12 comply with prudential regulations. Rumors were circulating of a blacklist of weak banks being targeted by the CBR, including even larger institutions, quickly leading to loss of confidence by contagion and acute liquidity shortages at a number of banking institutions. By June, the interbank market had almost entirely dried-up. A number of banks started to have liquidity problems because of increasing withdrawals of deposits. On July 6, Guta Bank, then Russia’s 22<sup>nd</sup> largest bank, collapsed. As Guta Bank depositors started to have problems withdrawing money at ATMs, rumors of an imminent crisis at Alfa Bank, Russia’s largest private bank, spread quickly. Within just three days, panicking depositors withdrew some $160 million from Alfa Bank, or about 12 percent of its retail deposits.<sup>21</sup> To defuse the crisis, the CBR launched a package of measures: (i) slashing the minimum reserve requirement on deposits from 7 percent to 3.5 percent, thereby providing additional liquidity to the banking system; (ii) acquiring Guta Bank through a public bank (VTB); and (iii) communicating to bank clients the isolated nature of financial problems in a few banks, dispelling rumors of systemic problems. On July 10, the Russian Duma enacted new emergency legislation providing a state-sponsored blanket guarantee to all private depositors up to 100,000 RUR. This guarantee covered deposits at all banks, irrespective of whether they qualified for the recently established DIS or not. These two measures prevented a further deterioration of the situation, and the panic among depositors abated within days. Private deposits in the banking system started to grow again shortly after.

_What can be learned from this episode?_ First, it is evident that there is a high level of wariness among depositors in Russia, many of whom lost their savings during the 1998 crisis. Although nobody lost deposits in 2004, a recent survey by VTsIOM indicated that 70 percent of Russians have not had a savings account in the past eight years, either because they had no money or simply because they did not trust the banks.<sup>22</sup> Second, although the CBR responded effectively and in a coordinated way with other stakeholders in 2004, this episode revealed that the CBR’s ability to resolve banks is limited (lack of legal tools), and there are deficiencies and huge risks<sup>23</sup> in enforcing prudential regulations.<sup>24</sup> Third, blanket guarantees are often provided by the state to avert a systemic crisis (i.e., Mexico in 1995), but they should clearly be only temporary. Although dismantling them has proved to be tricky, this was not the case in Russia. Fourth, a DIS should ideally only be adopted after the foundations of the banking system are considered solid.

In Russia’s case, it would have been advisable to first strengthen the CBR’s monitoring and enforcement capabilities before introducing a DIS. In other words, proper sequencing is critical to the effectiveness of a deposit insurance system, although “ideal sequencing” is often not feasible politically. The strategy adopted to “re-certify” banks willing to

> 21 Business Week Online, July 26, 2004.

> 22 See Faulconbridge (2004) and also Belianin (2005)

> 23 As evidenced by the recent tragic events leading to the assassination of Andrei Kozlov , CBR’s First Deputy Governor in charge of banking supervision.

> 24  See annual supervision report of the CBR.