the top five banks accounted for 36 per cent of total assets and the top 50 per cent for 71 per cent. The dominating bank of the system—Sberbank, which accounted for almost a quarter of all assets at the end of 1997—managed not only to survive the financial crisis. It was moreover able to increase its share of the retail market from 65 per cent before the crisis to 75 per cent and its loans portfolio from 16 to 35 per cent. In the aftermath of the crisis, the Russian authorities began extending ad hoc support to a number of banks in the form of “rehabilitation” credits. The Central Bank developed the Bank Bankruptcy Law, which was ratified in 1999 by the Parliament. With the adoption of the Bank Restructuring law the sole responsibility for restructuring banks was given to ARCO (the bank restructuring agency). The banks can be transferred to ARCO only by a Central Bank of the Russian Federation directive based on specific criteria for shareholder write-down, and ARCO is empowered to undo transactions made with the 12 Russian capitalism and money-laundering intent to defraud depositors and creditors of insolvent banks. It limits liquidity support to solvent banks or those implementing ARCO-approved restructuring plans. It was reported that ARCO had begun extending support to four banks implementing ARCO-approved restructuring plans. However, even operations by ARCO arouse suspicions about corrupt political and business interests influencing its decisions. Alfa bank is one of the winners of the crisis which has strengthened its market position by benefiting from a large influx of clients from its former and now insolvent competitors. But it also seems to have benefited from its far-reaching political connections as it received $40 million in capital injection from ARCO, which equals one tenth of ARCO’s $400 million budget. Despite the ill fate of many banks, Russians continue to believe that bankers are the most prosperous members of society. The prosperity of bankers in the opinion of the public seems to have less to do with the profitability of legal banking operations and more to do with their criminal or illegal activities. Those bankers who knew how to bend or break the rules were apparently better prepared to handle the crisis and even take advantage of it. The financial crisis of 1998 revealed that the crisis environment could be easily manipulated by those with access to the banks’ assets. The crisis and insolvency problems led to the enrichment of some bankers who used them to accumulate assets using various illegal mechanisms. There were reports of assetsstripping, of banks shifting assets to shell entities and the initiation of unilateral restructuring of their own balance sheets. Owners of banks stricken by the crisis have transferred their good assets into parallel banking structures, largely at the expense of foreign creditors and Russian retail depositors. The creation and operation of bridge banks can illustrate the point. Bridge banks are an ingenious creation of bankers by now insolvent banks,
such as Menatep, Uneximbank and SBS-Agro.37 Run by these bankers, they were created for stripping and shifting of assets. The Rosbank, the shadow bank of the troubled Uneximbank, is thought to be one of the best examples of resurrected banks. The bank has taken on the infrastructure and key clients of Uneximbank, most notably Interros industrial group. It left behind the insolvent Uneximbank, which was estimated to owe up to $2 billion to creditors, including $1 billion in forward currency contracts. Rosbank became one of the top 20 banks in the Russian Federation, with a capital base of $50 billion. The scheme worked so well for Rosbank that later on it even officially absorbed its original Uneximbank and turned the event into an unprecedented demonstration of good will by a major bank. Crimes in the banking and financial sector were more apparent and less sophisticated in the early and mid1990s. During this period, the Russian media was flooded with reports about fraudulent banks and financial schemes. Many banks appeared to have been criminal enterprises, designed to exploit their customers, from the very beginning. For example,
in 1994, Adelphi, a small Moscow bank, was reported to have profited greatly by cheating its customers. The bankers sold their customers shares of an infamous MMM fund, a pyramid type of investment scheme, which stripped many Russians of their savings. Despite periodic price updates, Adelphi bank kept selling to its customers shares of the MMM fund at a higher rate (quoted earlier) and simultaneously purchasing them at a lower (updated) rate. The shares of the MMM fund were plummeting at the time, as the fund had crashed twice by then, and all of its board members, except for the boss, Sergei Mawrodi, were in prison. Mr. Mawrodi, while out of jail on bail, managed to get elected to the State Duma (Lower House of Parliament) and gained immunity from prosecution.38
The period of massive fraud in the banking and financial sector was also the period of massive violence against high-ranking banking officials. The Association of Russian Bankers reported that 83 armed attempts on the lives of bank presidents and prominent bank officials were made during the three and a half years from mid1991 to 1995.39 A high frequency of violence was indicative of the efforts of criminal groups to establish their control over banks. In 1995, the Scientific Research Institute of the Ministry of Internal Affairs (VNII MVD) believed that criminal groups controlled over 400 banks and 47 exchanges. The control over banks enables an easy generation of illicit proceeds. It significantly simplifies criminal actions (for example, extortion or kidnapping for ransom) against the bank’s customers. It also facilitates the criminal penetration into other sectors of the economy, as it simplifies the financial servicing of criminal operations. For money-laundering activities, the control provides a long-term advantage and considerable protection in the event that banking regulations are imposed. When the criminal organization itself owns and runs a bank, even the most stringent regulation would not contribute much to curbing money-laundering. “It is not necessary to worry about suspicious transaction reports when one owns the bank
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