9 transfer services. In all three areas, Russian banks have a long way to go. With a branch serving 43,642 persons on average, the level of development of Russian banks’ branch networks is far below that of its OECD peers (e.g., 1,555 for France; 2,763 for the US; 9,992 for Brazil) and other transition economies (e.g., 8,718 for Hungary).<sup>13</sup> In Moscow, this average decreases to about 29,631 people per branch. The average individual deposit amounts to RUR 6,827, and total bank deposits represent less than 26.3 percent<sup>14</sup> of GDP, in contrast to 46.6 percent in Hungary and 79.9 percent in the Czech Republic. Only an average of 23 percent of the population has a bank account.

Such lack of development of the domestic financial sector is reflected in the total loansto-GDP ratio of just 29 percent, as well as significant borrowing abroad by large Russian companies (reported at $19 billion), while domestic banks’ funding of investment is estimated at a low 7 percent.<sup>15</sup> Total bank assets amounted to only 42.5 percent of GDP as of year-end 2004, compared to an EU average of 280 percent. Yet, this number is the result of the financial sector’s impressive growth since the transition to a market economy began, with a major disruption resulting from the 1998 crisis and some turbulence in the summer of 2004. One result of this low penetration rate is that only a limited number of institutions are involved in head-to-head competition for client deposits. Most Russian banks have either a limited geographical focus or are specializing in a niche client base. The same is true for foreign-controlled banks, which have been mainly active in the securities market and a few “blue chip” companies, and are only now venturing into consumer lending, which is growing at an exponential rate (270 percent growth since 2004).

While public oversight is improving, a high percentage of Russian banks are also weak by international standards and potentially vulnerable. In a recent report, Fitch Ratings assessed most of Russia’s 30 largest banks as weak. Another rating agency (S&P) considers the Russian banking system “to be one of the world’s riskiest from a credit perspective.” Given the poor accounting practices and their relative lack of transparency, smaller institutions are believed to be in an even more precarious state. Poor governance, lack of business diversification, portfolio concentration (partly due to related party lending), volatile and concentrated deposits, and poor loan quality are considered to be the primary sources of risks. Such weaknesses are somewhat mitigated by strong economic growth, a reduction in the underground economy, and rapid asset growth, particularly consumer lending. As shown in Table 2 below, the rapid growth of the banks’ loan portfolios in recent years (e.g., 44 percent in 2004 and 37 percent in 2005) should be monitored as it may expose systemic vulnerabilities in the months ahead.

According to CBR statistics, the quality of the banks’ loan portfolios is low, with loans classified as “standard” accounting for a mere 48.2 percent of the total outstanding loan

> 13 These figures were calculated based on the information provided by the Bank for International Settlements [Statistics on payment and settlement systems in selected countries - Figures for 2004 - Preliminary version], by the European Central Bank (2005), the Central Bank of Brazil, and various internet resources for population data.

> 14 This is as of January 2006.

> 15 Moody’s, Banking System Outlook, October, 2005.