Peter O. Kölle Managing Director CIS HVB Group A member of HVB Group DEVELOPMENTS IN RUSSIAN BANKING: WHAT POTENTIAL INVESTORS IN RUSSIA SHOULD KNOW Boston Financial Markets Conference Boston, May 5, 2004

page 2 A member of HVB Group Who is HVB Group? Total Assets$ 600 bn. No. of Employees60,214 No. of Offices2,062 RatingA- HVB Group is the most committed bank in Eastern Europe with offices in 16 countries, 19,000 local employees, USD 28.1 bn. of assets and 3.9 mn. clients HVB Group* (*As of Dec. 31, 2003)

page 3 A member of HVB Group –Main shareholder (43.4 %) of IMB (the largest foreign bank in Russia) –11 % of Russian exports are channeled through IMB –28 % of long-term corporate deposits of Russia are kept at IMB – retail clients –Leader in Project Finance (last transaction $ 450 m Gazprom 2003) –# 1 arranger of syndicated loans in CEE/CIS (91 deals, $ 1.4 bn. in 2003) –Among the top group of banks for commodity trade finance –No. 1 partner of EBRD ($ 514 mn.) and IFC ($ 433 mn.) in cofinancing programs What is HVB’s business / investment in Russia?

page 4 A member of HVB Group 1. Huge top and bottom line growth potential 2. Positioning as a major energy and raw material supplier 3. Improved political risk and excellent macros 4. Fear to miss the boat What drives investors to look at Russia?

page 5 A member of HVB Group The “bus“ question - too much depends on Putin. “Russians seem to prefer less democracy in exchange for more order“ (FT) Dependency on energy and raw material exports  high volatility  high risk Regional authorities de facto “ owners“ of the natural resources (battles for the control of the area´s cashflows) Danger of inflated asset prices/ unrealistic perception of owners about values of their assets What worries investors despite all this?

page 6 A member of HVB Group Fear of asset / cash flow diversion via Russian off-shore companies Fear of not getting justice within the legal system - inability to solve corporate disputes in a fair and civilized way (Soros case, Yukos case). Courts still likely to follow instructions from Kremlin / local governments Medium-sized companies afraid to invest in Russia because of constant pressure from lower-level bureaucrats extracting bribes Despite privatization government agencies retain powers to harrass business and government lives off rent of quasi-privatized businesses What worries investors despite all this?

page 7 A member of HVB Group High risk / reward  high cost of capital  high RoE  high leverage  possibility to borrow on the bank or capital markets. The main reason for equity in a company is to leverage (to decrease the WACC and to improve RoE) Growth is not sustainable if it is difficult to finance working capital and investments 95 % of financial needs in Russia cannot be fulfilled by capital markets (national or international) - not enough transparency and unable to accept capital market volatilities Foreign loans will predominantly go to Russian blue chips. Russian bank risk is still hard to swallow for foreigners (intransparent ownership and asset / capital structures) Why does Russia need a better banking system?

page 8 A member of HVB Group Local capital markets: IPOs small and scarce (only 3 IPOs totalling $800 mn), RUR bond market booming but risky. Equities: market capitalization $ 250 bn. Large Russian corporates tend to access the international capital markets for alternative, cheaper and longer-term sources of funding. Russian Banks, however, borrow less favorable than large Russian corporates (Western banks welcome mainly Russian raw material exporters). Small and middle-sized companies get hardly access to the domestic or international capital markets Russian Capital Markets (current situation)

page 9 A member of HVB Group Only Russian banks have the investment banking capabilities to take advantage of the increase in capital markets activity. MDM, Alfa, Rosbank all look for a foreign investor themselves Long-term funding of smaller Russian banks including capital market measures boosts their funding costs Problem for IPOs: Government and local entrepreneurs do not want to give up control Uncertainty over property rights from privatization and legal claw-back Russian Capital Markets (current situation)

page 10 A member of HVB Group Wide reforms in the Russian banking sector “Roadmap “ announced and developed by the Central Bank of Russia and the Ministry of Finance could lead to a consolidation in the Russian banking sector –More banks will have an adequate capitalization level to provide full range of the financial market services not only for large corporates –Possible access of the small- and middle sized enterprises (SME) to the domestic and international capital markets will stabilize and improve the SME sector, which plays the key role in Russia Russian Capital Markets (possible developments)

page 11 A member of HVB Group Some “mattress money“ finds its way into the banks More saving in Roubles and not only in USD Complex currency choices (weak USD, strong EUR, strong RUR) “Capital cleansing“ and deposit insurance on the way The Russian banking system - finally improving

page 12 A member of HVB Group Relicensing of banks will start mid 2004 (deposit insurance eligibility) Merger laws simplified, but many owners of banks do not want them to merge or expand their lending Foreign banks own only 5.7% of total Russian banking assets (lack of transparency, inflated capital, quality of loan portfolio, window- dressing of ratios, weak deposit base, complicated history, nightmare of legal due diligence - all this is a deterrent for investments into banking) Planned changes to the Law on Banks & Banking activity could remove distinctions between residents and non-residents in purchasing bank share capital (WTO) The Russian banking system - finally improving

page 13 A member of HVB Group SME loans encouraged and refinanced through IFIs Mortgage market developing, but long-term funds are limited Russian Banks are no longer used simply for making payments, but also for saving money. (18% of the Russian GDP are households deposits, which are an important refinancing source for some Russian banks, especially for Sberbank) The Russian banking system - finally improving

page 14 A member of HVB Group The challenges still remain Vulnerablility of the Russian banking system caused by concentrated loan portfolio and not diversified revenue structure remains the main reason for still missing trust into Russian banks The strong dominance of Sberbank distorts the balance in the Russian banking sector A Russian passion: Concealing the true ownership (70% of Russian business is owned anonymously, true owners are hidden behind offshore entities) Despite slowly improving trust of Russian households in Russian banks, it is still a long way for Russian banks to play the same role in the Russian economy like the western banks in their countries do