Speech by Bank of Russia Governor Elvira Nabiullina at the Federation Council Meeting on 26 November 2014

Dear Valentina Ivanovna! Dear senators!

I would like to start my speech with the issues which are being largely discussed now and cause public concern, in particular, the situation in the foreign exchange market, high inflation, and accessibility of lending to the economy, and then I’ll turn to the announced topic of regulation and supervision in the financial market.

The current economic situation is far from simple. On the one hand, the economic growth has slowed down significantly under the influence of both internal structural and external negative factors, on the other hand, inflation accelerated considerably. In these conditions, the Bank of Russia is going to be flexible, take a comprehensive approach, responding to the challenges facing the Russian economy not forgetting, of course, about the strategic goals.

The Central Bank takes measures to ensure price and financial stability, sustainability of the banking sector and the financial market. We use specialised mechanisms to eliminate bottlenecks, revealing inter alia market failures, we take into account the peculiarities of our economy and the specifics of the situation.

We realise that investments are a must to overcome the economic slowdown and switch to import substitution. Growth in labour productivity is possible only on the basis of investments in modernisation, in changing the worn-out fixed assets and bank loans are a must to build up private investments.

The government on its part also participates in investment projects, but these are primarily projects related to infrastructure development, investments in education and healthcare development.

As far as private investments are concerned, favourable conditions for investors should be created. For example, currently against the backdrop of increased uncertainty we watch many companies prefer paying out high dividends rather than investing profits. That is why we need to take a set of measures to improve the investment climate, reduce administrative restrictions, and ensure tax burden predictability. And, of course, along with this we need to cut lending rates.

What is the Central Bank doing for this purpose? First of all, we intend to ensure inflation reduction. Low inflation is an integral component of a favourable investment business environment.

Many believe that the rise in the Bank of Russia key rate have become a trigger for lending rate growth, but actually it was inflation growth that provoked rate increases.

If we look closely at how the rate for final borrowers, enterprises, is being formed, we shall see that household and corporate deposits make up banks’ major resources (although it has recently increased, the share of the central bank funds constitutes a mere 9.2%). If the deposit rates are lower than inflation, households and enterprises will not bring their savings to banks. If the deposit rates at banks are lower than inflation, people will prefer to spend money (on durables, etc.) rather than save it.

That is why the deposit rate and, therefore, lending rate cannot be lower than inflation. And even if the Central Bank held the rate at 5.5% now, the way it was at the beginning of the year, banks would not reduce lending rates, given the inflation of 8.6% p.a., and most likely use the resources provided by the Central Bank in the forex market.

Therefore, if we want to reduce lending rates, we need to lower inflation. That is why the Bank of Russia speaks so much about curbing inflation.

As a matter of fact, inflation is a tax on the poor. According to opinion polls, the rapid price growth remains the key problem for the population. And when we hear suggestions: “Let’s stimulate economic growth at the expense of inflation”, we should realise that this is the suggestion to finance not the most effective projects at the expense of income of not well-to-do people. Our task is to render assistance to make the process of choosing precisely effective high-performance projects at industry and import substitution start working. That is why along with the general policy of curbing inflation (and the required increase in the key rate) and taking into account the absence of long money in the economy, the Central Bank introduced special preferential refinancing mechanisms.

The investment project refinancing programme has been announced this year. The Bank of Russia will issue loans for a term of three years at a fixed rate, which is 1.5 percentage points lower than the key rate. It was planned initially that the preference would be 1%, but the latest key rate increase was rather significant and the preference was raised to 1.5%. We have a programme relating to small and medium-sized businesses. Our rate on this product stands at 5.5% p.a., but even with such a rate the programme is being implemented poorly, unfortunately, and we together with representatives of small and medium-sized businesses plan to change it. There is also a programme to support non-commodity exports. Currently we are drawing up the programme to support lending to agriculture. However, despite the fact that we are implementing such programmes (this is not a standard mechanism for the Central Bank) they may be of a limited character not to change the monetary policy stance and not to boost inflation.

The main measures to render support to the industries should be carried out under state programmes implemented by the government. Our strategic goal is to lower inflation to reduce interest rates. Low inflation means predictable financial conditions, which are necessary to implement precisely investment projects. However, we are not going to curb inflation to the detriment of the economy and therefore we always keep a close watch on the balance of these two aspects (inflation and economic growth). The Bank of Russia acts step by step focusing on the smooth slowing of inflation down to 4% in the course of the next three years.

Quite often there are doubts about the feasibility of this task, I mean reducing inflation to 4%. But we consider it to be quite real, although difficult. The level of 4% is adequate to the state of the economy, it is higher than in the advanced countries, but the situation in those countries differs greatly from that we have here.

In view of the measures taken we expect inflation to start slowing from the second quarter of 2015. By that time the impact of those temporary factors that have provoked its growth this year will have also been considerably exhausted.

If the Bank or Russia kept the key rate intact or even reduced it, this would produce a rather small effect on economic growth, but we would now have even weaker ruble and considerably higher inflation, which would entail risks to financial stability.

Later on, as there is a stable trend towards reducing inflation and inflation expectations, we will be prepared to ease monetary policy. According to our estimates, this will become possible in the second half of 2015.

Let us consider the situation in the foreign exchange market. There were objective reasons for the ruble to depreciate, they are primarily of external nature: restricted access to external financial markets for our companies and banks, oil price fall, and the Fed’s policy of dollar appreciation. Amid these objective conditions the speculative pressure on the ruble enhanced.

We took complex measures to solve two problems: first, to satisfy reasonable demand of companies and banks for foreign currency required, inter alia, to pay off external debts, and second, to suppress speculative activity. Besides, as had been previously scheduled, we abandoned regular FX interventions and moved to the floating ruble exchange rate.

The floating exchange rate eases the impact of negative external factors on the economy. Currently, ruble depreciation helps the economy adjust to objectively altered environment, supports export growth and creates conditions to stir up import substitution. We cannot afford neglecting these opportunities.

The floating exchange rate will also gradually result in lower dependence of inflation from the exchange rate fluctuations. The previous years showed a decline in price response to exchange rate fluctuations. Inflation acceleration is currently slower than it would have been if ruble depreciation of the similar scale had occurred several years ago. According to our estimates, the pass through effect of the exchange rate on prices would have been double as high, for example, several years before the crisis of 2008.

However, for all advantages of the floating exchange rate to become clear, the economy and FX market participants require time for adjustment to it.

The Bank of Russia does not abandon the foreign exchange market, we continue monitoring the situation and are ready to take efficient measures, including, inter alia, large-scale FX interventions, in case of financial stability risks.

Let me proceed to the situation in banking. This year, banks have faced, on the one hand, restricted traditional borrowings in the western markets, and on the other hand, increased demand for resources inside Russia. And in these uneasy conditions lending to the economy has increased by 5.5 trillion rubles or by 13% from the beginning of the year.

However, banks’ financial statements show deterioration in the quality of loan portfolio. But, given that the Central Bank required from commercial banks to provide weighted reliable estimates of loan quality and to create adequate loan loss provisions and imposed tougher capital and asset quality requirements, we believe that banks will overcome this situation.

As banks increase lending to the economy they require resources. One of the most important funding sources for most banks is household deposits. We can see a slowdown in attracting household funds to deposits. Nevertheless, the deposit growth reached 10% year-on-year, adjusted for currency revaluation. Unadjusted figure is 4%. Of course, it is below the previous year level and additional measures seem to be required to attract deposits to the banking system.

In order to preserve current lending rate many banks may require capital increase. This is a challenge for bank owners and meeting this challenge will demonstrate their responsible attitude to business, bank creditors and depositors. Some banks are already increasing their capital – ten months of 2014 saw capital increase in the banking sector by 700 billion rubles or 9.6%.

The Bank of Russia sees one of its tasks as ‘preventive treatment’, i.e. revealing and preventing various problems in the banking system at an early stage. And only if the bank does not recover we take such an extreme measure as the revocation of its banking licence.

The Bank of Russia consequently enhances its supervisory activity aimed at banking sector rehabilitation and strengthening.

The essence of this policy is to clean the market from the banks which are chronically unstable or involved in dubious financial transactions or illegitimate activity.

Let me make it clear that the revocation of licence by the Central Bank has no alternative solutions, other measures are already exhausted. And the banking sector should be cleaned up in order to avoid serious problems and to protect depositors’ and creditors’ interests. Currently, we can state that a significant part of this work has already been done: in 2013, 32 licences were revoked with 80 licences revoked this year.

I would like to emphasise that stable work of the deposit insurance system over the ten-year period is an important stabilising factor. According to the law, payments to the insured depositors start in two weeks after the insured event.

The Bank of Russia together with the Federal Financial Monitoring Service continues the policy aimed at gradual release of the banking sector from customers carrying out dubious transactions, and termination of activity of banks whose business is actually based on conducting such operations. 76 banks among those whose licences were revoked in 2013-2014 carried out dubious transactions, it makes 68% of the total number of licences revoked during this period. Most banks terminated such operations without revocation of their licences. Thus, in mid-2013 high risk level arising from dubious transactions was typical of 176 credit institutions, in Q1 this year there were 28 such institutions, 24 in Q2, and only 14 in Q3. I emphasise that these are risky banks, we will supervise them and assume that they will terminate these operations.

Supervisory activities resulted in smaller volume of dubious transactions.

We distinguish between two types of such operations: illegal cash withdrawal, which fell by half during the nine-month period, and overseas money transfers through the banking system. During the same nine-month period it amounted to 9 billion US dollars against 23 billion US dollars year-on-year. However, despite the positive dynamics, the volumes of such transactions are still large, therefore we will continue our work in this field and will watch closely the movement of these transactions, including, to the non-banking sector.

In its actions the Bank of Russia always aims at protecting interests of creditors and depositors and when it is economically sound employs, inter alia, the instrument of financial resolution.

In 2013-2014, the decisions on the financial resolution of eight banks were taken. Our actions are not voluntaristic, we rely on objective criteria: systemic importance of the bank for the economy of the country or a region, economic efficiency of resolution costs, and lack of large-scale involvement of the bank in dubious transactions (on the business model level).

Unfortunately, sometimes the management and owners of a credit institution not only fail to take financial resolution measures, but also harm the stability and conceal information on the real financial standing of the bank. Unreliable financial statements and information hiding remain one of the most acute problems. Therefore, it is highly important to use finally introduced criminal sanctions for presenting financial statements which conceal the signs of bankruptcy, and to show that the punishment for presenting unreliable data is inevitable.

The supervision also focuses on the aggressive policy of certain credit institutions in attracting deposits. We believe, that banks raising funds from households at the interest rates which are significantly higher than the market rates, should remit higher contributions to the Deposit Insurance Fund. Thus, it is important to promptly adopt a related law.

We can see that it is not easy to work out financial laws and we are grateful to the senators for their work. However, some important issues remain unsettled, including those of regulatory and supervisory nature, in particular the activity of rating agencies.

We hope that the federal law will be adopted that will create equal conditions for healthy competition between foreign and Russian rating agencies and enable to establish supervision over their activity in order to have high quality unbiased assessment of our borrowers and issuers. We should create our own independent industry of rating agencies.

We consider it important to accelerate the adoption of the bankruptcy law that will enable us to flexibly implement the resolution mechanisms and transfer assets and liabilities to healthy banks. We also believe it is necessary to toughen by law the requirements to the business reputation of bank owners.

We support the initiative to grant credit institutions the access to the information on households’ income, including the information of the Pension Fund, in order to confirm borrowers’ creditworthiness.

Slightly more than a year ago the Bank of Russia became a mega-regulator, adding to the control and supervision over the banking sector the supervision function over other financial market segments. This means a huge amount of work, dozens thousands of companies including: 572 insurance agencies, 1790 collective investment vehicles, almost 4.5 thousand microfinance institutions, over eight thousand pawnshops, etc. Just for comparison, I would like to remind that we have 842 credit institutions, including 790 banks.

The new mandate required a noticeable reconstruction inside the Central Bank, leading in effect to the establishment of a new control and supervision infrastructure. The process of mega-regulator creation, implying the integration of the FSFM, was completed nine months ahead of the deadline set by law.

There are three areas in the activities of the mega-regulator: regulation and supervision of financial market members, market development, protection of the rights of financial services consumers and of minority shareholders.

It is impossible to overestimate the significance of the control function, and it is even more important to lay the grounds for the overall development of the financial sector. Pension savings and insurance reserves constitute a source of long money for the economy, being a driver behind domestic investments. Fostering the emergence of domestic investors acquires a special meaning against the backdrop of limited access to external capital markets.

These markets are not sufficiently developed today. At the end of the third quarter 2014, for example, the ratio of insurance sector assets to GDP was 2%, whereas in the advanced countries it is 30%, the ratio of pension funds was 3%, compared with 70% in the advanced countries. This evidences a tremendous growth potential of the mentioned markets.

We believe that our policy goals and objectives should be comprehensible and transparent. Now we are preparing draft Guidelines for the Financial Market Development in 2015-2017. This document will, in essence, become a development strategy for all sectors in the financial market, outlining development areas and principle mechanisms.

Speaking about our accomplishments, I would like to mention the launch of the Financial Supervision Committee (similar to the Banking Supervision Committee). This committee is responsible for key regulatory and supervisory issues in the financial market.

We have set up a single inspection, i.e. the Bank of Russia Chief Inspection, which conducts on-site inspections both of credit institutions and nonbank financial institutions. It helps install straight through control in the financial market, allowing, in particular, to mitigate the risk of dubious operations’ migration from banks to nonbanks.

Similar to the banking sector, the insurance market has introduced a curatorship for 20 largest insurance organisations. This makes it possible to identify inherent problems of large insurance companies at early stages.

We intensified control over closed unit investment funds, seeking to stop false pricing in this sphere and put an end to exaggerated balance sheets created with the help of these instruments.

We have strengthened control over depositories in order to cut short abuse in ownership accounting and to prevent the existence of fictitious assets on the balance sheets of financial institutions.

In 2015, a guarantee system for non-governmental pension funds will be launched. Up to now, we approved the corporatization of 44 non-governmental pension funds. These are large players, occupying 90% of the pension savings market. Now, the said funds are subjected to thorough examination, so that only solvent companies with reliable financial reporting become members of the future system.

Significant changes have been made to the regulation of the Compulsory Motor Third Party Liability (CMTPL) insurance.

Within its legal mandate, the Bank of Russia has prepared necessary regulations, which, in particular, include rules of the CMTPL insurance, maximum base rates of insurance tariffs, insurance tariff ratios and requirements, rules for insurers when calculating insurance premiums, etc.

In summer, the Bank of Russia conducted on-site inspections of 17 insurance companies with numerous branches in order to check the availability of blank forms for the CMTPL insurance. We are aware of the existing problem when agreements were not concluded under the pretext of absent CMTPL forms. The number of complaints about absent forms has reduced by 17%, hopefully, due to the conducted examinations, among other things.

At the same time, measures were taken to enhance supervision over the financial sustainability of insurance companies engaged in the CMTPL insurance.

However, much remains to be done in this market, as problems have been piling during many years. Therefore, the Bank of Russia will continue its efforts in this sphere to maintain the resilience of business model for insurance companies, attaching a special significance to the availability of high-quality and reliable services for customers.

We have created a special service to protect consumer rights in the financial market. We would like this service to become well-ramified and expect a duly increase in the number of complaints as a result of its activities. At present, people choose not to complain, realising the usefulness of their complaints and not expecting any response. We believe that, as the efficiency of our reaction to complains will grow, their number will also increase, allowing us to make a real input to the improvement of control and supervision.

In the conclusion, I would like to say that, in the face of numerous objectives and challenges of this difficult time, we need to use all opportunities given to us for our development. Our firm assumption is that both financial sphere and financial sector will have a stable development, thus providing funding for the economy growth.

I would like to express my special gratitude to the senators for adopting much needed laws. Very many of them have been passed during the last session, including 42 laws related to financial issues in 2014 and 27 laws in 2013. We look forward to our future fruitful work.

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