Related-party loans are an important driver behind the high level of problem loans in CIS banks, which, on average, had 20% (including restructured) of their loans in the problem category at mid-2011. The average level of related-party loans at CIS banks was around 10% of gross loans and 50% of shareholders' equity at year-end 2010. This level is five times higher than in Central and Eastern Europe and two times higher than in the Middle-East.

The trend in related-party lending is mixed. Russian banks exposures to "insiders" decreased to 41% of capital in 2010, from 43% in 2009, due to increased lending opportunities in the corporate sector. A positive trend was also observed in Kazakhstan, Ukraine and Armenia. However, banks in Azerbaijan, Belarus and Uzbekistan increased their exposures.

The main drivers behind the high level of related-party lending in Russia and the CIS are (i) weak corporate governance and risk management; (ii) high risk appetite and low business diversification in retail and SME segments; and (iii) weaknesses in regulation and supervision.

"High credit risks from related-party exposures contribute to low bank ratings in the CIS region. We believe that lending to "insiders" is indicative of weak corporate governance and lax underwriting standards," explains Eugene Tarzimanov, a Moody's Vice President and Senior Analyst.

"The recent bailout of Bank of Moscow in Russia, which required USD14 billion in rescue capital, highlights the risks linked to "insider" lending. Related-party exposures were also one of the key factors behind approximately half of the 23 bank defaults in the CIS during the crisis," adds Mr Tarzimanov.

Moody's note that related-party exposures are often understated, as they are difficult for regulators and external auditors to capture due to often opaque and complex ownership structures of banks and companies in the region. While local banking regulators have acknowledged that this risk contributed to a large number of bank failures, little or no reforms have been undertaken in this area.

This report is based on audited IFRS reports of 116 Moody's-rated banks in Russia, Kazakhstan, Ukraine, Uzbekistan, Belarus, Armenia, and Azerbaijan. These banks represent 70-80% of banking system assets in their countries.