Bank of Moscow exposes Russian regulatory void

July 5, 2011

By Jason Bush The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The $14 billion rescue of Bank of Moscow shows that something must be badly wrong with bank supervision in Russia. The bailout amounts to almost half the assets of the country’s fifth-largest bank. Reforms are urgently needed. But new laws alone won’t eradicate the cronyist culture at the root of the mess.

Officials say the record bailout is needed because the ex-management of Andrei Borodin, an ally of disgraced Moscow mayor Yuri Luzhkov, blew billions of dollars by lending it to companies affiliated with management – or simply siphoned it offshore. Borodin now lives in exile in London.

While the scale of the losses is astonishing even by Russian standards, the underlying causes are not. The debacle comes just months after the collapse of another politically connected bank, mid-sized International Industrial Bank, exposed similar lapses in regulatory oversight. In typically complacent fashion, most analysts dismissed that bank’s collapse as a one-off.

In fact, the risky related-party lending in which both banks engaged is commonplace. Last year, ratings agency Moody’s estimated such loans at around 10 percent of the sector total and 50 percent of bank capital. This is allowed by current Russian regulations, and is twice as high as what’s practiced in the Middle East, or five times higher than in Central Europe. One obvious lesson is that Russia needs to introduce tighter restrictions on such lending. Loans to related parties are typically restricted to 20-30 percent of tier one capital in western Europe.

The debacle also underscores the urgency of proposed new rules that would give the central bank greater powers to investigate companies that are affiliated to banks, and make bank shareholders liable in the event of asset stripping.

But new rules will mean little unless they are enforced. This will long be the main problem in Russia. Russian bank failures usually have political causes: well-connected banks often have more clout than regulators. In this respect, the recent expansion of state banking giants, such as Kremlin favourite VTB, may ultimately make matters worse. Russia’s latest banking fiasco is unlikely to be the last.

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This was not a case of regulatory failure; rather, it is a power move by major Moscow players to seize Luzhkov-linked assets. Bank regulation has in fact been fairly effective nationwide, with about 200 banks closed by authorities for money laundering over the last several years. International Industrial Bank was a case of the regulators overriding close Kremlin ties to seize a bank, more of a success than a lapse in regulation. VTB had to know the Bank of Moscow was holding significant assets that were linked to Luzhkov — it has in effect taken a $10 billion gift from the government in the name of banking irregularities. Don’t mistake asset grabs for bad regulation!

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