OREANDA-NEWS. The conversion of subordinated loans granted by state-owned development bank Vnesheconombank (VEB) into preferred shares will improve regulatory capital flexibility at Russia's largest banks, Fitch Ratings says in a new special report. However, the conversion will not improve core capital, and may also weaken overall capital quality if banks raise additional subordinated debt on the back of it.

On 21 July 2014, President Putin signed a decree allowing 17 large Russian banks to convert subordinated loans received from VEB in the crisis of 2008 into preferred shares. Sberbank has also been given the right to convert its RUB500bn subordinated loan from the Central Bank of Russia (CBR) into either preferred shares or a perpetual bond.

Fitch estimates that the banks that convert will benefit from considerable uplift (ranging from 20bps to 450bps) to their regulatory Tier 1 capital adequacy ratios, which in most cases currently represent the banks' biggest capital constraint. However, core Tier 1 and total capital ratios will remain largely unaffected and may come under pressure in the medium term as a result of further loan growth.

The quality of the new capital will be moderate due to rather weak loss absorption, resulting from the low 2% conversion trigger for preferred shares (a higher 5.5% for the perpetual). The conversion will create the capacity and incentive to raise more subordinated debt, which if used aggressively, may weaken overall capital quality.