Financial liberalization in the Russian Federation
involved the abolition of State controls on credit
allocation and interest rates, privatization of financial
institutions, elimination of restrictions on the flow of
capital into and out of the country, development of securities and money markets as alternative sources and depositories for funds. It was expected that liberalization
would promote investments contributing to economic
development. However, it became apparent that the
failure to install the supporting monetary and legal
infrastructure in tandem with these changes exposed the
economy to the flow of illicit wealth. It revealed the
weaknesses of the system, exposing it to many risks and
increasing its dependence on foreign sources of financing
in general and, in all likelihood, sources of dubious
origin.34
The development of commercial banking—
regarded as a symbol of success of reform in the financial
sector—has been spectacular, at least from the quantitative perspective. Following the 1988 banking reform,
commercial banks mushroomed all over the country.
There were 225 registered banks in 1989, 1,360 in 1991,
2,019 at the end of 1993 and 2,605 in June 1996.35 It
appears that much of the growth was due to existing legal
gaps and lack of supervision. For example, some of the
entities registered as banks were simply exchange points
or branches of a few State banks. Much of the commercial banks’ profits in the early 1990s came from investing
cheap funds, obtained from enterprise deposits that were
paid negative real interest rates. Moreover, to a great
extent their methods of earning profits could be considered illegal, as many came from the deliberate delays
in executing transactions—payments between enterprises
and social security payments to beneficiaries.
By 1997, the Russian banking system became
significantly exposed to external and foreign currency
risks. Data from early 1998 indicates that the maturity
structure of foreign assets and liabilities was mismatched,
with liabilities to non-residents denominated in foreign
exchange of under $11.8 billion offset by similar assets of
only $5.9 billion. Although balance-sheets assets of the
commercial banking sector denominated in foreign
currency exceeded liabilities, the quality of the assets was
extremely poor due to large loans of dubious quality
extended in foreign currency to domestic enterprises.
Furthermore, the gross foreign currency exposure of the
banking system as a whole was substantial, with assets
and liabilities denominated in foreign currency exceeding
$40 billion. About 26 per cent of foreign currency
liabilities had maturities of less than one month.36
Exposed to foreign exchange and interest rate risks,
highly dependent on government securities, a large
number of banks, particularly Moscow-based banks,
became insolvent during the financial crisis of 1998.
Following the crisis of 1998, by the end of 1999 the
number of operating banks had fallen to 1,400, the
Central Bank having withdrawn over 1,000 bank licences
since the beginning of 1995. Additionally, the crisis and
after-crisis actions by the Government and the banking
sector seemed to contribute to the concentration of the
banking sector. At the end of 1997, the top five banks
accounted for 36 per cent of total assets and the top
50 per cent for 71 per cent. The dominating bank of the
system—Sberbank, which accounted for almost a quarter
of all assets at the end of 1997—managed not only to
survive the financial crisis. It was moreover able to
increase its share of the retail market from 65 per cent
before the crisis to 75 per cent and its loans portfolio from
16 to 35 per cent.
In the aftermath of the crisis, the Russian authorities
began extending ad hoc support to a number of banks in
the form of “rehabilitation” credits. The Central Bank
developed the Bank Bankruptcy Law, which was ratified
in 1999 by the Parliament. With the adoption of the Bank
Restructuring law the sole responsibility for restructuring
banks was given to ARCO (the bank restructuring
agency). The banks can be transferred to ARCO only by a
Central Bank of the Russian Federation directive based
on specific criteria for shareholder write-down, and
ARCO is empowered to undo transactions made with the
12
Russian capitalism and money-laundering
intent to defraud depositors and creditors of insolvent
banks. It limits liquidity support to solvent banks or those
implementing ARCO-approved restructuring plans. It was
reported that ARCO had begun extending support to four
banks implementing ARCO-approved restructuring plans.
However, even operations by ARCO arouse suspicions
about corrupt political and business interests influencing
its decisions. Alfa bank is one of the winners of the crisis
which has strengthened its market position by benefiting
from a large influx of clients from its former and now
insolvent competitors. But it also seems to have benefited
from its far-reaching political connections as it received
$40 million in capital injection from ARCO, which equals
one tenth of ARCO’s $400 million budget.
Despite the ill fate of many banks, Russians continue to believe that bankers are the most prosperous
members of society. The prosperity of bankers in the
opinion of the public seems to have less to do with the
profitability of legal banking operations and more to do
with their criminal or illegal activities. Those bankers
who knew how to bend or break the rules were apparently
better prepared to handle the crisis and even take
advantage of it. The financial crisis of 1998 revealed that
the crisis environment could be easily manipulated by
those with access to the banks’ assets. The crisis and
insolvency problems led to the enrichment of some
bankers who used them to accumulate assets using
various illegal mechanisms. There were reports of assetsstripping, of banks shifting assets to shell entities and the
initiation of unilateral restructuring of their own balance
sheets. Owners of banks stricken by the crisis have transferred their good assets into parallel banking structures,
largely at the expense of foreign creditors and Russian
retail depositors.
The creation and operation of bridge banks can
illustrate the point. Bridge banks are an ingenious creation of bankers by now insolvent banks,
such as Menatep,
Uneximbank and SBS-Agro.37 Run by these bankers,
they were created for stripping and shifting of assets. The
Rosbank, the shadow bank of the troubled Uneximbank,
is thought to be one of the best examples of resurrected
banks. The bank has taken on the infrastructure and key
clients of Uneximbank, most notably Interros industrial
group. It left behind the insolvent Uneximbank, which
was estimated to owe up to $2 billion to creditors,
including $1 billion in forward currency contracts.
Rosbank became one of the top 20 banks in the Russian
Federation, with a capital base of $50 billion. The scheme
worked so well for Rosbank that later on it even officially
absorbed its original Uneximbank and turned the event
into an unprecedented demonstration of good will by a
major bank.
Crimes in the banking and financial sector were
more apparent and less sophisticated in the early and mid1990s. During this period, the Russian media was flooded
with reports about fraudulent banks and financial
schemes. Many banks appeared to have been criminal
enterprises, designed to exploit their customers, from the
very beginning. For example,
in 1994, Adelphi, a small
Moscow bank, was reported to have profited greatly by
cheating its customers. The bankers sold their customers
shares of an infamous MMM fund, a pyramid type of
investment scheme, which stripped many Russians of
their savings. Despite periodic price updates, Adelphi
bank kept selling to its customers shares of the MMM
fund at a higher rate (quoted earlier) and simultaneously
purchasing them at a lower (updated) rate. The shares of
the MMM fund were plummeting at the time, as the fund
had crashed twice by then, and all of its board members,
except for the boss, Sergei Mawrodi, were in prison.
Mr. Mawrodi, while out of jail on bail, managed to get
elected to the State Duma (Lower House of Parliament)
and gained immunity from prosecution.38
The period of massive fraud in the banking and
financial sector was also the period of massive violence
against high-ranking banking officials. The Association
of Russian Bankers reported that 83 armed attempts on
the lives of bank presidents and prominent bank officials
were made during the three and a half years from mid1991 to 1995.39 A high frequency of violence was
indicative of the efforts of criminal groups to establish
their control over banks. In 1995, the Scientific Research
Institute of the Ministry of Internal Affairs (VNII MVD)
believed that criminal groups controlled over 400 banks
and 47 exchanges.
The control over banks enables an easy generation
of illicit proceeds. It significantly simplifies criminal
actions (for example, extortion or kidnapping for ransom)
against the bank’s customers. It also facilitates the
criminal penetration into other sectors of the economy, as
it simplifies the financial servicing of criminal operations.
For money-laundering activities, the control provides a
long-term advantage and considerable protection in the
event that banking regulations are imposed. When the
criminal organization itself owns and runs a bank, even
the most stringent regulation would not contribute much
to curbing money-laundering. “It is not necessary to
worry about suspicious transaction reports when one
owns the bank
