Banks' Internationalization: Estonian and Russian

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Dynamics of Estonian commercial banks' loan portfolio, interest rates and .... the early years of capitalism, the main activity of the banks was to offer local companies .... seeking argument – the domestic market was very limited by size and competition was ... together by that time formed around 15% of Estonian total export.
TUTWPE(BFE) No. 04/109

Banks’ Internationalization: Estonian and Russian Banks’ Expansion to the Foreign Markets Jari Jumpponen Department of Industrial Engineering and Management, Lappeenranta University of Technology P.O. Box 20, FIN-53851, Lappeenranta, Finland e-mail: [email protected]

Kari Liuhto Pan-European Institute at Turku School of Economics and Business Administration Rehtorinpellonkatu 3, 20500 Turku, Finland e-mail: [email protected]

Mart Sõrg Institute of Finance and Accounting at the University of Tartu 4–303 Narva Road., 51009 Tartu, Estonia Telephone: +372-7376332; Fax: +372-7376312; e-mail: [email protected]

Vello Vensel Department of Economics at Tallinn University of Technology 101 Kopli Street, 11712 Tallinn, Estonia Telephone: +372-6204058, fax: +372-6204051, e-mail: [email protected]

_____________________________________________________________________

Abstract Direct investment outflow from transition economies abroad is still modest compared to investment inflow towards transition economies. Global economy both creates preconditions for and also motivates the internationalization of banks. The main aim of the article is to study activities of Estonian and Russian commercial banks in their efforts to transform themselves from local banks to international ones. As the internationalization of banks has not proceeded without problems and setbacks, the present research tries to point out the reasons why some of the plans were not realized. The authors of the paper argue that international economic ties provide benefits to all the parties involved and that international integration is an effective way of building international stability and economic growth. JEL Classification number: G21 Keywords: banking sector reforms, banks internationalization and globalization, Estonian and Russian banks expansion abroad.

Announcements: The authors gratefully acknowledge the financial support received from the Research Foundation of the OKO Bank Group, from Göran Collert Foundation, and from the Estonian Science Foundation (Project 5185). 79

1. Introduction Global economy both creates preconditions for and also motivates the internationalization of banks. The 12-year development of the Estonian and Russian commercial banking has demonstrated it vividly. The internationalization of Estonian retail banks began with opening the correspondent accounts in foreign banks, the next stage was the improvement of international payment facilities in Estonia and the movement of credit resources cross-border, and by now the internationalization has reached the stage where the decision making rights are redistributed internationally. Development of the financial sector in transition economies has been one of the more difficult areas of reform since at the start of transition there were virtually no relevant financial institutions or markets (Fries and Taci 2001). The main problem is that banks in transition countries must restructure themselves, considering the needs of market economy, and join the globalization process at the same time. These two developments are to be performed at accelerated speed and in the midst of economic and financial crises. For this reason the internationalization of banking business in a transition economy has substantial differences compared to the internationalization of banking in developed countries. But internationalization of banks in a very small and a big transition country has also many differences. It is seen comparing Estonian and Russian banks’ entry to the foreign market. The aim of the article is above all to research the activities of the Estonian and Russian commercial banks in their efforts to transform themselves from local banks to international ones. The paper attempts to point out the different stages of these efforts and determine the impelling forces that direct the process. As the internationalization of Estonian banks has not proceeded without problems and setbacks, the present research also tries to point out the reasons why some of the plans were not realized. The first part of the paper introduces the reconstruction process of Estonian retail banking system. This provides a basis for understanding both the behavior of Estonian banks and the efficiency of their internationalization. The following parts research the internationalization process of Estonian commercial banks and compare it with Russian banks’ entry into the foreign markets.

2. The reconstruction of the Estonian banking sector Reform of the banking system in the former USSR started in 1988. Three big all-Union state-owned banks were reorganized into a central bank and five specialized banks. In the same year, a bill was passed to allow the establishment of cooperative and commercial banks. In addition to the transition to market economy, Estonia had one more aim in reconstructing its banking system — to restore political and economic independence, and the result was that Estonia became a pioneer in the reformation of banking system in the USSR. In September 1988, the first commercial bank in the Soviet Union, Tartu Kommertspank (Tartu Commercial Bank) was founded. Shareholders of the bank were mostly state-owned enterprises all over Estonia. The hyperinflation in 1991 had reduced the real value of the obligatory initial capital of the commercial banks by several times. Now businessmen who had made money with inter-mediation of government property had an opportunity to establish their own banks to pump supplementary resources into their business through their banks. In Estonia, a boom in establishing banks was observed in the first half of 1992 when 21 new commercial banks were issued a license. Before the currency reform, the 80

number of banks was the biggest, but the total number of commercial banks at the end of 1992 was 41. However, the banks were relatively small. The banks were also small with respect to the number of shareholders: at the end of 1992, 11 banks had less than 10 shareholders and among them there were two banks that had only one shareholder. During the central-planning system, the banking sector was doing little more than allocating funds to the various sectors and companies according to the authorities’ decisions. Consequently, at the time the transformation process began, the banking sector was characterized by parameters such as: • Competition practically zero; • Lack of customer orientation; • Low degree of management know-how and insufficient technical equipment; • And last, but by no means least: a very poorly developed loan-culture and riskawareness (Stepic 2002). Most of the transition countries have preferred commercial banking while reconstructing their banking systems to adjust them to a market economy. The main purpose of commercial banks shareholders and executive management is to increase the value of the company, which requires both a quick rises in the capacity of financial services and a high level of efficiency of the business activities. But in transition economies the macroeconomic risks are significantly higher than in countries with developed market economies. Therefore, the implementation of commercial banking in a transition economy means first of all that banks are very ambitious and subject to risks. In connection with the separation from the economic area of the former Soviet Union and transition from a socialist command economy to a capitalist market economy, deep economic crises started both in Estonia and in other Baltic States. That was a period of extremely comprehensive economic reconstruction when the output declined dramatically for several years and the countries passed a period of hyperinflation. The aim of maximizing profits forces the banks to look for profit opportunities also in the conditions of economic crisis and instability of currencies. As giving loans is an especially risky activity in times of economic crisis, given the privatization process and large bankruptcy risks, the banks found in 1992, before the currency reform, that even more profitable than lending is speculation with currency. The currency reform that started on 20 June 1992 established as the legal tender the Estonian kroon (EEK) with a fixed exchange rate. As the exchange rate against the German mark (DEM) was stable (8 EEK = 1 DEM), the currency risk remained only with respect to the currencies that were not pegged to the German mark. Also, thanks to the fixed exchange rate, inflation quickly started to decline. However, income and turnover from currency exchange declined significantly after the currency reform. This had to be compensated and the solution was found in activating the credit activities. As the economic crisis had reached its worst point in 1992, this was a very risky activity. Therefore, the interest rate was high. For some banks, the turn from currency exchange business to credit was too abrupt; they become illiquid and left the market. Unfortunately, these included some banks that were especially trustworthy in the eyes of the public. As the system of deposit insurance hadn’t been launched and due to the principles of the currency board agreement, the financial possibilities of the Bank of Estonia to restructure the banks were extremely limited, many people and firms partially or completely lost their savings. Also the cause of the 1998 Russian economic and financial crisis is considered by some researchers to be the negative attitude of banks toward lending to industrial 81

corporations and their continuing focus on foreign currency dealings and securities investment (Satoshi 2001). The interest rate on loans has continued to decline also in the following years (except the setback in 1998), because the inflation rate has also decreased and the competition among banks has forced them to concentrated more on the growth of their loan portfolios rather than maximizing the interest rates. We can see from Table 1 that in the period 1994–2000, the loan portfolio grew 8 times, but due to the decrease of interest rates, net interest increased only 3.3 times. Table 1. Dynamics of Estonian commercial banks’ loan portfolio, interest rates and the consumer price index Year 1994 1995 1996 1997 1998 1999 2000

Loan portfolio Billion EEK Growth, to 1994 4.28 6.73 12.10 21.30 23.90 26.70 34.20

Interest rate (%) … 1.57 2.83 4.98 5.58 6.24 7.99

21.4 15.9 13.7 17.8 16.5 8.6 8.4

Consumer price index (%) 47.7 29.0 23.1 11.2 8.2 3.3 4.0

Source: Listra 2001. Most of Estonian banks had quite ambitious growth strategies. Growth was achieved by introducing new ideas, by cheaper service or by cheaply acquiring competitors during banking crises. Hansapank was lucky because they grew mainly during crises. After the first banking crisis in 1993, Hansapank grew from 379 million EEK in the beginning of the year to 988 million EEK in the end of the year. The second banking crisis in 1998 gave Hansapank the opportunity to acquire Estonian Savings Bank (ESB) and this granted them more than 50% of the banking market. ESB also planned to become Estonia’s largest bank (several other banks had the same plan as well), but the biggest issue of shares in the Baltic States fell into the period of stock market crisis and the management of the bank took the risk of buying half of the emission by themselves. For this purpose, a loan was taken from the Daiwa bank, which was unlawfully guaranteed by the ESB. This kind of activity would was not permitted neither by law nor by risk management principles. Already the researchers analyzing the Finnish banking crisis discovered the fact that a banking sector that grows faster than the overall economy will in the long run end up in a banking crisis. The economists analyzing the Japanese banking crisis came up with two reasons for this: deregulation and excess power of the banking sector. These were the reasons why they did not pay very much attention on risk management and regulative measures (Kanaya 2001). Apparently, this was also the case in Estonia: rapid growth in several years led to excess capacity of banking and also to underestimation of risk management in 1997. The banking crisis in 1998 brought the banking back to the ground from the clouds (Table 2). To summarize, the weak regulations and supervision allowed the banks to take high risk, which in case of success resulted also in high profitability. This is another reason behind the previously presented statistics that showed the profitability of banks to be higher in transition countries than in developed countries. The decline in profitability, however, can be explained by the gradual increase of the efficiency of regulations and supervision. Because there were very few regulations in the transition banking, there was also no need for offshore banking. In experts’ opinion, the 82

development and enforcement of banking regulations are most advanced in Hungary and Estonia from among transition countries. This has been supported by the completion of the privatization process in banking (Nord 2000). Table 2. Growth indicators of commercial banks in Estonia Year

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

No of Total by the end of the Per bank, bill. EEK GDP (current Banks operating year, bill. EEK prices, assets, % of banks* bill. EEK) GDP Assets share capital assets share capital 41 5.2 0.5 0.13 0.01 14.3 36.4 22 6.4 0.4 0.29 0.02 21.8 29.4 24 10.1 0.6 0.42 0.03 29.9 33.8 18 14.9 1.1 0.83 0.06 40.9 36.4 13 21.9 1.4 1.68 0.11 52.4 41.8 11 38.8 2.4 3.53 0.22 64.0 60.6 6 41.0 6.1 6.83 1.02 73.5 55.8 7 47.1 6.3 6.73 0.90 76.3 61.7 7 57.8 5.9 8.26 0.84 85.4 67.7 7 68.4 6.1 9.77 0.87 95.3 71.8

* Incl. branches of foreign banks Source: Bank of Estonia. The number of banks in Estonia did not change in last three years; there are still six operating commercial banks. The only branch of a foreign credit institution in is Nordea Bank in Finland Plc Estonian Branch. At the end of 2001, over 85% of the share capital of banks belonged to foreign owners. No significant changes occurred in the division of banking market in Estonia. The share of Hansapank and Union Bank of Estonia (UBE) amounted to 83% of the sector’s total assets. Sampo Pank and the branch of Nordea offered considerable competition to the two leading banks in several fields of activity with both strengthened their positions, providing a more personal approach to the clients. Analysis of the development of commercial banking in Estonia and other transition economies points out several features, which are typical to the starting period of commercial banking in the transition countries: • Assets of the banks grow much faster than GDP. The main reasons are the high inflation rate and the expansive development strategy of banks. The number of operating banks is decreasing constantly; therefore the growth rates of the assets of major banks are significantly higher than that of the average. • In all stages of the transition period, banks may have high efficiency due to taking high risks by the rapid growth of their market shares, quick implementation of new products and skilful exploitation of the peculiarities of a transition economy. But due to the volatility of the macroeconomic environment and differences in the level of risk management, productivity of different banks is very different and is very volatile. The profitability of basic banking services is more stable and uniform, but that of new products and participation in non-financial businesses is unstable. • A transition economy selects quickly and in quite a rough way the very limited number of prosperous banks and displaces a great bulk of weaker banks from the market, which remained in the major banks’ way and were not ready to take sufficiently high risks or were unsuccessful in their risk management. Only the most ambitious business plans can be successfully realized. 83

3. Reasons and reforms for the internationalization of banks At different times, the internationalization of banks has had various goals and forms. In the early years of capitalism, the main activity of the banks was to offer local companies services by making transactions in a domestic currency. Only very few banks took the risk or were able to finance foreign trade, make foreign remittances or guarantee loans and payments for international transactions. Currently most of the companies are already closely connected with the global market and therefore banks must offer services also abroad and use foreign currencies. One of the factors that is going to change the nature of the internationalization of banks, is the building up of the European Economic and Monetary Union that converts the whole Europe to one big inclusive market. Grubel (Grubel 1977) first developed the theory of multinational banking and later researchers tried to answer some of the questions posed in his paper (Aliber 1984). This theory of international banking based on the theory of FDI in manufacturing. According to this theory, multinational banks have some comparative advantages. Banks go abroad to better serve their domestic clients, who have gone abroad, which is called the gravitational pull effect. Banking internationalization grows in parallel with FDI as banks try to meet the demand for banking services of multinational firms abroad. This bank behavior of moving abroad is seen as a defensive strategy necessary to assure the continued business with the domestic parents of foreign subsidiaries to that the existing flow of information resulting from the bank-client relationship will not be preempted by a competitor bank. Secondly multinational service banks also do some business with local and wealthy individuals by offering them specialized services and information required for trade and capital market dealings within their native countries (Paula 2002). The internationalization of banks has been significantly impacted by structural changes in the world trade, the growth of direct investments into foreign countries, development of military aid programs, etc. The oil crisis in 1973 was one of such macroeconomic factors. Because of the crisis, monetary resources began to accumulate in the oil-exporting countries without the purpose of exploitation, but the oil-importing countries suffered money scarcity due to the deficit in their balance of payments. The disproportion between the location and demand of money resources gave a powerful boost to the internationalization of banks – the banks began to set up subsidiaries in the oil states. Thus, an opportunity was given to pump money from the oil-producing countries back to the oil-importing countries. In the last decade, the end of the cold war and the breakdown of the communist regime have become especially important factors for the internationalization of banks. The western banks hurry to conquer the emerging markets, especially the Russian market as the bigger one. The resent wave of bank internationalization is characterized not only by following their existing clients. According to Focarelli and Pozzolo, the “follow the clients” determinant for banking internationalization is only relevant for small banks, while the behavior of larger banks is determined by more complex diversification policies (Focarelli and Pozzolo 2002). There are some recent works that try to establish a pattern of expansion for the recent wave of banking internationalization. One of the most common explanations is related to the effects of the increase in banking competition caused by financial deregulation (Pauli 1994, Berger et al. 2000). As margins and fees are tightened in domestic financial markets, banks seek to expand cross-borders to generate higher 84

returns. Thus, with banks’ net interest margins under downward pressure due to the increase of banking competition, and as the big financial institutions are in general with low potential for growth some banks seek to diversify geographically in markets with potential of growth and/or with greater net interest margins. The benefits from earnings diversification may increase bank value in several ways, since diversification may lower bank risk and reduce the possibility of failure (Berger et al. 2000). There exist already limited amount of literature dealing with the question, whether there exists difference in foreign market entry of production firms and service providers. Results are different. Dunning has concluded that the basic factors are similar, but the very realization of internationalization differs between production and service firms (Dunning 1993). Erramilli gave important input into the analyses about the specific aspects of service sector internationalization. He introduced the classification of internationally traded services into two groups: soft services and hard services, which serve as a useful tool in analyzing the pattern of internationalization of services (Erramilli 1990, Erramilli and Rao 1993). Hard services could be exported in similar manner like manufactured goods. Soft services require close contact and physical proximity of producers and consumers (trade, financial services). Firms producing soft services are typically not able to enter foreign markets by exporting first. Therefore they have to use from the beginning of internationalization process more sophisticated methods (franchise, investments). Consequently they could not obtain the experience and knowledge before and have to face the risks of foreign markets already at the beginning of their internationalization process. It means that in the case of soft services the pattern of internationalization can hardly fit to the Scandinavian sequential model. Management theories are also to be taken into account when designing policies of internationalization. What seems particularly important is the development of a global mindset, a state of mind able to understand a business, an industry sector, or a particular market on a global basis. The executive with a global mindset has the ability to see across multiple territories and focuses on commonalties across many markets rather than emphasizing the differences among countries (Jeannet 2000). Firms from evaluated transition economies seem to be more ambitious than aiming only to become a regional multinational. Some among them have already taken more global approach, are expanding outside the region, in wider Europe, and also on other continents. What is still lacking, however, is the strategic management approach according to which all the firms’ activities are to be intertwined in one system, in one decision-making process, regardless of location of the activity. Besides the macroeconomic factors that rule the internationalization of banks, the ambitions of bank managers also play an important role. In the bankers’ viewpoint the motives of internationalization can be divided into four groups (Rugmah and Kamath 1987): • Use the potential ability of a bank more completely. For example, the domestic management and sales skills may enable banks to offer services abroad at lower costs. It also enables the local companies’ subsidiaries abroad to use competent information about the possibilities and conditions in the mother country. • Use the reputation of a parent bank. The subsidiaries set up abroad may get competitive advantages as, by a rule, an international bank is considered more reliable than the local banks. The opinion research conducted in the Estonian companies in period 1994–2000 showed that when choosing a bank, the trustworthiness of the bank was the first order criterion for 29.9%, second order 85

• •

•

•

criterion for 16.1% and third order criterion for 16.7% of the companies (Aarma and Vensel 2002). Reduce banking regulations. In many cases, the main purpose of setting up subsidiaries and branches abroad is to overcome the restrictions on moving capital abroad. Reduce risks. As the economic situation, legislation, political situation and other circumstances may change, being present will enable to recognize the risks in time and take necessary countermeasures. It is rational to carry out the internationalization of banks in two stages: To secure the presence in a target country, in order to learn the local market better. Mostly there are used the following ways: setting up of correspondent relationships with local banks, opening of representative offices in the target country or acquisition of a minority stake in some local bank. Starting banking business in a target country either by setting up daughter banks and subsidiaries, buying up a bank or obtaining a significant stake in a bank through a merger or buying the shares.

4. Expansion of Estonian banks to foreign markets The banking sector has been among frontrunners in Estonia in understanding the opportunities and risks of globalization process. As banks must guarantee their clients and their foreign partners for international business the financial service of the same quality as the internal one then their efforts of internationalization are understandable and reasonable. On the other hand, due to its high speed of development, the Estonian banking sector has grown out from the narrow frames of domestic market and is trying to accomplish its goals more profoundly and to earn higher profit through internationalization. At the beginning of the 1990s, Estonia began to build up the market economy and also to integrate into the global economy. This forced the Estonian banks to pass in a short time the stages of internationalization that the banking institutions in developed countries had gone through in decades. The first steps of the Estonian commercial banks in the process of internationalization were most probably made in order to offer the clients better transaction services. The first step taken by Estonian banks was the opening of correspondent accounts in foreign banks. In 1991, four banks among the 27 registered commercial banks had a foreign currency license. By the end of 1993 most of the banks had licenses for foreign currency and correspondent accounts opened at least in the banks of the Nordic countries. The Bank of Estonia was interested in issuing the licenses because according to the regulations effective in 1992–1994, a bank, before converting foreign cash into kroons, had to transfer the money to some account in a foreign bank and only after that it was allowed to transfer the money to the correspondent account of Bank of Estonia abroad (EPB 1993). By the end of 1993, Estonian banks had correspondent accounts besides Europe also in America, Asia and Australia and it was possible to make transfers in 17 different currencies. Another motive of internationalization for Estonian banks was the possibility to invest their loan resources in foreign countries more favorably and without risk, or buy the resources for cheaper price. The process was started already by the Tartu Commercial Bank, which granted the credit outside Estonia in the conditions of former Soviet Union with higher interest rates than it would have been possible in the domestic market. At the end of 1994 the non-resident liabilities formed already 28.8% and assets 86

8.4% of the total assets of commercial banks. Estonian commercial banks had also high ambitions in non-financial business outside Estonia. In such business deals, a bank preferred not to lend resources but did the business itself, trying to use the big disparities in prices in transition countries. Thus the main reasons for liquidity difficulties and later crashes of some banks were unsuccessful international commercial deals. After the first banking crises, the remaining banks recovered and learned a lot and foreign banks trusted to grant them credit. In the middle of 1997, the commercial banks could proudly announce that the four major banks had gained besides subordinated loans also 2.4 billion EEK from foreign markets for re-lending. Banks had become too careless again and this carelessness began to cause headache when the stock market crashed in October 1997 and became a serious problem for Estonian commercial banks after the Russian financial crises in autumn 1998. Table 3 shows that until 1997, the assets and profits of the banks had increased rapidly but then this expansive growth, which was achieved mostly by entering foreign markets, began to generate losses in similar amounts. Table 3. Profitability indicators of Estonian commercial banks Indicator Total assets at the end of a year; billion EEK Annual profit; million EEK Equity multiplier, % Return on equity, ROE; % Return on assets %, ROA, % Profit margin, % Assets utilization, % Earnings per share, %

1994

1995

1996

10.1 68.7 11.7 5.7

14.9 288.5 12.6 30.5

21.9 517.4 10.4 30.6

0.5 0 15.9 8.6

2.4 0.2 15.6 40.4

2.9 0.2 18.2 47.9

1997

1998

38.8 41.0 963.1 –498.5 10.7 8.4 34.9 –10.1 3.3 0.2 20.1 74.3

–1.2 –0.1 11.5 –29.8

1999 47.1 637 6.3 9.2 1.5 0.1 12.0 31.6

2000

2001

57.8 68.4 625.1 1685.4 7.1 7.8 8.4 N/A. 1.2 0.1 11.1 29.5

2.7 0.2 11.4 N/A.

Source: Bank of Estonia. The list of motives of internationalization in Table 4 includes both, proactive and reactive factors. It seems that proactive motives were still dominating in decisionmaking about Estonian banks going abroad. Estonian banking crises in 1992 resulted in the strong consolidation of banking sector. In the process of consolidation also complete restructuring of banks occurred. It covered all aspects of banking industry starting with improvements in the quality of loan portfolios and ending up with boosted innovation. This increased competitiveness of Estonian banks compared with neighboring Baltic countries and Russia, Ukraine. The main reason for the internationalization of Estonian banks was market seeking argument – the domestic market was very limited by size and competition was heavy. Therefore Estonian banks started to use their created strategic assets in entering Latvian and Lithuanian markets. This process also included also strong component of competition between Estonian banks themselves in order to obtain strategic advantage of first entry. Foreign banks were still not interested to enter Latvian and Lithuanian markets and therefore Estonian banks used the suitable situation. Additional important aspect in entering Latvian and Lithuania markets was also need to serve domestic firms, which moved intensively into these markets since early 1995. Latvia and Lithuania together by that time formed around 15% of Estonian total export. As the stability of local banking sector in Latvia and Lithuania was very weak, then Estonian firms were 87

looked for stable financial services and it was provided by subsidiaries of Estonia banks there. Table 4. Motives of internationalization in Estonian banking sector PROACTIVE

REACTIVE

Internal triggers Search for market power, increase market share Distinctive service and brand. Increase brand identity Extend product range and life cycle Visionary leadership Diversification Improve levels of business performance Have excess capacity (human capital, technology) Suitable situation to obtain foreign bank (default)

External triggers Strategic presence vis a vis competitors Increasing concentration (through acquisitions and mergers) Improvements in information technology Improvements in physical infrastructure (communication networks) Decline, saturation of local/national market Intensity of competition Avoid the entry by cross-border rivals Service existing customers who have gone international

Source: Compiled by authors based on results of survey among Estonian outward investors (Sõrg and Varblane 2002). In other transition countries banking sector has not been in so strongly dominating position. In Table 5, the shares of different types of services in the total outflow of investments in Estonia compared with Poland, Slovenia and Czech republic are presented. Trade has been very important in the outflow of investments in Czech Republic. Manufacturing industry has been much more important than services in Slovenian case. Therefore one could expect that there were very strong motivating factors, why Estonian banking sector internationalized so strongly. The Estonian banks have used three strategies in their internationalization: • setting up subsidiaries and branches (green-field); • buying up local banks (complete takeover); • acquiring a significant stake in some local bank. Table 5. Share of services in the outflow of direct investments in some transition countries (% of the stock of total outflow) Poland 1999 Service sector Financial intermediation real estate, business services Transport, communications Trade and repairs Construction

Slovenia 2000 38.2 15.0 6.3 6.2

81.8 16.2 0.6 3.6 0.2 0.1

8.6 2.0

Czech Republic Estonia 1999 2000 79.5 25.9 7.0 N/A. 30.1 N/A.

83.1 40.4 23.5 13.6 4.8 0.8

Source: Stare 2002. The first one to succeed was Hansapank, who in 1996 used suitable moment and acquired a Latvian bank (Deutsche Lettische Bank), which had defaulted. The 88

former name of the bank was changed into Hansapank-Latvija, the shares of the former shareholders were exchanged for the shares of Hansapank, and the management of the subsidiary was changed. Because the credibility of Latvian banks had weakened, Hansapank with its reputation insured and in the second half-year of 1997 HansapankLatvija already earned profit. Later the name was changes to Hansapanka and the bank has increased rapidly. After the success of Hansapank became known, the other competing Estonian commercial banks began to make plans for buying up the banks in the markets of Latvia, Lithuania, Russia and Ukraine (see Table 6). Table 6. Major Operations of Estonian Banks Abroad Bank

Operations Abroad

Results

Hansapank

Bought in 1995 the Deutsch-Lettische Bank, was renamed Hansabanka; at the same year was established a leasing company in Latvia In 1995 in Lithuania was established a leasing company; in 1999 a subsidiary bank: in 2001 bought Lietuvos Taupomasis Bankas Bought in September 1997 in Moscow FABA Bank Bought in March 1998 in Latvia Zemes Banka

In 2002 Hansabanka was a third biggest bank in Latvia

Estonian Savings Bank

In 2002 Hansabankas and Hansa-LTB were merged and had second market position in Lithuania

After merger with Hansabank it sold FABA Bank in April 1999 After merger with Hansapank in April 1998 Zemes Banka was joined with Hansabanka Union Bank of In April 1997 was opened a Is operating nowadays, but have Estonia (UBE) representative office and a leasing marginal markets share company in St. Petersburg In March 1998 was signed a strategic In 1999 SEB from Sweden obtained cooperation agreement with Latvijas major stock in these three banks but Unibanka and Vilniaus Bankas they are operating separately Tallinn Bank Bought in 1996 20% stock of Saules After merger with UBE, UBE become Banka in Latvia; in the same year a new owner of Saules Banka. In established a leasing company in February 2001, UBE sold Saules Latvia; in December 1997 bought Banks off other 80% of stock of Saules Banka Forekspank In 1997 was opened a representative Office was closed in 1998 after office in Moscow merger Forekspank with Estonian Investment Bank EVEA Pank In 1997 was opened a representative Office was closed after finishing office in Moscow activities of EVEA Pank in 1998

Source: Zirnask 2002. As acquisition usually means taking over a poorly functioning bank, which needs restructuring or re-capitalization, obtaining a strategic share can meet the reluctance of other banks and the central bank, often the tactics of starting from scratch is chosen. Hansapank has reiterated its intentions to establish a subsidiary in Lithuania although the first two failed. On 7 July 1999, Hansabankas Lithuania opened the doors to the clients in Vilnius as typical green-field investment. It had only 200 clients but the subsidiary expected to seize 5% of the Lithuanian banking sector in the next three years. In reality much more rapid expansion on Lithuanian market happened. In addition to 89

strong organic growth, the Hansabank Group also completed the acquisition of the largest retail bank in Lithuania, Lietuvos Taupomasis Bankas (LTB) after long privatization process. In April 2001, Hansabank paid 43 million for its holding of 99.3% of the share capital of LTB. This acquisition significantly strengthened Hansabank's position in Lithuania as well as in the whole Baltic market. In Lithuania the market share rose to 30% and in Hansabank controls over one third of the banking market in Baltics. With this transaction Hansabank doubled its customer base and workforce - at the end of June the Group had over 2.7 million customers. Union Bank of Estonia had especially highflying plans. In autumn 1997 the bank announced its plans to establish a subsidiary bank of the total assets of 1.5 billion EEK in St. Petersburg (the total assets of UBE this time was ca 9.5 billion EEK). Even at the beginning of 1998 the value of UBE had not changed essentially as the bank is planning to spend a billion EEK on opening a branch in Helsinki and a bank office in Stockholm. Tallinn Bank had even more ambitious plans, in January 1998 the Chairman of the Board announced the bank’s goal to gain a market share of 35% in the Baltic market. The future internationalization of UBE was cancelled in 1999, after Swedish SEB took over majority of shares. Since 1999 up to 2002 the SEB started to create Baltic network of SEB subsidiaries and UBE lost its subsidiaries in Latvia and Lithuania. Now two Swedish banks – Swedbank and SEB – control five of the biggest banks in the Baltics. They have a combined market share of 51 per cent of bank assets and 60 per cent of all bank loans in the Baltics (Sutela 2002). The first stage of internationalization of the Estonian banks has given both positive and negative experience. We can make general conclusion that the internationalization was directed toward East, where Estonian banks had created specific advantage (knowledge, technology, organizational culture etc.). But the eastern direction raised the risk level of Estonian domestic banking and its sensitivity to crises, due to the higher risks and unbalanced character of internationalization. The second conclusion is that the realization of internationalization plans is often being dragged on, thus it will not be so successful as expected. Conclusively it indicates that either the banks were not able to foresee the risks of internationalization or they used in this stage the announcement of their internationalization plans to the public as the means of advertising and improving their image. The researchers of the banking globalization have reached the conclusion that excessive eagerness in entering foreign markets without sufficient preliminary knowledge about local economic conditions may rise the vulnerability of such banks (Balino et al. 2000). The Estonian banks’ experiences of the East expansion have proved this conclusion once more.

5. Russian banking sector expansion abroad Over 1000 bank-like institutions operate in Russia. The majority of them can be regarded as the financial department of their founding companies rather than a genuine bank. In addition to banks of genuine Russian origin, several foreign-owned banks have also entered Russia. Due to the large number of Russian bank-like institutions and their special function, it can be concluded that the Russian banking sector has not reached its maturity in servicing its clients either domestically or abroad. Therefore, it is understandable that the foreign activities of Russian banks abroad are rather limited. In the following, the authors describe some of the international operations of the major Russian banks. 90

As no earlier empirical study has been conducted on the internationalization of Russian banks (at least no such study was found) the authors decided to search for an answer to the following research questions: • To what extent have the largest Russian banks already moved their operations abroad? • What are the main driving forces behind their internationalization – and the main barriers in those cases internationalization had not taken place (R-factor)? • In which foreign areas is the bank currently operating and how important are the EU and the CIS market areas for the bank (E-factor)? • What are the main operation modes (subsidiaries, branches, representatives, etc.) used (M-factor)? Due to limited resources, the researchers were forced to limit the sample size; consequently they focused the study on the 100 largest banks, which were selected on the basis of their own capital (in more detail, see Liuhto and Jumpponen 2003). The authors deliberately decided to focus the study on the largest corporations for three main reasons. First, should the researchers have aimed at random sampling among almost one thousand bank-like institutions in Russia, the outcome of the study would most probably have been less successful, because a large proportion of these registered enterprises do not necessarily operate. Besides this situation, even finding the contact details of the largest 100 banks turned out to be rather problematical, so one could conclude that discovering information on 1000 banks would have taken even greater effort. Secondly, smaller banks have usually less need, customers, resources, or skills for their internationalization. This would most probably have resulted in a great percentage of replies indicating that the firm has not yet started its internationalization. Thirdly, the investigation focused on the largest banks, due to their economic importance. The success of these companies' internationalization efforts is crucial to the economic development of Russia, since they command a significant part of Russian financial market. The questionnaire designed for the research is based on the REM model. In other words, the questionnaire deals with the reason for, environment, and mode of internationalization. The authors considered that the questionnaire should be as clear as possible, to avoid any possibility of misunderstanding. It was also decided that the questionnaire should not exceed two pages and it should not include too sensitive issues, such as exact performance indicators or ownership arrangements, since both a lengthy questionnaire and over-sensitive questions would have reduced the managers' willingness to fill in the questionnaire. In order to avoid misunderstandings, the questionnaire was translated into Russian (both the English and the Russian versions of the questionnaire were sent to the banks). Almost all of the 100 largest Russian banks were also called before sending out the questionnaires, in order to inform them about the forthcoming survey, locate the correct respondent for the forthcoming questionnaire and to inform the respondent. In most of the cases the persons contacted could not name any particular person as respondent, but asked that we send the questionnaire to either a director of the bank or to the department of international affairs of the bank. The authors deliberately decided to focus the study on the largest corporations for three main reasons. First, should the researchers have aimed at random sampling among almost one thousand bank-like institutions in Russia, the outcome of the study would most probably have been less successful, because a large proportion of these registered enterprises do not necessarily operate. Besides this situation, even finding the 91

contact details of the largest 100 banks turned out to be rather problematical, so one could conclude that discovering information on 1000 banks would have taken even greater effort. Secondly, smaller banks have usually less need, customers, resources, or skills for their internationalization. This would most probably have resulted in a great percentage of replies indicating that the firm has not yet started its internationalization. Thirdly, the investigation focused on the largest banks, due to their economic importance. The success of these companies' internationalization efforts is crucial to the economic development of Russia, since they command a significant part of Russian financial market. The questionnaire designed for the research is based on the REM model. In other words, the questionnaire deals with the reason for, environment, and mode of internationalization. The authors considered that the questionnaire should be as clear as possible, to avoid any possibility of misunderstanding. It was also decided that the questionnaire should not exceed two pages and it should not include too sensitive issues, such as exact performance indicators or ownership arrangements, since both a lengthy questionnaire and over-sensitive questions would have reduced the managers' willingness to fill in the questionnaire. In order to avoid misunderstandings, the questionnaire was translated into Russian (both the English and the Russian versions of the questionnaire were sent to the banks). Almost all of the 100 largest Russian banks were also called before sending out the questionnaires, in order to inform them about the forthcoming survey, locate the correct respondent for the forthcoming questionnaire and to inform the respondent. In most of the cases the persons contacted could not name any particular person as respondent, but asked that we send the questionnaire to either a director of the bank or to the department of international affairs of the bank. The studied Russian banks were called during September 2002. In October, the questionnaires were sent either by fax or by e-mail, depending on the banks’ preferences, which they had indicated during the calls. At the same time, the questionnaires were sent out by traditional mail. Later on, two reminders were sent either by fax or by e-mail and in addition, the non-respondent banks were once again contacted by phone in the beginning of December. In spite of the researchers’ efforts, the response was no higher than 26 banks out of the 100 canvassed. The participating companies included both large and small units, if measured by their capital. Based on their answers it was also possible to notice that the participants included banks with notable international operations and those, which do not yet have any operations abroad. The empirical evidence shows that operating abroad tends to be connected with a relatively high number of existing correspondent banks abroad: over half of the Russian banks without foreign units have less than 20 foreign correspondence banks, meanwhile over half of Russian banks with foreign units have more than 50 foreign correspondence banks. Evidently, the main motivating factor for the internationalization of Russian banks seems to have been following and serving their current clients – especially whenever the expansion has been directed to the EU. The second most frequently mentioned reason for operations within EU countries has been “to be present in an international financial center”. As for declaration concerning operations in the CIS countries no particular dominant reason could be found; “finding new clients” was mentioned almost as often as “serving current clients”, which was the most common reason. 92

It is worth noting that the majority of the banks surveyed mentioned having plans either to start operations abroad or to further expand them within the nearest future, i.e. during the year 2003. Therefore it seems as if the internationalization of Russian banks is just about to emerge on a large scale, even though some of the largest banks have already been present in international financial markets for several years. The most commonly mentioned foreign target markets for banks were the EU, the CIS countries and the USA. According to the answers received, approximately half of the banks’ plans also require establishing their own unit in these markets and/or acquisition activity. On the other hand, in comparison with the aforementioned areas, the Baltic States and Eastern European countries were not mentioned as often as target regions for future operations. It remains to be seen, to which extent the expressed plans will be realized. As the banks were asked to tell about their expansion plans concerning the year 2003, the actual scope of the Russian banks’ expansion to foreign markets should be soon on view. In order to clarify, the extent to which the Russian banks have widened their operations in the international markets, we asked the respondents, how large a share of their assets and workforce are located in foreign markets. On the basis of our survey answers, we have constructed the following table, wherein the Russian banks are ranked according to their foreign assets (see Table 7). Table 7. The Top 10 Russian Transnational Banks (ranked by foreign assets – USD million, 2001) Rank (foreign asset) 1 2 3 4 5 6

Rank (asset)c 2 3 31 4 69 316

Rank (own capital) c 2 4 34 5 91 126

7 8

187 77

133 69

9 10

83 22

95 14

Bank Vneshtorgbank Alfa-Bank Promsvyazbank Gazprombank Evrotrast Russian interregional bank for development Lanta-bank Kreditnyi agroprombank Absolut-bank NOMOS-bank

Foreign assets a 1328,49 564,92 75,49 42,34 38,31 25,31

BTNI b (percent) N/A 12 9 N/A 16 12

15,77 6,36

18 5

.. ..

8 7

a

Based on survey responses. The Bank Trans-nationality Index (BTNI) is calculated as the average of three ratios: foreign assets to total assets, foreign profits to total profits and foreign employment to total employment. c Ranking among the largest Russian banks on the basis of assets and own capital. b

Vneshtorgbank is according to the above list, the most transnational financial corporation in Russia. The bank was established in October 1990 as a closed joint-stock company aimed at servicing the foreign economic relations of the Russian Federation. Vneshtorgbank has subsidiary banks in Austria, Cyprus, Luxembourg, and Switzerland and representative offices in China, Italy, and Ukraine. In Germany the bank has an associated bank, the Ost-West Handelsbank located in Frankfurt-am-Main. In total, the 93

company employs some 3500 persons, out of which 4% are working in the units abroad. The main motivator for the bank’s internationalization has been serving their current clients’ foreign operations in both the EU and the CIS markets. The foreign correspondence network of the bank is large and includes over 100 foreign correspondence units. Russia’s largest privately owned bank, the Alfa Bank, was founded in 1990. Today, the bank has more than 70 branches in Russia, Ukraine, and Kazakhstan and fully owned subsidiaries in the United Kingdom, the United States and the Netherlands. The fully owned subsidiary in the Netherlands (Amsterdam Trade Bank N.V.) has a full European banking license. The London-based unit (Alfa Securities) was set up in 2000 and it provides brokerage, research, and investment banking services. Nowadays, some 300 people altogether are working in the foreign units of the bank. According to the bank, the main reason for their expansion into the aforementioned foreign market areas has been “to be present in an international financial center” – in both the case of the EU and the CIS areas. Promsvyazbank was set up in 1995 by several telecommunications companies and has continued operating closely with companies representing the telecommunications and high-tech industries. According to the bank’s reply, it established a branch office in Cyprus in early 2002 and has a representative office in Kyrgystan. The bank indicates the “serve current clients’ foreign operations” as its main motivation for international operations. By the end of 2003, the bank plans to expand its financing activities to Ukraine. One of the Russian banks that have apparently followed its clients abroad is Gazprombank. Gazprombank has shareholding in two foreign banks - General Banking and Trust Co. (Hungary with 26% ownership) and Belgazprombank (Belarus, 34% ownership). In Hungary, the bank has 10 branch offices. Besides these units, the bank completely owns the Dutch-based Gazinvest Finance. In France, the bank has owned a 30%-share in Sofraci since 1999. The company announces that it will expand its operations further, but does not specify any particular area as its target market. The Russian Interregional Bank of Development indicates that it has no links to more than five foreign correspondence banks, but nonetheless still has operations and units abroad. As much as 30% of the bank’s total assets are presently abroad and according to the bank’s response, these assets are not in the CIS-market, as the company does not operate there. However, the bank does not give any more detailed information, where it currently has foreign operations. The company plans to enforce its presence in the EU in the near future. Lanta-Bank was originally founded by several metal and mining companies, which represent a remarkable share of the bank’s corporate clients. In 2001, the bank established a fully owned subsidiary in the Netherlands (Lanta Gold Finance) and a representative office in Belarus. However, according to the company’s reply, the role of the operations in the CIS market is relatively modest compared to their other market (the Netherlands), as only 5% of the assets and 2% of the profits are found in the CIS area. Respectively, their operations in the Netherlands cover a fourth of the assets and bring in almost a fifth of the bank’s profits. In the future, the company, however, plans to further expand both in the EU as well as in the CIS market. Russia’s seventh largest bank, if measured by assets, Rosbank, is a part of the Interros Holding Company, which has a majority ownership in several Russian companies, such as Norilsk Nickel. As is usual in the case of internationalized Russian banks, Rosbank also has several (over one hundred) foreign correspondence banks. 94

Rosbank has owned a subsidiary in Switzerland since 1995 and in the Netherlands since 2000. In Luxembourg, the company owns a unit “Rosinvest”. Besides these, the bank has a representative office in China. The company’s intention is to expand to the CIS during 2003. In order to promote joint business operations between Russia and the Czech Republic, a “First Russian-Czech” bank was established in 1996. The founders were the Investicni a postovni banka on the Czech side and the Vozrozhdeniye Bank on the Russian side. According to company’s response, in Belarus the Vozrozhdeniye Bank has a 15% stake in the “Bank of International Trade and Investments”, which was founded in 1998. Additionally, the bank has a correspondence network of some 110 banks in 40 countries. The “Trust and Investment Bank” (DIB, Doveritelnyi i Investitsionnyi bank) was formed in 1993. DIB is characterized as the main settlement bank of Yukos and it offers investment-banking services mainly to Russian exporters and importers, industrial companies and regional governments. The first subsidiary of the bank, T&IB Holdings B.V. was registered in the Netherlands in March 2001. The bank’s principal shareholder is the Menatep Group, which announced in November 2002 its plan to consolidate the Trust and Investment Bank with Bank Menatep SPb. The company stated its plan to further expand foreign operations, mainly in the form of providing foreign exchange and investment banking services in the future within the EU, the CIS, and the USA. BIN bank was founded in 1993 and currently has some 20 branch-offices in 10 Russian regions. In Germany, the bank has possessed a representative office since 1999. The company offers its services for both German enterprises interested in investing in Russia, and also for Russian firms as in “how to do business in Germany”. According to the bank’s reply, there have been several reasons affecting its decision to commence operations in the EU. In addition to the most frequently chosen alternatives, BIN bank indicates that “promoting co-operation with foreign financial institutions” has been an important factor in their expanding abroad. By the end of 2003, the bank plans to open a subsidiary in the EU area. Nikoil was established in 1993. In the beginning, the company operated as a petroleum investment company. Later on, the company has extended its operations to also cover other fields of financial business and has established representatives in the UK, USA, and Germany, so as to locate new foreign clientele. The bank has almost one hundred foreign correspondence banks. The International Bank of St. Petersburg has had a representative office in Finland since the summer of 2000. The representative office is said to have been established in order to serve both Finnish and Russian firms. The bank has also applied for permission to establish a branch office in Finland, but the Finnish authorities refused to issue a license. In Estonia, the bank established a representative unit in February 2002. The company confirms it has plans to further expand its operations within the EU and the Baltic States during the year 2003. Besides the aforementioned banks, several other banks have at least one representative office abroad. Among these banks are Centrocredit (representative in the UK), Krasbank (representative in the UK) and the Moscow Industrial Bank, which has an office in Austria. Of these banks, Krasbank announces having intentions to start operations in Asia in the field of trade and finance, meanwhile Centrocredit plans to expand to the CIS countries and to the Baltic States via mergers and acquisitions. 95

We have summarized the Russian banks’ foreign activities on the basis of their assets, profits, and employment abroad (see Table 8). Table 8. The Trans-nationality of the Studied Russian Banks Bank 1. Lanta-bank 2. European Trust Bank 3. Russian Interregional Bank of Development 4. Alfa-Bank 5. Promsvyazbank 6. Absolut bank 7. NOMOS-bank 8. Agromromkredit 9. Ural bank for Reconstruction 10 Vneshtorgbank

Assets abroad (%) 30 26 30

Profits abroad (%) 20 5 5

Employment abroad (%) 4 0 2

15 18 0 0 5 0 25

13 7 11 22 1 5 N/A

7 3 5 0 10 0 4

BTNI index 18 16 12 12 9 8 7 5 2 N/A

Out of the 26 respondents, 14 banks revealed possessing foreign units, while the remainder claimed to only have domestic units. The most common reasons for not having units abroad are presented in the following (see Table 9). Table 9. Reasons for Russian Banks Not Operating Abroad Reason

Frequency

“Banking in Russia is more profitable than abroad” “Our bank does not have sufficient financial resources to expand abroad” “Restrictions in the foreign target market to establish bank abroad” “Our bank has no need to expand abroad” “Our bank does not have earlier experience in operating in foreign market” “Russia’s government makes it difficult to expand abroad”

7 5 4 3 2 1

Notice: The respondents were asked to name three reasons, why their bank does not have operations abroad. Even though drawing up conclusions on the basis such a limited amount of responses is rather problematical, it appears as if the Russian banks had to face both internal and external barriers on their way to foreign markets. The most commonly mentioned argument is better profitability inside Russia. The banks might perceive that serving current domestic customers is more profitable than acquiring new customers in a foreign and unfamiliar market. Sberbank is among the studied companies that claimed to only have domestic operations. Even though the bank does not currently operate in any foreign market, the bank declares having had a representative office in the Czech Republic until 1999. The bank’s correspondence network consists of 250 foreign banks – “from all over the world”. Even though the bank is currently focused on operating inside the Russian borders, the bank has plans to start payments in local currencies, treasury deals, and trade finance transactions in both the CIS and Asian markets. One peculiarity of Russian banks seems to be a tendency to earn profits in foreign markets even without having units abroad. In the case of NOMOS-bank, the 96

share of foreign profits of all the company’s profits is over 20%. The Bank specializes in crediting enterprises and companies involved in export operations with foreign countries, and also the gold mining industry, as well as operating with precious metals in the Russian and international markets. Another bank without units abroad but with assets abroad is revealed to be Evrotrast (the European Trust Bank). Their foreign assets comprise some fourth of the bank’s total assets and some 5% of their profits are generated abroad. However, all of the company’s 250 employees currently work inside the Russian borders. In the future, the bank plans to expand into the EU and the US loan market through the mortgage sector. Agropromkredit (Kreditnyi agroprombank) has, within a year, overtaken over 600 banks in the asset rankings of the largest Russian banks, which quite well describes the current volatility of the Russian banking sector. Currently, the bank speaks of not having any operations abroad but, nonetheless, to have a tenth of its working-force in the foreign markets. Some 5% of the bank’s assets are currently abroad. In the future, the bank indicates its desire to start offering trading services to existing clients in various regions. Another bank, which informed us of earning profits in foreign markets is UBRR (Uralskiy bank rekonstruktsii i razvitiya, the Ural Bank for Reconstruction and Development). This Yekaterinburg-based bank has some 400 employees working in a handful of branches but the company speaks of having plans to provide a multitude of services in several foreign markets in the near future. Respectively, the BVT bank (Bank Vysokyh Tehnologii, the Commercial Bank of High Technologies) generates a smaller share of its profits in foreign markets. The bank plans on entering EU and US markets through providing currency exchange services. The Absolut-bank also refuses having foreign operations but, however, the bank maintains a network of over 50 foreign correspondence banks. Additionally, this bank has some 400 employees, out of whom 5% work abroad. Even though the company does not have any units abroad, the foreign operations accumulate a tenth of the bank’s profits. The company is considering starting operations in Scandinavia. Rosselhozbank, Sarovbiznesbank, and Neftyanoy also have plans to expand overseas. All of these banks currently have just a handful of foreign correspondence banks. In the case of Sarovbiznesbanks, the future plans are mentioned as being involved in the CIS market, whereas Neftyanoy is glancing over the EU market. In addition to both these aforementioned regions, Rosselhozbank is looking at the possibilities of starting operations in the USA but does not give any further details concerning the nature of its plans. A St. Petersburg-based Inkasbank and a Moscow-based Masterbank are banks without current foreign operations, nor do they have any intentions to expand operations abroad in the future either. Both argue that the banking in Russia is more profitable than abroad. Both have some 15-30 foreign banks belonging to their correspondence network. In this context, it needs to be stressed that besides the aforementioned banks, other Russian banks with foreign activities could be also found, which did not respond to our survey. In the following, we briefly describe some of these activities, which are based mainly on the companies’ own statements in their homepages or annual reports. Petrokommerz, established in 1992, states that “Expansion of its international operations is one of the priority development areas of the Bank”. The bank has subsidiaries in Ukraine (since 1996) and in Moldova (since 2001). The Bank plans to 97

further expand its presence in Moscow as well as the Russian regions, and to open up and develop its business in the CIS countries. The regional development program encompasses development in accordance with the regional interests of its major shareholder, which is Lukoil. Menatep St. Petersburg, a joint stock bank, was registered in 1995. The bank serves the financial flows of the enterprises in the Yukos-Rosprom group and is also a principal bank for Gazprom. The bank has a subsidiary in Armenia (Menatep-Erevan), in the Netherlands (Menatep Securities BV) as well as in Switzerland (Menatep Finance AS). This Swiss unit in turn owns a subsidiary in Cyprus “Fiennes Investments Limited”, which focuses upon international trading and investments. In September 2001, the bank became the first foreign bank to open a subsidiary in Mongolia. The bank made this decision following the interests of one of its largest shareholders, Yukos. The Moscow Municipal Bank - the Bank of Moscow was founded in March 1995, at the initiative of the Moscow Government, which currently holds a 63% stake in the bank’s capital. Other important shareholders are Sberbank, Lukoil, and Surgutneftegaz. The Bank of Moscow has a fully owned subsidiary in Belarus (the Moscow-Minsk Bank) - situated in Minsk as well as a subsidiary in Latvia, (the Latvian Businessbank). The correspondence network of the bank is comprised of about 300 foreign banks. Another oil company, Lukoil, is one of the principal shareholders of Sobinbank. This bank is currently among the 20 largest Russian banks in terms of its own capital. Sobinbank has a representative office in both Ukraine and Finland. The Mosnarbank (Moscow Narodny Bank, MNB) was established as early as 1911 in Moscow and foreign agencies were opened in London and New York a couple of years later. Between the World Wars, branches were opened in Paris and Berlin and in the 1970s in Singapore and Canada. Currently, the bank is owned by the Central Bank of Russia. The MNB head office is located in London, a subsidiary in Moscow and a branch office in Singapore. The representative offices are located in China and Canada. Smaller banks have also gone abroad. As an example from these smaller banks, the Ugra bank should be mentioned. The bank was originally established in 1990 in the Khanty-Mansiisk autonomous region and during the last decade it expanded, first of all to the major Russian cities, until in 1998 the company established its first foreign representative office in Belgium. If foreign firms have not succeeded in integrating Russia with global business, Russian corporations and them servicing banks, via their outward FDI, have integrated their country with foreign markets more intensively than the companies of any other transition economy. Statistical data suggests that Russian corporations have expanded not only in the West but also in CEEC and the former Soviet republics. From our overview of Russian banking sector expansion abroad it is noticeable that mostly the list of operating abroad banks (Table 10) includes financial-industrial groups (FIGs) who have become major players in the Russian economy. There is significant heterogeneity among these groups but broadly there are two main types: (1) industry-led groups formed either by large industrial firms that set up their own agent or ‘pocket’ bank for operational needs, as well as established regional holding groups and, (2) bankled groups formed either by direct acquisition of industrial firms by banks or as a result of debt-equity swaps after privatization. 98

Table 10. A Summary of the Russian Banks’ Activities Abroad (in order of appearance in the text) Bank Vneshtorgbank

Environment Austria, Cyprus, Luxembourg, Switzerland China, Italy, Ukraine Alfa-bank Kazakhstan, Netherlands, Ukraine United Kingdom, United States Promsvyazbank Cyprus Kyrgystan Gazprombank Netherlands Hungary, Belarus, France Russian Interregional Bank for Development n.d. Lanta-bank Netherlands Belarus Rosbank Luxemburg, Netherlands, Switzerland China Vozrozhdeniye Belarus DIB Netherlands BIN bank Germany

Nikoil Germany, United Kingdom, United States International bank of St. Petersburg Estonia, Finland Centrocredit United Kingdom Krasbank United Kingdom Moscow Industrial Bank Austria Petrokommerz1 Moldova, Ukraine Menatep St. Petersburg Armenia, Cyprus, Mongolia Netherlands, Switzerland Bank of Moscow Belarus, Latvia Sobinbank Finland, Ukraine Mosnarbank Singapore, United Kingdom China Ugra bank Belgium

Operations Subsidiary Representative Subsidiary Subsidiary Representative Subsidiary Minority shareholding n.d. Subsidiary Representative Subsidiary Representative Minority shareholding Subsidiary Representative Representative Representative Representative Representative Representative Subsidiary Subsidiary Subsidiary Representative Subsidiary Representative Representative

In principle, FIGs offer several advantages. First, concentrated ownership tends to improve corporate governance. Second, the interests of shareholders and creditors are aligned, as these roles are played by the same institutions with, the control rights over the group’s assets being held by the parent company, this might favor an effect allocation of funds within the groups, and help overcome any liquidity problems in financing profitable projects. 1

Based on the company information stated in the bank’s homepage and/or annual report(s). 99

6. Some concluding remarks: Similarities and differences of Estonian and Russian banks entry to the foreign markets Table 11 demonstrates economic and banking indicators and the banking reform’s scale in Russia compared with other CEE countries. According to the magazine The Banker, the most successful banking reforms were in Hungary and Estonia but very slowly developed in Russia. Table 11. Economic and banking indicators of CEE countries and Russia Country

Bulgaria Croatia Czech Republic Estonia Hungary Poland Romania Russia Slovakia Slovenia

GDP per capita (USD) 1697 4447 5347

Population per bank (000) 296 7 229

Private sector (% GDP) 60 60 80

Bank loans to private sector (% GDP) 14 40 60

State Foreign banks (% banks assets) (% assets) 66 15 37 3 19 13

Banking reform (scale 1–+4) 3– 3 3+

3593 4727 4000 1697 1897 3793 9826

242 253 466 61 101 225 59

75 80 65 60 70 75 55

25 23 21 13 13 NA 32

8 12 48 75 42 50 41

4– 4 3+ 3– 2– 3– 3+

29 62 37 7 7 19 6

Source: The Banker, July 2000, p. 158. One reason may be in banking regulation, what are most advanced in Hungary and Estonia and allows easily to entry of foreign banks. In Russia in April 2000 was scrapped a 12% limit of foreign capital in the banking system, opening the doors for western financial institutions to expand their Russian operations (Chazan, 2000). When foreign banks cannot come into Russia then Russians banks should compensate low rate of integration by opening door abroad. Comparing Estonian and Russian banks entry to the foreign markets we may notice several similarities but also some differences. Similar features are • the major banks are more active; • they are using several strategies (goals) at the same time: customer following strategy, new market seeking strategy, competitors leading strategy; • they are using several methods: setting up subsidiaries and branches, buying up local banks and acquizing a significant state in some local bank, establishing a new bank (green-field strategy). Estonian and Russian banks internationalization strategies have also some differences: • Estonian banks try to go only to the neighboring countries, but for Russian banks isn’t it important. • Estonian banks are entering at first to the culturally closer business markets (Baltic countries) but Russian banks prefer bigger markets. 100

Looking these differences between Estonian and Russian banks entry to the foreign markets it is noticeable that these differences may be explained by gravity theory, which describes the degree of spatial interaction between two or more points in a manner analogous to physical phenomena. Classical gravity theory states that the attraction force between two entities is proportional to their respective masses and inversely proportional to the squared distance between these entities (Paas, 2000). Quite clearly, the Russian market is much bigger than Estonian one, and the Russian banks are several times bigger Estonian ones.

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