Red Tide at the Casino

Illustration for TIME by Edel Rodriguez

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There's a celebrated scene in dostoyevsky's classic novel The Gambler in which a wealthy, 75-year-old Russian grandmother takes a seat in a casino and watches a young man pile up his winnings at the roulette table. After a few minutes, she nudges the narrator, and instructs him: "Tell him to stop and take his money with him. Soon he will be losing — yes, losing everything that he has now won."

In the wake of the meltdown of the stock market in Moscow this month, there are quite a few Russians who probably wish they had heeded that sort of advice. For after partying through several years of heady growth, much of it financed by borrowing from abroad, the nation's scrappy banking system and its underdeveloped financial markets are suddenly losing much of what they have won in the past couple of years — and more.

The main MICEX stock exchange shut down for two days on Sept. 16 after it lost 17% of its value in a matter of hours. At that point the market was down almost 60% for the year, its lowest level since early 2006, although it has since been boosted by measures taken by the Russian central bank and the Kremlin. Those measures, however, weren't enough to shore up the nation's largest investment bank, Renaissance Capital, which on Sept. 21 sold a 50% stake to the Russian oligarch Mikhail Prokhorov for $500 million. Just over a month ago, Forbes magazine, in a profile of Renaissance and its New Zealand – born chief executive, Stephen Jennings, reckoned the same stake would have been worth $3.5 billion — seven times as much.

Some Russia watchers are expecting much more upheaval. Vladimir Savov, an analyst for Credit Suisse in Moscow, sees the recent turmoil as the beginning of a broad consolidation of Russia's highly-leveraged banking sector. "We want to hope that this will improve the resilience of Russia's financial markets in the long term," he says, "although in the near term the process could be painful." Renaissance says it had been in talks for some time and didn't act out of distress. But its move came a few days after the first financial institution fell victim to the crisis, a boutique investment bank and brokerage firm called KIT Finance, which defaulted on its debt when the markets shut down; it was rescued by an investment arm of the state energy giant Gazprom. Other erstwhile high-flying financial firms in Russia remain at risk. According to the business newspaper Kommersant, the Russian central bank has drawn up a "red list" of 15 other second-tier banks that, like KIT, are in urgent need of financial assistance.

A variety of factors are speeding a shakeout. They include falling oil prices and Russia's war with Georgia, which spooked foreign investors and sparked capital flight. Of course, the tumult on Wall Street and the general seizing up of global finance has caused a liquidity squeeze for banks worldwide. But the root cause of Russia's current crisis is homegrown: wannabe oligarchs who used debt to continue doubling down while the going was good, only to find themselves on shaky ground now that the market has turned. As one wag said this month, it's a case of minigarchs turning into nanogarchs.

International lending statistics show the extent to which Russians have been bingeing on borrowed funds. The total volume of international financing of the private sector, including bonds, equities and loans, has more than tripled in the past three years to over $76 billion. Indeed, Russia has raised more on international bond markets alone than the whole of Latin America.

The big question is what sort of an impact the banking sector's problems and the cascading margin calls on stock-market investors will have on the Russian economy as a whole. In such volatile times, it's particularly hazardous to make any predictions. But Russia experts say that, for the moment at least, they don't expect the troubles to blow up into a huge national economic crisis like the one of a decade ago, when the ruble collapsed and the economy contracted sharply. If anything, there will be a welcome cooling off in the economy, which has been hit by rising inflation.