VEB's $20 bln bailout request casts harsh light on development bank's operations

* Kremlin (LSE: 0Q8D.L - news) mulls $20 bln rescue package for VEB bank

* Bank reported $4.5 bln loss in 2014

* VEB loans helped fund 2014 Sochi Olympics

* Also faces heavy losses from Ukraine investments

By Jason Bush

MOSCOW, Nov 27 (Reuters) - A $20 billion bailout request from Russia's state development bank is raising questions about the running of a lender which helped fund the Sochi Olympics in 2014.

The descendent of a Soviet foreign trade bank, Vnesheconombank or VEB assumed a bigger role in 2007 when Russia designated it as the country's development bank, since when its loan portfolio has expanded more than tenfold to reach 2.8 trillion roubles ($50 billion).

VEB, which also has around 1 trillion roubles in other assets, says it is modelled on state banks in other countries and serves important functions such as investing in infrastructure and promoting high-tech industries.

But last year it reported a loss of 250 billion roubles ($4.5 billion) and critics ask why taxpayers should fund loss-making projects whose economic benefits are often questionable.

"The main problem is that the bank is not governed as an independent agency or a business entity," said Sergey Aleksashenko, a former Russian central banker. "It (Other OTC: ITGL - news) is governed like a second budget ... (ignoring) economic efficiency or economic results."

VEB declined to comment.

Even (Taiwan OTC: 6436.TWO - news) some senior ministers are unhappy with how VEB operates. Finance Minister Anton Siluanov told Reuters the bank's activities "should be based on break-even principles".

Analysts say VEB's losses are unsurprising given how the government uses it to finance spending outside the budget, making government finances look stronger than they really are.

The 2014 Sochi Olympics are a case in point.

With (Other OTC: WWTH - news) an official cost of some $50 billion, they were by far the most expensive Games in history. Many projects linked to the Olympics were financed by VEB, which made loans to private companies to build facilities but which have since been unable to repay the loans.

SPENDING POSTPONED

"Basically what VEB did in terms of the Olympics was de facto government expenditure postponed until the future," said Karen Vartapetov, associate director at rating agency Standard and Poor's. "The government didn't want to fund it from the budget directly, so asked VEB to step in."

Andrei Elinson, deputy CEO of Basic Element, a conglomerate owned by prominent businessman Oleg Deripaska which was among the companies involved in Olympic projects, said it wasn't possible to repay the loans on schedule because forecasts provided by the government proved to be wrong.

A port built by Basic Element, for example, with a loan from VEB, was forecast to have annual cargo volumes of 10 to 15 million tonnes. In the event volume was only 4 million, not least because the government chose to build a railway as well.

"Some of the projects didn't go as planned from the very beginning," said Elinson, adding Basic Element planned to repay the loans.

The hole blown in VEB's books by the Olympics underscores how its difficulties predate Russia's falling-out with the West over Ukraine and the subsequent economic crisis, though those developments have exacerbated its problems.

VEB is among several state banks subject to Western sanctions, effectively meaning it cannot sell bonds to Western investors. That poses a bigger problem for VEB than for other banks because it does not raise money from private depositors.

Finance Minister Siluanov said financial support for VEB under discussion would enable it to meet its liabilities over several years and shouldn't be seen as an immediate injection.

HUGE LOSSES

But though only part of the financing is needed to repair capital destroyed by bad loans, these losses are huge. S&P estimates some 500 billion roubles of VEB's loans were directed by the government and are therefore regarded as relatively risky.

While the huge investments made in Sochi have generated public discussion in Russia, far less attention has been given to no less massive investments VEB made in Ukraine.

"That's still on their books and they keep rolling those loans over. Of course it's only a question of time before they accept losses on those assets," said S&P's Vartapetov.

In an interview in December 2013, VEB Chairman Vladimir Dmitriev said the bank had via Russian investors ploughed $8 billion into Ukrainian steel plants, mainly in the Donbass region, since ravaged in a separatist conflict. He said the investment had supported 40,000 Ukrainian workers, but did not say how the Russian economy had benefited.

Production at several plants was halted for months because of the war. But their financial condition was worsening years beforehand because of low global steel prices and rising material costs, said Ivan Dzvinka, an analyst at Eavex Capital, a Kiev brokerage.

The main company involved, Industrial Union of Donbass, said six months after the first VEB-backed investment in 2010 that it had restructured its debts because of "hard times".

The Russian investors who received money from VEB were never disclosed. The only one identified by Industrial Union of Donbass, Alexander Katunin, said at the time he was acting for others whom he declined to name. Katunin's own company, a Swiss trader called Carbofer, went bankrupt in 2012.

The lack of transparency and puzzling commercial logic has fuelled speculation that VEB's loans had a hidden political purpose. "The deal was interpreted as a way for Russia to strengthen its economic as well as political leverage on Ukraine," said Dzvinka. ($1 = 56 roubles, the exchange rate on 31 Dec (Shanghai: 600875.SS - news) . 2014) (Editing by Andrew Osborn and David Holmes)