The Russian central bank's efforts to clean up its banking sector may pose a risk to the solvency of smaller lenders in the country as investors and depositors increasingly seek safety in larger institutions, according to credit analysts and economists, who said there is no certainty what the regulator will do if these smaller banks run into trouble.

Over the last three years, the central bank has revoked the licenses of many smaller lenders due to asset-quality and solvency issues, including four each in July and August. The regulator also decided that from Oct. 1, all new bonds issued by lower-rated or unrated credit institutions will not be eligible for repurchasing agreements (or repo transactions), and it is further barring such lenders from taking deposits from state-backed institutions and private equity funds.

These actions have raised concerns about further closures of banks that are in a relatively weak financial position. Smaller private lenders, especially, are at risk now that a growing number of depositors are pulling their money and moving it to larger, more stable institutions, Fitch Ratings said in an Aug. 18 report. This "flight to quality" means those banks may have to raise deposit rates to keep their customers, according to the agency, which also noted that demand for repo funding rose by 300 billion Russian rubles in July and by another 280 billion rubles in the first half of August, indicating the increased pressure on the liquidity of some banks.

'Atmosphere of mistrust'

"The latest events highlight the vulnerability caused by having a very fragmented banking sector, and one in which some banks have expanded very rapidly," William Jackson, senior emerging market economist at Capital Economics, said in an email. "It seems reasonable to think that, as banks get shut down, depositors at smaller banks may be concerned, regardless of the health of the bank itself."

The revocation of mid-sized lender PJSC BANK JUGRA's license in late July caused more volatility in Russia's banking sector than other recent bank closures, as the central bank's swift action worried market participants, especially in the private banks sector but even among the largest lenders, according to Yuriy Kravchenko, head of banking and money markets research at Russian fixed-income investment company Veles Capital. As a result, a wave of customers — both private and corporate — are expected to switch to state-owned banks, while an "atmosphere of mistrust" is anticipated on the interbank market, where the central bank has become the main financing source for many lenders, he said in an email.

Decided in less than a month, the closure of JUGRA — Russia's 29th biggest bank by total assets — triggered depositor panic over the solvency position of four larger privately held local lenders: B&N Bank, PAO Credit Bank of Moscow, PAO Promsvyazbank and Otkritie Financial Corp. Bank.

Otkritie — Russia's largest private lender by assets — was hit hardest, as clients were already worried about its health after S&P Ratings downgraded the bank's long-term counterparty credit rating to B+ from BB- in May. A crash in its ATM network in early August made depositors even more nervous, and Moody's subsequently placed some Otkritie ratings on review, citing increased volatility and large outflow of customer deposits. However, the agency noted that the lender would likely get central-bank backing if it runs into trouble as it is one of 10 systemically important banks.

In June and July, Otkritie lost a total of 736 billion rubles in client funds and interbank funding, resulting in a 17% drop in total liabilities, Russian rating agency ACRA said Aug. 21. It placed Otkritie's rating "under revision: negative," citing fund outflows and Otkritie's "increasing dependence on refinancing transactions with the Bank of Russia" as the main factors that could lead to "a significant deterioration" in its liquidity position.

Two lenders less affected

The JUGRA knock-on effect on the other three banks considered at risk varied. B&N Bank — Russia's 12th in Russia by assets — lost around 2% of its liabilities (or 20 billion rubles) in July after losing 50 billion rubles in June, according to Fitch. Shareholder Safmar Group is reportedly considering a capital boost of some 15 billion rubles for the lender.

While Promsvyazbank maintained a stable level of outflows throughout June and July, Credit Bank of Moscow seems to have benefited from the recent deposit shift since its loans and funding volumes grew by some 250 billion rubles in July, Fitch said, adding that this suggests that some of the repo transactions previously handled by Otkritie may have moved to the lender.

The funding and liquidity profiles of both Promsvyazbank and Credit Bank of Moscow remain stable, and both banks maintain comfortable buffer of liquid assets in form of cash and repo-eligible securities, Lev Dorf, a Moscow-based credit analyst at Moody's said in an email. Promsvyazbank's customer base has been relatively stable since the beginning of the year, while Credit Bank of Moscow customer deposits have steadily grown, increasing by around 30% since 2016-end, he added.