Russia’s Run on Deposits and Yukos Demands: Ominous Signs for the Global Economy?

By Sergei Blagov

MOSCOW (KWR)—Despite high crude prices Russia’s largest oil firm drifts towards insolvency and the country is experiencing the biggest run on deposits since the 1998 financial meltdown. It remains to be seen whether events in Russia will have wider repercussions.

Russia's recently acquired image of order and stability became shaky in early July as bailiffs began dismembering the once-profitable oil giant Yukos and panicked depositors staged a run on several of the country's top banks.

Russia proved to have too many small, unstable banks and not enough large ones with transparent operations. Cracking down on even the smallest sends shockwaves through the system. Russia’s Central Bank revoked Sodbiznesbank's license in May for laundering what it said was some $1 billion of suspicious funds. CreditTrust went bankrupt in June.

Reports of a central bank list of banks under scrutiny were repeatedly denied by authorities. In early July, ratings agency Moody's said it had put 18 banks under review for possible downgrades. Banks have also begun closing lines of credit on each other, creating a climate of distrust along with a liquidity problem.

Among the worst hit was Alfa, the country's largest private bank. After what its directors called a black public-relations campaign by competitors, it had withdrawals of $100 million in the first week of July - 10 times more than normal - based almost entirely on rumors. Some branches had waiting lists to close accounts, leading the bank to introduce a temporary 10% commission on early withdrawals.

Largely unsourced media reports suggested that Alfa Bank, the nation's largest private lender and the third-biggest bank by personal deposits, might be next triggered a panic-driven run that saw Alfa clients pull some $160 million from their accounts in just three days. Alfa lashed out at the media for fueling fears of a full-blown crisis, in particular Kommersant daily and its owner, disgraced tycoon Boris Berezovsky, who is wanted by Russian authorities for alleged tax fraud and is living in self-imposed exile
in London.

However, Alfa Bank reiterated that all withdrawals would be honored. State-owned Vneshtorgbank has agreed to buy out Guta, thereby rescuing its depositors. The Central Bank cut the minimum reserve held by banks against ruble deposits to 3.5% from 7%. By halving mandatory reserve requirements for banks to 3.5%, it freed up some 130 billion rubles ($4.5 billion).

The State Duma on July 9 passed a bill guaranteeing deposits in uninsured banks that fail. It will apply to all banks that go under after February 2003, when the Law on Insurance Deposits was adopted. All deposits up to 100,000 rubles ($3,350) will be returned within six months. This means that clients of two failed second-tier banks, Sodbiznesbank and CreditTrust, will be covered.

Adding to the unease was a statement by international ratings agency Moody's that it would review 18 Russian banks, including Alfa, MDM, Bank of Moscow and Russian Standard, for possible downgrades. "The review will focus on the capacity and willingness of Russia's central authorities and other banking-market participants to provide prompt liquidity support to the solvent banks in need of such aid," Moody's said in a statement.

Moody's rivals, Fitch and Standard&Poors, however, both said they saw no reasons yet to review their ratings of Russian banks. S&P said it has already factored the "institutional weakness of the Russian banking sector" into its ratings of 21 banks, while Fitch noted that Alfa's liquidity is "consistent with its ratings." "While the current retail deposit runs and interbank market turmoil may end very quickly, institutional weakness in the sector will remain," S&P said on July 9. "Russia will not enter a banking crisis on the scale of the one seen in 1998," S&P said in a statement.

On the other hand, Russia now faces its oil major Yukos's imminent bankruptcy. Finance Minister Alexei Kudrin said on July 9 that Yukos had run out of time for striking a deal with the government on restructuring a $3.4 billion back tax bill for 2000, making asset seizures inevitable. His statements came a day after Yukos sent a proposal to the government offering to voluntarily pay more than $8 billion in additional tax payments for 2000 to 2003 on condition it was given three years to do so. The company has received another claim for $3.4 billion for 2001 and could face further sanctions for other years.

Last June, Russian President Vladimir Putin indicated the Kremlin did not support the bankruptcy of Yukos, however, courts have frozen the company's assets, leaving it without the funds to pay the back-tax demands and hence opening a way for the company’s formal insolvency.

"The actions of representatives of the Russian government have led Russia's best and most creditworthy company to the brink of an unintended and artificial situation of insolvency and bankruptcy, creating an unthinkable default situation with its bank lenders, all at a time when the company is experiencing the best results in its history," Yukos chief financial officer Bruce Misamore said in a statement.

The firm was dealt another blow when a syndicate of Western banks led by France's Societe Generale declared it in default of a one billion-dollar loan. Misamore said the consortium of banks was not demanding immediate repayment of the $1 billion yet, but could do so now at any time following the company's formal notification by the banks on July 2 that it was in default. As of July 8, "some action could be taken against our assets," Yukos's CFO Misamore admitted to investors during a conference call on Tuesday. Unless a negotiated solution is reached, the government will have "the full right to come in and try to realize the value of assets to pay the tax bill. This could be sale of assets conducted by the bailiffs ... either through an auction or direct sales," he said.

Yukos said the move to freeze its Russian bank accounts could force it to halt production because it would not be able to make the payments required to continue operations. Yukos could slash some of its 400,000 barrels per day of oil and products exported by rail and river in July as it struggles to find cash for core operations with its bank accounts frozen, according to media reports. Yukos' pipeline exports to destinations such as Poland, Slovakia and Hungary, much of which are committed under long-term deals, could also come under threat as soon as August, forcing the firm to declare force majeure.

Western institutions have been reportedly buying Yukos stock thinking everything is going to be fine because President Vladimir Putin said there would be no bankruptcy. Meanwhile, a group of minority investors has called on Russia to re-think the assault on Yukos. "A climate of fear and uncertainty has descended upon the market regarding the state's ultimate intentions toward Yukos," the group, which includes Deka, Germany's second- biggest mutual fund and Janus, the ninth-largest U.S. stock and bond mutual fund manager, said in a letter to Putin quoted by The Moscow Times. The group has requested a meeting with Putin to discuss the affair.

Another group of minority shareholders is suing Yukos for allegedly deceiving investors on the true state of affairs at the company from Feb. 13 to Oct. 25, 2003, the day Khodorkovsky was arrested. A lawsuit was filed at a New York court on Friday via the law firm Lerach Coughlin Stoia and Robbins, Vedomosti daily reported.

Last year, Yukos had been rumored to be considering selling a major stake to world oil No. 1 ExxonMobil, in an apparent bid to ward off official pressure by linking up with a foreign partner. Prior to flying on his last trip to the U.S. in October 2003, Yukos former head Mikhail Khodorkovsky announced he would rather go to jail than leave the country as a political emigre and abandon his fight with the Kremlin.

Western governments are warning Russia that its aggressive legal assault on the country's largest fully private company risks souring relations. New European Union member Lithuania on Jul 7 said that "all of Europe" would have to respond if Russia forces Yukos into bankruptcy. "Economic and trade matters can't be separated from politics and foreign policy when deciding the fate of such a huge company with assets in Lithuania and other parts of Europe," Lithuanian Prime Minister Algirdas Brazauskas told reporters in Vilnius. Lithuania owns 40.7% and Yukos 53.7% of Mazheikiu, the nation's biggest company by revenue. Mazheikiu operates the only refinery in the Baltics and owns an oil terminal and pipelines.

"The Yukos affair is being monitored carefully" by the British government, visiting British Foreign Secretary Jack Straw told reporters July 7. "We have some direct British interests in this," Straw said after meeting Foreign Minister Sergei Lavrov. “Many Yukos shareholders are British”, he stated.

The United States lashed out at Russia's judiciary, saying the case appeared to be lacking due process and was discouraging investors. "We've been concerned about this case all along, and will continue to follow it closely," State Department spokesman Richard Boucher said in Washington. "We haven't taken a position on the merits of this specific case, but we have been concerned about how this process is unfolding and the effect it might have on investment," Boucher said.

As the crisis around Russia’s banks and leading oil company, Yukos, unfolds, it remains to be seen how it can end without wider repercussions and whether these events will create new anxieties in global business and financial markets.

Sergei Blagov is a Senior Consultant at KWR International