Ksenia Yudaeva, First Deputy Governor of the Bank of Russia, speaks at the 5th Financial Stability Forum
This forum is dedicated to financial stability, that is why my statement will mostly cover possible risks. We should not be afraid of risks or avoid them. We should be ready to face risks, i.e., be equipped with tools for managing and preventing risks, as well as mitigating their spillovers. Therefore, in my statement I will briefly overview our vision of some principal risks and dwell on certain policy measures designed to mitigate risk effects on the Russian financial system. I would like to focus on three key issues:
1) possible risks connected with the global market environment;
2) Bank of Russia measures to mitigate currency risks in the financial system and the economy as a whole;
3) correlation between the monetary policy and financial stability in the current Russian macroeconomic climate.
I will start with the global markets. After the January volatility surge, the situation has stabilised somewhat in the recent weeks, but remains fundamentally unstable. The main problem is low economic growth and low labour productivity. Experience gained by the advanced economies in the past 7-8 years has shown that monetary policy measures alone are unable to set the economic ball rolling, unless accompanied with adequate structural reforms. We keep on evidencing such developments. Economic growth in the key world economic hubs remains low despite the unprecedented monetary policy easing.
On the other hand, excessively smooth monetary policy triggers market volatility and bubbles. Negative interest rates have a detrimental effect on the situation in the banking and financial sectors creating additional risks.
The situation in the oil sector is also still very uncertain. Supply persistently exceeds demand. The policy of some key players is still unclear. The oil price fall failed to result in accelerated economic growth in the global economy despite the expectations. The expected growth acceleration in oil consumers which should have set off the slowdown in oil producers is not yet in place.
It is likely to result from structural shifts in the global economy, with a transition of the Chinese economy from export and investment-based growth to the growth based on consumer demand being the dominant. Last year, concerns over the situation in China triggered volatility in the global markets. The situation has stabilised somewhat at the moment. We can see positive outcomes of the fiscal stimulus of 2015 H2. The People's Bank of China has also taken measures to mitigate risks. That is why current risks connected with the Chinese economy have abated significantly, but still should not be neglected.
If we look at all the emerging markets, most of them currently show slower economic growth and high volatility of the national currencies and domestic markets. The vulnerability of these countries results from high indebtedness of the corporate sector, among other things. The nature of this debt has changed after 2008: companies borrow less from banks and often raise funds directly in the global markets through the issue of bonds. The rate hike in the US leads to a rise in the debt value and hampers its refinancing, triggering additional exchange rate volatility in the related countries.
Russia has also faced this challenge. Our external debt repayments have already been widely discussed, and I will not focus on them. The issue of widely spread domestic FX lending is of equal importance. The share of corporate FX lending currently stands at about 40%, creating risks on both the micro- and macrolevel.
I will start with risks of the banking sector. Banks' equity instruments are usually denominated in rubles. That said, ruble depreciation automatically boosts risk-weighted assets and thereby brings down banks' capital adequacy ratio. In its turn, it has a detrimental impact on their stability and restricts their lending capacity. Therefore, lending dynamics become procyclical.
In addition, highly developed FX lending signals of incorrect risk assessment by banks. Neither banks, nor borrowers seem to have a clear understanding that the difference in the interest rates on ruble and FX loans reflects the currency risk. In other words, the borrower who takes an FX loan at a lower interest rate, accepts the risk of servicing higher debt in case of reduction in the exchange rate. The difference in the interest rates covers the costs, which are likely to be incurred. Only the lack of a clear understanding of currency risks can explain the ongoing active FX lending to borrowers who do not have any FX revenues, primarily in construction and real estate, in the aftermath of the 2008 crisis. Such underestimation of borrowers' currency risks also has macroeconomic consequences: it magnifies fluctuations of the economic growth (or downturn) rate on the back of fluctuating oil prices and enhances exchange rate volatility. The mechanism is clear: in the periods of exchange rate fluctuations, FX debt servicing requires more foreign currency, that is why its purchase increases boosting the exchange rate volatility. At the same time, growth in FX borrowing during the exchange rate appreciation leads to additional capital inflow that also boosts volatility.
Measures proposed by the Bank of Russia to set elevated risk ratios on loans and other claims in foreign currency are particularly designed to hedge these risks. Currently, plans are afoot to protect domestic exporters from heightened claims. We should be aware that such an approach has its pros and cons. Exporters have actually reached a certain level of the so-called natural hedging and their currency risks are lower. On the other hand, their share of FX lending is rather high already and it may even exceed the level of natural hedging. Finally, the conclusion that widely spread FX lending increases the ruble exchange rate volatility amid external shocks is true both with regard to lending to non-tradables sectors and with regard to exporters, though to a lesser extent. Moreover, if we speak about the forex hedging market development, it is important that there are not only importers, but also exporters among its participants. Their currency risks are usually opposed, that is why in the final count exporters sell insurance against importers' currency risks and vice versa. While foreign currency loans to exporters decrease their demand for hedging instruments.
Dollarisation is a complex problem connected not only with foreign currency loans, but also with a high share of foreign currency in banks' liabilities. A considerable degree of deposit dollarisation enhances the risks of foreign currency liquidity shortage and brings down the effectiveness of the monetary policy pursued by the central bank. That is why Bank of Russia measures are designed to discourage raising foreign currency liabilities: the ratio of allocations to the required reserve fund for legal entities' foreign currency deposits has been raised from 1 April 2016. It is clear that dedollarisation is a rather slow process. The equilibrium of foreign currency assets and liabilities is of great importance, that is why the Bank of Russia plans introducing these measures step by step.
A key condition for successful dedollarisation measures is the implementation of inflation targeting, which increases confidence in the national currency and reduces financial instability risks on the whole.
A moderately tough monetary policy, including keeping the key rate on hold for a long time, brings its yields. Inflation more than halved from its peak values. Market participants are becoming increasingly confident of the Bank of Russia's policy. As a result, interest rate curves are becoming inverted due to the decline in long-term rates. Sustainable reduction of inflation and inflation expectations will allow the Bank of Russia to cut the key rate more actively in the future without posing risks to financial stability.
A special mention should be made of the transition to the structural liquidity surplus expected this year from the structural deficit we lived with in the past few years. The structural surplus reduces one risks but may entail new ones.
The Bank of Russia curtails its refinancing volume, as a result of which the banking system is becoming less dependent on its refinancing facilities. The structural problem of market security shortage is becoming inferior. It is much easier for systemically important banks to comply with the liquidity coverage ratio.
However, foreign experience shows that structural liquidity surplus is not automatically conducive to market liquidity improvement. On the contrary, a certain liquidity deterioration has been recently observed in global markets against the backdrop of the structural surplus in a wide range of countries. Certain markets have become shallow and the volume of transactions, which do not affect prices, decreased. The so-called flash crashes are observed more frequently.
As far as Russia is concerned, one should be aware that an efficiently operating money market, which reallocates liquidity, is extremely important amid liquidity surplus. From this point of view new money market instruments are very useful, including repos with clearing participation certificates we will speak about further at our meeting.
The Bank of Russia will mop up excess liquidity through deposit operations and bond issue, as a result of which the banking sector liquidity amid structural surplus will be equal to that amid structural deficit. That is the amount required to satisfy money demand with the key rate set by the Bank of Russia. Nevertheless, amid liquidity surplus one cannot rule out the risk of bubbles in certain markets (the way it was, for example, before 2011, when the liquidity surplus and low interest rates were conducive to unsecured consumer lending market boom). The Bank of Russia will watch the situation closely and apply macroprudential policy measures, if necessary.
Now a few words about the situation in the Russian economy. It is improving, but remains complex, which is a factor of financial market vulnerability as in the rest of the world.
In view of the above, I would like to touch upon the budget situation. The Russian budget system has not yet adjusted to low oil prices and the drop in oil and gas revenues. The Reserve Fund makes it possible to finance an increased budget deficit, however a programme should be developed which will allow to balance the budget system in the medium term. It may be high time to think of a new budget rule. Otherwise the budget will be a source of risks for both the economy and financial stability.
Finally, a few words about the reason why the achievement of the 4% inflation target will mitigate financial stability risks. A lower inflation is as a rule less volatile and more predictable. The exchange rate is more stable since it depends on the monetary inflation and if the latter is more stable, then the exchange rate is more stable too. Risk premia decline amid low inflation together with financial stability risks. That is why the Bank of Russia's policy to reduce inflation and keep it low will foster financial stability risk mitigation and diminish Russian economic vulnerability to financial risks.