Kseniya Yudaeva’s speech at press conference: Financial Stability Review for 2022 Q2–Q3

Good afternoon, dear colleagues

This review analyses financial stability risks and the impact of the sanctions on Russia’s financial system. We describe measures aimed at mitigating the risks and stabilising the economic situation. I would like to focus on some lessons that can be drawn already now. I will certainly speak on how we view the situation today and what risks and vulnerabilities should be a particular focus for both the Bank of Russia and the financial sector.

I would start out with the general risk map. As compared to spring, risks have decreased. However, most of them are still higher than before the crisis. These risks are in the yellow zone or close to the red one. Credit risk that is currently lower than expected might materialise with a time lag. The situation still requires our close attention.

Nevertheless, one thing is obvious already now: the financial system and the economy, considering some regulatory easing and support measures, have proven to be sufficiently resilient to interest rate or credit risks. In particular, this is the result of the policy pursued in recent years to form capital cushions and enhance the regulation, supervision and risk management in financial institutions.

Now, I would speak on vulnerabilities and challenges that, with regard to financial stability, can be considered both in the short and longer term.

Firstly, these are external risks. Our Monetary Policy Guidelines describe the risk scenario as the scenario of a global crisis and tightening sanctions. The probability of risk scenarios varies in different years, but, this year, their probability is higher. Hence, we should understand the peculiarities of such a scenario and the channels of its impact on financial stability in Russia.

The main difference of the risk scenario this year is that it assumes high inflation worldwide and relatively high interest rates. Over the recent decade, markets have got accustomed to very low interest rates. Therefore, there might be some episodes when monetary policy might conflict with financial stability policy. We have clearly seen this in the case of the Bank of England that was forced to resume asset purchases in the market not for monetary but for financial stability purposes.

This case shows that the world is entering a period when the budget situation might affect markets more significantly. This might be both an excessive rise in the budget deficit, as it was in the UK, and debt crises associated with higher costs for servicing or difficulties with refinancing the already accumulated significant debt. The latter risk might be elevated for certain emerging market economies or poorer countries as we could observe in the case of Sri Lanka, for instance. Finally, risks to financial stability might arise through a worsening of the economic situation or a burst of bubbles specific for particular countries, for example, in real estate.

An essential issue in the current situation is the channels of a spillover of external risks into domestic markets. At first glance, owing to foreign exchange controls, the situation in our domestic market now depends on external markets to a lesser extent. This is really so, but this does not mean that there is no dependence at all. The influence is exerted through the economy, in the first place. A decline in the demand and prices for Russian exports in the case of a global crisis will entail a reduction in export revenues (for both companies and the budget), a weakening of the ruble, faster inflation, and a deterioration of the credit quality. Besides, there is an influence through financial markets. Fluctuations in the exchange rates of foreign currencies against each other are transmitted to the Russian market. Liquidity problems are likely to affect our market as well, as it was before. Finally, we can observe signs that fluctuations in long-term interest rates are also transferred to the Russian market. Apparently, external risks might translate more slowly than before, yet this does not mean that the situation does not require our full attention and additional measures if needed.

I would also like to comment on a price cap on Russian crude discussed by western countries. They have not yet reached any consensus regarding this issue, but I would like to stress that we are prepared for any developments. In recent years, the oil market experienced multiple episodes of sharp price fluctuations. In all these cases, Russia’s economy and financial system demonstrated resilience to shocks occurring in the energy commodity markets. Moreover, in previous years, the oil market shocks were exacerbated by capital flows, whereas now their impact is reduced.

The second important topic is the foreign exchange market and the transition to settlements in friendly states’ currencies. This area is also a priority for us. This was the materialisation of the foreign exchange risk that accounted for a considerable proportion of losses incurred by banks in the first half of the year. Because of the sanctions, the liquidity in the spot market decreased even in quiet times, and it became more dependent on the balance of trade. The volatility of the exchange rate might be associated with fluctuations in foreign currency earnings sold by exporters: an example of this is a more pronounced strengthening of the ruble during the tax periods now. Large transactions for imports, repayments of external debts, and asset purchases/sales might affect the market, eroding its liquidity position, due to which it is better to carry them out gradually. Finally, as we could see in late September, market liquidity might go down when there are expectations of sanctions against individual market participants. Furthermore, liquidity is affected by more complicated compliance and payment delays. All these imbalances are sometimes accompanied by differences in foreign exchange rates in the Russian and international markets.

Speaking of the FX swap market, a surge in demand from its participants, for instance, due to uneven dedollarisation of banks’ assets and liabilities, might also cause a temporary deficit of liquidity. This is what happened in early October.

Overall, the banking sector continues to actively dedollarise its balance sheets: the proportion of assets and liabilities in foreign currency decreased by 3 percentage points to 15%. Moreover, the share of the Chinese yuan is growing among foreign currencies. In the first place, this is explained by the shift towards settlements in yuan in external trade. The second reason is rising demand for yuan as a currency for retail and corporate deposits and for corporate loans. Exchange trading in yuan accounted for 33% in the total amount in November. Since the beginning of the year, households have purchased yuan worth 140 billion rubles. For reference, over the same period, households have bought US dollars and euros on the exchange or through banks in the amount of 230 billion rubles, that is, the figures are already comparable.

In this regard, I would like to note that today we have started to publish the official exchange rate of the yuan on the home page of the Bank of Russia website.

Although this topic is not covered in detail in our review, it should be noted that there are certainly risks for the economy and the financial system connected with payment and settlement problems. A considerable part of transactions are still paid for in US dollars and euros, while the infrastructure for such payments is contracting. The reasons are obvious, namely direct sanctions against banks, the disconnection from SWIFT, the closure of correspondent accounts, prolonged compliance, etc. On the other hand, the payment infrastructure for alternative currencies is still immature. The Bank of Russia is very well aware of this and is working on the creation of such infrastructure, using advanced technologies, among other things.

I would also like to emphasise that, in terms of risk control, it is critical to ensure a balanced transition to national currencies, including yuan, in exports, imports, and financial payments. Banks and financial institutions should also ensure that the dedollarisation of their assets and liabilities progresses synchronously and close their open foreign currency positions gradually.

Thirdly, I would like to stress the importance of a well-balanced budget. Russia’s gradual return to the fiscal rule is an essential step towards the stable functioning of markets and building a yield curve. However, over a short-term horizon, budget management might create fluctuations in bank liquidity. As usual, before the end of the year, the fiscal system first withdraws funds from banks as large tax payments and then directs this money to the economy, which causes a decrease and a subsequent surge in the banking sector liquidity. Large government borrowings might also provoke significant liquidity fluctuations. Normally, the Ministry of Finance does not use the raised funds at once. It places the money in its account with the Central Bank or provides funds to the market as very short-term liquidity until they are completely spent. This is exactly why, to ensure banks’ comfort, we created liquidity providing instruments through one-month and one-year repos. These instruments were extensively employed in autumn 2020 when budget borrowings increased by 2.5 trillion rubles. However, already from early 2021, they were not needed any longer as the Ministry of Finance had completed the main expenditures and banks had received long-term liquidity. A similar situation can be observed now as well and we also expect that long-term repos will not be needed any more as soon as the budget completes its considerable expenditures.

The next issue is regulatory easing, including with regard to the disclosure of reporting. This year, we have approved a really unprecedented package of support measures to help financial institutions adjust to the changed situation and protect them against new sanction risks. However, it is crucial to seek a balance between giving time to financial institutions to adjust and avoiding new risks associated with a too long period of non-compliance with ratios and non-transparency. We had to address this dilemma during the coronavirus pandemic. Then, we were gradually cancelling the easing, and these measures were terminated for the most part already by mid-2021. This helped to not only maintain confidence in the sector among clients and financial institutions towards each other, but also get prepared to the challenges of this year — by the moment they occurred, the financial sector had accumulated capital buffers. Currently, the logic is the same. We are going to cancel over a half of the regulatory easing measures from early 2023, including those associated with the revaluation of securities, fixing of the exchange rates for the calculation of the ratios, and compliance with the limits on open foreign currency positions. Besides, for some easing measures, we plan a gradual tapering and termination. In the first place, this is related to provisioning for non-performing loans.

Assessing the need for the regulatory easing with regard to information disclosure, we need to find a trade-off between risks of non-transparency and distrust, on the one hand, and sanction risks, on the other. None of these risks can be the absolute priority at this stage. Therefore, beginning from the new year, we are going to oblige financial institutions to disclose information in a reduced form that would be sufficient for assessing most financial risks without creating sanction risks.

In order to understand how the cancellation of the regulatory easing and a possible materialisation of credit risks in the future might affect the banking sector, we have carried out a stress test for the banking sector over the period until the end of 2023. In the case of the risk scenario, the banking sector will generally remain resilient and preserve the potential for lending. However, if the stress scenario occurs, some banks might need additional capital of up to 0.7 trillion rubles for the sector as a whole over the forecast horizon. It should be noted that banks are taking active measures already now to replenish their capital, owing to which the need for its increase might be lower.

I would now speak on interest rate risk. The key rate and interest rates in the market have been fluctuating quite seriously this year. In view of this, we could have expected that the materialisation of interest rate risk would have a notable adverse effect on the system. However, it has turned out to be moderate, largely owing to the broad use of floating interest rates and government support measures. The situation could have been even calmer if the banking sector’s agreements had been based not on the key rate but on the RUONIA Averages as their fluctuations are smaller although they are more extended. This is better for both borrowers and creditors and decreases the need for government support.

We continue to closely monitor the retail lending market.

The situation in mortgage lending has already become a matter of concern for us this year. Already since 2020 when the Government launched the subsidised lending programme, we have been observing an expanding gap between prices for new and existing housing. This is evidence of imbalances. A faster rise in prices caused a decline in the demand for housing. This involves risks for both banks and developers. This year, developers and banks started to spur demand even more by offering various lending programmes, for instance, mortgages at reduced interest rates, tranche mortgages, and others.

A mortgage loan at a low interest rate implies that the apartment will be sold at a higher price. This enables developers to maintain the gap between prices for new and existing housing. However, in this case, buyers will incur higher losses if they decide to change the apartment or become unable to service the debt. Banks in turn are misguided as they expect these loans issued for 25 years to be quickly repaid ahead of schedule. In view of this, in 2023 Q1, we will tighten the regulation of mortgage lending at low interest rates.

As to tranche mortgages, the mortgage payment is assumed to be small until the commissioning of the housing and then it increases. Such programmes also have their cons for the parties to the transaction. For developers, this is a slow inflow of funds into escrow accounts and a higher credit rate. For buyers, these programmes involve a sharp rise in loan payments after the commissioning of the housing.

The demand for housing and mortgage loans has been declining somewhat in recent months. In such a situation, it is necessary to promote a gradual decrease in imbalances existing in the housing market and to control risks in project finance.

Finally, I would like to address unsecured consumer lending. The growth of debt in this market slowed down from 0.9% in September to 0.3% in October. Despite this decline, consumer lending remains a priority segment for banks due to its high returns. Moreover, to build up their portfolios, banks are easing their lending standards. Specifically, loans issued to borrowers with a debt service-to-income (DSTI) ratio higher than 80% accounted for 32% in Q3, which is 4 percentage points more quarter-on-quarter. A further increase in households’ over-indebtedness amid the structural transformation of the economy might involve additional macroeconomic risks. This is why, at the end of November, the Bank of Russia set macroprudential limits for 2023 Q1. The proportion of loans to borrowers with DSTI above 80% should not exceed 25% of the disbursements or 35% of microloans — for microfinance organisations. The maximum share of loans for more than 5 years is limited to 10%. Depending on lending trends, we will consider whether it is reasonable to further tighten the limits beginning from 2023 Q2.

Summing up, it is possible to say that the situation in the financial sector is stabilising gradually and the quality of loans is still better now than expected. Our experience has shown that the resilience of the financial sector during a crisis largely depends on the preceding efforts of the regulator and financial institutions themselves. In this regard, it is crucial to taper the regulatory easing measures in due time and prevent bubbles in the market.

Thank you for your attention.