Banking and Credit Organizations in the Russian Market

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1 20. Banking 20.1 Introduction As of 1 February 2016 there were 676 banks registered in Russia. The Central Bank of the Russian Federation (the Bank of Russia ) is the key regulatory authority for banking and is also in charge of monetary policy. The primary pieces of banking legislation are the Civil Code of the Russian Federation, Federal Law No On Banks and Banking Activities, dated 2 December 1990, Federal Law No. 86-FZ On the Central Bank of the Russian Federation, dated 10 July 2002; Federal Law No. 177-FZ On the Insurance of Deposits of Individuals in the Banks of the Russian Federation, dated 23 December 2003, Federal Law No. 353-FZ On Consumer Credits (Loans), dated 21 December 2013 and Federal Law No. 115-FZ On Combating Money Laundering and the Financing of Terrorism, dated 7 August Banking and Banking Operations Banking and Credit Organizations in the Russian Market Pursuant to Federal Law No On Banks and Banking Activities, dated 2 December 1990 (the Banking Law ) there are two main types of credit organizations: banks and non-banking credit organizations. A bank is a credit organization that has the right to carry out such banking operations as opening and maintaining the bank accounts of legal entities and individuals, attracting deposits from legal entities and individuals and placement of those funds in its own name and at its own cost and expense. Conversely, a non-banking credit organization is an entity that is allowed to perform a limited number of specified banking operations as set forth in its license. Both banks and non-banking credit organizations are entitled to carry out banking operations from the moment of receipt of a banking license issued by the Bank of Russia. Both types of credit organizations may participate in banking groups (when the controlling 306 Baker & McKenzie

2 Doing Business in Russia company is a credit organization) and banking holdings (when the controlling company is a non-credit organization) Foreign Participation in the Banking sector Although foreign banks may not currently open branch offices in the Russian Federation, a local subsidiary or a representative office may be established. Foreign direct ownership A foreign bank may establish a subsidiary in Russia in the form of a Russian legal entity (joint-stock company or limited liability company) (see Section 4.2). The total share of foreign investment in the charter capital of all banks in the Russian banking system may not exceed 50%. If this limit is reached, the Bank of Russia is entitled to refuse to issue banking licenses to Russian banks with foreign investments. Also the Bank of Russia may restrict the increase of the charter capital by non-residents and distributions of shares (participatory interests) to non-residents if this limit would be exceeded as a result. The participation of foreign banks in the Russian market is subject to certain restrictions. In particular, non-residents need the Bank of Russia s prior approval if they acquire 10% or more of the shares in a Russian bank or non-banking credit organization. When a nonresident acquires more than 1% but less than 10%, the Bank of Russia need only be notified. This is similar to the regulation that applies to Russian residents. Also, the Bank of Russia may not establish additional requirements for the subsidiaries of foreign banks related to mandatory ratios and minimal charter capital. However, additional requirements on reporting procedures, approval of management bodies and permitted operations of the representative offices and subsidiaries of foreign banks may still be introduced. Baker & McKenzie 307

3 Representative Offices Representative offices of foreign banks and foreign citizens to be employed there are accredited by the Bank of Russia. A representative office of a foreign bank can be accredited for a term not exceeding three (3) years. Accreditation becomes effective if a representative office of a foreign bank starts operating within six (6) months after the Bank of Russia grants such accreditation. Accreditation can be renewed an unlimited number of times for a term not exceeding three (3) years. The Bank of Russia may grant permission to open a representative office to a foreign bank that meets all the following criteria: (i) the foreign bank has been operating in its country of incorporation for at least five (5) years; and (ii) the foreign bank has a stable financial position. Confirmation of the foreign bank s compliance with the latter criterion should be requested from the relevant supervisory body in the country where the foreign bank is incorporated along with the relevant regulator s consent or confirmation that such consent is not required. Representative offices of foreign banks have limited legal capacity under Russian law. They are allowed to study the economic situation and standing of the Russian banking sector, to maintain and develop contacts with Russian banks, and to develop international cooperation. While the representative office of a foreign bank may not solicit new clients for the bank, it may provide consultancy services to existing clients of the foreign bank. Representative offices of foreign banks are supervised by the Bank of Russia, which may close such a representative office if its activities threaten Russia s sovereignty, political independence, territorial integrity and national interests or are otherwise non-compliant with Russian law, if the banking license of the relevant bank is revoked or if the bank or its clients do not observe anti-money laundering regulations. 308 Baker & McKenzie

4 Doing Business in Russia Banking Activities Under the Banking Law only credit organizations holding the relevant license are allowed to carry out certain activities, which are called banking operations. The list of banking operations includes the following: Attraction of monetary funds for on-demand and term deposits and placement of such funds in the name and at the expense of the relevant credit organizations; Holding deposits and placement of precious metals; Opening and maintaining bank accounts for individuals and legal entities; Collecting money, promissory notes and bills of exchange, payment and settlement documents; Providing cash services to individuals and legal entities; Exchanging foreign currency; Issuing bank guarantees; and Transferring money (including e-money) with or without the opening of bank accounts. Banks and non-banking credit organizations are also entitled to perform certain non-banking operations, inter alia: providing financial suretyship; fiduciary management; performing operations with precious metals and stones; renting out safe deposit boxes; participating in financial leasing operations; and providing consultancy and other informational services. Subject to compliance with the relevant licensing requirements (see Chapter 5) credit organizations may act as professional participants on the securities market. Credit organizations are prohibited from engaging in any industrial, trade, or insurance activities, other than derivatives transactions (see Chapter 5). Baker & McKenzie 309

5 Corporate Lending One of the major activities of a credit organization in Russia is lending. While lending to Russian corporate entities, a number of issues should be taken into account. The parties to a transaction with a foreign element (i.e. a foreign counterparty) may generally choose foreign law as the law governing their contractual relationship. Thus, if financing is provided to a Russian company by a foreign bank, the loan agreement is usually governed by foreign law (usually English law and LMA-style agreements are used). The choice of governing law for security documents however is generally determined by where the proposed collateral is situated or created. It is noteworthy that Russian law does not recognize the concept of a trust. Therefore, straightforward use of a security trustee in syndicated secured financing may not work in Russia, where alternative structures are used. Although most of the currency control restrictions were removed in 2007, foreign banks should still take into account some currency control regulations when lending to Russian corporate borrowers, e.g. the necessity of opening a transaction passport, and repatriation of funds from export proceeds. Payments by a Russian borrower to a foreign lender under a loan agreement may, as the payer is a Russian taxpayer, be characterized as Russian source income. In this case the payments by the Russian borrower may be subject to Russian profits withholding tax at the rate of 20%, subject to reduction or elimination pursuant to the terms of an applicable tax treaty. Consumer Lending Lending to individuals is specifically regulated by Federal Law No. 353-FZ On Consumer Credits (Loans), dated 21 December Baker & McKenzie

6 Doing Business in Russia (the Consumer Credit Law ), which became fully effective in July According to the Consumer Credit Law the terms and conditions of consumer credit agreements fall into two categories: general and individual. General terms are drawn up by the lender for mass application and must include the following information: the range of total charges for the credit, for each type of credit program available in the bank; types of security for performance of obligations under a credit agreement; information about agreements the borrower must enter into to obtain a loan. Individual terms are agreed upon by the lender and the borrower and should be separately specified in the credit agreement. Individual terms would usually cover the following: the amount of the credit, the repayment period, the interest rate or method for its determination; liability of the borrower for undue performance; information about the possibility to assign the creditor s rights under the agreement; the total charge for the consumer credit in question. Individual terms may also contain other terms and conditions agreed by the parties. Even though the individual terms are supposed to be agreed by the parties, the Bank of Russia is required to adopt standardized individual terms which the banks will be required to adhere to. In case of any discrepancies between general and individual terms, individual terms prevail. Baker & McKenzie 311

7 The Consumer Credit Law also introduced the regulation of total charge for credit (the TCC ) which would generally include repayment of the loan and payment of accrued interest, other payments in favor of the creditor required by the agreement, payments to third parties (e.g., an insurance company), and some other payments. On the date the parties enter into the credit agreement, the TCC must not exceed the average market TCC, as calculated and published by the Bank of Russia, by more than one third. The average market TCC is calculated and published by the Bank of Russia for different types of credit on a quarterly basis. The Consumer Credit Law generally allows a creditor s rights to be assigned to third parties, including non-banking institutions, unless such assignment is prohibited by law or by the individual terms of the credit agreement. Upon assignment the initial creditor is entitled to transfer personal data of the borrowers and legal entities/persons that provided guarantees or collateral under consumer credit agreements Legal and Regulatory Framework The foundations of the Russian banking system are provided in the Banking Law and Federal Law No. 86-FZ On the Central Bank of the Russian Federation, dated 10 July 2002 (the Bank of Russia Law ). Bank insolvency is regulated by Federal Law No. 127-FZ On Insolvency (Bankruptcy), dated 26 October The Bank of Russia is responsible for regulating banking activities. Through its instructions, regulations, and other acts, the Bank of Russia establishes rules, standards, and obligatory requirements for banks and nonbanking credit organizations throughout the Russian Federation Regulatory Authorities The primary regulatory body governing the banking sector of the Russian Federation is the Bank of Russia. The Bank of Russia is one of the few institutions under the control of the Russian legislative (rather than executive) branch. The State Duma must not only approve the nomination of the chairman of the Bank of Russia, but also 312 Baker & McKenzie

8 Doing Business in Russia approve the resignation of the chairman. The Bank of Russia Law provides for the establishment of a special body within the structure of the Bank of Russia, the National Banking Council (the NBC ), comprised of representatives of various executive and legislative bodies. The NBC exercises control over the Bank of Russia s board of directors, and participates in establishing the basic principles of Russian banking and financial policy. The Bank of Russia and the Government share authority over monetary policy. The Bank of Russia is responsible for circulating monetary funds and ensuring the stability of the Russian ruble. As part of its regulatory role, the Bank of Russia establishes state registration, accounting, reporting and licensing rules for credit organizations, sets minimum reserve requirements for lending operations, mandatory ratios (capital adequacy, liquidity, etc.) and requirements on the amount of charter capital. The Bank of Russia maintains regional offices throughout the Russian Federation Licensing and Banking Supervision A credit organization must be registered in the Russian Federation further to a specific procedure and must be licensed by the Bank of Russia. Newly established banks can receive licenses permitting a limited scope of operations. A bank that has held a license for a period of two years or more is entitled to apply for licenses permitting an extended scope of operations. The Bank of Russia may refuse to issue a banking license in the event of the following: Non-compliance of the application documents with Russian legal requirements; Unsatisfactory financial standing of the founders of the credit organization, or their failure to perform their obligations before the federal budget, the budgets of constituent entities of the Russian Federation or local budgets; Baker & McKenzie 313

9 Failure of a nominee for the position of chief executive officer or chief accountant of the credit organization (or their deputies) to meet the qualification requirements, or an unsatisfactory business reputation of a nominee for the position of a member of the board of directors (supervisory board) of the credit organization. The Bank of Russia has controlling powers over Russian banks: it approves the appointment of the senior management of all credit organizations, holds mandatory reserves placed by credit organizations, and monitors credit organizations compliance with applicable requirements. If a credit organization fails to comply with these requirements, the Bank of Russia is entitled to exercise various sanctions, which range from a warning and fine to suspension of certain banking operations and revocation of its banking license, which triggers the dissolution or bankruptcy of the credit organization. Under certain circumstances banks have to cooperate with the Federal Antimonopoly Service ( FAS ). For example, in case of mergers, banks are required to obtain preliminary clearance from FAS if the purchaser will acquire more than 25% in the charter capital of a bank and at the same time the target bank s assets exceed RUB 29 billion. Where the figure does not exceed the established limit it is sufficient for the lending institutions concerned to notify FAS of the merger Deposit Insurance Federal Law No. 177-FZ On the Insurance of Deposits of Individuals in the Banks of the Russian Federation, dated 23 December 2003 establishes an insurance system for the deposits of individuals. It stipulates that all banks accepting individual deposits must be members of the deposit insurance system. The Agency for Deposit Insurance is responsible for supervising this system. Banks that hold a valid retail banking license need to apply to the Bank of Russia to become registered as a participant in the mandatory deposit insurance system. A bank is expected to pass a number of tests 314 Baker & McKenzie

10 Doing Business in Russia before it can be admitted. The Bank of Russia must be assured that: the bank s financial accounts and reports are accurate; the bank is in full compliance with the Bank of Russia s mandatory ratios; the bank s solvency position is sufficient; and that the Bank of Russia has not cancelled the bank s banking license. If a bank fails the above tests or chooses not to participate in the deposit insurance system, it will not be able to attract deposits from, or open accounts for, individuals. Member banks have to make contributions to a special deposit insurance fund. These contributions are calculated as a percentage of the average daily balance of individual deposits maintained with a particular bank, and are subject to an upper limit of 0.1%. All individual depositors with deposits in member banks are entitled to 100% compensation for aggregate amounts up to RUB 1.4 million for each bank. However, the deposit insurance would not cover e-money deposits Countering Money Laundering Based on recommendations made by the Financial Action Task Force on Money Laundering (the FATF ), the State Duma adopted Federal Law No. 115-FZ On Combating Money Laundering and the Financing of Terrorism, dated 7 August 2001 (the Anti-Money Laundering Law ), which came into force on 1 February The Anti-Money Laundering Law imposes certain requirements on credit organizations, professional participants of securities markets, insurance and leasing companies, postal and other entities that deal with the transmission of money or other valuables. These entities must: Identify clients and beneficiaries pursuant to a specific procedure; Require certain information on payers in payment orders; Report to the Federal Financial Monitoring Service on certain types of transactions of RUB 600,000 or more (or the Baker & McKenzie 315

11 equivalent in foreign currency), and transactions with real property of RUB 3 million or more (or the equivalent in foreign currency) and all complex or unusual transaction schemes that have no apparent economic or lawful purpose irrespective of their amount; Identify foreign public officials and the sources of their money and other property; Pay increased attention to transfers of monetary funds and other property between foreign public officials and their close relatives. The Anti-Money Laundering Law prohibits the creation and maintenance of anonymously held accounts Capitalization and Basel III Implementation Russian banks are required to comply with the capital adequacy requirements set by the Bank of Russia, which has recently approved implementation of Basel III developed by the Basel Committee on Banking Regulations and the Supervision Practices of the Bank for International Settlements. Regulation of the Bank of Russia No. 395-P On Methods for Calculation of the Capital of Credit Organizations, dated 27 February 2013 ( Regulation 395-P ) implemented the rules of Basel III on capital adequacy in Russia. It should be noted that the new capital adequacy rules are tighter than the default rules suggested by the Basel Committee. Under Russian law, the minimum capital adequacy ratio that banks are required to maintain is calculated (on an unconsolidated basis) as the ratio of a bank s owned funds (its capital) to the total amount of its risk-weighted assets. From the beginning of 2012 the minimum capital adequacy ratio required by the Bank of Russia is 10% for banks whose capital is RUB 300 million. If the capital adequacy ratio of a bank 316 Baker & McKenzie

12 Doing Business in Russia drops below 2%, then the Bank of Russia should revoke its banking license. From the beginning of 2012 the minimal capital of newly registered banks must be RUB 300 million. Implementation of Basel III heavily influenced the regulation of subordinated instruments widely used by banks to boost their capital. In order to qualify as a subordinated instrument and be eligible for inclusion into a bank s capital, subordinated instruments should meet the following requirements: the borrower should not be obliged to repay a subordinated loan before the maturity date and the creditor should not be entitled to claim early repayment of the debt; the terms and conditions of the subordinated instrument (including the interest rate) should not differ substantially from the market conditions; the subordinated instrument should expressly provide that it cannot be prepaid, amended or terminated without prior consent of the Bank of Russia; in case of the borrower s bankruptcy the subordinated loan may only be repaid after satisfaction of all other creditors claims; the subordinated loan may not provide for (i) any security directly or indirectly provided by the bank or by third parties if the bank agreed to reimburse them for doing so, (ii) nonmonetary form of settlement (save for a loan made in Federal Loan Bonds) or (iii) a natural person (does not apply to subordinated bonds), subsidiary or affiliated company as a party to the subordinated instrument; and subordinated loans must be provided for at least 5 years and, in certain cases, for at least 50 years or on a perpetual basis. Baker & McKenzie 317

13 The Bank of Russia has prepared Regulation No. 421-P On the Calculation of the Liquidity Coverage Ratio, dated 30 May 2014 (the LCR ) which became effective on 1 July The LCR is aimed at showing a bank s ability to properly perform its monetary and other obligations within 30 calendar days from the moment of calculation of the liquidity coverage ratio in times of economic instability. At first only domestic systemically important banks will be subject to the LCR rules. However, in the course of time the Bank of Russia will subject more Russian banks to the LCR rules. The Bank of Russia adopted Instruction No. 154-I On the Procedure for Assessment of Compensation in Credit Organizations and Rectifying Violations of the Rules on Compensation, dated 17 June 2014, which became effective on 1 January This instruction regulates the remuneration of the management and employees of banks who affect the risk profile of the bank. This regulation provides that at least 40% of such remuneration should be variable and paid taking into account the level of risk management and overall performance of the employee. However, banks are allowed to introduce higher thresholds for the variable part of remuneration for a wider range of employees. Banks should prepare remuneration policies, which should be approved by the Bank of Russia Financial Statements and Reporting Standards Accounting and reporting requirements in Russia are not comparable to those in other (especially Western) jurisdictions. All credit organizations in the Russian Federation must prepare Russian Accounting Standards ( RAS ) statutory accounting reports and, on an annual basis, their financial statements according to IFRS. The Bank of Russia devises reporting forms for credit organizations and works out procedures for preparing reports and filing them. Banks are obliged to submit a very large quantity of information to the Bank of Russia with some of the reports to be filed on a regular basis. The list of information may vary depending on the type of operations carried out by a particular credit organization and the number of 318 Baker & McKenzie

14 Doing Business in Russia licenses it holds. Thus, all credit organizations should disclose information concerning their affiliates, file accounting statements, provide information on analogous claims and loans grouped in portfolios together with information on the quality of the credit organization s assets and information on securities acquired by the credit organization, data on loans and market risks, information on obligatory norms and any deviation therefrom, information on forward transactions etc. If a bank is a joint-stock company and a securities market participant, it must also disclose information at various stages of each securities issue. Such information is disclosed in the form of an offering statement, quarterly securities issuer reports and disclosure of material facts affecting the bank s financial and business activities. Information to be disclosed must be published by one of the authorized services. In addition, a particular issuer may use its own or some other Internet site for such purposes. The rules covering this disclosure are set by the Bank of Russia. Baker & McKenzie 319