Ksenia Yudaeva’s speech at Financial Stability Review 2022 Q4 – 2023 Q1 press conference
Good afternoon.
Today, we present our regular Financial Stability Review. You likely remember that our discussion in the review has traditionally been structured to centre on vulnerabilities. In the last year, in a break with tradition, the two latest issues of the Financial Stability Review discussed the financial sector’s response to the sanctions. This current review takes us back to the discussion of vulnerabilities in the financial system and policies intended to limit them.
As a key conclusion, let me highlight the fact that our financial system is on a sure footing and is adjusting to the new conditions. For all the problems at hand, things are picking up. This is true of all sectors of the financial market. To be more specific, the capital cushion in the banking sector, net of the effect of the temporary support programme, amounted to about RUB 6 trillion as of 1 March this year. Against this background, we are gradually rolling back the regulatory relaxations, with the exception of those covering frozen assets. Most of the measures that were to expire on 1 July 2023 have been cancelled. This is also true of loss provisioning requirements for corporate loans, and the relaxation has not been extended. We are also gradually restarting the publication of information. This is necessary for risk assessment and, ultimately, to sustain the confidence of market players. It is also needed to ensure financial stability.
I traditionally begin my presentations with global risks. Today, however, I will conclude with that topic. I will discuss the lessons the Bank of Russia has learnt from current developments as a regulator.
What I would like to start with is the vulnerabilities caused by the sanctions and the overall geopolitical situation.
To start, I have to note the further deterioration of Russian banks’ access to foreign payment infrastructure. The survey presents the correspondent relationship indices we have begun to calculate. They provide evidence of a decrease in the options open for conducting settlements in dollars and euros. At the same time, a significant increase has been reported in the index for the currencies of friendly countries. The extensive use of alternative currencies has its pros and cons. The cons include the various types of restrictions on capital accounts in terms of both convertibility and the option of using particular currencies.
The yuan now ranks first among the most popular alternative currencies. In the domestic currency market, the spot rates for the yuan are overall consistent with global numbers. However, some segments of the yuan market remain underdeveloped. Formerly, in their foreign currency business, Russian banks relied on the mature market for currency swaps, which is dominated by foreign banks. At the beginning of 2022, this market was larger than $100 billion in dollar and euro terms (its all-time high was $160 billion). The market for currency swaps with the yuan is growing, but it totals a mere $10 billion. This is in large part explained by the effective currency restrictions that China imposes on the offshore circulation of the yuan. As a result, the options for hedging foreign currency risks through derivatives remain limited, and shortages of yuan liquidity occur. This sends swap rates higher. The currency swap we have introduced does indeed have a certain smoothing effect, but it cannot serve as a solution to a large-scale problem if one arises. In developing their yuan business, banks must take these restrictions into account and adjust to them.
As a consequence of the current situation, consumers are ramping up investment in foreign financial instruments in an effort to diversify their savings. In the past, some consumers also kept part of their foreign currency savings in deposits with Russian banks. In prior years, foreign currency savings grew in part on the back of foreign shares that Russian investors bought on Russian exchanges. Consumers also relied on payment cards issued by international systems to pay for travel and the import of goods and services. They are now building up other foreign currency instruments, primarily holdings of foreign cash and payment cards issued by foreign banks, as well as funds in accounts with foreign banks and brokers. Total investment in foreign instruments increased by 4.1 pp to 19.2% between 1 January 2022 and 1 April 2023. However, it should be noted that the use of these tools is not risk-free, especially for individuals, and the risks are primarily driven by geopolitics. For example, we can see that such accounts and transactions may be closed, even in friendly countries. There are also purely financial risks involved. Given that such investments may not be insured, the financial institutions that hold them should be closely monitored for stability. There are also risks for the Russian banking system, as the emergence of new tools has triggered an outflow of long-term liabilities. Importantly, it is foreign currency deposits that have traditionally been the most sustainable source of financing. Therefore, one important challenge that the regulator and the banking system now face is to continue their efforts to boost public confidence and expand the steady base of long-term liabilities in rubles.
This base has yet to grow, which explains another traditional vulnerability of the banking sector: its high exposure to interest rate risk. Later, I will discuss the banking crisis in the US, as that risk is one of the key crisis drivers there. We are not in crisis mode in this country, but the problem does indeed demand attention. Admittedly, the risks have abated somewhat over the past six months. However, we have seen a gradual expansion in liabilities longer than one year and in floating rate loans, which brings considerable risks. However, the interest gap — a measure of interest rate risk — is still higher than the pre-crisis level.
The absence of opportunities to increase interest rate risk and the ceilings on interest rate risk constrain banks’ investment in long-term fixed-coupon OFZ bonds. Meanwhile, the Ministry of Finance of Russia views such OFZ bonds as the key tool for financing budget deficits. As a result, banks are walking away from investment in OFZ bonds and their liquidity buffers have yet to be restored. This is another point I would like to highlight. Although the liquidity relaxations are still in place, a strategy for their rollback will need to be formulated, along with a strategy to manage interest rate risk.
Now, I will move on to credit risks. Credit risks are closely related to the vulnerabilities of the domestic non-financial sector. Risks in the non-financial sector are overall quite moderate, which is a result of the economy’s fairly rapid adaptation to the sanctions. However, there are a number of causes for concern.
Most major companies reported strong financial positions in their financial statements for 2022, but as early as the first quarter of 2023, many exporters noted a certain deterioration. This comes as a result of a major slump in foreign exchange revenue, which was caused by the oil embargo. At the same time, companies are confronted with mounting costs as exports are reoriented towards the East, European suppliers of equipment are replaced by domestic or Asian alternatives, and the tax burden is rising, to name just a few factors. Having said this, it is important to note that Russian businesses have so far been on a firm financial footing.
The industries hit hardest by the crisis — airlines, auto makers, and commercial real estate — are struggling to adjust to the restrictions. This owes to their past overreliance on foreign partners, and this factor is set to have negative implications for their lenders. We know that the largest air leasing companies have been incurring severe losses, and banks have restructured a substantial part of loans to all these industries. Specifically, as much as 30% of loans in commercial real estate have been restructured.
Another vulnerability consists in risks related to foreign companies selling their Russian assets. First, large volumes of foreign currency purchases, especially in a short period such as one day, puts pressure on the foreign exchange market and triggers spikes in volatility as the current account surplus shrinks. To minimise this risk, it is recommended that business buyers take a gradual and even approach to foreign currency purchases. Second, these transactions send the corporate sector’s debt burden higher, with many buyers taking loans from Russian banks to buy foreign assets. M&A loans tend to be riskier than others, which is a factor to recognise in our banking regulation. Such transactions are covered by relaxations through the end of this year, but the fact remains that there may be medium-term risks, and they need to be monitored. On the other hand, we would like to recommend that our buyers reduce their debt burdens, including by selling part of the holdings they have bought on the stock market in the future.
Finally, let me discuss two traditional vulnerabilities in retail lending. One is the mounting debt burden of individuals alongside a misbalanced mortgage market.
Since the beginning of this year, we have been using a new tool: macroprudential caps for banks and microfinance companies. It is intended to limit the issuance of unsecured consumer loans to highly indebted borrowers. Banks and microfinance companies have, on the whole, adjusted their operations to this new tool, and the structure of lending is improving. The share of loans to highly indebted borrowers dropped from 36% in the fourth quarter of 2022 to 29% in the first quarter this year. It is only the credit card segment that remains above the 25% level since, understandably, the caps are lagged there.
At the same time, unsecured consumer lending has been steadily expanding since the end of the first quarter, in defiance of the effects of the macroprudential limits. For example, debt was up 1.4% in March. Its growth was slightly more muted in April, but it remained high at 1.2%. Lending is supported by rising demand for loans. In the first quarter, the number of applications for consumer loans was up 15% on the previous quarter. We can see a certain redistribution of the market share towards banks — for which lending standards were more conservative prior to the imposition of limits.
Given the fact that both banks and microfinance companies have successfully adjusted their operations to our policies and that growth in lending is steady, the Bank of Russia’s Board of Directors has decided to further expand the macroprudential caps beginning in the third quarter. This move will reduce the growth of household loans, putting the structure of lending on a more balanced footing.
Now, I move on to housing market imbalances
Last year, banks and developers, seeking to shore up demand, went into overdrive with the developer-subsidised mortgage programme. In the first quarter, prices in the primary market were 40% higher than those in the secondary market. To limit the increasing risks, we tightened regulation, demanding that banks increase loss provisions on such loans.
Admittedly, banks had been gradually scaling back these dubious practices even before the new regulations came into force. However, overall lending standards remain soft. Of all mortgages being extended, more than half have downpayments of less than 20%. About 40% of mortgages are extended to debt-ridden borrowers (whose debt service to income ratio is over 80%). In addition, in order to reduce the amount of the monthly payment, banks extend the terms of such loans as much as possible. Thus, in the fourth quarter of 2022, 40% of loans were issued for terms of 30 years. Aiming to mitigate the risks, we have raised the macroprudential buffers, effective 1 May, most of all for low-downpayment mortgages.
As the old schemes in the mortgage market disappear, new practices are taking their place. For example, a new trend since last year has involved banks offering clients the opportunity to reduce their interest rates, including in the secondary market. The borrower is asked to make a one-time payment. For banks, there are two key incentives in this scheme. One is to reduce the amount of potential refinancing of loans in the event of future rate reductions. If borrowers have paid for the reduced rate, they will not have the benefit of switching to another bank. The second incentive for banks is the recognition of the fee amount as interest income and its subsequent inclusion in capital. The scheme also involves risks for banks. For example, the reduced interest fee is calculated on the assumption that the mortgage loan will be paid before maturity, within
As promised, let me say a few words in conclusion about global risks and the lessons we can learn from the situation in foreign markets.
Certainly, the problem that has recently attracted the most attention is the crisis of regional banks in the US (more precisely, the crisis of medium-sized banks). It comes as a result of, on the one hand, interest rate risks, as I have mentioned, since, throughout the period of low interest rates, banks bought securities and issued loans at rather low rates with fairly long maturities. When the rates rose sharply, they essentially began to incur losses on those securities or those loans. On the other hand, banks have been opening relatively many demand deposits, including uninsured deposits, and in the digital era, such deposits can ‘run away’ from banks very quickly. As things stand at the moment, there is a risk that the crisis that has taken shape may spill over into other segments, which could include commercial real estate or non-bank financial institutions. In the current situation, central banks will be forced to choose between the need to secure financial stability and the need to fight higher inflation.
The problems that have come up are at least partly due to regulatory deficiencies and a past lack of focus on emerging vulnerabilities. Therefore, as a takeaway, we must monitor emerging vulnerabilities in time and take action to limit their growth or create buffers in case the risks materialise. This is an important consideration as we work to deliver financial stability and sustain the flexibility of our monetary policy, which will ultimately retain its focus on price stability. As things are now, there is a real chance that new risks may emerge. Therefore, the Bank of Russia’s policy aims to roll back the regulatory relaxation at the earliest possible time. In this, the regulator will rely on the extensive use of macroprudential tools and will seek to improve regulation so that it is commensurate with current and future risks. This concludes my opening remarks. I will be happy to take your questions.