News Column

Retail Banking has Completely Changed

July 28, 2014

MOSCOW, July 28, 2014 /PRNewswire/ --

A member of the board of directors of TRUST Bank, Nikolai Fetisov, has told Russian financial magazine EXPERT that the lending market in Russia is beginning to stabilise following a period of deterioration which saw a peak in customers defaulting between Q4 2013-Q1 2014.

However, as a result, banks have had to "tighten their lending policies" which has meant that an increased number of customers in Russia have been turned away or granted less than expected when applying for a loan.

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Fetisov believes the demand for loans did not decrease, but banks have had to become more astute about who they lend to. Therefore, although the market may be returning to normality, TRUST has had to tighten its "risk policy" over the last year. This means that banks in Russia now have to carefully select new customers as a result.

But this does not signal bad news for existing customers according to Fetisov. Instead, TRUST is now rewarding "loyal customers" with better credit and interest rates.

Fetisov believes that retail banking is "completely different now". Whereas before a bank would issue anyone with a credit card, now the mind-set for growth has changed and banks like TRUST are working to help existing customers, particularly when caught in difficult or financially tight situations, with an improved product range.

Furthermore, TRUST is opening up to 150 regional offices and building on its successful remote banking network to improve its service.

Fetisov considers it vital that TRUST continues to increase its brand, exemplified by the advertising campaign with Bruce Willis. According to Fetisov, "People do separate trustworthy banks, usually larger banks with high brand awareness, from those they are suspicious of."

But Fetisov does not believe the banking industry should place hope in mortgage loans due to a slowdown in retail lending. He stated that TRUST had "no plans in the near future to develop mortgage lending as its main product" as it was simply not profitable enough. There was also an issue of debt collection placed with mortgages.

For the full interview, see below:

Interview With Nikolai Fetisov

Nikolai Fetisov, a member of Trust Bank's board of directors, says: "The demand for loans has not decreased, yet it is important to realize how much worse the quality of this demand has become."

Retail banking in its previous form, i.e. based on extensive advanced development, no longer exists. TRUST Bank is certain that the current reality of the banking business is much more focused on carefully selecting new customers and keeping existing ones.

In 2009, TRUST Bank revised their strategy and defined the retail sector as their priority. It was the right decision to make since, unlike corporate lending which had lost all its former attraction, consumer lending had, in the years leading up to 2009, become the market's main driving force. In that period of time, TRUST Bank managed to replace corporate funding with retail deposits, as well as attract several million private customers, and with the support of Bruce Willis, to firmly consolidate its position in the top twenty largest retail banks.

The retail re-birth was short-lived. In 2012, the Bank of Russia began to slow down the speeding market after its annual growth had reached 40%, and last year, Russian bankers were faced with increasing arrears. The current agenda is now defined by modesty and cost effectiveness. Some players optimize their sales network and reduce their staff. Despite all this, TRUST Bank has no intention of abandoning their consumer lending services, claiming that the reserve growth in the market is still there. Earlier this year, the bank increased its capitalization through an additional issue of shares. Nikolai Fetisov told Russian business magazine EXPERT about how to build a business in a new environment, where to look for the ideal customer and why it is still not worth even dreaming about a rapid development of mortgage lending.

- Retail Banking has seen better days. The main problems are actually quite obvious: lending is slowing down and arrears are increasing. How is TRUST Bank doing under these circumstances? What are the major trends that you can see in the market?

- In my opinion, there isn't really any unnatural slowdown in lending. It is developing rather steadily given the fact that our bank, as well as, I believe, our main competitors, have been gradually tightening credit policies. There are more customers facing rejection or getting less than they expected.

One of the main trends is the [widely talked about] increase of falling into arrears in the overall market. In principle, the situation is determined by the same macro parameters for everybody. When banks have millions, or even tens of millions of loans in their portfolios, the behaviour of these portfolios is a reflection of what is happening with these tens of millions of borrowers. When the economy stagnates or when a crisis occurs, and the income of the population starts falling, the number of defaults in the overall market does, of course, grow. Yet, in our opinion, the peak of falling into default is now over. In terms of various loan portfolios (whether it is credit cards, cash loans or POS-loans) the peak was in the fourth quarter of 2013 and in the first quarter of 2014. We saw the situation deteriorate, and now it is stabilizing.

- You are saying that the peak of falling into default is now over and that the situation has stabilized? Statistically, it is clear, but what does that mean in terms of specific customer behaviour?

- Let's say you gave out a thousand loans and assume that the default on this portfolio within three to five years will come to 120 loans. Their distribution in time will be very uneven. Approximately half of them (that is 60 loans) will be in arrears in the first year, half of the remaining 30 loans in the second year, and half of the rest in the third year. Very few loans will turn out to be non-performing loans in the fourth and fifth years, when customers will have been paying for three years and would default only in the event of drastic changes in their lives such as losing a job or losing business. Careless customers are those who borrow a lot, or want to take advantage of the bank, or are just looking for a beautiful life by means of loans without weighing their desires against real possibilities. These people drop out immediately, in the first year. This is what the normal behaviour of a portfolio looks like.

This, however, is not the case when the economy starts to experience a crisis, adverse events, or stagnation. Banks can see that borrowers in the second, third or even fourth year of portfolio suddenly begin to delay their payments, just like new untested clients. TRUST Bank, as well as the entire banking industry, has been witnessing this abnormal behaviour of portfolios over the last 12-18 months. The dynamics of falling into default are now returning to its normal level. Why this is happening is a separate issue. Maybe point-based improvements are occurring in the economy, or perhaps the reason is that for the last 12-18 months, banks have been tightening their lending rules, selecting their borrowers more rigorously and reducing limits on granted loans, meaning that portfolios are now formed as a result of better and more financially secure customers. TRUST Bank, for example, has been tightening its risk policy for most of the last year, particularly in the POS and express loans sections, therefore even early stage defaults are now decreasing. We believe that this trend will continue throughout the year 2014.

- Perhaps customers are gradually getting used to lower incomes? Once recovered from the first state of shock, they continue to pay back their loans.

- Of course, default doesn't always mean being in arrears. One can have the same market level of default but completely different losses. Anyone caught in a difficult or financially tight situation in life can find themselves in arrears, but ultimately, after restructuring, the client begins to pay and settles their debt. Also, a lot depends on the performance quality of banks' collection service and of collection agencies, as well as on the legal system and on the type of customers who initially formed the portfolio.

Now we can see how a certain negative social attitude is born: people get used to living with repayment debts and running away from collectors or bailiffs. You should add all the complexities of our legal system where recovery is a long and expensive process. Besides, the population's shadow income is growing faster and faster, and it cannot be called upon at collection. All these multiple factors eventually determine, for each bank, the percentage of losses in their loan portfolio.

Dangerous Managers

- Has anything changed in terms of the demand for loans?

- I don't think demand has decreased. In any case, we have not seen a fall in (the incoming flow of) requests. There was even a certain burst this year after the May holidays which generally isn't very typical, since the summer months are usually rather quiet in terms of demand.

It is important, however, to realize how much worse the quality of this demand is these days. Is it the second loan the customer comes to apply for, or his third, or fourth? Is he going to use it in order to pay back other loans, taken out at a higher rate?

- TRUST Bank has always had a fairly relaxed attitude towards the problem of debt load, which was discussed a lot and quite intensely last year. You claimed that household debt load was a local (in terms of a particular region or social group) problem and that although many customers were repaying three or four loans at the same time, these loans were small and did not cause them any problems. Is this picture any different today?

- The situation is constantly changing, because the credit history agencies' databases are accumulating more and more information, which allows you to better predict customers' behaviour and their propensity to debt load. One of the main reasons for the borrowers' default is not job loss but the debt load of certain groups of borrowers, when people take out three to five, or even seven loans (in conjunction with a high debt load). But if we are talking about what you cannot lend to people that already have six loans "hanging over them", we need to be careful in terms of defining them. The customer can have three or four bank cards with a credit limit that they once applied for "just in case", but we realize that they practically never uses these credit products. These cards will still be considered as three or four existing loans. It is quite different from when someone takes out a loan for half a million rubles at a high rate.

- And is there a reserve growth on account of "fresh" clients? According to the National Credit History Agency, an increasing number of economically active citizens are involved in credit relationships with banks.

- The number of new borrowers is decreasing. Eight or nine in ten people who come to the bank are already customers of other credit institutions, and only one or two in ten are people who have never taken out a loan or, they might have a credit or debit card in their name, but they haven't used it in a really long time. They are the best possible audience in terms of credit quality. The best customer, for a banker, is the one who refuses a loan. And these people have been saying no to loans for a very long time, for the ten or twelve years of the active development of retail banking. There is an influx of such customers, but we must understand that some of them will never use any loans or even payment products.

- Does this mean that the previous model of retail development, based on extensive expansion when it was not so important what type of customer came to the bank as long as it was a new customer, has had its day?

- Yes, I think retail banking is completely different now. It's not the way it was three or four years ago when bankers competed in area coverage. The logic was to open more branches, more call centres, to do more advertising, to send everybody letters, to call everybody, to put up a tent in the street and issue everyone with a credit card. However, of course, even at the time of the most extensive development, no bank would try to give out a loan to a bad customer, but this is exactly how the main growth was being formed, through untapped clientele.

Clients would often start off with very expensive POS-loans for small amounts and short terms. Nowadays, bankers need to learn to split their customers into groups and make attractive reduced rate offers to good ones while the bad ones would get offers which are most profitable for the bank itself or get no offers at all. In the ten years that we have been working in retail banking, TRUST bank has formed a broad customer base, customers that have left and then returned, constant borrowers, regular customers with current accounts and also a lot of deposit account customers. That's nearly 200,000 people in total. Our task in the retail sector now is to make clear distinctions and to work carefully and neatly with this clientele, and to come up with the most attractive sets of offers so that they won't leave us for anyone else.

- Can you give us an example? What specifically is the action plan in order "to work with clients carefully and neatly"?

- First of all, it is of course about reducing their rates. We have, for example, some products with a higher initial rate, and when the client begins to pay and we can see that they are reliable, the rate drops to the levels at which state-owned banks lend to their most preferential customers. Plus, our most loyal customers receive regular discounts and special offers like, for example, cards with a cashback option, which you can use to pay in retail chains and get refunds directly paid into your account. For existing customers, we have slightly higher interest rates on deposits. The idea is to increase the loyalty of our customers so that they get the best credit, deposit, fees and other proposals in the market, and so that the bank keeps a reasonable profitability.

- How has your approval percentage changed in the last year?

- There was a noticeable decline in the second half of 2013, by a quarter or even by a third. Currently, we can see an increase in percentage of approval, due to the improvement of the incoming flow, to a more careful selection of marketing activities and to the right, non-random audience.

Another important indicator is the percentage of adoption (how many of the approved bank customers ultimately accepted our offer). Let's say a client comes into the store, applies for ? trade credit in five banks, receives approval everywhere, but only takes the money from one. Percentage of adoption largely depends on the bank and on the quality of service: how efficient people in bank branches are, how many times the client is contacted by phone, how good the explanation given to him was, how careful the bank staff were about not being too pushy and offering him related products and the like. Our adoption on cash loans comes to approximately 70 percent. This means that there is a good reserve giving you a possibility and space for growth.

- Let us go back to the subject of extensive development. TRUST Bank, as well as many other retail players, has been actively working on the regional network. Are you now planning to reduce that, as some market participants do, for example, faced with losses and with a decline in profitability?

- We are pleased with what we have. In 2014, we are opening between 100 and 150 offices in new locations, all of which are small towns. The offices will be small (20 - 30 square meters) and simple with low maintenance costs. As for the rest of our network, it is already sufficiently broad, and we are not planning to expand. On the whole, we have more confidence in remote banking services, as it is cheaper than maintaining bank branches with a large staff. In addition, the main increase in the last year or two was due to our remote work.

- There's a lot of buzz around all these scoring models lately and I wonder just how reliable a tool they are? For example, a client comes to you, perfect in all respects, but he might have big problems at work (late salary payments, the company on the verge of bankruptcy, etc.) Can scoring reveal that?

- Indirectly, yes. Generally, some of the most high-risk customers in Russia are the ones who write "manager" or "deputy head of medium-sized enterprise" on the application form. And some of the most reliable ones are blue-collar workers. There are, in fact, many paradoxes, and all this is taken into account: profession, name of the company and education. Of course, no model can predict the sudden bankruptcy of a small business where you work, but you can make some trend predictions for certain types of companies and professions.

There is a lot of information upon which the scoring models are being built. Banks try to understand, for example, whether someone is a good or a bad customer if his payments were in arrears in one bank two years ago. Or, for example, the customer continually falls into default within a couple of days, but then always settles all their payments. So which one of these customers is worse? Each bank decides for itself what should be accepted out of the accumulated information and to what extent.

The number of new borrowers is decreasing. Eight or nine in ten people who come to the bank are customers of other credit institutions.

Mortgage lending is still far away

- You have been cutting down your corporate loan portfolio, yet last year it showed even higher growth rates than retail. And generally, corporate lending has been showing unusually high growth recently due to the closure of foreign markets. Are you planning to use this in any way?

- Last year's growth of the portfolio is associated with the projects that we have been crediting since 2008 or 2009. We have a relatively narrow range of clients to whom we give out these types of loans. There are several large-scale development projects that need to be taken to the exit stage. For example, wood processing projects in the Krasnoyarsk region and retail financing projects. It does bring in revenues to our bank, but in general, 60 to 70 percent of our business, both for portfolios and for funding, is retail banking. Therefore we are not going to change anything in order to change this ratio in favour of corporate clients.

- Today, with slowing retail lending, mortgage loans represent certain hopes for the banking industry. It is, in every sense, a useful sector both for borrowers who receive a more uniformed credit load and for the economy. Do you have any specific plans for mortgage lending?

- TRUST Bank has no plans in the near future to develop mortgage lending as the main product. If we do not take into account state-owned banks and foreign banks, the cost of raising money in retail banks such as TRUST exceeds 10 percent per annum. If you add the operating costs, it will be even higher. Even the state-owned banks are now offering loans at 13 percent, so what kind of mortgage is that? I think that most of the mortgages in the last few years have been loans taken out before the sale of previously owned properties. You would take out a mortgage before selling an old apartment. It's very rare now to take out a mortgage and be ready to repay the loan for the next 20 years.

In a normal economy, mortgage lending is a key factor in the economy's long-term financial leverage. A property represents a whole story of consumption, from refurbishing and repair works and furniture to household appliances. Russia took a different path. We have this leverage created through POS-loans or credit cards.

Mortgage lending at 13 percent is not profitable to any of the commercial banks which are not government-subsidized. For many people it is too overwhelming, for banks it is simply not interesting or profitable enough. In addition, we have big problems in terms of debt collection. The opinion that mortgage lending is secured by an unconditional pledge is a big illusion. There are plenty of legal ways to make sure that a flat or a house used as the collateral for a mortgage can be left to the owner who has fallen into default for a long indefinite period of time.

- Can securitization change anything here?

- Securitization mechanisms suggest that a source of funding at three percent should appear from somewhere. The only source of this kind possible is the Central Bank, given that our current money supply has a purely state character, and relations with the western market is not developing in the best way. Before 2008, we had quite a lot of money and all the banks were using Eurobonds, securitization, various trade lines, now it is still a very limited market, also coupled with significant currency risk. According to our estimates, there is, in general, zero demand for foreign currency loans in Russia, so it's a very weird question whether you can fund, for example, a mortgage portfolio through securitization in other currencies. As for the domestic market, our benchmark is banks' rate on deposits, corporate federal loan bonds, as well as first tier bonds. No one will place funds in assets any cheaper.

Everyone believes DIA

- Are there ways to radically reduce the cost of funding?

- It probably will not happen without any radical structural changes in the economy. It is impossible to describe a structure of money supply with a mortgage rate of four percent in the economy prevailing in Russia at the moment.

- Especially considering that the Central Bank can't see any reason to reduce the base rate. By the way, how is it reflected in rates for end borrowers? We are still talking about weekly repurchase agreements, whilst loans are issued for a longer period of time.

- Weekly repo is mainly used for the purchase of government securities. If the repo is expensive, banks hold state securities, and so the latter naturally grows in profitability. If the state securities are, relatively speaking, eight percent per annum, the corporate securities will be worth eight and a half percent due to higher risk. Corporate bonds are benchmarks for corporate loans. If you can buy a "Gazprom" security for the conditional eight percent per annum, nobody is likely to issue a loan to some developer at the same rate of eight percent, and so on, following the chain up to other assets. Deposits for private individuals and legal entities come next. Have a look at the average interest rate on deposits and you'll see that it has been increasing lately.

- And if we are talking about the cost of credit for the final retail borrower, perhaps there is scope for margin compression?

- If such a margin exists at all. But I have not noticed any banks reporting any incredible profits in the last few months. At TRUST Bank, we are closely watching the value of our resources and we do not make the decision to decrease the margin if the cost of funding increases. We actually do a bit of re-mortgaging. But we must understand that the main factor in determining the final rate on the loan, especially for the "physicists", is the risk component. You can make a mistake and put in the minimal rate funding. A far worse mistake, however, in risk assessment is, for example, to issue loans at very high rates and by doing so attract the worst customers. There is a concept of negative selection when the worst borrowers respond to the highest rates. Here is a simple conditional example: you can have an advertisement saying 'Outstanding loans under 70 percent.' And who will come to you? Probably those who will fall into default with a probability of 90 percent.

- How negative is the impact that permanently lasting clean-up has on the banking sector? To some extent, it is the reason why bankers were faced with a record slowdown in the liabilities base?

- TRUST Bank has had a reasonable liabilities inflow since the beginning of this year, with an average growth of approximately one percent per month. As for the clean-up, I think people do already separate trustworthy banks (usually larger banks with high brand awareness) from those they are suspicious of. According to our evaluations, customers consider that TRUST Bank belongs to the first type. Medium and small banks are having a harder time. In addition to that, the population has now started to believe in the deposit insurance system. That's without taking into account individual, totally wild cases when deposits were somehow not recognized in the financial statements. This is, incidentally, a very strange thing because the Central Bank and the DIA have access to every single bank and can check it all. But, anyway, the situation in the market has now settled. Take the Master-Bank case for example, that caused panic in the industry that lasted two weeks. This kind of thing hasn't happened recently, not even when the Mosoblbank licence was withdrawn and it later transpired that huge sums of money had been taken past the cashier.

There is, of course, the trend of large (above the insured amount) deposit outflow. Whereas only a year ago we had about 40 percent of deposits above 700 thousand rubles, now we only have 24 percent. But this money has not completely left the system. People crush their deposits, place smaller amounts into different banks, or in one bank, in their own and their relatives' accounts. Besides, this outflow is stable now.

- Do you have enough deposits growth to cover the loan portfolio?

- We also have on-demand deposit accounts for private individuals as well as legal entities' accounts. There was a certain volatility here too, but we've still reached a ten percent increase since the beginning of the year. Plus, there was no phenomenal growth in loan portfolios. One of the fundamental tasks of any bank is to monitor liquidity positions and maintain a liquidity cushion, and so far there hasn't been any complication. In general, I have not heard of any sudden slowdowns in the market because of a portfolio funding failure.

- Since the beginning of last year, the Central Bank has increased the amounts of refinancing support to the banking sector. They even employed the good old-fashioned lending system, secured by non-marketable assets. Do you use this?

- Sometimes we use repo regulator secured by FLO (Federal Loan Obligations). It's quite a clear and comprehensive mechanism used to provide liquidity. We do not invest in other assets and have no intention to pledge the Central Bank with anything else.

Of course, from the point of view of the banking system as a whole, and taking into account the current level of interest rates on retail deposits, clearer refinancing mechanisms for normal market assets, Central Bank's cheaper money can only be welcomed.

Contact: Elizaveta Dikusar Press-officer +7-(499)-647-90-21, Ext: 6207 e-mail: Lia Ebanoidze Press-officer +7-(499)-647-90-21, Ext: 6763 e-mail:



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