Analysts predict further losses: Greater Russian involvement ups Latvia's bank risks

  • 1998-10-29
  • Sandra L. Medearis
RIGA - As bankers at a Riga conference predicted more casualties among small Baltic banks in a second wave of reaction to the Russian economy, the Bank of Latvia lifted the license of a small Riga bank.

Latvia's central bank on Oct. 22 told investment bank Victorija, the third from the smallest of 31 Latvian banks, to stop its use of deposits. Setting aside provisions against capital involved in risky investments reduced the bank's equity capital below the 2 million lats required by law, the bank's vice president, Alexander Farbtukh, told BNS.

A few small banks in the Baltics could fail, and mergers and consolidations will occur if the present crisis follows a classic course, several analysts told bankers at a conference at the Radisson SAS Daugava hotel.

Paul Jennings, an analyst for the Thomson Bankwatch rating agency, said that Latvia, with more remaining ties to Russia than Estonia and Lithuania, is not finished with feeling the effects of its neighbor's agony.

"For many reasons, I would rate Latvia most at risk in the region," said Jennings, Central European analyst for his firm.

Jennings cited indirect hits from reductions in transit and exports that will adversely affect commerce bank customers, as well as direct exposure to Russian securities, as reasons for bank managers to have bad days in the weeks ahead.

Latvia was sending 20 percent of its exports to Russia in August before the crisis. Now food, fish and machinery companies are hard hit with no way to get money for their shipments. Latvia's banks have been more involved in Russian business than those of Baltic neighbors. The total exposure of Latvian banks to Russia is 8.3 percent of total assets or about 170 million lats ($303 million).

Jennings said that banks that do not have at least 70 percent backup for Russian investments are at risk and eligible for lower ratings, and that banks should make provisions for indirect effects on clients.

Provisioning, an accounting practice according to which the bank puts aside reserves against low-earning and risky assets, reduces the profit figures and lowers dividends to shareholders.

Banks should resist responding to the demands for shareholder profits as competition heats up with the privatization of banks, said Jennings. "We'd rather see a bank over-provision and then write back the surplus provisions if the situation improves."

Most banks have survived the first liquidity crisis, Jennings said, and now Thomson Bankwatch will attend closely to how banks handle adequate provisions against the Russian crisis especially in the weeks before the end of 1998.

There is nothing much special about the current situation relative to the Russian economy, said Istvan Lengyel, secretary general of the Banking Association for Central and Eastern Europe.

"It is the most recent - otherwise it is not an exception. Three-fourths of the IMF countries between 1980 and 1995 have had banking system problems." The key to investments in Central Europe is daily diligent monitoring, Lengyel said.

"Don't be satisfied with yourself," he said. "Banking business is risky business, and Central Europe and Eastern Europe can be very risky (in some areas). Be careful. It is better to be a Cassandra (doomsayer) and see something coming and not have it happen."

When something does happen, managers are stuck with having to tell stockholders that damage is minimal, Lengyel said.

Some types of involvement increase risk, such as investments promising outrageous 30 percent to 40 percent returns in dollars and cross-border payments without selecting counterparts with care, and syndicated loans. In the Russian case, banks have been allowed to pay only interest. The repayment of principal may be in danger after Nov. 17, Lengyel said.

"Probably most Russian banks will ask to renew the terms of the loans . Very likely, Russia will ask for another rescheduling of ex-Soviet debt and maybe, rescheduling of new Russian sovereign debt," Lengyel said. Use caution and do not blindly trust rating agencies, he said.

"If all banks make the same mistakes, no one is responsible, but ultimately banks are backed up by taxpayer money, Lengyel stressed. "For our mistakes, the taxpayers have to pay at the end of the day."

Lengyel predicted further losses in forward exchange contracts, trade finance, money markets and syndicated loans after the Nov. 17 end of Russia's 90-day moratorium on foreign debt.

Russian banks owe foreign banks about $6 billion for unfulfilled forward exchange contracts according to Andrei Kozlov, first deputy chairman of Russia's central bank, in a report from Radio Free Europe. These contracts may not be met, Lengyel said. "There may be very serious problems in the future." Likewise for ruble-dominated investments. "We still do not know the extent of the loss," he said.

Jennings could not rank Estonia and Lithuania banks' risks after Latvia as their exposures are different. Lithuania may suffer a decrease in transit trade and Estonia is more likely to see some problems with small banks, he said.

A Lithuanian banker said that Lithuania faces more indirect losses from transit and export ties to Russia than from direct investments.

"Volumes of trading with Russia and the growth rate of export companies go down respectively as a result of the devaluation of the Russian national currency. Trade volumes decrease further due to deterioration in the quality of trade accounts receivable and breakdowns in settlements," Julius Niedvaras, board chairman of Vilniaus Bankas said. "The major risk arises because of a slow-down in the economy. To maintain growth, companies will have to proceed with restructure, and the government will be obliged to take the correct political steps to protect the economy from slowing down."

Estonia, depending on foreign financing, faces higher refinance charges because of the loss of confidence of Western banks. The direct effect on the Estonian banking sector has been light, Helo Meigas, deputy governor of Bank of Estonia said, with banks' consolidated direct exposure in Russia and other former Soviet countries less than 2 percent. Still, she said, current developments in the international financial markets are clearly unfavorable. Foreign investors' perception of local problems lead them to make inadequate generalizations about neighboring emerging markets as a whole. To absorb these influences and possible shocks, Meigas said that the Bank of Estonia has banking practices stressing transparency and conservative risk-covering policies in Estonia's banks.

Vilniaus Bankas will continue conservative policies, Niedvaras said. these include limiting loans to one company to no more than 20 percent of its capital and holding the loan portfolio of one industry to 10 percent.

Latvian banks received support from bankers at the three-day conference, Banking and Finance in The Baltics '98.

"Latvian banks are involved in Russian business to a larger extent than their neighbors are. However, they are weathering the Russian financial crisis quite well," Peter Tils, head of the Middle and South Europe Group of Deutsche Bank AG, said.

The three Baltic currencies are effectively pegged to Western units and hard currency reserves are more than the local money in circulation, Tils noted.

Einars Repse, governor of Latvia's central bank said that even after the period of relative instability caused by the financial crisis in Russia, Latvia's foreign reserves exceed lats in circulation by 5.6 percent. Loss of Russian markets could be good for Latvia, Repse said.

"Losing at least part of the excessively profitable and, as it turned out, risky business in Russia will provide more incentives for expanding domestic business and will foster consolidation of the banking system, first and foremost through mergers," Repse said.

Lengyel said that mergers and consolidations are part of a pattern in emerging countries where liberalization of the banking system leads to too many banks. Small banks disappear and larger banks consolidate. What comes next depends on government and banking supervision and measures taken to create strong systems within strong banks, Lengyel said.

Ivars Kirsons, senior vice president of Latvijas Unibanka also predicted mergers.

"There will be some closures and more consolidations in the future. When they have lost the opportunity to earn high interest in Russia, for many small banks the music has stopped," Kirsons said.

"In boom times, the pressure on banks is so great that due diligence goes out of the window and everyone follows the sheep," Jonathan Harfield, a senior banker on ERBD's financial institutions team, said.

Meanwhile, back at Academijas Square 1 in Riga, the Victorija bank is calling on shareholders and potential shareholders to increase share capital so that the bank can meet capital equity requirements. Outcomes of these meetings will be known this week, its vice president anticipates.