Article / 07 June 2016 at 10:00 GMT

Don't worry — be happy, says Russian central bank

Russia oil and gas expert
United Kingdom
  • Russian central bank sees lending recovery by end-2016
  • Rouble rate still closely tied to oil price
  • FX distorted as top 30 banks exploit advantage in rouble money markets


Russia's central bank has rather a benign view on the state of the money markets. Photo: iStock

By Nadia Kazakova

As a wall of liquidity hits the Russian banking system, the central bank tells us not to worry.

This might be the purpose of the newly launched quarterly report, both to explain what is going on in the money and FX markets, and sooth the nerves on the future outlook. 

In one sentence, the Russian central bank thinks that the worst is very much over with little reason for concern, even if some niggling details are getting on the way.

So the central bank's spiel is that Russian banks are getting plenty of cash from the government. It would allow the banks to pay back most of their expensive repo loans to the central bank by the year end. 

The domestic FX market meanwhile is ticking away, in the central bank's view, and demand for USD (from several banks scrambling to refinance FX repo loans taken from the central bank a year ago) has been matched by USD supply from international investors (net inflow into Russian equity and bond funds was $842 million in February-March 2016).

There was no extra demand for FX cash from retail investors during a dip in the rouble FX rate in January. 

The volatility of the Russian currency against the dollar has been actually pretty stable, when adjusted for the movement in the oil price. Of course, the oil price is still the main driver for the rouble but the central bank believes that USDRUB volatility will decline, moving towards 20% or so (against market expectation of 24%) if oil price volatility remains at around 40%.


The oil price is still the pertinent factor for determining rouble direction. Photo: iStock

The Russian banking sector's profitability is on the rise, according to the central-bank assessment. Net margins (the difference between the cost of lending and the cost of borrowing) are improving despite rather a dire situation with bad loans (up to 6.3% of corporate loans and 8.4% of retail loans as of end-Q1 2016).

Net margins must have been helped by a drop in deposit rates, as the banks get awash with government cash. The drop in rates might also explain the increase in the share of longer-term customer deposits, which offer them a higher rate of return. Some recovery in lending volumes is expected before year-end. 

As ever, the devil is in the detail. Luckily, the central bank did not shy away from sharing this detail in the report.

The banking-sector liquidity position is definitely improving. The banks have been repaying repo loans back to the central bank, but the cash is ultimately coming from the central bank itself, which would be printing money to finance the budget deficit (It might explain why inflation is stubbornly above 7% year-on-year).

The cash ends up in the banking system either as deposits from the ministry of finance or as corporate and retail deposits, when the government pays its wages/bills/advances. 

By year-end, the central bank estimates that some RUB 4.65 trillion will flow into the banking sector as a result of budget deficit financing, enough to repay the outstanding central bank loans. Also note that the central bank seems to be cutting back by half the purchase of gold in 2016, possibly to keep a tap on overall money supply.

Net changes in the liquidity of the Russian banking system, RUB trillion.  
Source: Note: * = based on $30 average oil price and more than 3% budget deficit.  

However, the central bank itself admits that the liquidity flow is uneven. It seems to benefit disproportionally the top 30 banks. It has also been distorting both the rouble and FX money markets.

Most of the repo loans have been given by the central bank against relatively low quality/illiquid collateral. The larger banks now manage to replace these repo loans with cheap (free) government funds, while the smaller and mid-size banks are struggling to get a crumb from the liquidity feast. They might have to continue to borrow from the central bank despite an overall surplus of liquidity in the banking sector.

Banks' net borrowing from the central banks, RUB trillion

The liquidity problem is made more severe for the banks outside the top 30 by the fact that retail/corporate depositors prefer larger banks (for safety as the central bank continues to put a couple of mid-ranking banks in administration every week). On top of that, large and higher quality borrowers tend to go to large banks for loans. It leaves mid-size and smaller banks with shrinking assets, increasing share of bad loans and collapsing profitability. 

According to the central bank, only the top 30 banks have seen an improvement in profitability in the first quarter, while the aggregate net profit for the rest of the sector was close to zero. 

For the rouble and the FX market, the picture is also far from straight forward. While the overall situation in the domestic FX market is described as stable, the central bank does acknowledge that there has been a significant demand for FX from several banks in Q1 and will continue into Q2. They need FX liquidity to refinance expensive FX repo loans, taken from the central bank a year ago. These banks go about it in a quite peculiar way. 

They take cheap roubles (presumably, they are first in line to get budget money through deposits) and then swap them for USD, rolling the swaps over on a daily basis. Apparently, the cost of such USD loans is about 1.2% annualised against 2.4% annual interest on the central bank's own FX repo loans. 

The slight issue is that it distorts interest rates in the rouble money market and increases the cost of FX borrowing for all Russian banks not just domestically, but also offshore. The central bank, however, believes that it only shows that the domestic FX market is well supplied and balanced. 

It must also reduce the need to use FX reserves, which must be always welcome.


Russia's top 30 banks have find a route to boosting their balance sheets, but the rest of the banking sector is chugging behind as FX borrowing becomes more expensive. Photo: iStock

 — Edited by Martin O'Rourke

Nadia Kazakova is a specialist on Russia, particularly the oil and gas sector.


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