Markets should be allowed to deal with NPLs

Non Performing Loans continue to be an issue for the Russian banking system but key industry players say the market should be left to handle the problem rather than the creation of a bank for bad assets.

According to the research conducted by Russian rating agency, RusRating, non performing loans in the banking system currently stand at $67 billion, or 9.9% of all credits in the system, with the number expected to increase to $70 billion, or 10.5%, by the end of 2010.

While Russia’s Central Bank has been publishing data on loans and overdue payments for several years already, it started to talk about loan quality and disclose NPLs’ volume only in the second half of 2009, and according to the RusRating study, based on official Central Bank data, the volume of NPL’s has been constantly growing since the beginning of the reporting period, from $48.4 billion posted in July 2009 to about $67 billion as of June 2010.

Speaking about NPLs in Russia’s banking system, RusRating CEO Richard Hainsworth notes the differences between the retail and corporate loans, as the first do already have a small market for bad assets, while the latter, so far, doesn’t. Currently about 80% of all bad loans are in the corporate sector, on the balance sheets of 30 Russia’s largest banks.

A price issue

According to RusRating, today NPLs worth just $1 billion are being managed, which accounts for approximately 2% of the potential market size. Hainsworth says setting up an efficient market system for bad assets would help Russia’s financial system development as well as help the broader economy through improving efficiency. However, adds that the key factor behind NPL’s not being well addressed is the absence of a fair price, with sellers and buyers so far unable to agree on one particular methodology.

“Today there’s absolutely no understanding of the market in terms of the price for bad assets, which is also coupled with the absence of the infrastructure necessary to address the problem.”

Sergey Shpeter, Senior Vice President at Pristav Collection agency, says that Russia’s NPL market belongs to sellers, who usually are looking to maximize price and minimize transparency, which gives the wrong price signal to the market.

“Today there’s a set and quite limited number of Russian banks that usually sell their bad loans, while most of others prefer not to fairly disclose all the information about the quality of their portfolios and simply don’t offer their bad assets for sale. At the same time there are a lot of investors interested in the market, which creates a market of a seller. Russian banks go the easiest way and mostly decide to sell their NPLs to those who put fewer terms and offer a higher price, that in most cases isn’t backed by any reasonable assessment of NPLs. So, as a result, non qualified investors with enough money and huge ambitions but with no necessary experience often buy NPLs at a high price, creating significant imbalance in the market in terms of a price.”

The market plays better than the Government

Vadim Udalov, a banking consultant at International Financial Corporation (IFC), believes it’s up to the market to solve the problem, saying only a commercial interest can help to efficiently decide the problem.

“In my view, the right way out would be a creation of the market with the whole set of entities that have some commercial interest. So, this is a commercial environment that can successfully build such a market, I think.”

The IFC’s Vadim Udalov said there were a range of potential players that could efficiently operate in the market.

“First, these are collector agencies, that either act as agents or invest directly. Secondly, there are banks that can be both sellers or a buyer of bad assets, provided they have properly functioning departments that work with NPLs. Also, it can be investors that see a commercial interest in these bad assets. Investment banks that can operate in this market in the interests of some investors that are not present in a particular geographical region. These can be international asset management companies, international investment banks, that act as intermediaries to the international investors’ society.”

Tim Krauze, head of financial markets in Central and Eastern Europe at the IFC, notes that international experience shows increased government involvement usually complicates the recovery, brining in politics to a financial issue.

“I’d like to add that according to the study conducted by IMF and the World Bank, state-owned asset management companies took longer to emerge from the crisis than non – government entities, as, when the state interfered, the issue became very political.”

However, Krauze added that in this situation the Government should play the role of an organizer and provide for the proper conditions for the efficient market to emerge .

“I think, there’s one way the State could help – it can contribute to the set up of such a market. If we look at Russia’s banking sector, we’ll see that 50% is owned by the State. And this means that at least 50% of NPLs are state-owned. I think, that’ll be terrific if the Government demonstrate their ruling out of the issue. Sberbank is now addressing it, VTB could also start to do this and Deposit Insurance Agency is an apparent candidate for doing this.”