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15 January 2013

Financial industry: positive outlook for the hard times

Dmitry Dmitriev, Global Co-Head of Research at VTB Capital:

What is the most powerful thing in the world? An idea! But what is an idea without money? Almost nothing. We are all amazed by how quickly the world changes nowadays, and how fast the cutting edge of science comes to everyday life. And few would dispute that money stands behind any invention or breakthrough, be it Columbus’ expedition or the widespread use of smartphones. However, this positive role of the financial industry often goes unnoticed, with people tending to focus on events such as the Great Depression or other currency, credit or budget crunches.

That said, banks are now going through hard times, with hits raining in fr om all directions. These include the rapidly deteriorating financial positions of individuals, corporates and even sovereigns as a result of past policies that have proved unreasonable. The key difference during this current turmoil is that questions have been asked about the credibility of sovereigns, which had previously served as investors of last resort saving economies and boosting growth. This no longer holds, as government resources are limited and so there is unlikely to be a rapid recovery back to the pattern of stable growth. Another hit has come fr om the regulatory front, with an extensive set of new rules and restrictions now being imposed on the banking industry in order to limit bankers’ appetite for risk.

As a result, the total amount of profits that banks earn has dropped dramatically, with little expectation for any change soon. Banks have thus been forced to optimise their structure, expand their client coverage and widen the product range where they are strong while leaving those markets wh ere their competitive advantages are lim ited. Tough times indeed, but the system and its institutions will, in our view, emerge stronger than before.

What about Russia? The Russian banking sector is relatively young but it plays the same role as everywhere else and is exposed to the same risks. The first hit taken by the Russian economy and banking sector in 2008 was hard, as the drop in commodity prices was accompanied by substantial capital outflows. However, most of the lessons have been learned by the government, companies and banks. Private indebtedness has dropped noticeably, there is a de facto flexible rouble rate and strengthened lending discipline at banks has made the system more bullet-proof against further global turbulence.

What next? Well, the Russian economy still needs vast amounts of investment, and probably more so than ever before, while consumers continue to be relatively debt free. So, the growth potential remains significant, although it is getting harder for banks to play on it. The banking business is becoming more competitive, with lower margins, and the Russian market is now taking an evolutionary step towards more sophisticated products, global standards of client work and internal efficiency. The corresponding steps on the regulatory and market infrastructure front are on the government’s agenda, and we have already seen notable progress with regard to implementing Basel standards of supervision, merging exchanges and creating a central depository.

Markets and capital are often capricious, and there can be no certainty that they will ultimately gravitate towards Russia in general, and Moscow in particular. That said, the efforts to build an international financial centre in Moscow are set to improve the landscape of Russian financial intermediation, bringing it towards global standards. And that is surely for the benefit of economic agents, both companies and individuals, as well as for the economy as a whole, which is why it is the ultimate goal of the reforms to develop the market. 

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