Providing corporate loans almost requires a jeweller’s approach. The Chairman of the Board of Directors of Bank Zapadny, Dmity Leus, talks about his partnership with Vnesheconombank (VEB), today’s survival strategies of Russian niche commercial banks, the idiosyncracies of state-of-the art risk management, and the Bank’s expansion plans.
By Natalia Trushina, Bankir.ru
— Dmitry Isaakovich, what is your assessment of the current state of the Russian economy? Is the banking sector feeling the stagnation announced by certain analysts?
— To give assessments and predictions is an ungrateful task. The Russian and worldwide economy are such that no one can hope to grasp the full picture and make plausible forecasts. Today, even senior analysts equiped with the most refined methods of forecasting struggle at making straightforward statements. I will therefore not engage in forecasts and complex theories. However, I am prepared to simply share some thoughts on the current market situation.
In my view, at the present moment neither a crisis situation nor a sudden breakdown is to be expected. What is more likely is a situation of slow stagnation requiring some time for adaptation. The banking sector, the regulator, and private enterprises will need to focus on their core activities again. In such circumstances, market participants need to adjust their behaviour in order to work effectively and survive.
We must keep in mind that the popularity of any bank’s core products is in many ways a function of the general market situation. How to explain otherwise the fact that almost all financial institutions rushed into consumer credits in recent years? Banks are only ready to take risks if they are rewarded by profits. If, however, costs of funds are high, banks need to play by different rules if they want to develop sustainably.
Thus, as long as costs of funds were low, Bank Zapadny actively increased its mortgage loan portfolio. At the same time, we heavily invested into our IT infrastructure, created a professional management team, and opened new branches at strategic locations. However, we were constraind to adjust our expansion plans in the aftermath of the financial crisis of 2008. For a short while, we had recourse to various refinancing options, but quickly realized that our profit margin in this particular segment was too small. Like many other financial market players, we finally had to adapt our strategy to the new environment. Hence, our attention switched to new lending products with smaller margins but higher volumes, and repayment schedules ranging between 2 and 3 years.
Currently, we plan to slowly return to mortgage lending, albeit on a much smaller scale than before.
— Is it true to say that Bank Zapadny is now mainly active in the segment of consumer loans like most of its competitors?
This is correct, but we are not inactive, and plan to expand our presence in other sectors. Consumer loans constitute a significant part of our current portfolio, but we also plan to address the capital needs of small and mid-size businesses (SMB) and to provide corporate loans.
As you may know, we have recently signed our first contract with SME Bank (The Russian Bank for Small and Medium Enterprises Support) – a subsidiary of Vnesheconombank (VEB). Funds will be used for corporate lending, mainly through our regional offices. This will undoubtedly have a positive impact on the development of Russia’s regional economy. Bank Zapadny has the intention of continuing its co-operation with SME Bank and sign additional contracts over RUB 3bn.
Overall, we have been providing loans to SME Bank for quite some time. For example, in the past we offered a product called “The Millionaire”, whereby individual entrepreneurs were eligible to receive credits amounting to RUB 1 million if they met certain criteria. Accordingly, we have accumulated experience in valuing small businesses and have even developed our own approach when lending to entrepreneurs. We can always return to this practice even when times are difficult.
It is my deep conviction that banks need to be diversified, even if some of my Russian colleagues may disagree. In today’s market environment, only effective diversification is able to successfully mitigate certain regulatory risks. Thus, as long as there is a popular consensus that higher than normal profit margins can only be attained at the price of higher risks, even a profitable bank, if it concentrates its assets in high-margin product lines, may face the risk of a regulatory crackdown.
— There is room for debate. The crisis has also shown that in the segment of consumer lending repayment shortfalls have only slowly increased whereas corporate creditors have had recourse to several tricks such as automatic rollovers in order to hide away their repayment difficulties.
— I agree with your observation. Every credit decision involves a bank’s model for financial risk management.
Bank Zapadny disposes of a strict system for financial risk modelling. Every day, we receive approximately 2500 new credit requests from private individuals. Among all these requests, only about 18% receive final credit approval. In addition, repayment shortfalls of up to 60 days are being addressed by our debt collection services. The latter’s collection strategy is permanently being adapted to prevailing market conditions. For example, there existed a period when we completely stopped lending to individuals under the age of 25, as we observed a specific age-related absence of repayment discipline.
Furthermore, our analysts are monitoring Bank Zapadny’s credit portfolio on an ongoing basis. We provide RUB 1bn of finance to the Russian population every month, which constitutes a relatively small amount. On the other hand, it is just enough to subject our credit porfolio to a thorough analysis and take ad-hoc decisions when needed. In light of the Bank’s 70 branches across Russia I may add that working in the Russian regions has proven easier than in the capital, as loan repayment rates have historically been higher in the periphery. In total, our current private-loan default rate amounts to only 6 percent.
In contrast, in the realm of small and mid-size businesses we have so far practically not seen any arrears at all, which may be due to the fact that we have entered this market relatively recently. Thanks to our cautious approach to risk, I am convinced that our default rate in this segment will be even lower than in our private lending activities.
Let us not forget that consumer lending in general is a mass market that is dominated by standardized processes. SMB lending, on the other hand, allows for an individual approach taking into consideration a credit request’s multitude of layers. Thus, prior to being forwarded to our centralized Credit Committee in Moscow, every corporate credit submission is carefully prepared in one of Bank Zapadny’s regional branches. For example, our regional credit specialists conduct site visits during which they value the respective company’s market standing, monitor contractual partners, and go through a potential client’s consolidated financial statements. This in-depth approach enables us to select the top tier out of 10 applications.
— Your bank has been in existence on the Russian market since 1993. This is an important period for the relatively young Russian banking sector. Bank Zapadny has lived through more than one crisis. Based on your experience, which should be the strategy of today’s commercial banks in Russia.
The survival strategy for niche commercial banks in contemporary Russia with its economic uncertainties consists in sound risk management.
From a business perspective, the secret of success for weathering any crisis consists in the strong will of a bank’s owners and stakeholders to preserve and develop their business. The first thing which is thought in business administration courses is the theory of economic choice, that is, the choice one must make when faced with two or more alternative uses of a resource. Crisis economics simply dramatizes this basic economic choice.
The banking industry today presents higher risks than other economic activities. Taking these risks is the choice of every shareholder and manager. I arrive at work before 8 am and leave the bank after 8 pm. But this is the only way to work in order to achieve good results. The banking industry consists of a multitude of little things hardly recognizable to outsiders. However, taken together they critically impact the bank’s financial results. Every aspect of the business must receive its due attention, starting with administrative tasks and ending with the closure of big transactions. There are a million of details which may escape the attention of the bank’s managing director. A permanently heightened state of alert should therefore become the responsible banker’s second nature. In my opinion, a bank controlled and managed by its owners is the best guarantee of success.
The right risk management does not consist in doing the maths and ticking the box. Rather, it consists in picking up the faint signal of today that will become tomorrow’s big challenge – a practice the Austrian economist and management consultant Peter Drucker has called the anticipation of a future that has already happened. Risks are present in every form of business. However, some risks are balanced by reasonable rewards, others are not. The essence of entrepreneurship consists in getting this balance right.
As stated earlier, when a financial institution concentrates on a few core products it is already taking an important risk. We have therefore taken the decision to enlarge our product palette to include lending offerings for SMBs in the Russian regions, in addition to corporate lending.
— What motivated your decision to develop SMB lending?
First and foremost, we came to the conclusion that our financial positions would allow such an undertaking. Secondly, we already disposed of in-depth market knowledge and had the feeling of having a good understanding of our future customers. In addition, the platform was already in place – a professional team, our prior expertise, functioning IT solutions and regional presence.
— Which are the most popular products your bank offers for SMBs? Are there any joint programs?
Our lending solutions for SMBs do not exceed RUB 3m with a minimal amount of RUB 30k and durations not exceeding 3 years. Interest rates are calculated on a case-by-case basis reflecting the client’s financial indicators, with a minimal interest rate of 15% p.a. For seasonal businesses we may provide for individual repayment schedules.
To qualify for a loan, a company must have been on the market for over a year, and state participation should not exceed 25%. Also, the company’s headcount should not be over 250 people. The company must have met all its tax and social obligations. On the other hand, we do not have any preferences with regard to the nature of the business and are prepared to deal with companies operating in such various sectors as shops, restaurants, hotels, software firms, car service stations, and building companies. Everyone is welcome.
When making the credit decision we analyze a company’s business plan, its financial situation, in addition to its credit history with other banks, etc. The company should have sound financials and be profitable.
We stimulate entrepreneurs to engage in joint ventures and are prepared to gain a deep understanding of their core activities. Bank Zapadny has an individual approach to every borrower. We are interested in a long-term partnership with our corporate client. Hence we invite them to transfer their working capital to the bank. This allows the bank to easily analyze its clients’ financial condition and provides them with the opportunity to deepen collaboration through more favorable conditions and interest rates.
We practically do not take account-keeping commissions and where we do such commissions are in stark disproportion to the liquidity we provided. Rather, having our clients’ account with us enables us to better understand their activity, thereby increasing transparency. Based on my experience I can say that most such clients remain faithful to us, event long after the loan has been paid back. This means that we have gained their trust. They know that they have earned their right for preferential treatment going forward. In addition, we know the management team of such companies, their market standing, and many other details.
— Over the last year Bank Zapadny has significantly increased its presence in the Russian regions. What dictated such a move? Is it the smaller amount of initial capital investments, the lower level of competition with other financial market players, or a heightend focus on the renaissance of SMBs in the regions?
This choice was determined by a whole range of factors. First of all, corporate borrowers in the regions are much more disciplined – their default rate is below 1 percent. Secondly, in opposition to the capital, the regional credit market is not overheated. There is a lack of financial institutions in small Russian towns, and clients are far more attentive to new opportunities. Our regional network counts over 70 branches, with a rising tendency. Our strategy in this regard is very simple: we open a branch, take it to its break-even point, and open a new one. Finally, with regard to organizational issues, it is easier to set up a new business in the Russian regions. Our managers have the opportunity to visit their customers, evaluate their businesses, and establish a personal relationship.
I see great potential in the revival of small and medium-sized businesses in the Russian regions.