TOP INTERVIEWS Interview with Mr. KOZLOV First Deputy Chairman of the Central Bank (Bank of Russia)   Moscow, July 17th, 2002 You are in the process of reforming the whole banking system. Can you briefly tell us what are the three or four key points in this reform? First of all, I would like to describe the general situation and explain why we are working on this reform and modernizing the banking system. The banking system needed the last three years to recover from the financial crisis of 1998, and pre-crisis levels were reached three or four months ago. The situation is changing in the right direction: banking assets are growing, the profitability of the banks is growing, capital is growing, 90% of Russian banks are profitable and 75% are experiencing growth. The growth rate of the banks was three times higher than last years GDP growth. However, there are structural problems within the banking system due to the various different types of banking behaviour and business model, and these differences prevent the banking system from developing faster. For example, approximately half of this country s GDP is linked to commodities industries, but this part of the economy is served by only a handful of banks, which are affiliated with these industrial groups. This means that these financial industrial groups are choosing their banks not according to their competitive advantages, but according to personal capital links. Some major banks are therefore acting as internal treasuries of these groups. These groups obviously like to keep their financial earnings and they use these banks as intermediates to place their liquidity assets abroad. Approximately USD 5 billion is not used by banks in the country, not because they do not know how to use it, but because of the policy of these financial industrial groups. This is one of the structural problems, for which a solution needs to be found: how to use the resources generated by the Russian economy in favour of the Russian economy? This is not only a problem for the banking community, but also for the economy as a whole, as the banking system is closely linked to general economic patterns. Small and medium banks, especially in the regions, try to compete with each other for the second smaller part of the economy: import substitution and domestically produced products, which is approximately one third of the GDP. The number of banks trying to serve this part of the economy is approximately one thousand. This means that a couple of dozen banks are servicing 50% of the economy whilst around one thousand banks are servicing approximately 30%. This is why the conventional banking business is not profitable in this country as competition is severe and administrative barriers are high. Last year, the Government decided to make changes in its general economic policy to also support the retail economy. The banking system has to be motivated to be involved in the general changes of the economic policy. We can do this by reducing the administrative barriers and the excessive tax burden, and changing some structural problems in different parts of the country and different segments of the economy. A second issue is the low level of trust in the banking system since the financial crisis of 1998 and the collapse of fifteen out of twenty of the largest banks. Only five of the largest banks survived, including two large state owned banks: Vneshtorgbank and Sberbank. Many of the small and medium sized banks survived, but the landscape changed dramatically. One of the consequences of this crisis is the very low trust people have in banks and this why we are introducing a deposit insurance system in this country. This will raise the level of trust, but also allow us to clean up the banking system of bad banks. There are now 1327 banks in the country: a majority of them are proper solvent banks; but there are banks with bubbled capital and shady way of doing business, and these banks do not have a future under market economy conditions. Only proper solvent banks will be allowed to become members of the deposit insurance scheme. There will be a transitional period of two years, after which, in approximately January 2005, we will cancel all the banking licences of those banks that were unable to comply with the scheme s requirements. A third point is to increase the transparency of the banking system by introducing international accounting standards (IAS). Our goal is to complete the transition from the old Russian accounting standards to the modern IAS by the beginning of 2004. Furthermore, we noticed after the crisis that efficient bankruptcy procedures for banks were not in place. Minority creditors are suffering because of this, as the procedure favours majority creditors and interested shareholders. The bankruptcy process can last for up to three to five years. However, bankruptcy is an extreme situation that should be executed as soon as possible, in order to return as much money as possible to the creditors. Our goal is to promote a new law on bank bankruptcies, the draft of which has already been prepared and proposed, which will also help to clean the banking system from unsound banks as soon as possible, with minimum losses to creditors. On top of this, at the end of last year, the government and the Central Bank adopted a mutual strategy for developing the banking system. We enlarged the focus of the strategy this year to also promote the overall efficiency of the banking system. This goal was promoted at the 11th International Banking Congress, which took place in June in Saint Petersburg. The Central Bank gave a presentation about the development of the banking system in order to convey our general idea to the public. We are now executing our action plan. You mentioned that only a couple of dozens banks, which serve a large part of the national economy, whilst there are many small banks. Could consolidation take place among all these small and medium banks and how do you believe would this affect the banking system? We would like to promote consolidation, but not by administrative means. Our goal is to create motivation for consolidation as we believe that medium sized banks are better prepared to serve the needs of certain clients, whereas small banks would be better off specialising on some particular products or segments of the market or merging with each other to create more solid banking institutions. This is our message and we will try to explain this to the banks and the banking associations. Small banks should either increase their capital or merge with each other. If they prefer to remain small banks, it would be better for them to focus on a particular segment of the market. At the same time we also try to create a better environment for mergers and acquisitions. Some changes should be made in the legislation and regulations for mergers and acquisitions of banks to make this process easier for them. If we spoke with you again in two or three years, would there be far less banks in Russia? Maybe yes. First of all, we will clean the banking system of unsound banks. At the same time mergers and acquisitions, and the creation of networks, especially in the regions, will also play a role. How will this banking reform and the probable consolidation be a boost for the whole Russian economy? The main idea is that the banking system should support all positive movements of the economy, but it is currently still behind the economic developments and does not always support the positive developments of the economy. Our goal is to make the banking system immediately responsive to all the positive economic changes. At the same time the banking system should have a reserve of liquidity to serve new needs that could emerge in the near future. The big banks, which are linked to industrial groups, should also try to diversify their capital base and diversify the range of services provided in order to reach more clients. You mentioned before the importance of building up trust in the banking system. Is this trust the key solution to get access to the millions, or maybe billions of dollars, which never enter the banking system? Yes, it is a very important issue to return savings back to the banking system. As the economy is developing and the income of the population is growing, the potential for savings is growing. The question is not only to attract the past savings, which are now under mattresses, abroad or somewhere else, but also to make the system absorb future savings. It is about attracting newly emerged savings into the banking system and to use these savings in the best way for the economy. Will all banks be prepared to survive these changes? Unfortunately not all of them will be able to survive. I cannot tell you exactly how many banks will be excluded from the system, but not all banks are sound, proper and viable for the future. Are there any banks that are  ahead of the pack , and having already prepared for change gained some advantage over the others? Probably yes. The process of positive changes in the banking system is not only sponsored by us, as most banks are doing it by themselves. There are many improvements: enlargements of the capital base, diversifying of the product range, etc. Our goal is to support these positive changes. We do not want to push them, but instead we want to promote their further development. The majority of the biggest banks are very forward thinking. We are not just watchdogs, but to some extent are colleagues because our goal is not to punish them for their past mistakes, but promote their future development. Do you mean that by  being colleagues there is a cooperation between the Central Bank and some major banks? We cooperate very closely with two important banking associations, namely the Association of Russian Banks and the Association of Regional Banks of Russia. We participate in the congresses they organise and discuss major documents with them. We are currently discussing the introduction of the depositary insurance scheme and how to organise exams for commercial banks. We try to maintain a close cooperation not only with some particular banks, but also mainly with these banking associations. Do you also work with the Ministry of finance or other Ministries to make this system work smoothly? There are at least three Ministries with which we cooperate, as well as other institutions. We work with the Ministry of Economic Development and Trade, as they are the leaders and main action force behind the economic reforms. The second one is the Ministry of Finance because they are responsible for the financial and taxation system. We also work together with the Federal Commission for the Securities Market and the Ministry for Anti-Monopolistic Policy. Do you believe that this banking reform will push foreign investments into Russia even faster and give more confidence to foreign investors? I hope so as we are moving in the direction that is expected from us. Foreign investors and the foreign banking community are looking for the same things: transparency, trust, reliability and banking services  issues that we are trying to promote. We believe that our action will improve the internal quality of the banking system, as well as enlarge its attractiveness for foreigners to cooperate with our banking system and to invest money in it and through it. There have been a number of changes in the Central Bank, including your recent return to it. What do you see as your major challenge now? I was here in the same position during the financial crisis; I left in 1999, and then came back in April of this year. There were several issues and challenges to be tackled when I came back, but before taking any actions, we have to make a diagnosis of what is going on. The second challenge was to create a mission, both for the Central Bank and for the whole banking system. These two short-term goals were completed. I now know what is going on and I have produced the mission. Our report at the Banking Congress in June was the disclosure of this set of ideas. This was presented not only to the general public, but also to our 80 000 staff members, of which only 4 000 are employed in the supervisory "part" of the bank. They all should be motivated and understand in what direction this huge machine is moving. For the near future, there are two main challenges. First of all, we have to execute the action plan we produced this summer for the next couple of years. The second challenge is to rebuild the internal supervisory infrastructure of the Central Bank. It was inherited from the past and this heritage has both positive and negative points. In order to promote positive changes in the banking system we should have our structure changed in the right direction first. My second challenge, therefore, is to rebuild the supervisory machine in this bank to make it more efficient, more professional and trustworthy. This is the most difficult goal because it is a huge managerial challenge to make such huge changes in a very short period of time What would be your final message to our readers? Be connected. The international business community has some perceptions and ideas about doing business in this country, but these perceptions are not always right. In order to get a better understanding of the future, the business community should be more focused on details. This is why the international business community should be better connected to the events here, by acquiring new information, by analysing this information and by weighing up all the pros and cons. To understand us better, they should analyse the situation and by doing so be connected. Of course the situation in this country is not so easy and is not totally transparent, but to understand it better and to make the right decisions, foreign businessmen should be more attentive to details. I am convinced that if they know this country and its environment better, they would be interested in doing more business with Russians. Do not rely on limited, and not always correct, perceptions but develop your own understanding about this country and rely on it. Note: WINNE cannot be held responsible for the content of unedited transcriptions.