By Alexander Golovin
Source: Banking Review, www.bosfera.ru
The Russian banking system is showing signs of a liquidity crisis, with growing fears of a financial crisis, and Alexei Kudrin is speaking about a full-fledged economic crisis. At the same time, the Chairman of Bank Zapadny, Dmitry Leus, speaks about hyper-liquidity and contemplates conducting an IPO.
- Dmitry Isaakovich, there is a general belief that small banks must specialize in order to be successful. On the other hand, you offer a relatively broad product line and behave like a universal bank. Why did you choose such a strategy?
— The truth is that we are not a universal bank in the full sense of the term, as our main focus is still in retail banking. But our retail offering is universal indeed – mortgage loans, car loans, overdraft loans, and other consumer lending products. When it comes to loans for small and medium-sized enterprises (SME), we currently adopt a more cautious approach. I am not saying that we are not working at all in that sector, but corporate lending requires a more complex analysis of our customers. In addition, the last two years have seen defaults mostly in the sector of SME lending.
On the other hand, an analysis of default statistics shows that mortgage lending is a relatively safe product. Unfortunately, it is impossible to survive from mortgages only, due to lower profit margins in this segment.
- Can you tell us more about the mortgage lending market? Are you working with the Agency for Housing Mortgage Lending (AHML), an institution studying the international experience of mortgage lending in order to introduce best practices into Russia?
— AHML requires its partner to fulfil certain criteria. However, in my opinion, a large part of our country does not meet these criteria. Unfortunately, unofficial revenues still constitute an important part of the Russian economy.
In general, the belief that credit should only be awarded based on documented income is misguided. Take a 15-year mortgage – who in our country can look back to a 15-years track record within one single company? The focus should therefore be on the collateral. If a loan can be justified in light of the collateral, then less attention should be given to the income history of the creditor.
- Does that mean that you raise capital based on your liabilities?
— Correct. We basically use deposits when lending, in addition to the Bank’s capital, of course.
- Is this not too risky? A bank’s liabilities are of a short-term nature, as deposits may be withdrawn at any moment. A bank’s assets, however, often take years to mature.
— I do not deny that there is a certain risk involved. Nevertheless, on average, a mortgage loan’s maturity amounts to 5 years. In addition, any loan, even if it hasn’t been awarded according to AHML standards, may be ultimately sold. Sberbank, for instance, offers such programmes, as well as the other banks. There are also partner programmes that allow raising liquidity when necessary. But for us this is the last resort, because it is not our goal to work as an agent. We intend to preserve our client base and to offer them the products and services they ask for.
- I have often heard private bankers complain that the mortgage sector is an “unlevel” playing field. Do you agree that privately-owned and state banks are not competing at arm’s length?
— I agree, but we should keep in mind that unequal conditions do not only prevail on the mortgage market. A big player such as Sberbank is able to provide SME lending at a rate of 8% p.a. whereas our average-weighted cost of funds ranges between 8.5 and 8.75%.
On the other hand, we have our own competitive advantages. We can afford to show flexibility when it comes to evidentiary requirements with regard to a client’s income. In addition, as a small bank, we can immediately adapt to sudden market changes. To turn around a big bank is something else. Our mortgage rates are therefore cheaper than Sberbank’s at the moment. This is because we were recently able to sell an important portfolio of securities, and have even excess liquidity now. These funds need to be invested somewhere, and this enables us to lend at lower margins.
Every international consultant will confirm that an ideal credit portfolio should have the following outlook: 50% of it should be invested into collateralized loans, 10-15% should be invested into consumer lending, or other high-yield credits, and 20-30% should be kept in treasury bonds or other safe-haven securities which can easily be sold or refinanced with the Central Bank.
- You have recently engaged in consumer lending. What has been your experience?
— We had mortgage rates starting at 9.95% and noticed that some client agreed to these conditions. The average rate on the market is currently 10%. We can afford lower rates and have no plans to raise them because we dispose of sufficient liquidity. However, at some point we will nevertheless have to increase our rates, because the next wave of funding is likely to be more expensive. In any event, consumer loans are a good way of boosting our overall profitability
- There are many similar products on the market now. What is your competitive advantage?
— The most important thing in consumer lending is a good organization of sales, in addition to a high-quality client service. For instance, our “New Year’s Loan” is designed for people who cannot afford to buy Christmas presents for their beloved ones. What counts for such clients is the speed at which the loan is issued. They are not bothered by the fact that they will have to pay a premium of RUB 200 per month. We can offer a quick service if the client has good scores and underwriting results. The first criterion is credit scores. Some lenders get satisfied with good scores and will mechanically award the loan. For us, scoring is just the first step, the second step being underwriting. We may not have the lowest rates on the market, but in order to keep default rates low we put quality over volume.
- Let’s return to funding. Is it correct to say that client deposits constitute about half of your liabilities?
— Yes, we have more than RUB 9bn in deposits and an overall balance of RUB 18.5bn.
- At the same time, I understand you are not attracting clients by means of higher deposit rates. By which means do you attract them?
— I have the impression that we have less and less people shopping around and going from bank to bank in search of the best interest rates.
- Well, I shop around…
— You must be a very reliable client then… [laughs]. No, of course, there are such people, but they are not in the majority. We have a lot of clients who know that Bank Zapadny has been working on the credit market for over five years – and has survived the crisis. Of course, we will have to increase our rates at some point, to be in line with the market, but we will never be able to offer the highest interest rates. In fact, our experience has shown that even during times of strong discrepancy in deposit interest rates, capital outflows do not exceed 20-30%.
- You are working on a joint project with the pharmacy chain “Rigla”. A small bank collaborating with a big network of pharmacies…? What is the nature of your collaboration?
— We are currently launching a pilot project during which Bank Zapadny will be present with a small bank counter in ten “Rigla” branches. For “Rigla” this generates an inflow of new customers mainly interested in our services but also having a look at the pharmacy’s offering – and vice versa. At the same time, such an approach brings the bank closer to its clients. Traditionally, a visit at the bank has to be planned long beforehand and involves long waiting hours. In contrast, here the client finds himself in a quite natural way right in front of the bank’s counter and can easily profit from the full spectrum of our services ranging from account opening, deposits, loans, and credit cards. I repeat that the project just started, but if everything goes well its prospects are excellent. “Rigla” disposes of a large network across the country with points of sale in top locations.
In addition, also in collaboration with “Rigla”, we have started to implement a joint loyalty programme. If the interest payments from Bank Zapadny’s deposits are spent in a “Rigla” pharmacy, the client receives a 20% discount on the pharmacy’s products. In reality, to get such a discount is impossible, as medicine prices are regulated by the state, but here the costs are borne by us. We offer a similar product for credit cards.
— Why did you choose a pharmacy chain as your strategic partner? Is it to enhance your visibility?
— This is not a coincidence. A person visiting a pharmacy is psychologically speaking in the ideal state of mind for us. It is a perfect place to combine physical and financial health, implying a certain concern about one’s condition and a strong resolution to enhance or at least to conserve it. We were offered a partnership with the chain of coffee houses “Shokoladnitsa”, but refused in light of the coffee-house’s connotation of relaxation and socializing. Our banking products need focused customers.
In general, I feel that the pharmacy’s customers will appreciate to have an open window into the banking world, and that people may grow used to it.
- In addition to these unconventional plans, you are systematically opening new conventional branches. More than 15 branches were opened since 2011. Can you tell us more about this rather aggressive growth strategy?
— I don’t think our strategy is aggressive. Rather, it is a survival strategy. We have simply understood that our development in the Russian regions is a top priority.
Our experience has shown that the default rate on loans in the regions is by far lower than in the capital. In a small town everybody knows everybody. And the local security officer is most likely an ex-chief of police who knows his way around. In such an environment it becomes very difficult for creditors not to service their debt, or not to return their loans, because of the negative publicity it immediately creates in the neighbourhood.
Moscow is different. When we launch a new lending product in the capital we immediately get hundreds of suspicious applications coming from fraudsters who are testing whether there is a weak spot in our scoring or underwriting processes. Today such fraudsters dispose of very sophisticated mechanisms. Normal clients only materialize in a second phase. In the periphery, however, this pattern is significantly shorter – if not fully absent.
- You have increased your capital. With what?
— With revenues, in addition to the issue of new shares.
- Did the current shareholders repurchase these shares?
- You have also issued bonds. Who are their buyers and what is their yield?
— We have a good idea of who the potential bond buyers may be, as we have a well-known underwriter. Even if the market is not purchasing our bonds, our underwriter and partners have committed to purchase them. The funds raised will flow into our pipeline products, but it is still too early to speak about yields.
- In September you surprised observers with having Bank Zapadny audited by KPMG. When I recently checked who audited Bank Moscow – a publicly listed company – it turned out it was no one from the Big Four. This begs the question why you hired such an expensive auditor. Is this only linked to the bond issue or are there deeper reasons?
— You are right in noticing that this was an expensive audit, in particular for a bank of our size. The reason is simply that we already today strive to comply with tomorrow’s standards. At the end of the process, auditors usually recommend what needs to be changed or improved. We listen carefully to this advice. If we want to go public – and going public is the epiphany of every business – the right asset structure is of key importance. If a globally recognized auditor acknowledges our structure, this already means an 80% rate of success. We recently visited the London Stock Exchange and were told that a public listing is possible without a credit rating, but it is not possible without an international audit. Investors think the same way. This is why we believe that having a good auditor will provide us useful guidance and help us avoid mistakes going forward. In short, a KPMG audit is an investment into the future.
— An IPO is a long-term goal. What about the short term? Are you planning to attract investors?
— Certainly, but let us first ask: with what objective do we wish to attract investors? We want to become a model bank with an absolutely transparent business and a clear focus on improving processes in line with international standards. This must be the objective – and not the dissolution of our shares through a financial investor. This is why we are only interested in attracting an investor such as, for example, the European Bank for Reconstruction and Development. Put differently, we are looking for a partner ready to share his know-how, expertise, and experience, and guide us by best practices and model behavior – not unlike an older brother. This must be the objective. With such an investor on our side we will walk gently into the future.