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Enabling Banking Business in Russia: the cost effective approach

Gennady Tsepkov

Since the collapse of the Soviet Union, Russia has been constantly moving forward towards a truly market economy, and by now it has gone a long way indeed. Russia today is not like the Russia of old communist days, neither is it the chaotic Russia of the early 90's, nor the post-crisis Russia of 98' - 99', full of uncertainty and ambiguity. Nowadays significant continuing economic growth is considered a norm, financial markets are becoming more and more open, business is becoming more transparent and the government is following the course of structural reform. With the political scene stabilized and credit ratings increasing to investment grade, Russia is beyond doubt becoming one of the most attractive countries for operational expansion. And yet Russia remains a unique country, requiring a special approach.

Why do business in Russia?

Russia is a unique country - unique from a cultural point of view, unique from a historical point of view, unique from a geographical point of view. But it is not this uniqueness that makes it attractive for a foreign bank. For a bank what makes Russia unique is its economic situation and even more importantly its potential. And it is not only its uniqueness that makes it attractive - what makes it really attractive are the growing similarities.

Just recently, Moody's increased the credit rating of the Russian Federation to investment-grade. This opens the path for those categories of western investors, which previously were not authorized to work on the Russian market. On the long term Russia has clearly stated its intention to join the World Trade Organization, which means that the trend towards a higher degree of openness will not be reversed. Even today foreign banks are successfully doing business in Russia - out of the 30 most profitable Russian banks, 8 are under foreign ownership. At the same time there are only 23 foreign banks among the 1300 banks in Russia.

One of the most positive trends is the gradual decreasing of limitations set by the Central Bank of Russia (CBR) on daughter companies of foreign banks. According to new regulations, from last February the minimum capital for any newly created bank is just 5 million euro, be it Russian or foreign owned. It should also be noted that it is the announced intention of CBR to make banking accounting practices in Russia compliant with International Accounting Standards.

There are, however, some remnants of the past. One should not forget that even though much has changed, Russia is only on the road to becoming a true market economy. It will become one some day, but at the moment it is still in a transitional period. And the Russian government, just like any government of a country undergoing substantial structural changes, strives to control as many economic variables as possible. For a commercial bank this has at least one negative consequence: control by the government means reporting, and thus the main goal of banking accounting in Russia is to provide the supervising agency, which is for a Russian bank the Central Bank of the Russian Federation, with a seemingly endless array of constantly changing reports which have to follow the strict formatting guidelines set by CBR.

What difficulties do foreign banks encounter?

Reporting to CBR differs significantly from generally used reporting in western banking systems. There are differences in the guiding principles of report preparation and more importantly in the context of the reports. International standards determine declarative principle of financial reports. These reports are created mostly for external users: investors, clients, owners and state institutions. Other reports - management reports - are made for inside use of the management and internal auditors. Contrary to international reporting, Russian reporting is aimed at satisfying the requirements of just one prime user: CBR. Using the information provided by the banks on regular basis (daily, weekly, monthly, quarterly) the Central Bank supervises the activity of all credit institutions in Russia and controls all their operations. The Central Bank cross-checks the figures, checks their consistency, evaluates the indexes, and checks the legality of the operations. The volume of mandatory reports is huge.

Apart from the problem of reporting, one must bear in mind that the accounting system itself is very strictly regulated and its principles differ significantly from IAS applied on western markets. For example, Russian accounting standards are cash based, not accrual based. The way accounting is to be conducted is defined in great detail by special instructions, which regulate even the conducting of accounts for all types of operations. The differences in accounting and reporting approaches are treated in more detail in the inset.

Another specific feature is the National clearing system, which is used for conducting payments in parallel with SWIFT. The technology of National clearing system (swapping order, file templates etc.) significantly deviates from western technology and is restricted by Central Bank institutions. For direct ruble payments between banks usually SWIFT is used, but there is a significant number of payments that have to be made through the National clearing system (such as taxes, for example).

These are just some examples of the difficulties encountered. The biggest problem, however, are the constant regulatory changes at all levels of government that are required in the process of creating an efficient base for regulating the economy and society. The reforms conducted in Russia require such changes all the time, and regardless of which body of government is making them, they have an impact on the banking system and are reflected in the orders, rules and regulations issued by CBR. If you ask how frequently this happens, you will get a discouraging answer - very frequently, up to several times per year.

The usual approach to penetrating a new market

As a general rule, when opening a branch in a foreign country, large international banking institutions want to have a transparent view of all its operations and a high level of control over the new business unit. This is usually achieved to a significant degree by using their standard corporate banking systems tuned accordingly to international accounting and reporting standards as a primary system. But any such system by its nature is not compliant with the rules and regulations set by the Russian laws and Central Bank. There are several approaches that could be used by a bank, though all of them have some drawbacks:

Adapting the corporate system
One of the potential solutions to overcoming this problem is to adapt the corporate system to the accounting and reporting rules applicable in Russia and use a special localized version. This approach has a significant drawback: Taking into consideration the fact that CBR requirements are more strict and detailed than IAS, and are mandatory, it is really difficult for foreign banks to comply with them. Considering difference between two accounting systems the project will demand huge expenses - financial, human and time - from the very beginning. Besides, after adaptation, developers will have to continue providing efficient support and on-going revisions of the corporate system according to changes in CBR requirements. More importantly, after multiple revisions, the localized corporate system will no longer work according to corporate standards because of principal differences in accounting and reporting. In terms of single installation in Russia this approach is not reasonable with its realization and support cost.

Parallel data input
Another potential solution is purchasing a local system, installing it along with the corporate one and using parallel data input. In this case the Russian system supports the preparation of Russian reports, and corporate system supports the preparation of reports according to international accounting and reporting standards. But such an approach is only possible if the new branch will have a low level of transactions. If the volume of transactions begins to grow, the supporting costs will increase inadequately. Complex manual data reconciliation will be required and there will be a high risk of information loss. This approach should be used when the branch is just opened, but it is cannot be regarded as a permanent solution.

Use a Russian banking system as a primary accounting system
One more solution is to use a Russian banking system as a primary accounting system for posting of daily transactions of the branch. There are two ways of preparation of IAS and CBR reporting: 1) primary accounting data is exported from Russian system, which provides CBR reporting, to corporate system, which further generates IAS reporting, 2) Russian system produces both CBR and IAS reports.

In the first case, there is a problem of correct data conversion from Central Bank standards to the corporate standard. Both this problem and opposite problem (correct data conversion from the corporate standard to Central Bank standard) proved to be complex due to differences in Russian and IAS accounting principles. This approach demands significant data corrections/adjustments in the corporate system. Such approach dramatically increases workload of personnel involved, risks of information loss and operational risks.

In the second case the branch provides to the Head Office reports prepared according to IAS and corporate standards. But in this case the corporation loses the transparency of transactions in the branch; therefore, the management in Head Office experiences problems with adequate understanding of current situation in the branch. This approach can only be valid for the banks having minority stake in Russian subsidiary equity.

It should be noted that not all international financial institutions are ready to use a Russian system as a main system in the Russian subsidiary due to different reasons.

Develop own in-house system for the Russian branch
Yet another potential solution is to create a software department within the new branch and develop special software to provide reporting according to CBR requirements. In practice this approach is not very efficient due to potential costs and risks associated with development and further support of the reporting system. When the volume of transactions grows, it leads to increasing of technological expenses - night shifts for IT-specialists, additional employees for data reconciliation etc.

All these difficulties could make one think that starting business in Russia is not worth all the problems that it creates. But there is a cost efficient solution, choosing which will allow the bank to overcome these difficulties and obtain a stable platform for future development.

The Enabling Solution

According to our experience, the approach when a Russian system is interfaced with the corporate system and used as reporting software proved to be the most effective solution for the Russian subsidiaries of foreign banks. This approach addresses both IAS and CBR reporting in the most effective way.

The bank's corporate system is used for primary data input. The system provides transparent processing and reporting in line with the corporate standards. The data (exchange rates, clients, contracts, accounts, transactions etc) are further exported from the corporate system to a Russian one. The Russian system imports data from the corporate system and uses these data for CBR reports generation. Russian system also provides adequate processing of ruble interbank payments via National Payments System. The main advantage of this approach is that the corporate system installed in the branch does not require any significant modifications, because this system will not be responsible for CBR reporting. Only some export (to the Russian system) functions need to be slightly adjusted, but these modifications are non-comparable with costs associated with customization of corporate system to provide CBR reporting.

Another advantage of this approach is that a Russian software vendor provides timely and adequate support of the system in response to changing requirements of CBR. It is extremely important that nobody inside the Bank needs to develop special algorithms for reporting. This allows to dramatically reduce maintenance costs without impact of ability of the organization to timely comply with CBR requirements. But not all Russian software companies have technology for such solutions and can provide further support and logical processing of data from western system to Russian one.

This approach has many advantages, among which we can list:

  • Fast implementation. After making a decision about a new business in Russia, a foreign bank is interested to start banking activity as soon as possible. Therefore the problem of fast and high-quality implementation becomes a top-priority goal. At this point the qualification and experience of implementation specialists both on bank's side and software vendor's side is extremely important. Technological approach and successful realizations of similar projects are also important.

  • Minimization of risk of penalties. As it was already mentioned, changes in the laws and regulations governing the banking sphere in Russia are frequent. And if not enough effort is devoted to tracking these changes, there appears the risk of not making the changes required to the accounting system on time. This in turn leads to the submission of inaccurate or incorrect reports to CBR. And this is penalized. In case of a serious fault the Central Bank can even withdraw the banking license. As it's the Russian software provider who will track the changes, the Bank will not risk being penalized due to incorrect report generation.

  • Usage of standard corporate reports. At the same time for the purposes of corporate reporting the corporate system is used in the usual manner. This allows the mother bank to achieve its goal of transparency of operations of the new branch.

  • Lower total cost of ownership. A comparison of the costs of the solutions described above shows that even though the suggested solution might have a higher initial cost, it allows a minimization of future maintenance costs and significantly reduces risks for the new bank. Thus the total cost of ownership for this solution is comparatively lower.

Banking Information Systems, Ltd. has been implementing such solutions in a number of Russian subsidiaries of Western banks since 2001, working together with such international consulting companies as Accenture. We have the resources and experience necessary to do the job the right way, on time and within budget.

Examples of differences between IAS and Russian Accounting Standards

Accounting principles
One of the main IAS principles is the substance over form - substance and economic reality, not merely legal form. In international accounting standards the meaning of operations does not correspond to legal form, but shows economical essence of operation. In Russian accounting all operations are considered according to their legal form. In accordance with IAS effects of transactions and other events are recognized when they occur, and recorded in the accounting records and reported in the financial statements of the periods to which they related. Russian Accounting Principles do not provide these estimations; only completed operations are brought into accounting.

Corporate and international standards determine the rules of posting of operations into financial reports (internal and external). In contrast to them Russian standards strictly determine the rules of accounting down to the smallest details: opening and numeration of analytical accounts and rules of transactions fulfillment. Thus, different levels of reconciliation of information about credit institutions' activity exist: in Russia - on transaction level, in western banks - using reports, based on IAS. As a result foreign banks experience serious difficulties with preparation of obligatory reporting according to the Central Bank standards.

And even though it is planned to make Russian banking accounting compliant with IAS during 2004-2006, this will not have an impact on the accounting for reporting purposes, which will be submitted exactly in the same manner as it is done today, together with IAS-compliant accounting.

Profit and Loss accounting
Profit and loss accounting according to IAS standards is accrual based. It means that operations' results are taken into account when they appear, but not when the real money are received or spent. The results of operations are shown in financial statements for related periods.

Russian Accounting is cash-based, profit and loss are taken into account at the time of real profit or loss.

This difference leads to incompatibility of Balance Sheets and Profit and Loss Reports received according to different standards.

Analytical accounting
Internal Accounting Policy regulates corporate accounting. Usually this Policy is obligatory for all branches. Internal journals, analytical accounts, rules of data codification, order of operations fulfillment and registration, principles, forms, methods and procedures of corporate reports forming are determined according to this Policy. Corporate Accounting policy is created according to IAS standards. The purpose of the policy is providing with clear, reliable and complete information. Financial (IAS) and managerial corporate reports are built using this information. The General Ledger is the core of company's accounting and financial management records. It contains all GL-Accounts. These accounts are synthetic in classification hierarchy. Every GL-Account has analytical accounts for records of contracts, operations, transactions, business activity results etc. Each corporation creates its own rules. Therefore IAS determines general principles of accounting and reporting, and that allows foreign banks to be flexible in analytical accounting of daily operations.

On the contrary, Central Bank of Russia strictly defines standards for analytical accounting. Therefore the Russian subsidiary of a foreign bank must develop Internal Accounting Policy which would comply with CBR requirements, and design relevant IT infrastructure which enables appropriate analytical accounting and reporting for regulatory bodies.