Leaning on Thin Air
Russian banks are attracting short-term reserves and giving out long-term credit. Companies are taking this credit and financing even longer-term investment projects with it. The only thing that the financial authorities can propose in this situation is a cool-down in the crediting activity of the banks
Photo: Photoxpress.ru
The Bank of Russia has announced that as of July 1, the banks’ withholdings in the Required Reserve Fund (FOR) will be raised. Credit organizations will have to set aside 7% of the volume of their debts to non-resident banks in rubles and foreign currency (as opposed to the current 5.5%), 5% of their debts to private individuals in rubles (currently 4.5%), and 5.5% of other debts in rubles and foreign currency (presently 5%). In the official announcement of the Bank of Russia, it is noted that these decisions were made “with the goals of lowering the growth rate of the money supply and providing conditions for the slowing of inflation”. The Central Bank’s logic is simple” if Russian banks put more of the resources they have taken out into reserves, they will be able to spend less of it on issuing credit. According to some estimates, due to the straitening of reserve requirements, the total volume of bank-issued credit in the Russian economy will decline by 80-100 billion rubles.
The reader will recall that this is already the Bank of Russia’s fourth decision made in the last five months in an attempt to slow down the banking sector: on February 1, the FOR withholdings were increased; then the refinancing rate was raised by 0.25%; then the refinancing rate was pushed up by 0.25% again on April 29, to a total of 10.5%. All of these measures are the direct result of the Central Bank’s concern over the high growth rate of the banking system in general and the volumes of corporate credit lending in particular.
On May 23, first deputy of the chairman of the Central Bank Gennadiy Melik’yan noted in his speech at the 23rd annual meeting of the Association of Russian Regional Banks that the increase in credit issued to non-financial organizations over the first four months of this year had been 14.2% – that is, about 50% per year. However, the problem is not even with these extremely high growth rates, which the Central Bank is inclined to consider as indicators that the economy is overactive. The problem is that the fast increase in credit issuance is going on despite the quite modest growth in the banks’ reserve bases.
One of the main sources of liquidity for the largest Russian banks – foreign loans – fell to nearly 25% of its last year’s level: the influx of foreign capital for January-April of the current year was $12.8 billion against the $40-45 billion seen during the same period in 2007. Also, almost all this money has gone to pay off debts on previous loans. According to the estimates of Natal’ya Orlova, head economist of Alpha Bank, in the first quarter of this year, deposits to the retail accounts of Russian banks increased by $16 billion, while those to corporate accounts grew by $27 billion. At the same time, the volume of credit issued to the corporate sector during that period was $55 billion – i.e., $12 billion more than the increase in reserves. The only explanation for this lack of correlation is that banks are financing the increase in corporate credit using the deposits of private individuals (which are, as a rule, rather short-term: approximately year-long), repossession operations, and inter-bank credit. It would be hard to call a situation like this normal, and the increase in the withholding norms in the FOR in rubles and foreign currency for debts to private individuals and others should correct the problem.
However, the fact that the given norms were raised by only 0.5% while the norms for foreign bank debts were increased by 1.5% proves that the problem of inflation is worrying the Central Bank considerably more than is the issue of crossed credit wires in the banks’ financial activities. “The Central Bank is concerned about the high dependence on foreign financing; they are afraid that as soon as foreign markets open, many banks and companies – banks, first and foremost – will again begin to actively borrow abroad,” says Natal’ya Orlova. “For the Bank of Russia, this is a negative tendency, because the influx of funds will push monetary inflation higher and higher. The significant increase in the FOR in regard to its foreign loan requirements is, without a doubt, a sufficiently effective stabilization measure. On the whole, the raising of the norms is an expected and predictable measure. The numbers for the predicted inflation rate in May have just been released. They are at 1.4%. This is, of course, very bad; I had counted on there being 1.2% in the worst-case scenario. Our overall year-to-year inflation therefore comes out to at15.1%. And that means that we should see some additional increases in the FOR norms in the next couple of months, so that inflation stays down at 12-12.5%. As a stabilizing factor, these measures taken by the Central Bank are doubtless effective; they have a definite psychological influence: they force the banking sector to slow down. But are they enough to lower the inflation rate from 15% to 12%? No. But it is a very important step, and if a stricter budget policy follows the increase in the FOR for the second half of the year, we will have some kind of chance at keeping inflation down.”
Incidentally, many specialists are not so optimistic. In the opinion of Anatoliy Aksakov, president of the Russia Association of Regional Banks, the anti-inflationary effect of the increase in FOR norms is extremely limited and will only cut inflation by a few tenths of a percent; moreover, this reduction will be delayed and will only be seen in full next year. “These measures can only lead to increases in the prices of credit products, since it is obvious that the demand for them is huge in a growing economy,” Mr. Aksakov assures us. “According to our estimates, small business, for example, needs to increase its credit resources by 25-30%.”
The People Will Not Help
It is not news that the Bank of Russia believes its main goal to be the battle with inflation. In one of his recent interviews, first deputy chair of the Central Bank Aleksey Ulyukaev came right out and said that the Central Bank considers its only tasks in regard to the banking sector to be securing payments and accounts. It appears that this same approach will be the basis of the new “Strategies for the Development of the Banking Sector” currently being completed at the Bank of Russia. Director of the Central Bank’s Department of Banking Regulation and Supervision Aleksey Simanovskiy announced the main ideas of this document to the public next week: the credit method of distribution of funds should have priority over the budgetary method, legislation should be developed with the subprime mortgage crisis in mind, and the unwarranted administrative load on the banks should be lifted. In addition, the Central Bank is against an aggressive credit policy, an easy money policy, and relaxed regulation. As bureaucrats from the Bank of Russia have confirmed, the banks’ development tendencies today are causing double-digit inflation, and the policy of stimulating economic growth through a lax monetary policy is connected with unacceptably high risks – in part, with the risk of the appearance of a bubble on various markets.
This seems to mean that the main source of reserves for banks should be funds from the general population (it stands to reason that funds from the corporate sector – with the exception of funds from raw materials companies, which have already been shared out between a few large banks – cannot be counted on under deficit conditions). The potential volume of resources from savings from the private sector that could be involved in the task is estimated at three to five trillion rubles (and this is not counting funds in offshore accounts or foreign resources belonging to the more well-off section of the population). However, it will be impossible to increase the volume of deposits by private individuals quickly. This is blocked by the absence of a tradition of saving money, a habit of living only for today, and the high inflation that the population notices first and foremost in the rise in utility tariffs and prices on essential goods. As a result, the amount of savings by private individuals has only been declining recently: whereas in 2006, Russians saved 10.3% of their income, in 2007, that figure stood at only 8.9%. In the first quarter of last year, the population’s deposits into savings accounts increased by 5.8%, while in the first quarter of this year, it rose by a mere 2.9%, to just under 5.3 trillion rubles, regardless of the fact that, according to data from the Agency for Depository Insurance, 60-100 of the largest retail banks in Russia have increased their savings account interest rates within the last six months.
It is understood that if the financial authorities are seriously counting on the idea that the banking sector should be developing due to a rise in the amount of deposits by private individuals, they must somehow stimulate the savings activities of the population. This is in part what the legislature being prepared by Anatoliy Aksakov, which should be put up for discussion in the Duma in June, is about. According to this document, profits made by private individuals from interest earned in ruble savings accounts should not be subject to income tax “in sum, calculated on the basis of the 1.5% refinancing rate of the Bank of Russia”. That is, with the current 10.5% refinancing rate in place, there will be no need to pay taxes on profits from savings account interest if the interest rate does not rise above 15.75%. Such taxes would only have to be paid if the interest rate were higher than that, and then only on the profits over and above that percentage. However, the Ministry of Finance has a rather cool attitude toward this legislation, concerned as usual over the “potential for decreased budget surpluses”.
There is a chance that this bill will be approved, since even the bureaucrats from the Ministry of Finance admit that it corresponds to the declared policy of offering stimulus to the population for saving and simplifying tax administration processes. However, the banks will not be thrilled with this innovation if the Duma does not simultaneously approve amendments to Article 837 GK finally, which gives banks the option of offering savings accounts that do not allow early withdrawals – bankers have been lobbying for this for decades already. There is no guarantee, though, that even these improvements will be able to disrupt the negative tendency of the population to deposit less money into savings accounts.
A Paper Foundation
The bureaucrats of the government and the Central Bank cannot but admit the seriousness of the problem of a shortfall of long-term bank reserves. The colossal demand for credit resources by the national economy exists objectively, and the Central Bank’s attempts to slow down the banks’ activities bear a striking similarity to trying to make a person breathe less. However, the facts that the Bank of Russia does not intend to reexamine its system of priorities and that the government apparently supports it in this is causing analysts to develop non-trivial hypotheses on the idea behind what is going on.
Probably the only more or less logical explanation, or, if you will, justification for the current policy of the Central Bank and the Ministry of Finance may be in that the financial authorities have made a principal decision on the construction of the Russian financial system according to the American model – that is, not on the basis of the banking sector, but on that of the funds market.
In such a context, Vladimir Putin’s May 8 announcement to the State Duma on the necessity of creating a world financial center in Russia also seems completely logical. Additionally, as Expert has already noted, all the proposals put forth during the development of this thesis have exclusively to do with the development of the funds market: this is the creation of a real derivatives market, the push to get the maximum number of Russian citizens possible involved in investment activities, and, finally, the easing of the taxation regime for participants on the bonds market. We would emphasize that in the context of discussions on the world financial center there have been no notable measures proposed to develop and strengthen the domestic banking sector.
There is basically nothing terrible about this; the strategy for building a national financial system on the basis of the funds market has a right to exist, all the more so because such a financial system is much safer from an inflationary point of view than is the policy of pumping resources through Central Bank channels and then issuing credit to businesses. However, there is a whole set of circumstances that lead us to think that in today’s actual conditions, this path is connected with perhaps more expenses and risks than is the creation of a normal system of bank refinancing.
In the first place, in the USA, a fully developed banking system exists alongside the powerful funds market – there are three times more commercial banks in America than in Russia today. All of these banks make use of the active support (and, should the need arise, of the full-fledged help) of the Federal Reserve System. We have been seeing proof of this over recent months. Unlike the US Federal Reserve System, our Central Bank denies out of principle the possibility of supporting Russia’s national banks as long as real threats to payments and accounts do not arise.
In the second place, in order to make the switch from a financial system based on the banking sector (which has formed in Russia de facto) to a system based on the funds market, cooperation and coordination of efforts is needed between the Bank of Russia and the Federal Financial Markets Service. Today, when these structures are not engaged in outright conflict with each other (for example, on who should be regulating the General Funds for Banking Management), they are, regardless, certainly not working in cooperation. In any case, the Concept of the Development of Financial Markets prepared by the Federal Financial Markets Service, has, as far as we can tell, nothing in common with the Strategy for the Development of the Banking Sector prepared by the Bank of Russia. And it is unlikely that anyone can predict what we will get as a result of the simultaneous realization of both these strategies.
Last but not least, for the development of the funds market and the construction of a modern, effective system based on it, a radical capitalization of the resources located inside Russia is needed. Moreover, according to the estimates of the Expert RA rating agency, at the beginning of 2008, less than 7% of our national resources were capitalized (that is, were liquid and had a market price). Major funds, land, minerals, natural biological and subterranean water resources, real estate, and non-material resources such as patents and intellectual property all remain non-market in nature. This means that more than 90% of Russian resources are completely removed from the financial system, although bringing even 10-15% of them into the market could bring our financial system from 70 to 120 trillion rubles.
The main reason for this sad state of affairs is that ownership is not legally formulated on the majority of the resources in our country, and therefore, these resources cannot be used as collateral or the personal capital of economic agents. The lack of legal services for private property and businesses, in its turn, is largely due to bureaucrats looking out for their personal interests and the literal absence of an independent judicial system.
The reforms to the judicial system announced by Dmitriy Medvedev, as well as the new President’s intention to limit corruption if positive results arise from them, could give the development of the funds market a stronger push then dozens of strategies thought up by the bureaucrats.
Only then will we be able to talk about the real possibility of building a financial system in Russia that is capable of providing not only the chance for the national economy to remain stable in unfavorable international conditions but also the formulation in Russia of an independent and influential center of decision-making in the financial sphere that works in the interests of Russian investors on both domestic and foreign markets. By and large, there is only one alternative: the domination of the Russian market by foreign financial institutions, the loss of control over the conditions of financing the national economy, an increase in expenditures, and the loss of the competitive edge by even those few Russian businesses that still look successful today.
