OREANDA-NEWS. November 30, 2010. With the current deficit of long-term resources in the internal and external markets, one of the main sources of cheap money for small and medium business is the Russian Development Bank. However, the bank has its limits, and its requirements to partners are rather high. Sergey KRYUKOV, Chairman of the Board of Russian Development Bank, told NBJ about how RDB will cooperate with the banking industry, and what the bank regards as priorities, reported the press-centre of RBD.

GOOD BORROWERS ARE SCARCE
NBJ: Mr. Kryukov, the number of funding sources for the banking sector has significantly decreased during the crisis. Therefore, the importance of state programmes and institutions that provide funding has risen. How did the money deficit affect the business of Russian Development Bank?

S. KRYUKOV: In the last year, the number of contracts executed by RDB has increased by over 350% and almost doubled this year. However, the volume of SMB credits has not yet reached the pre-crisis levels. Thus, the market share of Russian Development Bank has considerably increased during the crisis and post-crisis period. Still, this is only 2.4% of the total SMB credits. The amounts provided under the interest rate subsidy national programme are much bigger.

However, we believe that our resources are more promising, since they are not free and must be repaid. Only if these two conditions are met, the business understands that it has to turn over the money and repay strictly on time. This understanding has a positive impact on the company's efficiency. At the same time, by providing discounted funding, we do not interfere with the competitive environment, neither do we dictate our terms to market players. Only one thing is important to us: make resources available for each end borrower.

NBJ: In times of rapid development, banks noted that they had problems using the money as they struggled to find good-quality borrowers. The crisis has undermined the financial stability of many entrepreneurs, so the problem of effective investment in the banking sector has only worsened.

S. KRYUKOV: Indeed, deficit of quality borrowers has always been in place in the banking sector. And the situation, of course, has deteriorated during the crisis: in 2008-2009, the consumer demand has reduced and, accordingly, the demand for SMB goods  and services has  also  reduced. Furthermore, many SMB businesses are linked in their production chain to large enterprises. And it is well known that during the acute phase of the crisis, some large businesses defaulted on their liabilities to small businesses and undermined the stability of their suppliers. Thus, many borrowers during the crisis have faced financial difficulties and damaged their credit history: their debt was restructured, companies were closed and changed the line of business, employees were laid off, losses were taken.

The situation is now gradually improving. A trend of increasing financial stability and growth of business in SMB has emerged. However, the market is revived very slowly. In order to speed it up, the government has approved a number of incentives, but their results are stretched over time. If tax holidays for three to five years were adopted as an anti-crisis measure, as in many other countries, it could provide an almost immediate effect. However, the unified social tax has been introduced instead. The consequences of this tax may be quite grave: while now -75% SMB enterprises are legal, according to a study by OPORA ROSSIYI, one quarter to one third of small businesses may move to the grey area again after the unified social tax takes effect. For this reason, a good borrower will certainly remain hard to find. And the banking sector now fights for such borrowers.

NBJ: How did credits granted under the RDB programme perform during the crisis? What is the overdue level?

S. KRYUKOV: Before the crisis, the average overdue level in the portfolio of our partners was within 3% to 5%. During the crisis, this metric has nearly doubled, I.e. reached 8 to 10%. The overdue level in the credit portfolio of RDB is significantly lower, because we do not work with businesses directly, so it remains at 1.5-2%. Still, the programme has just been launched and the repayment deadlines are still ahead, so it is too early to determine the overdue level.

FRIENDS OF RDB
NBJ: The number of partner banks is constantly growing, with over 140 banks already participating. What is the share of regional and national banks?

S. KRYUKOV: We try not to focus on national or regional banks only. We welcome participation of various level banks in regional markets, since each of them has some advantages. Large banks have modern technologies and wide opportunities for adopting complex financial instruments. Regional banks have knowledge of the local market and have close relationships with businesses.

SMB credits normally represent a large share in the portfolio of regional banks. When national banks enter a new market, they are mainly interested in attracting large businesses, and small businesses are funded with whatever is left over. About 70-80% of our partners now are regional banks.

NBJ: How stable are regional banks now?

S. KRYUKOV: The market had a lot of rumours regarding increased requirements to the minimum bank capital last year. However, the consequences of this measure have been minimal: only three banks were unable to reach the required minimum amount. Thus, the banking community has demonstrated high stability and responsible attitude to business.

Some regional banks currently have problems with the quality of their credit portfolio andcompliance with long-term liquidity standards, because unlike national banks, they are unable to reach external capital markets. However, the savings of the population are increasing, and most banks are attracting new customers and increase their passive base. In general, we view the status of this segment as stable. That is why the number of our partner banks is growing mainly due to regional banks joining the programme.

NBJ: Were there any of your partners among the rehabilitated banks?

S. KRYUKOV: Yes, two banks that were subject to rehabilitation, received funding under the RDB programme. The customers who have received credits under our programme have now transitioned to our services. According to the agreement, in the event that a partner bank ceases its business, the rights of claims to borrowers are transferred to us. However, as you know, RDB does not directly work with businesses, so we will soon transfer such customers to commercial banks. We are now actively cooperating with the deposit insurance agency to do this.

NBJ: What will be the terms of transfer of the credit portfolio to another bank?
S. KRYUKOV: We will sell them at the same price that the funds were provided, i.e. basically at their nominal value. We are now negotiating this issue. I believe it will be resolved by the end of this year.
NBJ: Are you planning to further increase the number of partner banks?

S. KRYUKOV: Certainly. The limits of the programme currently prevent active engagement of new banks. But these limits are not forever, they will be gradually relaxed, and then we will have much more than just 140 partner banks. We are interested in engaging new participants, because increased access to resources will increase competition in the market, which will contribute to reducing interest rates for end borrowers.

NBJ: Federal banks are now actively joining the RDB programme and use a significant amount of resources. But external markets will be open soon. Do you think that large banks will again switch to cheap Western money?

S. KRYUKOV: Everything is possible. It will depend on the business model of the bank in question and the structure of its balance. Of course, if cheaper money appears on the market, the banks will strive to use this opportunity. However, the cheap external market only interests those market players dealing with foreign currency. SMB usually prefers credits in rubles, since they are reluctant to accept foreign exchange risks. If the international market rate for foreign currency credit is analyzed and compared with the current ruble rate, the price of Western money will be even more than the price of funding under our programme.

LOWEST MINIMUM

NBJ: RDB has decreased the funding rate for its partner banks several times within the year to reduce the price of credits for end borrowers. What are the current rates for credits provided under the RDB programme?

S. KRYUKOV: The credit interest rates for end borrowers receiving credits under the SMB RDB programme is now around 15%. By the end of the year, due to the decreased funding costs, the interest rate will approach 12%. It is a good result compared to the current market prices.

However, the rate still remains a two-digit value and businesses have difficulties compensating for it. But this is the fact of life. Even for large corporate creditors, the interest rate is rarely less than 10%. Another reason is that we provide long-term credits - main credit products come with the credit period of three to five years, and as much as up to seven years in case of Funding of Innovations and Modernization programme. Alternative variants with similar conditions are hard to find in the market.

NBJ: You said that the average market interest rate for credits provided within the RDB programme is now 15%. Why is it so if you provide funding to banks at 9% per annum, and the margin recommended to partner banks is 3%?

S. KRYUKOV: First of all, I should clarify that we cannot dictate the margin. Each bank applies for the programme and states the interest rate it can charge from businesses. Depending on the offer and economic situation in the region, we set regional quotas for the bank. Obviously, the smaller the rate the bank claims, the more resources we can provide. The average margin for credits of our partner banks is now 4-5%. As I have already said, the rates for SMB will decrease from 15% to 12% by the end of the year.

The Ministry of Finance has decreased the interest on the deposit that Vneshekonombank receives from the National Welfare Fund, and we were able to reduce the funding price for our partner banks in August. Borrowers receive money with a small delay: technical operations, like execution of the credit agreement or provision of collateral, may take up to 90 days.

NBJ: Why is it so that RDB initially recommended a 3% margin, but the market increased it to 4%?

S. KRYUKOV: As you have just mentioned, 3% is our recommended margin. The bank itself bears the risks when it grants any credit, so we cannot impose any terms. If we limit the interest rate, the number of borrowers will immediately decrease, because banks will provide credits only to a limited segment of the most reliable borrowers. Banks may now use a higher margin in case of customers with no liquid collateral or with a bad credit history.

NBJ: Are there any cases when banks abuse their freedom to set the interest rate and use a high margin to obtain excess profit?

S. KRYUKOV: Such cases certainly occur, but we discover them quite quickly. RDB checks the registers submitted by the banks every month. Sometimes we visit them and check their documents on the spot.

Moreover, businesses themselves may contact us via the website or the business community. We are checking all information we receive. And if we discover any abuses, we negotiate with the bank in question. The price of the credit for the business is usually decreased as a result. However, I should still note that we are unable to impose the credit terms, because relationships with borrowers are governed by internal policies of the bank.

NBJ: So you do not apply any penalties?

S. KRYUKOV: There is only one case when penalties are possible: if a bank takes part in the tender for regional quotas and claims a certain interest rate, and if we later check the register and discover that it has provided a credit at 13% and not 12% as it initially claimed during the tender. Should this occur, certain penalties may be applied, but there have been no such violations to date.

NBJ: The interest rates are now below the pre-crisis level. Is it possible that they will go up again due to adverse economic factors, such as if prices continue to rise?

S. KRYUKOV: We cannot increase the price of funding, because the funds for these programmes are provided by the government on a long-term basis. Predictability of the price of funding is crucial for banks, especially for regional ones, which are sensitive to momentary market changes. If a bank has access to long-term funds, it can clearly plan its budget, build an efficient credit policy and participate in long-term projects.

Some banks say that cheaper money can be currently attracted on the market. They mainly refer to refinancing in the Central Bank and unsecured auctions of the Central Bank that have existed recently. Some banks may also afford to enter public markets. However, issuing bonds or even attracting a syndicated credit or bonded loan on the external market is something only a limited number of banks can do. That is why alternative sources of funding on the internal market are currently hard to find.

RDB LURES BANKS INTO INNOVATION PROJECTS
NBJ: Russian Development Bank has always tried to focus on crediting the industrial sector. As you have pointed out,   the   quality   of   borrowers   has decreased during the crisis. Does the industrial sector still remain a focus?

S. KRYUKOV: Yes, commercial and service sectors currently prevail among our borrowers, accounting for about 60% of the total number of borrowers. The industrial sector considerably lags behind, and innovation businesses in SMB are extremely limited. We carefully monitor the fate of each of them and try to grow them. For this purpose we have just launched a funding programme for innovation and modernization in small business, where we provide the longest-term credit (starting from seven years) with the lowest interest rate (from 1/2 to 3/4 of the Central Bank refinancing rate).

Risks of such borrowers are, of course, much higher. First of all, these are long-term projects. Secondly, it is unclear whether the market will accept the new technologies and whether they reach the designed level. It is hard to predict the situation, and there are good reasons why banks cannot grant low-interest credits to innovation companies. By reducing the funding price for our partner banks, we provide them with an incentive to consider such projects.

It should be noted that this product is based on state and private partnership, i.e. the project must be funded by both the business owner and a partner bank. The owner should be sure that the project will be a success and be prepared to accept some financial liabilities. The partner bank supervises the development of the project. We do not enter any projects at zero point, i.e. when it is just an idea. We are ready to get involved at the intermediate stage, when a test sample is being manufactured.

NBJ: Are banks interested in innovation projects? These are not just high-risk projects, they also take a lot of efforts.

S. KRYUKOV: Banks certainly prefer less risky projects. It is much simpler to credit a trade company where the funds are turned over within about 40 days. However, after we launched the funding mechanism for innovations and modernization, we have seen unexpected interest of our partners in this programme. Around 100 banks immediately responded to our offer to take part in the programme, and some of them have already brought definite projects. As a result, our limits for funding of innovation and modernization projects are now over 4 billion rubles. But one needs to understand that this cannot be a mass product. It is targeted support of individual companies or projects that, in our opinion, are promising.

NBJ: The crisis has to a certain extent helped the economy. Market development used to be uncontrolled, but now there appeared a lot of incentives for priority industries and sectors.

S. KRYUKOV: As they say, if it weren't for bad luck, there would be no luck at all. Indeed, it is in 2008 and 2009 that most of resolutions and decisions to stimulate the SMB were made. In particular, regions were allowed to reduce the business tax from 15% to 5%, the procedure of connecting to power networks has been simplified, as well as the procedures of rental and purchase of premises, state subsidies have been offered, the number of business checks by regulatory authorities has been reduced, the list of businesses that can be opened with a simple notice was expanded, and long-expected microfinancing and cooperative laws have been adopted. All of these measures are aimed at creating a comfortable business environment.

However, a study by OPORA ROSSIYI has surprisingly shown that only a few percent of the funds granted by the government for anti-crisis programmes are for small and medium business.

NON-CORE BUSINESS
NBJ: Last year, RDB has expanded its range of activities. In addition to banks, now you also provide credits to factoring and leasing companies, and to microfinancing companies. What are the reasons behind the decision to enter auxiliary markets?

S. KRYUKOV: There are not many good borrowers in the market. In order to somehow compensate for this, we tried to understand the biggest burdens for business. As a result of our studies, we have learned that industries have two key expenses that strongly affect corporate budgets: real estate and equipment. The real estate sector is completely unrelated to us, so we decided to help them reduce the second type of expenses.

The easiest method to upgrade the car park or equipment today is to use various leasing options. This is why we have developed special programmes to establish cooperation between enterprises and leasing companies. We now have agreements with over 60 leasing companies of different specialization (vehicles, special-purpose machinery, equipment etc.) that we provide with cheap funding.

NBJ: But leasing and factoring companies have been destabilized during the crisis, and even the largest players were forced out of the market. Are you afraid of high risks in this segment?

S. KRYUKOV: You are right, the situation in this market is not simple. Leasing companies have accumulated a lot of unneeded equipment. But the business is adjusting and the demand is restoring. In addition, we only select the best companies whose business is clear to us, where we can calculate their limits and watch their business.

NBJ: Microfinancing risks are especially notorious. Many investors view this market as a black hole…

S. KRYUKOV: I agree that microfinancing is not an easy market. Even its players cannot determine how many of them are on the market: some say 150, others say 200 or 400. However, a law has been recently adopted that, as we hope, will shape it into a more civilized market.

We consider all the risks and are entering the market slowly. We currently cooperate with several leading players. They have participated in drafting the law and we trust their feeling of the market.

NBJ: Some microfinancing market players say that the program exists, but nobody can actually benefit from it, because RDB limits the maximum interest rate to end borrowers. Is it possible that such limits may be removed?

S. KRYUKOV: We set such limits in the interests of the end borrower. If a micro-financing company cannot provide loans at 22% per annum, it can look for funding on the market with any terms it finds convenient. But the funding price there is much higher.

The problem is that some companies want both to receive cheap funding and earn a lot with it. Some microfinancing companies charge 40% per month. We cannot encourage such behavior.

ROAD TO THE FUTURE VIA THE CAPITAL MARKET

NBJ: You have received 30 billion from the National Welfare Fund. Are these funds sufficient?

S. KRYUKOV: The portfolio of contracts with our partners currently exceeds 60 billion rubles. We use different sources for funding: capital markets, federal budget, etc. Our credit rating is on the federal level, which helps us initiate issues and attract loans. The only problem, as I said, is foreign currency risks. But we are monitoring the market situation.

NBJ: That means you can go public?

S. KRYUKOV: It is not likely that we enter the market on our own due to the “large scale law”. Vneshekonombank, our shareholder, usually enters the market, and uses some of the resources it attracted to fund RDB programmes.

NBJ: You have planned to reach 100 billion rubles in 2010. Do you think the limits should be increased in the next year?

S. KRYUKOV: Just increasing the numbers is unreasonable. The goal of RDB is not to hand out cash to SMB, but to support priority areas of business. Large funds are not required to achieve this goal. What's required is clearly defined and proven credit products understandable for businesses. An example of such ad hoc products is the innovation and modernization funding programme, with only 8 billion rubles allocated to it in 2010.

In order to find the most essential projects,  we  communicate  with  local administrations who know which industry or company needs support. Having visited dozens of single-industry towns, I can say that they all have a common problem -lack of service companies and insufficient production of daily consumption goods. For this reason, we have started implementing several interesting projects. For example, we have launched a pilot project in Petropavlovsk-Kamchatsky to upgrade the utilities, where only SMB companies provide installation and maintenance of utility meters. This experience has been quite successful and we are now repeating it in other territories.

NBJ: Your colleagues, EBRD and EDB, are operating not only in their area, but also on developing markets of neighbouring countries. Do you plan to expand to international markets?

S. KRYUKOV: In favourable economic conditions, we may enter international markets if our shareholder approves it. We have a SMB securitization project. This is an essential and interesting product for the development of this sector, since it will enable to attract funding from the capital markets.

NBJ: But it will require standardized products, which will probably take a lot of time?

S. KRYUKOV:True, this is not something we can do in one day, but we have already started moving in this direction. We have suggested to our partner banks to implement a strict crediting standard. We are not aiming to instantly securitize 100% of the portfolio. Initially it might be 5% or 10% of the portfolio.

In order to reach international investors, we need to resolve legal issues. Our laws still do not comply with the requirements of international investors. The work in this area is rapidly progressing, since we need to create the financial market infrastructure as Moscow is becoming an international financial center. First transactions may already occur in 2011-2012.