The Sleeping Bear

  Russia has more potential for payment card growth than any other Eastern European country. What will it take for Russia's card industry to fulfill its promise?
  While the Russian payment card market has expanded rapidly over the past two years, it remains substantially underdeveloped, both relative to former satellite countries and even more so compared with the European Union.
  At the end of 2001, there were fewer internationally branded cards in Russia than in the Czech Republic, which has one-fifteenth of Russia's population-just 4.4 million cards in Russia against 4.5 million in the Czech Republic. Though Russian cards overtook the Czech Republic in 2002, the comparison shows the slow development of Russia's card business.
  One reason is the low level of foreign bank involvement. In Czech Republic, according to the analysis by HVB's Bank Austria-Creditanstalt, foreign banks controlled 78% of total bank assets. That compares with 5% in Russia. Though players like Citibank, Austria's Raiffeisen and France's Soci?t? G?n?rale are present in Russia, their impact in terms of upgrading technology and injecting know-how has been much more limited than in Eastern Europe.
  The modernization of Sberbank, the state savings bank, will be one key to the expansion of Russia's card business. It accounts for about 35% of the card market and for nearly 70% of ruble deposits by individuals. With 21,000 branches and agencies across 10 time zones, as well as more than 200,000 employees, it has the biggest physical network in the world.
  Based on 1.5 million Maestro, 500,000 Visa Electron and over 2 million proprietary inter-regional Sbercard chip cards, Sberbank had issued 4 million cards by August 2002 and is now close to 5 million. Sberbank reflects Russia's approximate fifty-fifty split between international and proprietary card programs.
  No other bank has more than 150 branches and none has so far issued over 1 million cards, says Lou Naumovski, Visa's regional general manager for Russia and the CIS. "But others are showing leadership in new products and giving Sberbank a run for its money."
  The Moscow Social card, in which Visa is partnering with Bank of Moscow and Moscow city authorities, is a case in point, Naumovski says.
  "It will reach 1 million cards by (year-end) 2003 and has the potential to reach 3.5 million cards within a few years," he says.
  Sberbank is organized along federal lines, with a structure of 17 regional banks of which Sberbank Russia, based in Moscow, and North-West Bank, based in St. Petersburg, are the most important. The Central Bank of the Russian Federation (CBRF) owns 60% of Sberbank's shares.
  The Sberbank group has been attempting to upgrade its technology base against a background of shortages of funds and, until recently, lack of official encouragement for retail banking. In February, it installed a new processing system from OpenWay, the Brussels- and St. Petersburg-based software supplier, which will support real-time processing for all 17 units.
  Focus on Debit
  Like most other Russian banks, Sberbank has focused on debit cards issued within so-called salary projects, where a company pays employee salaries directly to a card account. Salary card programs account for between 80% and 90% of international cards issued and for almost all the cards issued under domestic projects.
  Outside these projects, most Russians prefer to conduct their banking through traditional hand-entered savings books, and spontaneous demand for personal debit card accounts is low. Development of the mass market therefore depends currently on the ability of banks to sign up new salary projects.
  "There remains a persistently high cash usage in Russia, due to the high unbanked population and mistrust of banks after the financial collapse in 1998," says Igor Gaidarji, country support manager at Visa International's Moscow office. Bad telecom links, inadequate capitalization of many banks and low overall merchant penetration are other problems, he adds.
  The slow development of Russian payment cards-and by extension, of retail banking generally-continues to reflect the banking crisis of August 1998, the key event in the country's post-communist financial history. As the crisis hit, Europay and Visa temporarily suspended the licenses of several banks and blocked their bank identification number codes.
  Amid widespread negative media coverage, cardholders in many cases were unable to access their accounts. Reporting on the aftermath of the crisis, Moscow-based analyst Oleg Smorodinov wrote: "It will take a long time before people 'from the street' would want to come into a bank's office and apply for a card."
  Even today, CBRF figures show 887 "credit institutions liquidated owing to revocation of license," for reasons including "violation of banking legislation and Bank of Russia regulations" as well as mergers or reorganization. With 1,200 banks licensed to accept personal deposits, the retail banking system beyond Sberbank is extremely fragmented.
  The card business stagnated between 1998 and 2000, with the number of cards issued little changed by the end of 2000 as the rest of the region charged ahead (table, p. 50). Only in 2001 and 2002 did the business start to grow rapidly again.
  With just under 8 million internationally branded cards for a population of 145 million, however, there is a long way to go before reaching EU levels of almost one card per inhabitant. Progress is at best likely to be steady rather than spectacular, observers say.
  "Five years from now, we expect 10 million cards and that's conservative," says Andrei Korolev, Moscow-based general manager at MasterCard Europe's Russian representative office, referring to MasterCard- and Maestro-branded cards only. The vast majority will be debit cards, though Korolev notes some interest in credit cards, including the programs recently launched by Russisky Standard, a local monoline issuer.
  "There are things we can't control, but we've had phenomenal growth in the past three years," says Visa's Naumovski. "Our market share will continue to grow and we expect 9 million cards by (year-end) 2003. Five years out, it could be anything from 25 million to 35 million."
  Taking Moscow and St. Petersburg together, the payment cards business in Russia is more developed than figures for the country as a whole suggest. Naumovski says the two cities account for 20 million people-about 13% of the population-but 75% of issuance and acceptance.
  On this basis, there are probably around 0.3 cards per capita in St. Petersburg and Moscow-"about the same as a medium-sized Eastern European country," Naumovski says.
  However, the further implication is that other regions of Russia are hardly developed-about 2 million international cards for 125 million people.
  To complete the picture, international cards account for just over half the payment card market in Russia, according to CBRF figures. At year-end 2002, there were 15.4 million payment cards, of which the international element was just under 8 million.
  The CBRF figures also show the preponderance of automated teller machine transactions over those at the point of sale. Cash withdrawals accounted for 93% of total transactions in 2001 and 2002. Based on a rate of about 30 rubles to one euro, total volumes were about E22 billion in 2002, running at E7 billion in the fourth quarter.
  Other banks also are expanding nationally, including Alfa Bank and Bank of Moscow. There are also strong regional players, Visa's Gaidarji notes, in the Urals, Volga and parts of Siberia.
  "Our new strategy is to focus on areas outside St. Petersburg and Moscow, where the growth potential is highest," he says. "We want Russian consumers to perceive Visa as a local brand with global reach."
  Korolev notes that there are 11 cities apart from St. Petersburg and Moscow with populations of more than 1 million. But he notes that "there is still room to grow in St. Petersburg and Moscow. Income levels are higher, the big retail chains are more developed and T&E is mostly there. So if you weight it, St. Petersburg and Moscow are worth 50% of your efforts."
  Legislative changes are increasingly shaking up the Russian banking market and forcing it to become more competitive. After the August 1998 crisis, Sberbank gained market share as the only bank permitted to offer a state guarantee on deposits up to Rbs 95,000 (e3,150). Within about 18 months, this privilege will be extended to other Russian banks, under a proposed deposit-guarantee law.
  There has been talk of privatizing Sberbank, but CBRF officials say this would merely transfer a semi-monopoly from public to private hands. They expect privatization to take place in a few years when Sberbank's market share is likely to have fallen in the face of greatly expanded retail banks.
  The country's rulers have also recognized that cards can help drive growth by increasing liquidity in the economy. "Salary projects will become mandatory in Russia-they are voluntary at the moment," says Andrey Gamolsky, general manager of the card payment division at Rosbank.
  Many salary projects are for individual factories, which in Russia are often large enterprises. Moscow World Bank is one of the country's top 10 issuers, with 180,000 cards. "We operate six large salary projects such as metallurgical plants, with 5,000 to 10,000 cards," says Alexander Dubovik, deputy head of the payment systems department.
  More substantial still are the salary projects within Russia's "closed cities," those which undertook strategic functions like armaments production in Soviet times. Norilsk, the Arctic nickel and platinum mining complex, is an example of one of the biggest closed cities, with 80,000 employees.
  Companies like card-based salary projects, says Gamolsky, "because they can close cash desks, save on cash delivery and cut staff queuing time."
  In partnership with Norilsk Nickel, Rosbank has launched a salary project, alongside the existing proprietary smart card-based Duet system from BGS Smartcard Systems.
  "We had to meet with the Council of Brigadiers and their attitude was hostile-they wanted cash," says Gamolsky. "But they support families in other parts of Russia and the CIS, so they need a funds-transfer system. We issue a second card to a family member, who can access the salary account from anywhere in the world. Now people are asking for the cards voluntarily-their friends have them and the supplementary cards are popular." Previously, Norilsk workers had to transfer funds via Sberbank for a fee.
  Another feature of the card program is that it offers Norilsk workers credit equivalent to twice their monthly salary, repayable over two months at an annual interest rate of 12%. The Visa Electron cards currently have magnetic stripes and about 8,000 are thought to have been issued. A pilot with VSDC smart cards is under way.
  The Duet system has run for nine years, with 50,000 electronic food voucher cards and 40,000 salary payment cards.
  "After many years of successful operation, due to corporate political considerations favoring Visa, Rosbank decided to replace 40,000 Duet salary cards with international online Visa cards," says Yuri Demidovich, executive vice president for business development, CIS region, at BGS.
  Norilsk Nickel, Rosbank and UCS, the biggest Russian acquirer of foreign cards, are all owned by the same financial group, "thus Rosbank gained strong political influence on the Norilsky combine," he adds. "The future for the Duet system in Norilsk is uncertain, but after nine rather exclusive years, the new system still has to prove its feasibility, profitability and reliability."
  Adds Naumovski: "We estimate there are 70 million 'cardable' people between the ages of 14 and 60. (The current) 15 million cards is low penetration and that's going to grow, along with the preference for international cards-the real losers are going to be the local payment brands."
  Like the cards market generally, ATM and POS networks are underdeveloped in Russia at present, even in relation to former satellites like Czech Republic and Poland. Russian banks would need to install around 100,000 ATMs and 2 million POS terminals-a challenge probably requiring between 10 and 15 years-to reach EU levels.
  Not least, the networks need to be linked up and managed across the most demanding and widespread physical geography in the world. Whatever model the Russians adopt, the task of making it happen is not, as Pravda used to say, for the chicken-hearted.