While the number of banks in Russia rose to more than 1,000 before a banking law was introduced in 1967, the track record for foreign direct investment in the banking sector remains modest. The first joint venture bank was founded in 1989, ending the state’s monopoly in foreign currency operations, and the first fully foreign-owned bank subsidiary was set up in 1993. At the same time, numerous newly established private Russian banks sought government protection for their domestic and foreign currency operations. Despite various deficiencies in markets and the operating environment, by June 2002 Russia had still managed to attract 26 fully foreign-owned bank subsidiaries and another 11 banks with majority foreign ownership.

The emerging, cautious state of banking in Russia is reflected in foreign involvement that differs from the situation in most Central and Eastern European countries, as all major foreign-owned banks in Russia are greenfield operations and their position is substantially weaker. Of the 30 largest Russian banks, only 6 are foreign owned, and the share of the 10 largest foreign banks amounts to no more than 7 percent of the banking sector’s total assets of about $100 billion. Foreign banks in Russia have notably differing business profiles than elsewhere in Central and Eastern Europe, reflecting the differences in parent banks’ strategies regarding Russia. Some of the largest foreign banks have been active in collecting corporate deposits, and more recently household deposits, which account for 5 to 25 percent of their balance sheets. Assessing the state of the market via major assets is complicated by caution in relation to risk taking. For example, foreign banks’ corporate loans and interbank loans may contain limited exposure to Russian risk.

Distrust of banks remains a leading reason for the low level of deposits, although the large shadow economy also avoids banks. Various Russian banks have mistreated their depositors, and banks thus face an uphill struggle to restore public confidence. Moreover, the sheer size of the largest bank, Sberbank, may restrain competition. The evolution of transparency in Russian banks has yet to reach real disclosure, and there is still no formal pressure on banks to be open. Only some of Sberbank’s shares are publicly quoted. Most large banks apply International Accounting Standards, but small banks do not. Moreover, the general introduction of International Accounting Standards, which is slated for 2004, needs to be coupled with other improvements in internal and external bank supervision. In 1998, for example, all large banks that failed had previously published sound figures based on International Accounting Standards. Banks’ balance sheets are heavily weighted with short-term liabilities, as the number of potential investors with long-term interests in ruble assets is limited, which is also hampering investment financing. As concerns borrowers, transparency is naturally important, but in the current stage of lending, such basics as collecting collateral require significant improvement. Indeed, the preconditions for bank lending even extend to the reform of Russian courts.

In such an environment, even the largest foreign banks could not make much headway, and caution prevails. Foreign bank subsidiaries remain unwilling to engage in substantial investment, and parent banks are wary about injecting equity to prop up their lending capacity. In the future, expansion of foreign banking services in Russia may be a combination of two directions. First, while there is currently no need for large foreign direct investment in the financial sector for financing large investments in Russia, if a bank wants to become a serious player in Russia’s still relatively volatile market, it must have a local presence. Second, some leading international banks may also make major acquisitions of Russian banks in the next couple of years, mainly to gain local retail banking capacity.