Statement by Bank of Russia Governor Elvira Nabiullina at the State Duma plenary meeting held on June 20, 2014

Dear Mr. Chairman! Dear colleagues!

A year ago, I received a mandate from the State Duma to govern the Central Bank of the Russian Federation. Today, as I’m presenting the Bank’s Annual Report for 2013, I would like to speak about the Bank of Russia’s work in the second half of 2013 and the Bank’s current tasks.

Monetary policy is the first area of our work.

The Bank of Russia’s monetary policy was conducted proceeding from the Bank’s basic constitutional function of protecting and maintaining the ruble’s stability and was aimed at achieving inflation targets.

The policy was based on the analysis of the economic situation.

The need to overcome the trend of slowing economic growth is the main challenge for the country’s economic policy as a whole. The Bank of Russia estimates that slower economic growth is caused by structural rather than by situational or cyclical factors and reflects many problems that have accumulated in the Russian economy, in particular, labour productivity stagnation and the shortage of competitive industries, which can be evidenced by the persistence of low unemployment amid slowing economic growth.

Monetary policy measures cannot overcome these difficulties. Problems will persist, no matter how much money will be injected in the economy. In order to resolve these problems, it is necessary to raise governance efficiency, improve business processes, look for new markets, increase the level of workforce skills, reduce administrative barriers for business and use these factors as the basis to make large-scale investment in technological upgrade and infrastructure.

The Bank of Russia used this vision of the structural nature of the ongoing economic slowdown to develop its monetary policy, ensuring a reasonable balance between the goals of price stability and economic growth. This policy should not be too tight in order not to suppress economic growth but it should not be loose and soft in order not to provoke inflation. This year, higher inflation risks have been registered in this balance. In this situation, it is extremely important for us to avoid a negative scenario, which predicts economic growth to continue slowing down (due to its structural nature) and inflation to grow constantly. Incidentally, polls indicate that inflation has overshadowed problems in the housing and utilities sector that had been a matter of primary concern for our citizens for a long time. Therefore, I consider the proposals of the economy’s monetary stimulation through the price growth at 10-15%, as some believe, to be unacceptable.

In 2013, inflation exceeded the target value by 0.5 percentage points and reached 6.5% but we did not tighten our monetary policy, leaving the key rate at 5.5% throughout the year. We decided against raising interest rates because inflation growth in the second half of the year was caused by temporary non-monetary factors.

At present, inflation stands at 7.6% on an annual basis and exceeds both the level of late 2013 and the 5% target level for this year, staying above the permissible range of upward or downward deviations by 1.5 percentage points from the target.

The inflation growth is related to the effect of a combination of monetary and non-monetary factors, such as the rise in inflationary expectations amid external shocks, the ruble’s depreciation and specific factors affecting the food markets.

The Bank of Russia has had to raise the key rate from 5.5% to 7.5% to bring inflation back to the downside path and a forecast now suggests that inflation will return to the target values in the medium term, if the Bank of Russia maintains the current stance of its monetary policy.

Despite an upsurge in uncertainty under the impact of geopolitical factors, the Bank of Russia’s prompt measures, including larger foreign exchange market interventions, have helped preserve and maintain the country’s financial stability.

Along with the task of curbing inflation, the Bank of Russia was constantly improving its refinancing mechanisms, allowing banks to obtain required liquidity from the Central Bank. For this purpose, the Bank of Russia extended the list of instruments for liquidity provision, including liquidity secured by non-marketable assets, i.e. loans to the economy. In the summer of 2013, the Bank of Russia held an auction for 12-month loans secured by such assets and subsequently three-month loan auctions began to be conducted regularly. These measures helped the Bank of Russia increase gross credit by 1.8 trillion rubles in 2013 to 5 trillion rubles (i.e. by 56%) and to 5.6 trillion rubles by the end of the first quarter of 2014.

In addition, in order to stimulate banks’ investment lending (and this is the main problem today amid the shortage of long-term funds), we have resorted to such an unconventional instrument as three-year refinancing against the pledge of loans extended for investment projects and also against project securities. The interest rate on this instrument has been set at 6.5%, which is below the inflation level. We are doing this with account taken of the need to maintain the general stance of our monetary policy aimed at curbing inflation.

In the past few years, the Bank of Russia has maintained the policy of a floating exchange rate band, which was introduced back in 2009. However, in the wake of the trend of the ruble’s weakening, the volume of the Bank of Russia’s foreign exchange interventions totalled almost $27 billion in 2013 and in January-June 2014 the regulator had to spend over $40 billion on foreign currency interventions amid increased uncertainty. The Bank of Russia’s interventions were designed to restrain excessive volatility threatening financial stability rather than to maintain the ruble exchange rate at a certain point.

Households have historically paid great attention to the exchange rate, although inflation figures are considerably more important for their well-being. This is because citizens receive their wages and salaries in rubles, spend and make savings also largely in rubles and, consequently, it is important for an overwhelming majority of people to maintain the purchasing power of their pays and insulate their ruble savings against depreciation (let me remind you that 80% of household bank deposits are kept in rubles) and this can be ensured by low inflation rather than by the exchange rate, despite all its significance.

Low inflation enables enterprises to plan longer-term investments.

At the same time, we are well aware that the so-called non-monetary factors, primarily the growth of tariffs for the services of infrastructural monopolies and housing and utilities charges, make a considerable contribution to inflation. The path of inflation decrease to 4%, which we projected over the three-year period, was based on the government’s decisions on the parameters of restraining the growth of these tariffs. We expect the government to keep these parameters unchanged.

The banking system, banking regulation and banking supervision are the second area of our work.

The banking system remains stable as a whole, despite the increased uncertainty and the slower economic growth. The banking system stability can also be judged by stress tests regularly held by the Bank of Russia.

The stable condition of most Russian banks allows them to smoothly introduce the Basel III international standards into their practice.

The growth rates of bank lending to non-financial organisations were unchanged in 2013 from the previous year and stood at 12.7%. At the same time, the growth of lending to small and medium business was faster than lending to non-financial organisations and averaged 14.8%. The growth of overdue debts on loans slowed down from 4.6% to 4.2%. In January-May 2014, the growth of lending to non-financial organisations accelerated to 16-18% compared with the previous year. These relatively high indicators also include the effect of the return of Russian borrowers from external markets, which have been closed for them.

Nevertheless, overall lending growth rates remain fairly high. From the standpoint of economic growth, it is important in this situation to change the structure of lending and increase the share of investment loans rather than to build up lending volumes. But I would like to emphasise that competitive income-generating projects are required for this purpose. That is why, it is the task of both the banking system and businesses to develop new projects and reduce costs. It is generally the task of the economic policy to create conditions conducive to developing such projects on a large scale rather than in single instances.

The sectoral structure of lending in 2013 registered a faster growth in loans to industries producing coking coal, petroleum products, transport vehicles and equipment. At the same time, agribusiness lending grew by 10.3% over the year, with the debt burden of agricultural producers twice as much as the amount of outstanding loans in other sectors. In order to resolve problems accumulated in agriculture, measures are required to increase agribusiness returns and avoid further growth in the agricultural producers’ high debt load.

In 2013, the Bank of Russia paid special attention to reducing systemic risks in consumer lending. As a result, the growth of unsecured consumer lending slowed from 53% in 2012 to 31.3% in 2013 and 24.4% in May 2014 on an annual basis.

The slower increase in consumer lending prompted an accelerated growth in overdue debts on household loans. This growth amounted to almost 41% in 2013 compared with a 29% increase in the consumer loan portfolio. However, the Bank of Russia’s measures to regulate this market helped banks create loan provisions that cover their potential losses.

At present, banks are substituting unsecured consumer lending in their loan portfolios with other instruments, including mortgage loans and loans to manufacturing companies. Mortgage loans are currently growing at an annual rate of 34%.

The task of the Bank of Russia in banking regulation and banking supervision is to ensure a balanced development of the banking sector without a loss of banks’ sustainability.

Banks have become to conduct more prudent credit policies, assess credit risks more adequately and create loan impairment provisions commensurate to their exposures. Larger loan loss provisions can be evidenced, among other things, by a 13.7% fall in banks’ profits and a growth in their reserves by more than 20% this year.

The volumes of dubious operations have also decreased. The Bank of Russia estimates that capital outflow from Russia under dubious reasons declined by a third in 2013 to $26 billion and continues to fall in 2014. We understand, however, that dubious operations may also be rechanneled into other sectors of the financial market and we need to tighten banking regulation and banking supervision in such segments.

Tighter banking supervision has resulted in the larger number of banking licence revocations. The Bank of Russia withdrew licences from 29 organisations in the second half of 2013 and has revoked 36 licences since the start of 2014. Banks experienced big difficulties with the quality of their assets while many of them were exposed to report unauthentic data and part of the banks were involved in large-scale dubious operations.

The Bank of Russia considers a licence revocation as a last resort measure, when all the other instruments of influencing banks’ policies have been used up.

However, the volume of problems exposed after the revocation of licences shows that we need to raise radically the responsibility of bank owners and managers for the banks’ financial health. Their actions cannot go unpunished because it is the state, creditors and a part of deposits that have to pay for their results. Document forgery and capital withdrawal schemes cannot be prevented by supervision measures, which is why the Bank of Russia is requesting legislators to take a decision and introduce criminal liability for falsified financial statements.

Now let me talk about financial rehabilitation measures. The Bank of Russia takes such decisions, if there are economic grounds for that, taking into account the systemic importance of particular banks.

One of the Bank of Russia’s tasks in banking regulation is to develop healthy competition in the banking sector. We consider it important to ensure the development of banks with various forms of ownership – both private and state-owned – irrespective of their size. In our view, the withdrawal of unscrupulous players from the market primarily helps bona fide market participants improve their positions and contributes to healthy competition in the banking sector.

Financial market regulation is the third area of our work.

This is a comparatively new sphere of the Bank of Russia’s activity. We were granted these powers in September 2013 after the law on the mega-regulator came into force. All the necessary organisational changes have been implemented by now. The Federal Financial Markets Service has completed gradually transferring its functions to the Bank of Russia. But, of course, we have a lot of unresolved problems and tasks.

First. The Bank of Russia has paid special attention to the pension system both in the past year and this year to turn pension accumulations into long-term investment resources and ensure their reliable protection. For this purpose, conditions have been created for converting non-governmental pension funds into joint-stock companies and introducing a system of guaranteeing the rights of insured persons. The Bank of Russia has approved corporatisation of 14 non-governmental pension funds. The system of guarantees will come into effect from January 1, 2015.

Second - the insurance market. We see our task in streamlining procedures in the market of compulsory third-party liability car insurance (OSAGO). Problems in this area have accumulated for years and the base tariff has not been raised in the past 11 years. These problems cannot be resolved without amendments to the legislation. We should create a business model that would allow insurers to work efficiently and stay in the market. We need legislation that reliably regulates and protects all the rights of insured persons.

Third. Last year, the Russian legislators passed for the first time a law that regulates the rapidly expanding microfinance market. Key changes were made to the legislation and now we are working on a special regulatory framework to create uniform procedures of regulating legal relations between the creditor and the borrower, irrespective of the type of creditors.

Fourth. Actuarial opinions are an integral part of supervision over insurance companies and pension funds. In late 2013, Russia passed a law on actuarial activity, which aims to ensure a proper level of actuarial assessments. We’ll undoubtedly implement this legislation.

The development of the national payment system is the fourth area of our work.

This theme has become especially topical in the wake of the recent developments when some of our banks were disconnected from international payment systems.

We are implementing our own strategy of developing the national payment system but in the near future we’ll undoubtedly focus on carrying through the legislation recently passed by the Russian parliament on developing the country’s own payment infrastructure. That is why, we have set up a special commission that is selecting the best technological solutions based on Russian developments and Russian technologies. We are establishing a joint-stock company (currently at the stage of registration) in accordance with law to function as the national payment card system operator and we’ll carry out work to develop the national system of payment cards.

As the first stage of this system’s development, banks are now establishing channels of interbank interaction to lower short-term risks, if they emerge. By now, over 90% of direct participants in international payment systems have already established such interbank interaction channels and will be able to use them, if some of them see their card operations blocked by foreign payment operators.

Let me note that a possibility remains for the international payment systems to continue working on the Russian market.

In conclusion, I would like to thank the State Duma for very fruitful cooperation and interaction. We discussed the Annual Report in detail at meetings of the working group, at expert councils and in committees. Our Report is quite a detailed document and I touched upon only a part of important issues in my speech. I hope that such interaction will be continued, especially with regard to the adoption of bills important for the development of the financial sector. Let me emphasize once again that our interaction should cover such themes as the introduction of criminal liability for falsified financial statements, the adoption of amendments to the Law on OSAGO and the Code on Administrative Offences, as well as the introduction of banks’ differentiated contributions to the deposit insurance fund. We are working jointly with MPs. I hope that all these decisions will be adopted.

Thank you very much for your attention!

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