Putin’s Banker

CEO Kostin seeks to make Vneshtorgbank Russia’s national champion.


Only three years ago, when liberal economic reformers held sway in Russia and Yukos Oil Co. was at the forefront of an ascendant private sector, Vneshtorgbank seemed set to define the future of Russian banking. The European Bank for Reconstruction and Development and the International Finance Corp., the World Bank’s private sector affiliate, were negotiating with the government to buy a minority stake in the state-owned bank in preparation for a full-fledged privatization. Western capital and management expertise, so the plan went, would modernize the country’s second-largest bank and help transform Russia’s crisis-prone, state-dominated banking system into a trusted guardian of savings and an efficient provider of credit.

Much has changed since then, of course. Reformers are on the run in the face of resurgent authoritarianism under President Vladimir Putin, the government has effectively renationalized Yukos by stripping it of its main assets, and talk of banking reform has gone quiet. Yet Vneshtorgbank’s star as a national banking model is shining brighter than ever.

Credit the leadership of Andrei Kostin, chairman and CEO since June 2002, who has tacked deftly with Russia’s treacherous political winds since his days as a promising young Soviet diplomat. Under Kostin, Vneshtorgbank has shelved plans for privatization and learned to enjoy the benefits of state ownership, not least state support for a series of local acquisitions. Notably, the bank took advantage of last year’s brief crisis in the commercial banking sector to snap up Guta Bank, the nation’s 22nd largest, for the modest sum of 1 million rubles ($34,000) in July. That deal, arranged by the Central Bank of the Russian Federation, allowed Vneshtorgbank to draw even with Alfa Bank, the country’s largest private sector bank, as the No. 2 retail institution behind the state behemoth Sberbank.

In September, Vneshtorgbank also agreed to buy 25 percent of Promstroibank St. Petersburg, Russia’s ninth-largest bank, with an option to purchase the rest over two years. Among Promstroibank’s shareholders: Vladimir Putin, who disclosed a 0.00015 percent stake while running for reelection last year, as well as a savings account at the bank worth $17,435. And in December the National Banking Council, a group of ministers and State Duma members chaired by Finance Minister Alexei Kudrin, recommended that Vneshtorgbank take over the central bank’s remaining stakes in five foreign banks, including London-based Moscow Narodny Bank, left over from the Soviet period.

Vneshtorgbank is flexing its financial muscles, too. It used its investment-grade credit ratings from Moody’s (Baa2) and Fitch (BBB-) to raise $2 billion on the Eurobond market over the past 15 months. It is plowing the proceeds into new business lines such as credit cards, where it doubled issuance in 2004 to some 630,000 cards, and investment banking, where it became last year’s second-biggest underwriter of ruble bonds, with a volume of 9.4 billion rubles. Kostin’s troops also are undercutting private competitors to gain a bigger share of the corporate lending market.


The aim is to make Vneshtorgbank, which was founded by Russia’s then-president Boris Yeltsin only 14 years ago (its name means “foreign trade bank”), into the country’s dominant bank, explains senior vice president Alexei Akinshin, a key Kostin lieutenant and a member of the executive board. “If Russia doesn’t have a national, or more accurately, transnational banking champion like Deutsche Bank, that means we consider ourselves worse than Western Europe,” Akinshin told Institutional Investor. “And why should we be worse?”

The bold expansion bid is certainly in tune with the times. The Putin administration is strengthening the state’s control of strategic industries, most notably with the $9.3 billion sale of Yukos’s Yuganskneftegaz unit to Rosneft, which itself is being taken over by state-run Gazprom. Prime Minister Mikhail Fradkov has put the brakes on a proposed restructuring and privatization of Unified Energy System of Russia, the national electricity grid. And plans for selling off the national flag carrier, Aeroflot, this year were canceled in September by the Ministry for Economic Development and Trade.

Russian banking remains dominated by the state, notwithstanding the efforts of domestic and foreign commercial banks. Sberbank and Vneshtorgbank, the two biggest by assets, are owned by the federal government. Gazprombank, the No. 3 player, is indirectly state-controlled through its dominant shareholder, state-owned Gazprom. Bank of Moscow, the country’s fifth largest, is majority-owned by the city government and closely watched by Mayor Yuri Luzhkov. (The only privately owned bank in the top five is Mikhail Fridman’s Alfa Bank, which ranks fourth.) The setup suits the Russian government; Vneshtorgbank last year took the lead on a number of state-friendly initiatives, ranging from a $250 million loan for capital improvements at Russian Railways to the opening of a branch in Chechnya, analysts and bankers say.

“There is a deliberate policy of keeping state banks in control of more than half the banking system for a transitional period of, say, three to five years,” says Alexei Yazykov, banking analyst at Moscow-based Aton Investment Group. “They want the state banks to control interest rates and exert some financial control over key economic sectors.”

The 48-year-old Kostin, who spent much of the 1980s as a manager at the Soviet embassy in London and the early 1990s as a top officer at two Moscow commercial banks, is eager to show that Vneshtorgbank is no lumbering proto-communist bureaucracy. He has moved aggressively to expand ever since taking the helm in June 2002. The bank’s assets rose to $12.1 billion in June 2004 (the latest figure available), nearly double the level of 2001. Deposits more than doubled, to $4.2 billion, in the same period, while the bank increased its retail customer base fivefold, to 620,000. The purchase of Guta Bank added an additional 400,000 retail customers and $1.2 billion in assets.

Kostin and company are using the bank’s financial strength to gain market share in the wake of last summer’s minicrisis, offering loans to corporate customers at rates as low as 10 percent; private sector rivals, such as Alfa Bank, MDM Bank and Rosbank, typically charge 13 to 14 percent. Vneshtorgbank’s assets (excluding Guta Bank) jumped a further 15 percent in the third quarter of last year, according to the Russian magazine and research agency Expert, while Alfa Bank’s fell 8 percent and MDM’s edged up 1.5 percent. Interest income leaped 46 percent in the first half of 2004 from a year earlier, to $201 million.

Vneshtorgbank has its sights set squarely on Russia’s expanding, Western-oriented middle class. Its television advertising campaign, using the slogan “the energy of success,” depicts stylish urban couples faced with upscale dilemmas, such as whether their ceilings are high enough for a new potted palm tree. Kostin himself, a generally reclusive figure who refused to be interviewed for this article, tried his best to loosen up and appeal to the young post-Soviet generation at Vneshtorgbank’s Christmas party for the Moscow press corps, which was held at a trendy restaurant off Pushkin Square and featured entertainment by four pop bands. The bespectacled CEO appeared briefly to assure the reporters that “we love you,” hand out gag raffle prizes and kiss one miniskirted young winner on the cheek.

A number of reform-minded observers believe Kostin’s image is more than a façade. “This is a man who understands modern finance, a more sophisticated man than we are used to from the Russian state sector,” says Lubomir Mitov, an analyst of Russian banks at the Institute for International Finance in Washington.

Kostin also is credited with running an honest commercial operation that shows no sign of corruption and relatively little indication that politics influences credit decisions. “Vneshtorgbank is regularly audited internationally,” says Tomasz Telma, principal investment officer for the International Finance Corp., the World Bank affiliate, in Moscow. “And the picture, by and large, is that it is pretty well managed and profitable.”

The bank earned $264 million in 2003, according to accounts audited by Ernst & Young. Volatile securities markets caused earnings to plunge in the first half of 2004, however, to $18 million, from $119 million a year earlier. Profits on securities and foreign exchange trading fell to $38 million, from $218 million, as the Yukos affair triggered a sharp correction in Russia’s booming stock and bond markets. Costs also rose by $44 million, to $207 million, partly offsetting a $63 million rise in interest income.

Even some of Kostin’s commercial rivals have good things to say about him. “Vneshtorgbank has a market-oriented management team,” says Natalya Orlova, chief economist at Alfa Bank. “The rise of Vneshtorgbank could help the financial system become better.”

One reason for that hope is that Vneshtorgbank’s expansion is likely to take a big bite out of its enormous rival, Sberbank. The state savings bank has lost some of its overwhelming Soviet-era dominance but still holds 62 percent of all retail deposits in Russia. Greater competition from Vneshtorgbank could make life better for retail customers like Elena, a Moscow accountant who declined to give her last name. She is trying to save $25,000 for an apartment within commuting distance of the city center. She moved her nest egg to Vneshtorgbank, lured by interest rates of about 9 percent on hard currency deposits, or 1 percentage point higher than Sberbank’s. Alfa Bank pays in the 10 percent range, but Elena, like 98 percent of Russians who responded to one survey last summer, doesn’t feel safe putting her money in a private sector bank.

Commercial banks may ultimately benefit as Vneshtorgbank challenges Sberbank, argues Richard Hainsworth, banking analyst at Renaissance Capital in Moscow and president of the ratings agency RusRating. “The biggest problem for commercial banks is the anticompetitive policy of Sberbank, which hoards all the liquidity in the market,” he says. “Vneshtorgbank will help the private sector if it weakens Sberbank.”

The competitive threat posed by Vneshtorgbank, as well as growing inroads by foreign banks, could accelerate a much-needed consolidation of Russia’s sprawling and inefficient banking sector, something the EBRD and the World Bank have been advocating for years. Last year Rosbank, Russia’s sixth-largest bank, absorbed Pervoye OVK, the rump of the once-mighty SBS-Agro, and No. 12 UralSib Banking Group bought No. 20 Avtobank-Nikoil.

Russia still has some 1,300 banks, but the vast majority are thinly capitalized or tied to the interests of their owners. The leading commercial banks started out as in-house financing arms for particular oligarchs -- Alfa is owned by Fridman, MDM by Andrei Melnichenko and Sergei Popov, whose industrial interests are concentrated in coal and power, and Rosbank by Norilsk Nickel magnate Vladimir Potanin -- or for local government chieftains such as Luzhkov. Russians still remember the 1998 financial crisis, when most private banks abandoned their depositors. That distrust explains why the central bank’s seizure of tiny Sodbiznesbank last May over criminal allegations triggered a brief banking panic that led to the collapse of Guta and culminated in a two-day run on deposits at Alfa.

“The client base is fragmented in Russia, because every sizable client has wanted to have its own bank,” says Vladimir Tikhomirov, chief economist at UralSib, one of whose biggest shareholders is Vagit Alekperov, CEO of oil giant Lukoil. “More people are realizing since the crisis that their space for operation is quite limited, so I think you will see a push to consolidate.”

Expansion by foreign banks is also pressing Russia’s commercial banks to get bigger or sell out, says Alfa Bank’s Orlova. Last summer BNP Paribas paid about $270 million to buy a 45 percent stake in Russky Standart, which pioneered the consumer credit boom over the past two years, while GE Consumer Finance paid an estimated $100 million for DeltaBank, one of the leading Visa card issuers. Citibank, which opened in Russia in the early 1990s, has grown into the country’s 13th-largest bank by assets and the fifth most profitable, posting a sevenfold increase in operating profit in the third quarter of 2004 to 3.3 billion rubles ($118 million), compared with 480 million rubles in the second quarter, according to Expert. Raiffeisenbank, No. 11 in Russia by assets, more than doubled its profitability in the quarter, to 1.9 billion rubles.

“Private banks are in a very squeezed market right now,” notes Orlova. “It’s difficult to see how we can match the risk profile of state banks, on the one hand, and foreign banks like Raiffeisen and Citigroup on the other.”

WHEN YELTSIN ESTABLISHED VNESHTORGBANK, he wanted to create a rival to the hard-currency monopoly then enjoyed by Vnesheconombank, the country’s foreign trade lender, as part of his power struggle with the then Soviet leader Mikhail Gorbachev. When the collapse of the Soviet Union ended that struggle a year later, Vneshtorgbank settled into a quiet niche, providing trade finance to a handful of state companies.

After Putin’s election as president in 2000, the bank began to attract the attention of multilateral agencies, which saw it as a vehicle for building a private counterweight to Sberbank with Western strategic investors. The EBRD’s and the World Bank’s interest soon found an echo inside Russia with new leadership at the central bank, headed by chairman Sergei Ignatiev and his influential deputy, Andrei Kozlov.

After joining the central bank in April 2002, Kozlov held a joint seminar with the World Bank, which was attended by representatives of the International Monetary Fund and the U.S. Treasury, to discuss a World Bank report recommending that Russia privatize Sberbank to jump-start a financial system still traumatized by the 1998 crisis. Kozlov told the foreign visitors that privatizing the vast bulk of Russian savings was too radical a step, recalls RusRating’s Hainsworth, who participated in the colloquium. Instead, the central bank decided to promote Vneshtorgbank as a competitor.

Kozlov’s first step was to recruit Kostin, then head of Vnesheconombank, to take over at Vneshtorgbank. The second was to transfer formal ownership of Vneshtorgbank from the central bank to Russia’s Finance Ministry, which started talks with the EBRD and the IFC on Vneshtorgbank’s privatization. The plan, modeled on the transformation of former Socialist banking champions across Eastern Europe during the ‘90s, enjoyed the support of Putin’s reform-minded prime minister, Mikhail Kasyanov.

At the time, Kostin was a close associate of Kasyanov, who served as Finance minister before taking the premier’s post in 2000. The two men had teamed up to negotiate a rescheduling of $32 billion that Russia owed to private bank creditors. That agreement, reached in 2000, paved the way for the resurrection of Russia’s international creditworthiness.

Kostin’s reputation is that of a cautious and pragmatic bureaucratic survivor rather than a dynamic reformer, however. As Kasyanov’s political star faded in the run-up to Putin’s 2004 reelection, Kostin quickly adjusted to the Kremlin’s new statist line. By June 2003, when the IFC approved a $200 million loan to Vneshtorgbank, intending to swap it into equity at a future date, Kostin had cooled on the proposed deal. He never accepted the loan. Negotiations between the EBRD and the Finance Ministry have also stalled under Kasyanov’s successor, Fradkov.

“The new government has signaled that it needs more time to think through what it wants to do with Vneshtorgbank and the banking sector as a whole,” says the IFC’s Telma diplomatically.

The EBRD and the Finance Ministry are still ostensibly haggling over price. The London-based bank is sticking to its original 2002 offer of $300 million for a 20 percent stake, Akinshin says. Vneshtorgbank and the government think the stake is worth at least twice that by now. By comparison, Sberbank, with five times the assets but slower growth prospects, has a market capitalization of roughly $9 billion, based on the 14 percent stake of the bank that trades publicly.

Akinshin insists that Vneshtorgbank is still headed for some sort of privatization eventually, but he appears to rule out any revival of the EBRD-IFC plan. “We’ve gotten to the point where we don’t need an intermediary,” he says. “Any real investor can come to us directly.” He cites International Moscow Bank, which is 68 percent owned by Germany’s HVB Group and Scandinavia’s Nordea Bank, as a possible model but acknowledges that the government is committed to retaining a majority stake in Vneshtorgbank “for now.”

Industry speculation has focused on Deutsche Bank and Italy’s Mediobanca as leading candidates to invest in Vneshtorgbank. German newspapers reported late last year that Deutsche would soon take a stake. Deutsche Bank declines to comment, but Mediobanca is more forthcoming. “We have had much cooperation and good relations with Vneshtorgbank,” a spokeswoman says. “We don’t exclude investing in the future.”

KOSTIN’S BACKGROUND PREPARED HIM TO RIDE out the power struggles between economic reformers and the siloviki, the shadowy figures from Russia’s security services who have taken increasing control of policy over the past year. He earned a Ph.D. in economics in 1979 from Moscow State University, the Harvard University of the former Soviet Union, and then became a rising star in the Foreign Ministry. He began at the Soviet consulate in Sydney, then returned to the Ministry’s European department in Moscow in 1982. Between 1985 and 1990, he served as deputy administrator at the Soviet embassy in London. There Kostin formed an advantageous friendship with Alexander Lebedev, another young economist serving as an embassy secretary, who went on to head the National Reserve Bank in Moscow. He is Russia’s 25th-richest man, according to Forbes magazine.

In 1992, Kostin and Lebedev formed a brokerage called Russian Investment Co. From 1993 to ’96 they worked together at Bank Imperial and National Reserve, both controlled by Gazprom. That experience brought Kostin into the circle of thenprime minister and Gazprom founder Viktor Chernomyrdin. Kostin joined the political council of Chernomyrdin’s short-lived political party, Our Home is Russia. In 1996 he was picked to head Vnesheconombank by Sergei Dubinin, the central bank chief who later became a director at Gazprom.

Observers describe Kostin as a low-key, thorough manager who gets his way while avoiding publicity and the squabbles endemic to Russia’s power circles. “He’s a bureaucrat of the gentle type,” says Sergei Rutkovsky, research director at Moscow-based bank analyst Rating. “You never see him in the newspapers boasting about what a wonderful dacha or hairdresser he has. You never see him on either side in any scandals.”

Kostin certainly managed his 2002 shift from Vnesheconombank to Vneshtorgbank with quiet efficiency. He and the central bank leadership drew up a plan to split Vnesheconombank’s corporate banking business from its foreign debt functions and merge the corporate business into Vneshtorgbank. That move added some $1 billion in assets to Vneshtorgbank’s balance sheet in the second half of the year.

More important, Kostin brought in a management team in his own image, executives in their 40s who had graduated from top Soviet universities and made technocratic careers in the public and private sectors. The 45-year-old Akinshin, for example, is a graduate of the Moscow Finance Institute and spent the early 1990s at timber exporter Exportles and the semiofficial Russian-German Trade Bank before joining Kostin as head of foreign currency operations at Vnesheconombank.

Kostin’s team quickly transformed Vneshtorgbank from a stodgy, narrowly based lender (nearly half its assets were loans to Gazprom) into a dynamic and diversified bank. Loans expanded by 55 percent in 2003 and a further 25 percent in the first half of 2004, outpacing increases of 44 and 18 percent for the overall banking sector. Kostin shifted exposure away from oil and gas, where competition from international banks had beaten down margins, to Russia’s booming construction and consumer sectors. Vneshtorgbank made just 12 percent of its loans to the energy sector in the first half of last year.

Building the consumer business was Kostin’s next priority. Vneshtorgbank nearly doubled its Moscow branch network, to 45, in the first half of last year and tried to jump-start its mortgage business with a team poached from Delta Credit, a Moscow boutique founded by the U.S. governmentbacked U.S. Russia Investment Fund. (Delta’s sister organization, DeltaBank, was bought by GE Consumer Finance in August for its Visa card business.)

Last year Kostin stepped up the pace of growth with acquisitions, beginning with Guta Bank. “For a fairly symbolic price, we picked up a good bank,” Kostin explained at a rare press conference following that deal last July. Analysts believe Vneshtorgbank has had to inject large sums to cover Guta’s liabilities, though.

Kostin still has to show that he can manage growth and turn his bank into a genuine national champion able to compete with the strongest commercial rivals. Some analysts and competitors question his capacity to do so.

Analyst Hainsworth notes that Vneshtorgbank has written few mortgages since the Delta Credit team arrived in late 2003, ceding early leadership in the field to Raiffeisenbank. “The problem with Vneshtorgbank isn’t the top management,” he says. “It’s the middle management that can’t implement top management’s big initiatives.”

Rutkovsky of Rating pours cold water on another of Kostin’s projects: a plan to offer $1 billion in credit to small and midsize businesses, which Kostin announced in January 2004 after one of his periodic meetings with Putin. “A state monster like Vneshtorgbank doesn’t have the flexibility or the culture to give credit to small business in this country,” he says. “They live in parallel universes.”

Vneshtorgbank’s costs, which grew 27 percent year-on-year in the first half of 2004 after a 49 percent jump in 2003, also could be cause for concern. (In a terse statement the bank attributed the increase to “growing staff costs and intensification of its activities.”)

Notwithstanding the doubters, Vneshtorgbank has gained plenty of momentum. The government and the central bank plainly want its role to grow, and grow fast, and Kostin has demonstrated the acumen to lead the bank in a commercial fashion. By contrast, the willingness of his oligarch rivals -- immersed in other high-margin businesses ranging from commodities to cell phones -- to defend their banking franchises is in question. Speculation is rife that some of Russia’s commercial banks will sell out to foreign institutions like UniCredito Italiano or Citigroup.

All of which leaves Kostin in an enviable position, as even a senior executive at one leading private sector bank acknowledges. “My niece graduated from university this spring and asked me where she should go to work,” he relates. “I told her Vneshtorgbank.”