S&P Viewpoint

Standard & Poor's follows the fundamental principles of consistency and objectivity in its research. As a general rule, all methodological changes are disclosed, the reasons for these changes are communicated and their effects are discussed. Based on the feedback on our 2005 survey, and reflecting the evolving requirements of international investors, we have introduced several changes to our methodology.

First, because creditors and depositors are by far the largest group of financial stakeholders in the sector we modified the questionnaire to strengthen the creditor's perspective on transparency. For instance, we introduced new criteria items in the financial and operational information block, omitted a number of questions relating to disclosure on shareholder rights, and amalgamated some close-in-meaning questions to make distinctive categories. Consistent with the idea that information requirements of shareholders and creditors do not differ radically, this change resulted in a minor 1.7 p.p. upward shift on average with a standard deviation of 2.6 p.p.

Second, our approach to accounting for disclosure in various media has been altered. Under the new weighting system, public disclosure, regardless of the source through which it is made, yields 80% of the maximum score on each point of the questionnaire. The remaining 20% of points are awarded if this information is present in the other two sources as well (10% to each). This scoring system reflects the notion that replication of information in various sources holds the same value for investors, but makes it more easily accessible, which has, however, incremental value, compared with the fact of disclosure. The corresponding alteration to the scoring system has a moderate effect on the individual scores--the average upward shift is 6.1 p.p. with the standard deviation of 2.9 p.p.

Third, in the present survey we accounted for information contained in the Eurobond issue prospectuses classifying them as regulatory reporting. Prospectuses are usually highly informative, and they are often made public by either the company or the stock exchanges. Accordingly, we accounted for prospectuses for the bonds issued after Jan. 1, 2006, that were published either on a bank's Web site or that of the stock exchange. This significantly affected several individual scores, but had a relatively minor effect on the average score, as relatively few banks had published prospectuses.

We strongly believe that these changes enhanced our T&D methodology and allowed it to reflect current disclosure practices in today's Russian banking sector more accurately, thus making results more objective and relevant. At the same time, we recognize that these changes impair comparability with the results of last year's survey. Accordingly, we provide individual company scores under the old methodological approach (i.e., the old weighting system and the earlier set of questions) to enable such a comparison.

As a part of the T&D project, we also updated our study on ownership concentration and disclosure. This research complements the questionnaire-based T&D study by providing an in-depth view of ownership concentration and disclosure practices by Russian banks. An additional part of this research explores the links between transparency and the cost of international borrowing for the largest Russian banks. Furthermore, we provide a separate analysis of banks' transparency from the viewpoint of the existing or potential minority shareholders, reflecting the growing interest of some Russian banks in performing IPOs. Finally, as an extension of our study of transparency, we conducted a survey of corporate governance structures of banks included in the survey.

Results show that the level of transparency of the 30 largest Russian banks is still quite low--the average score is 48.3% (see table 2). It has gone up by about 12 p.p. from the previous year's level of 36%. However, the increase net of methodology change is only about 3.1 p.p., which can be seen as a reserved step forward.

Table 2

Transparency Scores On Russian Banks, 2006
2006 rank	2005 rank	Bank	Total (%)	Ownership and corporate structure (%)	Financial and operational information (%)	Board and management structure and process (%)	2005 total (%)	2006 total (2005 methodology) (%)
1	3	MDM-Bank	69	73	72	54	51	54
2	7	BIN-Bank	67	64	73	51	43	60
3	28	Alfa Bank	65	82	65	43	23	56
4	8	Rosbank	64	71	68	41	40	52
5	5	Sberbank	61	59	65	50	46	55
6	1	VTB	61	72	64	38	55	51
7	19	Gazprombank	60	69	66	33	34	50
8	16	Russian Standard	60	64	66	39	36	45
9	N/A	Absolut	59	49	68	43	N/A	45
10	10	MBRD	59	70	58	45	40	46
11	4	Transcreditbank	58	63	62	37	51	49
12	2	Vozrozhdenie	56	63	59	37	55	49
13	21	Ak Bars	53	62	55	35	33	39
14	24	Promsvyazbank	53	56	56	40	31	41
15	N/A	Rosselkhozbank	52	74	48	42	N/A	41
16	12	Petrocommerce	52	44	60	37	39	41
17	N/A	Sibacadembank	51	62	54	30	N/A	36
18	9	Soyuz	51	64	51	32	40	34
19	25	TRUST	45	38	54	25	31	38
20	6	NRB	41	53	37	40	44	35
21	15	Bank of Khanty-Mansiysk	41	54	36	38	38	34
22	22	Uralsib	39	31	47	24	32	32
23	14	Bank of Moscow	36	46	33	33	38	31
24	26	Surgutneftegazbank	35	20	46	19	26	26
25	27	Globex	33	50	29	23	25	26
26	20	Sobinbank	31	30	32	32	34	22
27	23	Zenit	31	28	29	40	31	29
28	11	NOMOS-Bank	30	20	35	26	39	25
29	N/A	Bank St. Petersburg	29	37	25	30	N/A	25
30	29	MezhPromBank	12	3	12	23	17	8
		Average	48	52	51	36	36	39
N/A--Not applicable.

This year there was an increase in the range of scores. The new leaders: MDM-Bank and BIN-Bank, disclose information on more than two-thirds of the items included in the survey. Taking a creditor's angle, a significantly larger number of banks disclose information on more than half of the items on the criteria list--18 banks scored higher than 50% compared with only four banks last year. The 2006 top score of 69% is 14 p.p. higher than the top score last year (VTB scored 55% then). The lowest score went up by 1 p.p. (MezhPromBank, 12%, compared with First Czech-Russian Bank with 11% last year). Therefore, the range has gone up to 57 p.p. from 44 p.p., primarily due to improvements within the group of leaders. At the same time, although 14 banks increased their scores, net of methodological changes, the transparency of 12 banks has gone down. We observed a decline in disclosure by NOMOS-Bank (reduction of 14 p.p.) and MezhPromBank (reduction of 9 p.p.). This was due to less-informative annual reports, Web sites, and lack of translation of some materials into English (e.g., the English version of the Web site of NOMOS-Bank did not function at the date of our research).

Nonetheless, Russian banks still lag significantly behind their international peer group--the 10 world's largest banks, which demonstrated an average disclosure level of 79% in 2005 (see table 3).

Table 3

International Banks Peer Group*
Bank	Total (%)	Ownership and corporate structure (%)	Financial and operational information (%)	Board and management structure and process (%)
Deutsche Bank	88	79	92	85
ING	81	90	77	79
ABN AMRO	80	88	76	81
HSBC	78	79	78	78
Bank of America	78	84	74	82
Citigroup Inc.	78	78	78	79
JPMorgan Chase	78	72	76	86
UBS	78	74	78	79
Royal Bank of Scotland	76	75	75	79
Credit Suisse Group	71	63	75	68
Average	79	78	78	79
*Scores as of Aug. 12, 2005, but based on the set of questions introduced in 2006. Based on pilot sample, we expect that the disclosure practices have not changed significantly during the last year and 2005 results can serve as a good indicator for 2006 results.

We suppose that a large portion of the disclosure gap can be explained by the fact that all the international peers are publicly traded companies and thus are subjected to stricter disclosure rules set by stock exchanges or financial markets authorities. Among the Russian banks, only two banks have their shares traded. Moreover, since they have Level I ADR programs only, their exposure to the Western regulatory environment is limited.

The distribution of scores became more homogeneous this year (see chart 1). The differences between the banks closest to each other in ranking do not exceed 6.0 p.p., with an average gap of 1.4 p.p. The only exception is MezhPromBank, which lags behind the "next-best" bank by 17 p.p. Taking into account common disclosure patterns in addition to the score thresholds, we can identify three broad groups--"leaders," "middle-scorers," and "underperformers."

 Chart 1

Descriptions of the extreme cases of disclosure patterns are given below.

• One can identify all or almost all of the bank's beneficiaries. The share of disclosed ownership is at least 90% (and more than 95% in case of Alfa-Bank, MDM-Bank, and Rosbank).
• These banks publish audited annual and reviewed interim IFRS financials with fairly detailed notes.
• Operational and financial information (Block 2) is detailed. For example, MDM-Bank and BIN-Bank provide information on nearly all the items in the criteria table, and scores for the second block of questions are at least 65% (Alfa-Bank) and can reach as high as 73% (BIN-Bank).
• Information about the directors and board's committees is detailed. MDM-Bank and Alfa-Bank disclose detailed biographies and complete list of board committees and their members and describe the role of the board in the bank.
• MDM-Bank, BIN-Bank, and Rosbank make some attempts to disclose the remuneration of top managers or board members, or both, and the principles and forms of their pay.
• Sources of information are, however, highly heterogeneous in their content. The average score for Web site disclosure is 70% (with a standard deviation of 3%), while annual reports earn a 47% average and regulatory filings score a 41% mean (7.4% and 6.2%, respectively).

The banks closest to this group, Sberbank, VTB, and Gazprombank, which are concentrated around 61%, share some of these characteristics, but not all.

• Information on corporate procedures is either not disclosed or partially disclosed.
• Few of these banks disclose IFRS financials, and those published do not contain notes.
• Disclosure of operational and financial information is moderate-to-weak and insufficient for detailed analysis.
• No information about top management or board remuneration is disclosed (only Sobinbank and Zenit attempted to disclose some nondetailed information).
• Information is presented mostly in Russian, and only fragmentary attempts are made to translate it.
• Regulatory filings are either not made public, or their information content is poor.

The middle-scorers positioned in between these clearly defined groups are rather diverse in their disclosure both in terms of overall level and relative strengths and weaknesses. The upper middle portion of this group is close to the leaders in many respects. For example, these banks have consistently better disclosure of ownership structures, corporate procedures, and operational and financial information. Banks falling in the lower middle group share most of the traits of the underperformers.

The three largest banks (Sberbank, VTB, and Gazprombank) all scored around 61% this year (with an average of 52% under the 2005 scoring criteria). These banks jointly account for about 62% of the total net assets of the 30 largest Russian banks. In total, banks with scores over 50% account for 84% of total net assets, up from 15% of these assets last year (see charts 2 and 3). This is mainly due to improvements in disclosure by the three largest banks.

 Chart 2

 Chart 3

If we look at the amount of assets held by the three groups outlined above, 10.2% of total net assets is held by the leaders, while 9.9% is held by the underperformers, and the remaining 79.9% by the middle-scorers.

The more detailed analysis of six components shows that general disclosure patterns by component stayed nearly the same over the year (see table 3). Like in our previous survey, there was very weak disclosure on executive and board compensation (component 6, average score, 9%) and slightly better but nevertheless weak disclosure on corporate procedures (component 2, 34% on average). However, this year there was a significant increase in disclosure levels on ownership and group structure (component 1, a 25 p.p. increase from the 2005 level of 32%, see Ownership disclosure). However, a comparison with the international peer group again shows significant gaps in disclosure practices. The largest gaps are in components 6 (84 p.p.) and 3 (37 p.p.). Again, we are inclined to attribute these differences to different corporate setups and regulatory environments in which these banks operate.

Russian private banks are often managed by beneficiary owners, which makes them particularly reluctant to present information on their pay to the general public. However, there are a growing number of exceptions. For instance, BIN-Bank, where the largest beneficial shareholder is the CEO and director, fully discloses the levels and form of both the board and executive pay (i.e., provides an individual breakdown), while MDM-Bank, where two beneficial shareholders sit on the board, provides information on the decision-making process on executives' and directors' pay, as well as the form of managers' pay. Despite their leadership in this area of disclosure, these banks still have moderate-to-low scores for component 6: 30% for BIN-Bank and 34% for MDM-Bank. This is explained by the fact that BIN-Bank does not present this information in English, and does not disclose specifics of performance-related remuneration for directors and managers. MDM-Bank, on the other hand, provides only the aggregate compensation figures, and does not disclose the form of directors' remuneration or specifics of performance-related pay for directors and managers.

Table 4

Comparative Table On Disclosure By Components By 30 Largest Russian Banks In 2006 And 2005
	--Component--
	1	2	3	4	5	6
30 Russian banks, 2006	57	34	52	48	46	9
30 Russian banks, 2005	32	24	39	53	40	10
International peer group, 2005	82	67	84	66	74	93
Note: Component 1: Ownership and group structure. Component 2: Corporate procedures. Component 3: Financial information. Component 4: Operational information. Component 5: Board and management information. Component 6: Board and management remuneration.

The disclosure of specific best- and worst-disclosed items by Russian banks in 2006 is summarized in chart 4. The classification of the items as best or worst disclosed is based on the number of banks that provide information on a particular item, as a proportion of the total number of banks, where such disclosure may be relevant.

 Chart 4

In our opinion, the most critical areas in which banks' disclosure practices are poor include detailed information about related-party transactions (e.g., exact terms) and transactions with the companies from the same group), while Russian banks typically have substantial exposure to these transactions. Other critical areas are auditor engagement (scope of services, nonaudit services, and remuneration), board structure and process, and board and executive remuneration.

Among the positive changes in addition to those mentioned above is that disclosure of risk management policies has improved. This year, 26 banks provided information on this issue, which moved this item from the worst- to best-disclosed. Besides that, the quality of information has gone up--banks do not simply give a skin-deep description of their risk environment, but seek to provide investors with elaborate information on its specifics, including political and regulatory risks pertinent to Russia, as well as a detailed overview of risk-hedging mechanisms employed by the bank and financial characteristics used to assess risk (debt and credit/deposit portfolio structure and concentration, liquidity/profitability ratios, asset quality indicators, and so on). In addition, the three leaders (MDM-Bank, BIN-Bank, and Alfa-Bank) publish full ratings reports produced by the rating services on their Web sites, which enhances the quality of risk information. In general, there is a distinct positive correlation between an individual transparency score and quantity/quality of disclosure on risk management policies.

As in the previous year, corporate Web sites are the most informative channel with an average score of 49% (3 p.p. up from last year; see table 5). The fact that Web sites still hold the lead is partly explained by our approach to scoring--we consider all the information contained on the Web site even if it was actually contained in annual reports or regulatory filings published on the Web. (The potentially confusing effect of "multiple accounting" of the information is minimized by our new scoring method, which gives a modest reward for replication of information in various disclosure media.) We also appreciate the increasing willingness of modern corporations, including banks, to position Web sites as the most informative channel. Web sites have the unbeatable advantage of being cheap in maintenance/production and easily accessed by a large number of users. Annual reports became the least informative channel despite a 2 p.p. growth in this average score. There was a significant relative increase in regulatory filing disclosure--this year we began to classify bond issue prospectuses as regulatory filings, which led to a significant increase in the average score for this source to 36% from 26% under the updated scoring criteria. The international peer group shows homogeneous distribution of information among the sources, which may reflect differences in disclosure philosophies.

Table 5

Sources Of Disclosure
	Annual report for the previous year (%)	Web site information (%)	Regulatory filings (%)
30 Russian banks, 2006	29	49	36*
30 Russian banks, 2005	27	46	26
Peer group, 2005	79	79	76
*Includes bond issue prospectuses.

We have identified several banks that demonstrated outstanding growth from the last year. The banks with increased scores of more than 20 p.p. are Alfa-Bank (+42 p.p.), Gazprombank (+26 p.p.), Russian Standard (+24 p.p.), Rosbank (+24 p.p.), BIN-Bank (+24 p.p.), and Promsvyazbank (+22 p.p.). Several drivers have allowed these banks to improve their ranking.

• Five of these banks disclosed their ownership structure (Alfa-Bank, BIN-Bank, Rosbank, Promsvyazbank, and Russian Standard).
• There were improvements in interim and annual IFRS reporting. Some of the banks newly produced IFRS reports or translated them and published notes (Alfa-Bank, Gazprombank, Rosbank, and Promsvyazbank).
• Four of these banks improved the disclosure of related-party transactions and their English-language presentation (Alfa-Bank, BIN-Bank, Promsvyazbank, and Rosbank).
• The quality of operational information and information on board of directors has increased (all banks).

In addition, the score of BIN-Bank benefited from the fact that it started to disclose detailed information on specifics and form of managers' and board members' pay, which is a rare practice in Russia.

As can be seen from table 2, the most transparent banks in our survey are private. Three most transparent private banks belong to the group of leaders with the average score of 66.0%, while top three government-controlled banks enter the upper middle group lagging on average by 5.2 p.p. behind. Beside that, five out of six high-growers are private.

This is likely to be related to the fact that in competing for funds of depositors and investors in debt issues, the leading private banks rely among other things on enhancing transparency as a means to decrease the cost of borrowing, while government-controlled banks enjoy a higher implied creditworthiness due to perception about potential government's support in the stress situation.

To reflect the growing interest of the largest Russian banks in attracting equity on the domestic and international markets, we provide a separate analysis of transparency from the perspective of existing of potential minority shareholders (see table 6). A questionnaire developed specifically for the purposes of this analysis is presented in Appendix II.

Table 6

Transparency From The Shareholder’s Perspective
Bank	Disclosure of information for shareholders (%)
Vozrozhdeniye	61
Alfa-Bank	58
Gazprombank	45
BIN-Bank	43
Vneshtorgbank	39
MBRD	38
MDM-Bank	38
Bank of Khanty-Mansiysk	36
Sberbank	36
Soyuz	35
Zenit	35
Transcreditbank	35
Rosbank	35
Uralsib	34
Ak Bars	33
Bank of Moscow	33
NRB	33
Sibacadembank	33
NOMOS-Bank	32
Russian Standard	30
TRUST	28
Absolut	26
Promsvyazbank	26
Surgutneftegazbank	23
Sobinbank	23
Petrocommerce	20
Bank St. Petersburg	18
Rosselkhozbank	16
Globex	15
MezhPromBank	6
Average	32

Only two banks, Vozrozhdeniye and Alfa-Bank, disclose information on more than half of the items relevant for minority holders. The average of 32% and the fact that 26 banks scored less than 40% show very low transparency from the perspective of minority shareholders. For instance, this compares negatively with an average score of 87% by Russian companies with NYSE listings for the same set of questions in 2005. Apparently, the largest Russian banks, which are not yet offering their shares in the markets, are considerably behind in following the stringent disclosure rules of the world's leading stock exchange.

This is perhaps not surprising in view of the concentrated ownership structure of the largest Russian banks, which makes such disclosure irrelevant. In most cases, banks' shareholders are represented on boards and therefore need not rely on public information. This may change, however, as access to equity capital becomes a strategic issue for private Russian banks, which are becoming increasingly constrained in their growth by shortage of capital. As their dependence on equity financing is expected to rise, banks are likely to come under pressure from equity investors to improve disclosure and adopt shareholder-friendly governance structures.

This year we continued our study of ownership concentration and disclosure of the 30 largest banks. As before, we used total net assets as a measure of the banks' size.

We noticed a small decrease in ownership concentration of the 30 largest Russian banks. First, among the largest 30 banks there is only one bank with relatively dispersed ownership (i.e., the largest stake does not exceed 25%): the Bank St. Petersburg. There were no such banks last year. Second, we observed a decrease in the number of majority owned banks (where a stake exceeding 50% is present)--21 as opposed to 26 last year. This is a result of two banks dropping out of the sample on the size criterion, one additional share issue (The Bank of Moscow), and two banks providing more detailed disclosure of shareholding by managers that allowed us to treat the respective interests as individual stakes rather than blocks (TRUST and Sobinbank). This is consistent with our policy of treating individual holdings of management as independent stakes, rather than constituents of a consolidated block, unless there is evidence of an existing shareholder agreement. If individual holdings are not disclosed, however, we treat all equity positions held by management as one block. Nonetheless, the banking sector remains highly concentrated. The relative magnitude of these changes is not significant--Bank St. Petersburg accounts for only 0.5% of the aggregate total, and majority owned banks still represent the overwhelming part of the banking sector (86.6% of these assets).

The other trend deals with the growing relative presence of the government in the banking sector, and a respective decline in the relative share of private capital in the sector. Banks in which the government holds more than 50% of stock, directly or indirectly, account for 66.1% of total net assets of the group--up by 2.1 p.p. from the last year (see table 7). At the same time, banks in which the government holds more than 25%, directly or indirectly, comprise 71.4% of group's total net assets (the number of such banks increased by two to nine). The increase in net assets of state-controlled banks is explained by the rise of their retained earnings, as well as by capital injections at several banks. The share of large private stakes in total net assets has gone down by about one-third to 21.1% due to more dispersed ownership, but also as a result of rapid expansion by state-owned banks. Shortage of capital is one of the principle constraints on the growth of private banks, as current private investors do not always have resources to stimulate their development. None of these banks have ventured to raise capital through equity placements to date, although some have announced they were considering plans for an IPO.

Table 7

Concentration Of Ownership, 30 Largest Russian banks, 2006
Concentration of ownership	No. of companies	Banks in TNA (%) (1)	Stakes in TNA (%) (2)
Dispersed-largest stake less than 25% (3)	1	0.5	0.5
Banks with at least one block holder (>25%) (4)	29	99.5	73.7
Majority owned banks (>50%) (5)	21	86.6	68.5
Banks with a direct big government stake (>25%) (6)	6	61.3	43.1
Banks with a large direct government stake (>50%) (7)	5	57.1	41.1
Banks with big stakes (>25%) indirectly owned by govt. (8)	3	10.1	9.4
Banks with large stakes (>50%) indirectly owned by govt. (9)	2	9	8.9
Total banks controlled by the government (10)	7	66.1	50
Banks with big (>25%) private stakes	20	28.1	21.2
(1) Share of combined net assets of the relevant banks in total net assets (TNA) of the 30 largest banks. (2) Share of the corresponding stakes in total net assets (TNA) of the 30 largest banks. (3) Bank St. Petersburg. (4) All banks except Bank St. Petersburg. (5) All banks except Alfa-Bank, Bank of Moscow, Bank St. Petersburg, Zenit, TRUST, NOMOS-Bank, Sobinbank, Vozrozhdeniye, and VTB. (6) Bank of Moscow, VTB, Sberbank, NRB, Rosselhozbank, TransCreditBank, and Bank of Khanty-Mansiysk. (7) All (6) except Bank of Moscow. (8) AK Bars, Gazprombank, and Zenit. (9) AK Bars and Gazprombank. (10) Consists of (7) and (9). TNA--Total net assets.

Ownership disclosure by Russian banks has improved markedly. There was an increase this year in the number of banks disclosing all large beneficial owners--now 21 banks disclose all stakes that exceed 25%, compared with 11 last year, and the share of these banks in the group's total net assets has grown from 69% to 89% (see table 8). Besides that, 13 banks disclose all large private owners, and the share of such banks in total net assets has nearly tripled as compared with our previous survey. Moreover, the share of disclosed private ownership in total private ownership stands at 52% this year, as compared with 16% last year. This is a significant step forward in terms of ownership disclosure in Russian banking sector.

Table 8

Transparency Of Ownership, 30 Russian Banks, 2006
Transparency of ownership	No. of companies	Banks in TNA (%)(1)	Stakes in TNA (%) (2)
Banks disclosing at least one owner (3)	28	98.3	77
Banks disclosing all large beneficial owners (>25%) (4)	21	88.9	65.1
Banks disclosing ALL stakes >25% directly or indirectly belonging to govt. (5)	8	70.3	52
Banks disclosing ALL large (>25%) private owners (6)	13	18.6	13.1
(1) Share of combined net assets of the relevant banks in total net assets (TNA) of the 30 banks. (2) Share of the banks’ stakes with disclosed ownership in total net assets (TNA) of the 30 banks. (3) All banks except MezhPromBank and Surgutneftegazbank. (4) All banks except Uralsib, NOMOS-Bank, MezhPromBank, Zenit, TRUST, Sobinbank, Bank St. Petersburg, Surgutneftegazbank, and Soyuz. (5) All government-owned banks except Zenit. (6) Absolut, Alfa-Bank, BIN-Bank, Vozrozhdeniye, Globex, MBRD, MDM-Bank, NRB, Petrocommerce, Promsvyazbank, Rosbank, Russian Standard, and Sibacadembank. TNA—Total net assets.

The improvement in the aggregate figure is driven by two factors. First, based strictly on the asset size criterion, four new banks were included in the sample for the first time this year: Absolut, Bank St. Petersburg, Rosselkhozbank, and Sibacadembank, and those have transparent ownership structures. At the same time, four banks with opaque ownership were excluded from the sample. This suggests, in fact, that banks with transparent ownership tend to outgrow the less-transparent banks. In addition to that, several banks included in both surveys--Alfa-Bank, BIN-Bank, TRUST, Petrocommerce, Rosbank, and Russian Standard, have disclosed their beneficiaries within the last year, thus driving the average score for this component up. Improvements in disclosure by these banks reflects the fact that a growing number of Russian banks raise capital on international capital markets or plan to do so in the near future, either through Eurobond issues or IPOs. This often necessitates ownership disclosure to lower the costs of debt. For instance, ownership disclosure by Alfa-Bank was first made before a Eurobond issue in March 2006. It is probably too early to speak about the end of the era of opaque banking structures in Russia, but it looks like the overwhelming aspirations for raising capital are guiding the disclosure pattern these days.

Regulators play an important role in determining the level of transparency of the entire banking sector and that of individual banks. CBR sets out normative guidelines for information disclosure. Regarding disclosure, current regulatory policies impose a reporting burden on banks, which has, however, only a limited effect on transparency.

Based on OECD principles and Basel Committee recommendations, CBR has set its own disclosure guidelines. Letter # 119-T (Sept. 13, 2005) "On Modern Approaches to Organisation of Corporate Governance In Credit Institutions" (letter) contains recommendations on banks' public disclosure policy. CBR recommends that banks disclose ownership structure, strategic decisions, material risks, types of banking operations and transactions, market position of the credit institution, and observation of business ethics principles. In addition, the annual report might contain information on the scope of engagement of an auditor, including nonaudit services rendered to the bank, its affiliation, facts that impair its independence, and remuneration details. The letter advises banks to include in the auditor's contract the obligation to inform the bank's board of directors on the following issues discovered in the course of audit process: critical changes in accounting policy, suggestions on accounting practices, the changes that may have material effect on the reliability of financial statements, the nature of disagreements with the executives, existing weaknesses in internal controls, and so on.

The actual effect of the CBR's letter on transparency in the banking sector has been limited to date, as shown by the modest growth in the average figures (adjusted for methodological changes). Additionally, we observed the greatest improvements at banks that are active in international borrowing or have discussed plans for an IPO. We conclude that, despite its sound messages, the potential of the letter to have a meaningful effect on the sector is constrained by its "advisory" status.

Morever, CBR's requirements for mandatory public disclosure (formulated in documents other than the letter) concern only a limited scope of information. Prescription # 1270-U (April 14, 2003) requires that credit organizations publicly disclose annual RAS financial statements (balance sheet, profit and loss account, cash flow statement, and information on capital adequacy and reserves, all prepared and calculated in accordance with CBR guidelines), and quarterly RAS financials (similar in scope to the annual accounts except for the cash flow statement, which is not included). Beside these reports, banks that have subsidiaries are required to disclose consolidated financials under RAS, a list of companies included in the group, and consolidated capital adequacy and reserve figures. All these filings are made available on CBR's Web site. This information is not detailed, however, (e.g., the entire balance sheet consists of 30 very broad items without notes) and thorough analysis is hardly possible based on this data alone.

In contrast, banks file a burdensome number of reports with CBR that are kept for internal use by the regulator. According to Prescription # 1376-U (Jan. 16, 2004), banks submit detailed information including: financials (annual, quarterly, and monthly), detailed information about loans/assets and their quality, borrowing/lending interest rates, capital adequacy, liquidity, reserves, investment plans, internal controls, and so on. Moreover, Prescription # 1379-U (Jan. 16, 2004) "On Assessment of Financial Standing of a Bank for the Purpose of Determination of its Appropriateness for Participation in Deposit Insurance System" requires banks to submit a detailed evaluation of their capital, assets, management of their operations and risks, profitability, and liquidity. Furthermore, banks are required to file IFRS-reconciled financials with CBR. The reconciliation principles follow the guidelines formulated by the CBR, which in several respects deviate from the IFRS principles, however. As in the case of most other reports to CBR, banks have full discretion in deciding whether to publish these statements and in choosing the format of presentation (CBR's Letter # 19-T (Feb. 10, 2006) "On Methodical Recommendations 'On The Way of Preparation and Submission Of Financial Reporting By Credit Institutions'").

Despite the reliance on RAS and certain other weaknesses, many of the reports required by the CBR are helpful in analyzing the financial position and creditworthiness of banks. Banks commonly present these reports to counterparties such as major creditors, and to rating services, but seldom choose to make them publicly available. Apparently, transparency of the banking sector would improve notably had the banks been required to disclose information filed with CBR (e.g., Prescriptions # 1376-U and # 1379-U).

While the debate on the use of IFRS-reconciled accounts by the CBR for the purposes of oversight continues, a considerable number of banks--as many as 200 out of 1,180--prepare fully IFRS- or U.S. GAAP-compliant statements on their own initiative and employ international audit firms to audit these accounts. The quality and level of detail in these voluntary reports is often limited and the scope of disclosure varies greatly across banks. Moreover, accounting principles and the scope of consolidation applied in voluntary IFRS statements differ from that used in RAS and statutory IFRS-reconciled reports. This hinders a coherent analysis because information contained in different reports is often hard to reconcile.

In addition, the role of regulatory bodies in stimulating disclosure of ownership to the general public is minimal. CBR collects information about beneficial holders in the course of checking whether banks satisfy criteria for participation in the deposit insurance system but does not require the banks to publish it. To comply with the rules set in Prescription # 1379-U (Jan. 16, 2004) banks must provide information on shareholders and persons that may influence decisions indirectly to CBR but are not obliged to publish it. At the same time, shareholders are not required by the FFMS to report substantial indirect equity positions, as is common in most jurisdictions. In practice, this means that Russian banks and corporations do not have legal means to ascertain their beneficial ownership structure. Even when banks make ownership disclosure voluntarily, which has become more and more common, the lack of information on external equity positions of shareholders may complicate the analysis of related-party lending.

This year we enhanced our analysis of the link between transparency and the cost of international borrowing. Clearly, the cost of borrowing is almost entirely determined by the creditworthiness of the issuer. However, it does not fully explain the observed market variation in bond yields (even netted of changes in macro-fundamentals). We believe that transparency is one of the important "soft" factors that additionally influence the cost of borrowing.

We built a model relating duration-based Eurobond spreads to creditworthiness and our transparency scores. We selected Eurobond issues with similar structure--in particular, we chose those issues that were publicly traded, had a fixed yield, did not belong to a class of asset-backed securities, were not subordinated, were denominated in foreign currency, and were registered on Bloomberg. The average duration-based spreads were calculated for the one-month period ending Aug. 10, 2006, in basis points. Whenever more than one Eurobond issue by the same bank fit these criteria, we selected one issue that was closest in its duration to the median duration of all Eurobonds issued by Russian banks. To account for the effect of an issuer's creditworthiness on the costs of borrowing, we included one-year probability of default as a control variable, as implied by the banks' credit ratings. The model shows the negative association between transparency and cost of borrowing (see table 9 and chart 5).

Table 9

Relationship Between Cost of Borrowing And Transparency
Variable	Coefficient	Std. Error
Intercept	423.9	85.4*
Ln (Default probability)	72.7	13.2*
Transparency index	(3.3)	1.5¶
R-squared	0.69
F-statistic	15.3*
*--Significant at 0.1% level. ¶--Significant at 5% level

 Chart 5

These results suggest that a 10-point increase in the transparency score is associated with a 0.33% (33 bps) decline in the cost of funds attracted through Eurobonds. This clearly supports our view that transparency is a valuable intangible asset that allows banks to attract cheaper funding in capital markets.

Although this area of governance is reasonably strong by international standards on the back of solid applicable legislation, with an average score of 64%, the studied banks in general make little effort to go beyond the scope of requirements provided by the Russian Law On Joint Stock Companies and related acts and regulations. Russian law provides for a "one share-one vote" principle, as well as sound procedures for general shareholder meetings (GSM), including those on notification and circulation of respective materials, proxy and in absentia voting, the right to nominate board candidates (for holders of 2% of votes and above), preemptive rights for new share issues, supermajority vote on several critical corporate issues such as amending the charter, and so on. Shareholders in all banks under Russian jurisdiction enjoy the reasonable level of protection provided by these norms.

At the same time, several loopholes in the legislation and lack of regulation in several domains of shareholder rights result in systematic governance weaknesses. While a majority of the studied banks publish GSM notifications on their Web sites, none of the banks provide adequate background information on the questions included in the GSM agenda. Few banks made IFRS financials available before GSMs. Among the 25 banks that made their IFRS financials public, the average period of time from the end of the financial year (2005) until the publication was 5.5 months (see table 10).

Table 10

Timeliness Of Publication Of IFRS Financials By Russian Banks In 2006
	April	May	June	July	August
No. of banks	9	5	4	4	3
Cumulative no. of banks	9	14	18	22	25

While these informational drawbacks hardly impair the rights of strategic shareholders that dominate the sector, they indicate a lack of procedures needed to cater to a larger shareholder base. Furthermore, while nearly all banks disclose dividend history and pay dividends within two months after GSMs--much sooner than the six months required by law--none of the banks follow a single payout day as is common in international practice. In addition, none of the banks pay interim dividends. Dividend policies typically have little value for shareholders as they contain nominal information only.

Board compositions and procedures appear to be the weakest area of governance in terms of their potential for serving the interests of a broader shareholder base. The average score for this component is 15%. We found that in more than half of the banks the representation of the majority shareholder and management on the board exceeds the share of the majority shareholder in the capital. In addition, only five banks have one-third or more of external board members (defined as independent directors and representatives of portfolio shareholders); among these, three banks have a majority of external members, and four banks have external board chairmen. This shows that the institution of independent directors is in its early stage of formation in the Russian banking sector. The existing board compositions impair their ability to serve the interests of all the shareholders as opposed to only the controlling shareholders. Accordingly, this increases risks for potential equity investors and raises potential discounts in banks' market valuations.

Positively, there is a high level of expertise present on the boards, as judged from publicly available biographical data. In 28 banks, boards included members with experience in strategic management (beside the bank's executives), and the boards of 23 banks had a majority of members experienced in strategic management of the banking sector and finance/auditing. This expertise is mostly represented by strategic shareholders: Only six banks have external board members with expertise in finance/audit, and seven banks have these members with relevant industry experience.

The structure and composition of board committees are among the least developed areas of governance in our survey. We found that only six banks had audit committees (up from two last year), five banks had strategy or risk committees, and four banks had nomination and remuneration committees. It appears that relatively few boards are taking advantage of committee-level discussions to raise the quality of the decision-making process. Furthermore, this finding may signal the nominal role of boards at several banks, which may exist due to legal requirements, but have little actual role. Only MDM-Bank has a fully independent board-level audit committee, and independent majorities on two other committees. Only three banks (MDM-Bank, Rosbank, and Sberbank) have external chairmen of audit committees, two banks (MDM-Bank and Rosbank) have external chairmen of remuneration and nomination committees, and only MDM-Bank has an external chairman of the strategy/risk committee. Three banks have fully nonexecutive audit and strategy/risk committees. Only in two banks (MDM-Bank and Alfa-Bank) do all members of the audit committee have financial background.

At two banks, we observed a questionable practice of appointing non-board members to board-level committees. Indeed, such external experts are not subject to fiduciary duties even if they are given voting rights at committee sessions. In only one bank (MDM-Bank) does the internal control department report directly to the audit committee and not to management, as is commonly done in international practice to ensure the independence of the audit process and internal controls.

Although banks typically do not disclose the actual statistics of board sessions and attendance rates, we observed that few banks have adopted bylaws that provide for a greater frequency of face-to-face meetings than that required by the law (four meetings per year). VTB is the only bank with bylaws providing that in-person board meetings be held every two months, and MDM is the only bank at which there is a requirement that the audit committee should meet every quarter. In our opinion, lower frequency of meetings may signal limited ability of these bodies to provide effective oversight in their respective domains.

Finally, only 11 banks do not practice lending to management or directors. We regard this as a weakness, because lending to board members may impair their independence and may distort compensation policies.

Research assistance provided by Elena Pastoukhova, Vladimir Greeniv, and Eino Rots

Disclosure of:

1. The number and par value of issued ordinary shares.

2. The number and par value of other types of issued shares (e.g., preferred, nonvoting).

3. The number and par value of authorized but unissued shares of all types.

4. The identity of the largest shareholder.

5. The number and identity of all shareholders holding more than 10%.

6. The identity of holders of all large stakes (blocking: > 25%; controlling: > 50%).

7. The identity of shareholders holding at least 25% of voting shares in total.

8. The identity of shareholders holding at least 50% of voting shares in total.

9. The identity of shareholders holding at least 75% of voting shares in total.

10. A list of external assets held by the blockholders.

11. Shareholding in the bank by individual senior managers.

12. Shareholding in the bank by individual directors.

13. The description of share classes.

14. A review of shareholders by type.

15. The percentage of cross-ownership.

16. Information about indirect ownership (e.g., convertible instruments).

17. A list of affiliates in which the bank holds a minority stake.

18. A list of subsidiaries.

19. The ownership structure of subsidiaries or affiliates.

Disclosure of:

20. The contents of corporate governance charter/guidelines.

21. The contents of a code of business conduct and ethics.

22. The provision of details about the bank's articles of association, such as changes.

23. A formalized dividend policy.

24. The existence of a review of last shareholders meeting (e.g., general presentation of voting results).

25. Detailed press releases covering last corporate events.

26. Policy on information disclosure.

Disclosure of:

27. The bank's accounting policy.

28. Annual filings to the Central Bank of Russia for the last year (RAS).

29. Quarterly profit and loss statements (RAS).

30. Monthly balance sheet statements (RAS).

31. Annual financial statements according to an internationally recognized accounting standard (IFRS/U.S. GAAP) without notes.

32. Notes to annual financial statements according to IFRS/U.S. GAAP.

33. An independent auditor's report with regard to annual financial statements according to IFRS/U.S. GAAP.

34. An unqualified (clean) audit opinion with regard to annual financial statements according to IFRS/U.S. GAAP.

35. Formalized policy on related-party lending.

36. Disclosure of related-party transactions (RPTs): sales to/purchases from, payables to/receivables from related parties.

37. Transactions with the companies with the same group.

38. Indication that RPTs are made on market or nonmarket terms.

39. Exact terms of RPTs.

40. Interim (quarterly or semiannual) financial statements according to an internationally recognized accounting standard (IFRS/U.S. GAAP).

41. Notes to such financial statements.

42. Whether these financial statements are audited or at least reviewed.

43. A basic earnings forecast of any kind.

44. A detailed earnings forecast.

45. A segment analysis (results broken down by business line).

46. Revenue structure (detailed breakdown).

47. Cost structure (high degree of detail).

48. The name of the bank's auditing firm.

49. Whether the audit firm is a top-tier auditor.

50. Auditor rotation policy.

51. How much the bank pays in audit fees to the auditor.

52. Whether or not the auditor renders any nonaudit services.

53. Nonaudit fees paid to the auditor.

54. Whether there are consolidated financial statements or whether only the parent or holding company is audited.

55. Methods of asset valuation (including depreciation).

56. Information about reserves.

57. Information about average interest rates on loans, deposits, and promissory notes.

58. Capital adequacy ratios.

59. Information about observing norm ratios states by the Central Bank of Russia.

60. Liquidity indicators (immediate, current, general, and liquidity gaps).

61. Indicators of concentration (industry, client/shareholder, insider, and so on).

Disclosure of:

62. Details of the products/services provided.

63. Output in physical terms (e.g., number of clients).

64. Efficiency indicators, such as ROCE, ROTA, net interest margin, and so on.

65. A discussion of the bank's strategy.

66. Analysis of the bank's risks (list of risks, their description, and the way they may affect the bank).

67. Risk management policy.

68. Any plans for investment in the coming years.

69. Detailed information about investment plans in the coming year.

70. Asset/capital forecast.

71. An overview of regulatory environment with regard to the industry.

72. The market share for any or all of the bank's businesses.

73. Social reporting (e.g., global reporting initiative).

74. Principles of corporate citizenship.

75. The list of top-five providers of funds (creditors).

76. The list of top-five receivers of funds (borrowers).

77. Information on interbank limits and their availability.

78. Reservation policy.

79. Information about asset quality.

80. Information about creditors with unsatisfied claims.

81. Information about internal controls.

Disclosure of:

82. The list of board members (names/titles).

83. Details about the current employment and position of directors.

84. Other details (previous employment, positions, and education).

85. When each director joined the board.

86. A named chairman listed.

87. Details about role of the board of directors.

88. List of matters reserved for the board.

89. List of board committees.

90. Names of all members of each existing committee disclosed.

91. The bylaws on internal audit functions besides the audit committee.

92. Information about the ratio of in-person and in absentia board meetings.

93. Attendance record for board meetings.

94. An overview of the last board meeting.

95. A detailed review of board meetings (minutes, including voting results on each item of the agenda).

96. The list of senior managers not on the board of directors.

97. The backgrounds of senior managers.

98. Details of the CEO's contract.

99. The number of shares held in affiliated companies by managers.

Disclosure of:

100. The decision-making process for directors' pay.

101. The specifics of directors' pay, including the salary levels.

102. The form of directors' salaries, such as whether they are in cash or shares.

103. The specifics of pay for directors.

104. The decision-making process for determining managerial (not board) pay.

105. The specifics of managers' (not board) pay, such as salary levels and bonuses.

106. The form of managers' (not board) pay.

107. The specifics of performance-related pay for managers.

1. Share registrar is independent.

2. CEO is elected by the board of directors.

3. Dividend payout period does not exceed 60 days.

4. Bank follows single-day dividend payout policy.

5. Bank pays dividends for three quarters of the last year and the first quarter of the current year.

6. Bank pays interim dividends.

7. Preemptive rights in case of share issue.

8. One share-one vote principle.

9. GSM competence includes basic shareholder rights (changes to Articles of Association, reorganization and liquidation, deciding upon quantitative and personal board composition, increase/decrease in charter capital, choosing an auditor, deciding upon interim dividends, approval of annual reports and financial statements, approval of share issues, deciding upon large transactions and related-party transactions, approval of internal company documents).

10. In absentia and proxy voting are allowed.

11. Bank uses electronic voting systems and facsimile electronic messaging systems.

12. GSM notifications published on the bank's Web site.

13. GSM materials are published on the bank's Web site.

14. Annual GSM materials include IFRS financials.

15. Annual IFRS statements are published within three months after the end of the reporting year.

16. Shareholders must be notified about GSM at least 20 days in advance.

17. Owners of more than 2% of share capital can place items on the GSM agenda and nominate candidates to the board.

18. Owners of more than 10% of share capital can call EGM.

19. Shareholders vote by ballots.

20. Directors are elected by cumulative voting.

21. The term of the entire board directors does not exceed three years.

22. When submitting the question on related-party transaction the bank uses the control-principle definition rather than of direct affiliation.

23. Supermajority voting rules on critical corporate issues (75% supermajority, such as decrease in charter capital, share issues, changes to Articles of Association, reorganization and liquidation, share buyback, approval of transaction for the sum exceeding 50% of bank's total assets).

24. Buyer of 30 and more percent of capital must make sell offers to other shareholders.

25. Shareholder has a right to claim buyback when he objects to critical corporate decisions (reorganization, changes to Articles of Association that may limit shareholder's rights).

26. Representation of the majority shareholding group and management in the board of directors does not exceed their share in capital.

27. Majority of the board is external.

28. More than one third of the board members are external.

29. Board chairman is external.

30. Board includes external members with relevant industry experience.

31. Board includes external members with expertise in finance/audit.

32. Board includes external members, except for executives of the bank, with expertise in strategic management.

33. At least half of the board members possess expertise in these spheres.

34. Existence of audit committee.

35. Existence of nomination and remuneration committee.

36. Existence of strategy or risk management committees.

37. Majority of the audit committee is external.

38. Majority of the nomination and remuneration committee is external.

39. Majority of strategy or risk management committees is external.

40. Chairman of the audit committee is external.

41. Chairman of the nomination and remuneration committee is external.

42. Chairman of strategy or risk management committees is external.

43. Nonexecutive audit committee and risk committee.

44. Audit committee consists of external members only.

45. Confirmation of high level of financial expertise of audit committee members.

46. Existence of Code of Ethics for board members.

47. Existence of bylaws on audit committee (description of role and procedures).

48. Existence of bylaws on nomination and remuneration committee.

49. Existence of bylaws on strategy or risk management committees.

50. Audit committee does not include nondirectors.

51. Nomination and remuneration committee does not include nondirectors.

52. Strategy or risk management committees do not include nondirectors.

53. Internal control department reports to audit committee.

54. Board meets every two months.

55. Audit committee meets every quarter.

56. Bank does not provide loans to management or directors.

57. The board of director's competence is formalized and includes the following: determination of strategy (key bank's development directions), calling GSM and determining its agenda, increase in charter capital, approving share buyback/share issues and their terms, deciding upon the auditor's remuneration, recommendations on dividend payments, approving share registrar and his contract, deciding upon large transactions and related-party transactions.

58. Board of directors decided upon transactions the sum of which exceeds 5% of bank's assets.

59. Board of directors decided upon transactions the sum of which exceeds 10% of bank's assets.