EKATERINA YUDINA – MARCH 16TH, 2021
EDITOR: MILLIE KHOSLA
Prior to 1991, the government of the USSR had managed to wield full control over one of the state’s largest sectors: the banking industry. Yet after the USSR’s collapse, the banking sector of the Russian Federation privatized in a rapid and decentralized manner. As a part of this quick privatization, the voucher system was introduced in 1992, which gave even more power to top managers at the banks, resulting in profound changes in political power and the socioeconomic life of the country. The effects of the 1990s privatization system continue to be seen to this day, both in terms of where capital power lies and at what stage full privatization stands currently. The rate at which privatization occurs, how beneficial the current system of privatization is, and the effects that commercialization has on both Russia’s economy and society as a whole continue to be debated.
Privatization in the Years Following the Fall of the Soviet Union (1991-1996)
Privatization was not initially a priority in Russia’s reform agenda after the fall of the Soviet Union. Despite not being a priority, privatization was soon seen as an imperative for the government, as the ruling regime was on the brink of an economic crash due to the financial turmoil of the early 1990s. Because of this, privatization, especially in the financial sector, was quick and decentralized, with incumbent managers (rather than new ownership) allowed to control newly formed banks. This process began with the privatization of the Russian branches of three out of the five Soviet specialized banks in 1991. The government itself took no initiative to carve out bad loans or to recapitalize banks.
Despite multiple possible approaches to privatization, the free distribution of state-owned enterprises to the Russian population was ultimately chosen in 1992. It was followed by the creation of privatization vouchers that allowed workers and managers to obtain a large portion of the stock on terms that were advantageous to top management, most of whom had been previously appointed by Soviet officials.
Every citizen was given a privatization voucher supposedly worth 10,000 rubles which ultimately went down to approximately 3,000 rubles by the summer of 1993. The vouchers were truthfully only valuable to workers that were a part of the privatized industries, as workers and top managers were able to purchase vouchers from other citizens to get enough shares to take ownership of their factory, land, or other industrial property. In fact, managers often forced their workers to hand over their vouchers by withholding paychecks from workers, and within a few months, a few select individuals such as these managers were able to become millionaires and even billionaires. As a result, managers have been able to increase their control over these banks in comparison to private shareholders. For others not involved in the privatized sphere, it seemed much more logical and worthwhile to place vouchers into the hands of investment funds and most people sold their shares for a small sum of money. Despite the promises of such funds to turn large profits in the future, most investment funds vanished. Soviet citizens were extremely unprepared in terms of financial competence to do anything worthwhile with their vouchers, so for most people, privatization and the voucher system weren’t of any benefit.
The strategy, operations, and performance of banks all have continued to be thoroughly influenced by the manner in which they were privatized. The removal of the state from the direct ownership of banks and the gargantuan increase in licensing mostly unregulated, small, private banks in the early 1990s resulted in a 75% private Russian banking sector by 1996. However, this exposed shortcomings of privatized banks’ operations. The liberal licensing that had increased the formation of new, private banks contributed to instability in the system, due to the regulatory and supervisory capabilities of the government being unable to keep up with the creation of new banks, although it at first did foster beneficial competition within the financial industry itself. By the end of 1996, over half of all banks in operation in Russia had originated privately as a result of this liberal licensing. As a result of instability in the financial system due to the system of privatization, a large and stable middle class was not able to be created, and private ownership was spread too thin to a narrow group of top managers and government officials.
Despite the many detriments of the privatization of the financial sector, it did create profound changes in the socioeconomic life of the Russian people, specifically in terms of shifts in society, capital, and political power. The voucher system was a significant start for the start of business in Russia, as private capital emerged which therefore guaranteed that there would not be a return back to communism. A new social structure emerged based on the distribution of former state-owned property, and individuals were now presented with incomes from private capital that did not previously exist. Today, anything analogous to the voucher system is unlikely to be efficiently implemented to further fully privatize any industries, and the voucher system is more of interest to historians rather than to those currently aiming to come up with solutions and systems to further implement privatization.
Current Status and Effects of Privatization
Privatization in Russia is still a continual process. There are many debates on the correct way to privatize businesses and at what rate government shares of enterprises should be sold. One popular argument states that a key prerequisite for the restructuring of the financial system is the depoliticization of firms, which would ideally maximize profits rather than please politicians. The theory behind this depoliticization of firms is based on the notion that privatization reduces the amount of inefficiency that firms are willing to accept in order to satisfy politicians. Currently, privatization continues to lead to significant ownership by managers and workers, as well as some ownership by large outside shareholders. The financial industry itself is primarily political and continues to be dominated by the government and the Central Russian Bank (CBR); commercial banks play a minor role in capital allocation. Although privatization is believed to be steadily progressing in the long term, other estimates find that banks are currently becoming increasingly state-controlled, and that these banks are irremovable, integral pieces of Russia’s financial industry that are considered to be “too big to fail.” Large conglomerate banks such as Sberbank and VTB are partially state-owned, thus, when these banks incorporate smaller, failing private banks, the state-controlled shares of the banking industry grow as well. In fact, according to some studies, partially state-controlled banks dominate practically all areas of the financial industry, while truly private banking is in a period of decline.
Another issue that currently plagues the banking system is the Central Russian Bank’s duality in being a regulator and an owner in the banking industry, creating an enormous conflict of interest. Although the share of deposits and credit taken by the ten largest private banks hasn’t fallen, suggesting that established private banks are able to weather the difficult current economic conditions, the share of the state in the banking industry has climbed to nearly 65% after many banks were forced to close due to licensing issues and the recent economic recession due to economic sanctions, highlighting the CBR’s massive involvement in the industry. The CBR’s role in regulating and holding partial ownership and the delay of selling government shares of giant semi-private banks such as Sberbank and VTB exposes regulatory weaknesses in Russia’s financial sector.
This has thus led analysts to challenge the notion that Russia is following a path to a European-model financial market, and suggest that Russia’s financial industry should be rather compared to the environment of China or India. The difference between Russia and other middle-income developing countries such as China and India is that Russia’s banking system wasn’t set up to be state-dominated and in theory would invite the participation of private banks. The government has stated its consideration to eventually privatize large state companies, in order to attract much needed revenues. One such state company is the second-largest bank in Russia: VTB. The Russian recession however, due to low oil prices and sanctions for the Russian annexation of Crimea, could make selling stakes difficult. Kostin, the CEO of VTB, believes that market stabilization is more of a priority at the moment than privatization. Those with similar views to Kostin believe that the eventual push to privatize the government shares of large banks such as Sberbank and VTB and the overall financial industry will only become a reality after the stabilization of the banking industry and in better economic conditions. Instead, these experts state that privatization should first continue in non-banking sectors.
Nevertheless, some stakes in state-controlled companies are being sold off to foreign countries, especially to those with good foreign relations with Russia (such as China and India). This creates issues in keeping with the philosophy of depoliticizing the financial sector, as stakes are sold based on Russia’s foreign policy. In the Russian banking industry there is so far no competitive environment; the field is dominated by giants such as Sberbank and VTB, and if these banks were to vanish, then the largest competitors for Russian banks would become international credit organizations that are significantly more powerful. With the financial industry being closely tied to Russian domestic and foreign policy, the presence of these international credit organizations will most likely continue to be second to giant semi-private banks.
Political Perspectives on the Strengths & Weaknesses of Privatization
There are several potential weaknesses of the current manner of privatization in the Russian financial sector, resulting in controversy on the efficiency and stability of privatization, as well as its impact on corruption and overall depoliticization. The Russian banking industry, according to Professor Andrei Vernikov from the Institute of Economics at the Russian Academy of Sciences, has evolved three tiers: the central government bank (Central Russian Bank), the partially state-controlled giants such as Sberbank and VTB, and a small amount of private banks, with the middle tier being the level currently expanding the most due largely to government help. As the government (who acts as the controller and main shareholder) is separate from the owner, the middle tier is an attractive option to invest in for the Russian government since public scrutiny towards the government over the use of funds is weakened. This indirect state ownership is also prefered by owners and high ranking officials in both the government and the private sector, as it decreases their accountability in the financial industry, allowing self-trading, the dilution of majority stakes, and other forms of opportunism.
Experts argue that there is minimal evidence that this government control of banks will provide any substantial benefits to the banking sector, the economy, or banking services in comparison to private ownership. President Vladimir Putin continues to maintain that the Central Russian Bank (CBR) is only taking more shares or taking over smaller banks to work towards eventual privatization. However, a large Russian bank hasn’t been acquired by a private buyer since 2014. Only government-controlled banks (Sberbank, VTB) are in the market; in fact, VTB has recently taken over Vozrozhdeniye, Russia’s 40th bank by assets, with its main shareholder, Dmitry Ananyev, being forced to sell by the CBR. And although the government has always verbally supported privatization, a prime example being Former President Medvedev’s 2012 commitment to privatization, authorities most likely don’t intend to relinquish control over major state-controlled banks in the near future, and such gestures are merely to boost political image. It is likely that the government will continue to steer the decisions of major banks for the time being.
In terms of privatization’s political impacts, lawyer and political activist Alexei Navalny doubts that privatization will be able to free the financial private sector from the control of the government. Navalny cites the 2010 merging of the Bank of Moscow with VTB after a series of problems having to do with the Moscow government (who had previously owned ⅕ of the shares of the bank) as an example of corruption that continued despite privatization. Navalny states that this merger was done in a strange and disorganized fashion, with VTB later having received nearly 14 billion dollars in compensation for the merge, and when asked, VTB CEO Kostin stated that he wasn’t able to disclose exactly to what the compensations would go. In line with Navalny’s perspective, partially state-controlled banks such as VTB and Sberbank are at the front of Russia’s international economic expansion into Europe and Asia, a trend that seems to pursue more of the Russian government’s geopolitical goals, for which there is little to no economic justification. Navalny cites this as a prime example of distrust between the public and the financial sector; in order to prevent corruption and dissociate the private sector with the government, it is imperative to actively involve outside shareholders and the public itself.
However, public finances are currently being quickly drained from the economic crisis hitting the Russian economy. Important social welfare programs such as pensions and salaries for doctors and teachers, as well as military and security budgets, are at risk of being cut down. The major state-controlled banks are the primary receivers of state aid during periods of economic stress such as the current Russian economic recession as these institutions supply credit, bail out weak institutions, and support the money exchange and stock market in these periods of stress. The government is the source of two-thirds of all investment in industry and infrastructure, with all of this investment being channeled through these state-controlled banks, only further consolidating their power. The Central Russian Bank is warning private lenders that if there is further economic downturn, that they are at risk to be taken over by the government. In the past three years, the Central Russian Bank has revoked 300 banking licenses from small private banks. Interventions such as these have often been justified as ways to fight corruption, keep jobs, or remove bad assets, but others believe that the government wants to relocate money and capital from privately owned banks into state-controlled ones to use those funds for government purposes amidst the financial hardships due to sanctions.
Some argue that nationalizing smaller, private banks, has made the Russian banking system much safer; the government or central bank is highly unlikely to let a state-controlled bank go under. Partially state-owned banks often tend to be much larger than other Russian banks, with the mean assets of the top six core state-controlled banks being nearly one hundred times greater than all other Russian private banks. State-controlled banks also tend to rely less on household deposits to fund their operations, and these banks run against conventional wisdom in that their profitability and efficiency is higher than private banks at the current moment, which could prove beneficial during the current period of economic stress.
For the non-financial sector, the increasing presence of these state-controlled banks forces industries to be more reliant on the state as the state is monopolizing credit resources. However, as the economic crisis in Russia continues, in order to decrease the risk of budget cuts, Russian authorities are expected to soon resort to selling shares in state-owned industries such as oil and transportation companies, and potentially state-controlled banks. The Finance Ministry believes that revenues for these institutions will reach approximately 1 trillion rubles (about 15.5 billion USD). Putin has ambitious goals for the Russian economy, including higher growth and jumping into the top five world economies, but a state-controlled banking system is historically and theoretically unlikely to help reach these goals in the long term. To achieve true and sustainable growth, experts believe private investors are needed, something that isn’t likely in Russia’s economic and political climate today.
Future of the Privatization of the Financial Sector: Sberbank
Although the discussion of privatizing Russia’s largest partially government owned bank, Sberbank, has been present since 2012, the push towards its privatization has increased since Russia’s economic recession. This sudden increase in interest towards privatizing the banking industry suggests that Russia’s government is increasingly desperate to get ‘immediate’ and ‘fast’ money. The CEO of Sberbank, Herman Gref, stated that rather than the Russian government raising taxes, it would prove wiser to sell government parts of Sberbank: “I don’t see any reason as to why the government is still holding us [our shares], when there is a need for money to fulfill the orders of the President.” Officials in the Ministry of Finance (who had just raised taxes and increased the retirement age), are in support of Gref’s initiative. Approved in February of 2017, the gradual privatization of Sberbank and VTB is included in the government’s 2018-2020 privatization plan, to which the government has stated it intends to stick to, although government profits from those two banks will drop two billion rubles (equivalent to nearly thirty billion USD). In response to this loss of profit for the government, Gref cites another reason for the privatization of Sberbank: if Sberbank was to be privatized, it would be able to purchase and incorporate failing private banks. The government holds approximately 52% of the shares of Sberbank, while the rest are in free circulation; of those, nearly 70% of shares are owned by investors in the United States and Great Britain, thus if Sberbank was to be privatized, the percentage of shares flowing past the borders of Russia (analysts predict a large chunk of shares would go to Chinese investors due to US and British sanctions), would sharply increase, providing some economic relief to the Russian economy.
Role of Privatizing the Banking Industry in Fostering Economic Stability
Although privatization is a process that has been integral in transforming Russia’s economy from its Soviet predecessor, privatization as a whole does not seem to be a lasting and final solution to establishing economic stability and growth in the financial industry. Privatization, due in part to the recent economic recession caused by sanctions, has almost started to reverse, with the Central Russian Bank’s shares of the entire banking industry growing to nearly 70% in the past year. Large state-controlled banks such as Sberbank and VTB are used by the government to provide investments and funding for infrastructure and industry, and potentially for more lucrative, opportunistic purposes, leading to speculation about corruption in the banking industry. The privatization of these large state-controlled banks, though thought to potentially bring in a large source of revenue for the Russian government, is deemed to be illogical at this point in time by many experts; both potential foreign and domestic buyers are reluctant to buy shares of Russian companies during this period of economic downturn and in Russia’s heavily regulated financial industry. In terms of decreasing potential corruption in the financial industry, privatization from the side of the government seems to be a lost cause; it is deemed more effective for the public and shareholders to get involved with companies, which could prove difficult given the political and economic turmoil of Russia. Although the government has always spoken of privatization in a positive way and as an eventual goal, it seems as though government strategy is leaning heavily towards involvement with middle-tier banks: state-controlled giants such as Sberbank and VTB. Despite historical and theoretical evidence indicating that an increase in privatization could increase economic stability in the long term, the short term realities caused by poor economic and rigid political conditions demonstrate the inability to decrease Russia’s reliance on conglomerate, partially state-controlled banks in favor of a private banking industry.
Privatization in Russia is seemingly stuck between a lack of private investment and activity, both foreign and domestic, and the Russian government favoring large semi state-controlled banks for short-term economic and political reasons, thus, at this point in time and in this fashion, privatization cannot definitively be the lone solution to economic stability and a decrease in the political dependence of the financial industry. With continuing speculation as to Russia’s murky political future, stability in many financial sectors seems to be far out of reach, the banking sector far from the sole exception, yet an interesting case study nonetheless.
Featured Image Source: FT Property
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