How does RusRating go about processing the information it collects?

The first step is running all of a bank's financial data through computer programs that calculate a wide range of indicators and coefficients, more than a hundred of them. This information is presented in the form of tables, diagrams and graphs, which make it more convenient for the analyst to work with the data. The next step is using mathematics to evaluate the data, and the most important ingredient here is the analyst's own expertise. After examining and analysing all available financial and non-financial information, the analyst moves step by step through a series of key questions about a bank's condition in accordance with a scoring model. These questions are designed to ensure that nothing critical is overlooked, that every factor of potential importance is given due consideration. Around 50% of an analyst's work goes into answering these questions and drawing appropriate conclusions. We should emphasize again that the analyst's own qualifications are extremely important here.

How are the questions structured?

The first group of questions concerns a bank's owners and managers. We look at who owns the bank, estimate the owners' financial resources, examine their other businesses and their interest in the banking sector per se. In effect, we are looking at whether the owners are able and willing to providing support to a bank and help it grow. Both here, and when we look at management, the root of the question is people's motivation and the results that flow from that motivation. Is a bank capable of generating profits and at the same time protecting itself from risks given its particular approach to management?

How do you evaluate owners' and managers' motivation?

Every bank is a special case, but roughly speaking we take the following approach. We study the bank's behaviour in a range of situations and examine how choices are made. These choices reveal the priorities and motives of its owners and managers. Then we think about why a particular choice was made. Logical analysis makes it possible to anticipate how a bank is likely to act under other circumstances. This is where the analyst has to use a bit of psychology as well. To help us form the most accurate possible picture of a bank's owners and managers we also make efforts to meet with these people and with key professional staff. This contributes to a clearer picture of their model of business behaviour. In a similar way we evaluate political and system wide risks, or more precisely, how sensitive a bank is to those risks. We also look at the capacity of a bank's owners, managers and clients to lobby on its behalf.

Does an ability to lobby reduce risks?

Not in general. This factor has to be looked at in the context of a particular bank at a particular point in time. Sometimes scope for lobbying can reduce risks for a time, but in itself can become a more serious source of risk. There is always a chance that interests might diverge in future, or that people move. Our risk estimates are short term, for a period of one to three months.

Within that time frame lobbying capacity generally acts to reduce a bank's exposure to certain risks. In the longer term, however, reliance on political connections is itself a risk factor.

What other aspects of a bank's business do you look at?

One section of the analysis examines a bank's market positions and the history of its development, along with accumulated experience. We look at what kind of transactions the bank handles, who are its clients, which markets it operates in, and whether there are any particular priorities or chosen niches. In looking at a bank from the point of view of various markets, the main factor we consider is risk, just as in other parts of the analysis. For example, a bank is expanding its retail presence. On the one hand, this is a positive factor: the bank is gaining access to potentially long-term money that under stable conditions can be used to finance longer-term projects. On the other hand, the move involves infrastructure and technology costs and also makes the bank more dependent on the behaviour of retail depositors. We have to look at the specific risks found in each sector. The same applies to operations in the financial markets and the associated risks. Balance sheet figures can both support and call into question the conclusions reached by an analyst on the basis of the preceding sections. That is why we devote so much attention to integrated analysis, taking all information into the picture.

How does analysis of Russian banks differ from analysis in the world at large?

We look at the same range of factors as western consultants: capital, assets, profits, liquidity. But there are also important differences. For example, in the west it is generally assumed that capital represents real funds put up by a bank's owners and therefore provides a degree of protection to creditors. Furthermore, in the west client funds tend in some sense to be uniform; they move in accordance with the same principles. We have to look more closely not only at capital, but also at a bank's external funding: corporate resources, money market funds, retail deposits... In particular, we look very carefully to assess the stability of these resources and examine possible risk factors. For example, although we take capital adequacy measures into consideration we know that in most cases the measure is more a formality than a reflection of the actual situation. It is far more important to look at how much of the owners' live money is working at the bank. Unfortunately, common practice in Russia, particularly in the 1990s, has been for bank owners to put up resources in the form of corporate client funding rather than capital. The reason is simple: in case of difficulties it is much easier to withdraw client funds. Like international rating agencies, we examine the structure and quality of assets, returns, recoverability, and liquidity. But we also take into consideration special features of the way various financial instruments are structured in Russia and peculiarities of Russian accounting. For example, one day is left to the due date of a one-year loan but in the books its tenor continues to be classified as one year. This means we have to draw on our knowledge of the market and analysis of turnover patterns to estimate the real term structure of assets, the volume of loans being repaid, and so on. In some cases a bank with a “poorly structured” balanced sheet performs better in the Russian market, and is more stable and profitable, than a bank that meets international standards for asset structure. For example, some banks do not work with securities. Foreign consultants accuse these banks of holding unbalanced assets. In our opinion, however, if a bank doesn't already have specialists able to work effectively and without undue risk in this market, investing in an expensive team of experts will not necessarily improve its performance. We take a more flexible approach. Instead of using standard formulas, we look at the reality of a bank's business. In examining profitability we try to allow for unofficial measures. We know that officially reported earnings measures may be heavily adjusted. Formal profitability figures are therefore a questionable guide in judging performance. That is why we look at returns on the various operations carried out by a bank and estimate how much profit is generated by its business in reality.

By estimating true profitability on the basis of returns, couldn't you cause certain complications for the bank?

We understand that our reports could end up at the Central Bank or in the hands of other government bodies. But at the same time it has to be realised that as outsiders we are not in a position to calculate profits precisely. Without internal data these figures can never be wholly reliable: bank owners themselves may not always receive totally accurate information. That is why we are always careful to use qualifying words such as “possibly”, “it may be assumed”, and so on. In every case where outside analysis is inadequate, we point out the key issues to our subscribers who are themselves finance professionals. They can then use these issues as starting points when asking counterparties for the additional information they need to come to more solid conclusions. An extremely important section of the financial analysis concerns liquidity. In all of our analysis, and in looking at liquidity in particular, we consider not only balance sheet figures as of reporting dates but also turnover dynamic cash flows for a period of at least a year. These flows are much more informative than static balances, particularly reporting date figures. Turnover measures are particularly informative when they are correlated with one another, and many interesting conclusions are possible. Our analysis is not limited to current liquidity, but also examines liquidity in terms of the flow of funds passing through the bank. In fact, this is the high point of the report. Since we are examining risks from the point of view of the interbank market, liquidity is the single most crucial factor.

How is the analysis transformed into a letter rating?

Conclusions in the various areas we have already described are compared with the conditions associated with the various rating categories. In order for a bank to receive a particular rating, assessments in every section must be at least as strong as the criteria specified for that rating. A bank that has a strong rating in one area but is weak in others will be rated according to the lower assessments. In our opinion, averaging or summing is inappropriate in the case of risk analysis. The result for our clients is a detailed report that describes all aspects of a bank's operations, together with a summary rating that reflects an overall assessment of risks.