By Anatoly Kurmanaev 

ST. PETERSBURG -- After Russia's central-bank chief, Elvira Nabiullina, moved to shut down a large lender last year for allegedly falsifying accounts, the nation's top prosecutor's office issued an order to leave the bank alone.

She closed it anyway.

In her five years in office, Ms. Nabiullina has closed hundreds of weak banks, stymied the exodus of Russian wealth abroad and transformed monetary policy to bring inflation to record lows. That has earned her an unusual amount of freedom to make tough decisions, even if that means treading on powerful interests.

Thinking of Ms. Nabiullina merely as a central banker understates the significance of her role. As President Vladimir Putin bids to return Russia to great-power status, challenging the U.S. and Europe from Syria to Ukraine, it's her job to shore up the economy against volatile oil markets and sanctions. Russia's ability to continue its quest rests in large part on whether Ms. Nabiullina can keep the financial system stable.

Given Russia's messy, corruption-filled banking system, that is a challenge. She has struggled to regulate some state banks, analysts said, and her job has grown more difficult with looming new U.S. sanctions against Moscow for a nerve-agent attack against a former Russian spy in the U.K. Moscow has repeatedly denied involvement.

Ms. Nabiullina has earned public praise from Mr. Putin, who rarely commends subordinates, as well as from abroad. Last year at the Kremlin, Mr. Putin told her that "under your leadership, the central bank has done a great deal to stabilize the economic situation." Managers at big investment funds, from Pacific Investment Management Co. to Pictet Asset Management, call Ms. Nabiullina one of the world's most skilled central bankers. Christine Lagarde, managing director of the International Monetary Fund, lauded her in May for setting "standards of quality for macroeconomic policy."

International investors have piled into Russian government bonds, despite its weak economic growth, weakening currency and deepening U.S. sanctions.

"Nabiullina was clearly given a mandate from the highest level of the government to bring stability," said Kirill Lukashuk, head of the financial sector at ratings agency ACRA. "The government realized they can't be stable without a healthy banking sector, strong reserves and low inflation."

In an interview, Ms. Nabiullina said her focus has been on improving the health of Russia's banking sector. "It became obvious to everyone that something had to be done," she said. "In the circumstances when we started facing external challenges and geopolitical risks, the financial system had to become very strong and very stable."

The Kremlin didn't respond to a request for comment.

When Ms. Nabiullina took over Russia's central bank in 2013, it was a sleepy institution with poorly trained staff and limited powers, investors and bankers said. Mr. Putin criticized her predecessors for lacking the will to clean up the country's banks.

In 2006, the central-bank official responsible for revamping the system, Andrey Kozlov, was shot dead in his car. Russian financier Alexey Frankel, whose banking license Mr. Kozlov had revoked earlier that year, was later convicted of organizing the killing.

Today, bodyguards accompany Ms. Nabiullina even inside her headquarters.

Detractors include presidential advisers and industrialists who say her focus on low inflation and iron regulation is stifling the economy.

"From stability to stagnation is just a short step," said Andrey Sokolov, chairman of Russia's largest private lender, Alfa Bank.

There are about 480 active banks in Russia, triple the number in Brazil, which has a similar-sized economy. Russia's top 20 lenders, however, account for 70% of the banking assets. Almost a third of the banking system is in the hands of state-owned Sberbank, the successor of the Soviet Union's banking monopoly.

Ms. Nabiullina, 54 years old, was born into a working-class Tatar family in the Ural Mountains. She earned an economics degree from Moscow's top university during the final years of the Soviet Union and immediately began working on policies for Russia's burgeoning market economy.

She spent the 1990s working at the country's largest business trade group and in the economy ministry. She has earned a reputation for bookishness, personal honesty and fixation on detail, according to government advisers. Those qualities drew the attention of Mr. Putin, who brought her into his think tank to help draft an economic manifesto shortly before he assumed the presidency in 2000.

As president, Mr. Putin consolidated power, curbing the political clout of tycoons and regional strongmen. At the time they also controlled a large part of the banking system, using weak regulation to finance political campaigns and personal ventures and to transfer wealth out of the country.

When banks collapsed under the weight of bad lending decisions and unsustainable deposit rates, owners often moved abroad, usually to London, where they bought mansions at record prices. The U.K.'s government has denied extradition requests from Russia, citing lack of trust in the country's judicial system.

Industry veterans said that before Ms. Nabiullina took over, banking licenses were mostly used as mechanisms to funnel money abroad and process insider deals.

"We used to open a newspaper in the morning and look at the banking deals and said -- that's capital flight, and that's asset stripping," said Sergey Khotimskiy, co-founder of one of Russia's largest private banks, Sovcombank. "The dodgy enrichment schemes were obvious to everyone."

The 2008 global financial crisis exposed the weakness of the system. Indiscriminate lending saddled banks with mountains of bad debts, which they camouflaged with increasingly elaborate balance-sheet exercises, said Mikhail Zadornov, a veteran state banker. Bank failures snowballed, leaving the state to pick up the tab for insured deposits.

Banking woes slowed Russia's economic recovery, which convinced Mr. Putin to act. In Ms. Nabiullina he saw a loyalist who had the expertise and the stomach to clean up the financial system, according to two people who were government advisers at the time. Mr. Putin appointed her as his economic adviser in 2012, and head of the central bank the following year.

When she took over the institution, banks and companies were moving $5 billion out of the country every month, and inflation topped 7%.

She shut down 70 banks in her first year.

In 2014, the West met Russia's military interventions in Ukraine with sanctions. The impact, combined with a precipitous fall in the oil price, caused the value of the ruble to fall by half against the dollar that year.

Ms. Nabiullina stopped a longstanding policy of spending billions of dollars from the country's reserves to try to prop up the ruble. In December 2014, with the ruble continuing to fall, the central bank nearly doubled its key lending rate to 17% at an emergency late-night meeting.

The rate increase restored calm to markets but strangled the country's consumer-fueled growth. The country's emerging middle class, which had become used to foreign vacations and European cars, is still feeling the effects of the ruble's collapse.

Some government advisers and lawmakers criticized Ms. Nabiullina for the rate increase. "Difficult decisions are difficult to explain [to the government]," she said. "For me it was easy to make that rate decision, because I was sure there was no alternative."

Ms. Nabiullina turned her attention next to homegrown problems. Since she took office, she has halved the number of Russian banks, shutting down about 440 lenders. She has reduced capital outflows by about 50% to $2.5 billion a month.

Many of the banks she closed had been considered untouchable, analysts said. Some, such as Promsviazbank, counted lawmakers and state-company executives among its shareholders and held money for national oil companies and the Orthodox Church. Others, like Bank Sovetskiy, had served political objectives, providing banking services in Crimea, the Ukrainian region the Kremlin annexed in 2014.

A dozen shut-down lenders have tried suing the central bank to get their licenses or assets back. None have succeeded.

"Nabiullina has freedom to operate as she chooses in the interests of stability, even when it hurts vested interests," said Alexander Danilov, a banking analyst at Fitch Ratings. "She has stepped on many toes."

Yugra, the bank she closed last year over the objections of the prosecutor's office, is owned by construction magnate Alexey Khotin. The bank had used credit taken from other banks to subsidize market-beating deposit rates, and became the 12th-largest holder of retail deposits in the country last year, according to the central bank. It also sponsored an amateur hockey league founded by Mr. Putin, who occasionally plays in it.

When the central bank took over Yugra last June following repeated warnings, it said it found a $600 million deficit in its balance sheet masked with bad loans. Just hours before the bankrupt bank's license was due to expire, the prosecutor's office ordered a halt to the closure, calling the bank "a financially stable credit organization." Ms. Nabiullina rejected the order.

Mr. Khotin's representatives and the prosecutor's office didn't respond to a list of questions on Yugra's closure, which the bank is contesting in court.

"It was a test of will, and she won," said banking analyst Mr. Lukashuk.

Ms. Nabiullina's freedom stands out from her peers in developing economies from Turkey to Argentina, where central bankers are under pressure from the government to keep interest rates low to keep credit flowing to voters and businesses.

In January, inflation hit a record low for the post-Soviet period of 2.2%, a result of Ms. Nabiullina's decision to keep interest rates high after the Crimea sanctions. Some tycoons have urged a faster reduction.

Ms. Nabiullina's confidence in Mr. Putin's backing was on display at the central bank's congress in St. Petersburg in June.

She publicly traded barbs with the chief executive of Russia's banking behemoth, Sberbank, and criticized the head of a major state oil company for raising gasoline prices. She chastised the police and courts for not doing enough to punish errant bankers.

Still, she has struggled to regulate Russia's lesser, underperforming state-owned banks, whose executives often treat them as fiefs, analysts said. These banks are kept afloat by constant injections of state funds, which the executives have funneled into unrelated assets ranging from supermarkets to railroad cars.

Almost a trillion rubles of public capital, about $16 billion at today's rate, went to just three state-owned banks -- VTB, Gazprombank and Rosselkhozbank -- in the first four years of Ms. Nabiullina's central-bank term, according to Fitch Ratings. All are still saddled with bad debts or illiquid assets.

Ms. Nabiullina said the same regulatory rules apply to all banks, adding that she has shut down several regional state-owned lenders.

The central bank has also come under criticism for bailing out three large private banks last year, including the country's seventh-largest lender, Bank Otkritie. The move has cost the government about $44 billion and continues to drain public funds.

Private bankers said Otkritie should have been sold off in pieces instead of becoming yet another state bank. Government-owned lenders now account for two-thirds of all lending and private deposits.

Ms. Nabiullina said Otkritie was "too big to fail" and required a quick takeover to avert a financial crisis.

While the cleanup of the financial sector is nearly finished, she said, she sees bigger problems for Russia's economy as a whole. "The previous model of [consumer-led] economic growth has been drained," she said. Her modest economic forecasts have consistently lagged behind Mr. Putin's goals, which she said can only be achieved through deep, unpopular changes to the system.

Even if the price of oil rose to $100, from around $65 today, she said, "it's very unlikely that our economy can grow above 1.5% to 2%" a year.

--Anna Mikheeva and Mike Bird contributed to this article.

Write to Anatoly Kurmanaev at Anatoly.kurmanaev@wsj.com

(END) Dow Jones Newswires

August 20, 2018 10:11 ET (14:11 GMT)

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