Bank of Russia Governor Elvira Nabiullina addresses 28th International Financial Congress

Good morning, distinguished colleagues.

I am pleased to welcome you to the International Financial Congress.

It is a traditional gathering of representatives from all the sectors of the Russian financial market, and a chance to discuss the challenges that our financial system and the regulator are facing.

Previously, the key challenge for the Russian economy and the financial sector was to adapt to the new realities, with lower oil prices and a sharply higher uncertainty where geopolitical factors have become game changers. It took a greater effort to achieve macroeconomic stability in a new environment.

Now Russia has a solid foundation for development: low inflation and tools to stabilise it around the target level, first of all, the inflation targeting policy and a disciplined fiscal policy pursued by the Government.

On its part, the Central Bank has worked hard to clean up the financial system, bolster supervision and regulation, and expand the range of instruments that support financial stability. It is our contribution to the present situation where our country is much more protected from external risks and prepared for any surge in volatility.

However, I do not think that any of those present here today have an illusion that we have done enough and the situation is under control. On the contrary, we are now likely to be facing a much more formidable challenge, with very sluggish economic growth, businesses that are not optimistic, household income that has virtually stayed the same and a widespread sentiment among people that stability has done little to improve their living standards.

What holds growth back?

It is always tempting to blame externalities but I believe they are by far not the only reason. Indeed, the global economy is slowing down. Trade wars and geopolitical escalation only make it worse.

We do not have any reason to believe that the external environment is going to change in any foreseeable future. True, there will be ups and downs both due to new actions and arrangements between the countries locked in a trade war and to the attempts by central banks to counter the most adverse effects, or, on the contrary, due to a resurgence in populism and geopolitical escalation. In essence, the external environment will always remain a challenging one. We have to keep that in mind. But, on second thought, it is not that bad. In any case, the present situation is definitely not the scenario where the risks have materialised. Oil prices are slightly higher than expected, and Russia has retained its appeal for global capital markets.

The key barriers to development, in my opinion, are internal ones. And I would like to use the opportunity to focus on the role of the financial sector and the Central Bank policy and economic policy in general in changing the trend.

The answer is well-known: we need to remove structural barriers.

The mandate of the Central Bank is to support price and financial stability. It is not our whim. It makes sense because the tools that the Central Bank has at its disposal have an impact on price and financial stability, ultimately. Even by itself, low inflation and lack of risks to financial stability create a favourable setting to boost the pace and quality of economic growth through a longer planning horizon, higher level of transparency and lower macroeconomic risks. This is why we have lately concentrated our efforts on bringing inflation down to the target of 4% and maintaining it at that level, as well as on ensuring financial stability both at the level of the system and selected institutions.

The Government’s commitment to the fiscal rule is a major pillar that underpins macroeconomic stability. It was instrumental in isolating the economy to a large degree from oil price fluctuations and building up a safety cushion in case the risks materialise.

But macroeconomic stability alone does not drive growth. Our economy is growing at about 1.5–2% right now, and in the first quarter the rate was as low as 0.5%. We have slow growth despite a very low unemployment. This is the outcome that will sustain unless we embark on structural changes. The policy that supports macroeconomic stability can only go as far as to stabilise the economy around its current potential.

If we attempt to push potential growth rates higher with the Central Bank tools, we would eventually end up with a high inflation or bubbles in the financial market, and most likely we will be facing both of them.

It is only through structural transformations that we can boost our potential, harness all the opportunities that the economy offers to accelerate growth and, ultimately, improve the well-being of our people. These must be transformations that will facilitate a re-distribution of resources, both labour and financial ones, into areas with a greater return, greater productivity, and greater value added.

Kick-starting the economy would require, first and foremost, a drastic improvement of the investment climate. We cannot waste our efforts on shifting the focus of economic policy or getting distracted by backburner factors.

This year, the Government has embarked on a series of national projects that are designed to remove structural barriers. These projects will channel investment into education, healthcare, infrastructure, and, if managed effectively, must yield results.

However, there are two major issues that we cannot gloss over if we are to ensure sustainable economic growth.

First. We need to create incentives for entrepreneurs. It is the business community that fosters economic growth, not the state. Public investment cannot replace private capital. Even if national projects are successful in their state-funded component, there is no guarantee that they would create a proportionate multiplier effect through an expansion of private investment. What is important is that private investment should not be considered to be equivalent to loans taken at concessional interest rates from banks with government guarantees.

Private investment primarily comes from additional equity and own funds by both major corporations and small entrepreneurs that they are ready to invest at a risk in the hope of future growth of their business and revenue. But whether they are prepared to take on the risk is conditional on the often-mentioned investment climate.

If an efficient business is not ready to invest and demand for financing only comes from struggling companies that need it to survive, rather than develop, it should not come as a surprise that the financial sector is reluctant to provide loans to businesses.

Second. Structural changes take time. Initially lulled by soaring oil prices, then faced with the need to focus on strengthening macroeconomic stability, we delayed many structural reforms that were long overdue, and now we want fast deliverables. It is a deja vu when we start searching for simple solutions, like searching for a lost item not where we lost it but where there is light. Ironically, such an attitude would usually lead the search efforts to the Central Bank.

Back in the 2014-2015 crisis, suggestions for quick fixes included capital movement controls, a sharp key rate cut, or massive handouts to enterprises ‘that the country needed.’ Today, we hear new ideas. Some argue we need to curb consumer lending in the hope that once banks stop issuing loans to retail customers, they would ramp up lending to the corporate sector, which would by itself start up the engine of the investment boom.

I have to say it again and again: there are no quick fixes. Those who have experience in streamlining operations are very well aware of it. If there is indeed one factor that drags everything down, and in our case it is primarily the investment climate, then it would not make a difference no matter how hard we try to improve in other areas.

Furthermore, if we go down this path and give away cheap money to mask our structural issues, our country will just be wasting more time: it would first lose macroeconomic stability, which came at such a huge cost, and then we would be faced with the challenge of restoring it, undermining hope among households and businesses.

Efforts to improve the investment climate, alas, do not boil down to easing administrative barriers. It requires private property protection, independent courts and resolution of corporate conflicts in court, better corporate governance, and human capacity development. This has become a mantra that we have repeated in our statements for many years. First, it seemed like the right message, then it became commonplace, later bringing up the investment climate looked like empty promises by officials, and now it may come across as crying out loud in despair.

We still need a better business environment, but it is an enormous and time-consuming effort.

What can and should the financial system do under the circumstances to facilitate economic growth? The financial system must also become part of structural changes through building a long-term investment potential, developing the stock exchange and commitment to lending exclusively to effective projects.

The Bank of Russia wants to see more active lending to the real sector. As part of the so-called incentive-based regulation, we would seek to make corporate lending more attractive to banks, without compromising risk management and borrower due diligence functions. As I said, handing out loans to just any or the so-called ‘right’ companies is not an appropriate move and would only stall economic growth or funnel funds into ineffective sectors.

Sound corporate lending is, first and foremost, providing credit to companies that seek to expand their production capacity. What we see so far is that banks are far more eager to finance mergers and acquisitions, which is in fact a re-distribution of property and not expanding operations. In the meantime, there is an increasing number of cases when it is difficult to recover earlier loans.

We voiced our concerns about the trend a year ago, but banks begged us to delay regulatory action to limit contracts that fund mergers and acquisitions. We did them a favour and gave them time to brace for new measures. However, what we see is that without direct changes to regulation, without regulatory pressure on our part, the trend will not change. This is why we will no longer delay these policies.

Higher ratios for loan loss provisions for such deals will be adopted and introduced by the end of the year. We will classify such loans as category III, with the level of provisions at 21%, and a possible cut to 10% in case of collateral. Moving loans up to category II will be possible if the borrower demonstrates good financial performance, but provisions will not be lower than 5% in any case. We would also have a short list of exemptions: investment into authorised capital as part of federal targeted programmes, or into strategic enterprises, and a lower level of provisions in case of state guarantees.

Our pension funds play a key role in nurturing long-term investment in the real sector. Our policy serves to amplify the role of pension funds as a source of long-term funding.

We have adjusted regulation to stimulate long-term investment by non-state pension funds into the real sector. In particular, we scrapped the need for asset revaluation due to short-term market fluctuations, expanded opportunities to invest in concessional bonds, introduced caps on the size of investment in the financial sector. We have recorded a drop in investment by non-state pension funds in the financial sector and a rise in the real sector, but there is still room for further growth.

Our priority is to control sustainable operation of pension funds, which underpins trust in pension savings in general and facilitates the development of the funded element in the pension system.

Financing small and medium businesses is another priority for us. We believe in banks with a basic licence as an institution that is supposed to support SMEs. The new type of licence has de-facto been in place for just six months and it is too early to estimate its success, but we will continue to monitor progress in this type of the banking sector. There will be a dedicated panel on business models for banks with a basic licence.

Green financing is a relatively new topic.

Socially responsible and environmentally friendly businesses must be eligible for the best terms in the financial market. These are forward-leaning companies.

We have now teamed up with the Ministry of Economic Development to work on a guidance to disclose non-financial corporate information, including in such areas as environmental and social responsibility. We have seen the first issues of green bonds, with the yield being subsidised by the Ministry of Industry.

Nevertheless, green financing is still perceived in Russia as something exotic but in developed markets it has grown into a real factor of investment policy that has an impact on access to capital. I believe it is important to develop it in Russia, and the Central Bank will put an extra focus on it.

Now I would like to move to the immediate challenges that the financial sector and the regulator are facing.

The key challenges come from digitalisation. It is the main driver behind the changes in the financial system and transformations of business models.

The Russian financial sector has been quite successful in harnessing the digital trend. We are ranked third in the level of fintech penetration, but that also brings new challenges.

First, we are aware that digitalisation needs huge investment. The price of the ticket into the digital world is high and unaffordable for small players. We are working to change it. It is infrastructure that is most costly, but once it is there even small players can offer innovative and competitive products. This is why we have launched our infrastructure projects like the biometrics, ‘Marketplace’, and faster payments. There will be dedicated sessions on that later today looking at how they work and what the outcomes are.

But here is the most pressing issue: these projects by themselves drive a transformation of the market, and the market may be happy with it but sometimes it is far from happy. One clear example is the faster payments system. When it only involved payments between individuals, almost all the market players were elated to be able to slice off a piece of the biggest banks’ pie and compete with them in payment services. The biggest players then voiced their grievances saying it is unfair for the regulator to change status quo by destroying the model that allowed them to maximise profit from a combination of their position as a monopoly and innovations.

We have argued that the priority for the regulator is to spur competition to improve conditions for consumers in getting financial products and services. Ultimately, infrastructure should serve the economy and its consumers, rather than the financial market.

And now, when the second stage of the faster payments system is about to be launched that will enable payments to legal entities, the same banks that initially supported the system wholeheartedly, are concerned about the future of their high-profit card business whose conditions are causing heated debates with the retail sector.

But our response is the same. We will facilitate the development of technology and competition in the market to push for a better price and high quality service for consumers and sustainable and profitable business for all the market players. Any attempts to stall progress because the stability of your existing business models is at stake is depriving yourself of the future.

We must look forward and develop modern technology, make it cheaper and provide convenient services to consumers.

The second challenge is a function of the first one, and that is the need to control and manage data. Major financial and non-financial institutions that own disproportionately bigger amounts of data compared with the smaller players will become new monopolies. How will we control their market force? How will we ensure security and data protection, particularly in case of new supranational players entering national markets. We believe it is important to establish conditions for a non-discriminatory access to data, and we are working together with the Government on the concept of a digital profile. We are thinking about RegTech solutions, for example, personal ratings or scoring of small and medium businesses that could be produced by credit history bureaus or dedicated companies and then offered to smaller market players.

The third, and the most massive, challenge comes from platform solutions where one buyer can offer different types of financial products, and here we see non-financial players entering the financial market, including major BigTech aggregators.

This development is a big challenge for the Central Bank as well. What kind of regulation should be applied to non-financial companies that offer financial services?

How do we regulate players that sell different types of products – banking, insurance, investment and even medical and other non-financial services?

Who should have access to the Central Bank’s facilities? Just the banks, like it is today? Or should it be also fintech companies and other enterprises that offer financial services?

Take a look at what other countries are doing. Switzerland offers a special licence to fintech companies, Hong Kong licences virtual banks, and the Bank of England also started working with new players under the financial market rules. We are mulling an option to allow transactions with the Central Bank for fintech companies as well.

Given these challenges, I would like to discuss two major initiatives that would require digitalisation and your input.

First. Shifting to regulation by types of operations, rather than by requirements to legal entities.

There is different regulation now for players that offer different financial products and services.

For instance, regulating banks, insurance companies, microfinance organisations primarily relies on regulating requirements to legal entities while regulating professional participants of the stock exchange, collective investments, trade organisers, and others is built around requirements to their type of operations. So we have a mixed system at the moment.

Market development trends that I mentioned are pushing us to shift the focus from the legal entity-based to operations-based regulation. If a company starts offering financial services, it would have to apply for a licence for a particular type of operations.

In fact, it is a major regulatory shift that would need a comprehensive debate with the market, and we are planning to launch the debate.

Second. How do we ensure conduct supervision under the new realities? As you know, the Central Bank is a mega-regulator and also has a mandate to protect consumer rights in the financial market.

What we see is that the rise of platform solutions has made banks the key channel in the sale of different financial products since banks are far more advanced than other types of financial operations. Today, banks offer investment life insurance contracts and other kinds of investment products. These products are becoming increasingly complex and consumers need to have real risk management expertise to be able to embrace the products.

An overview of the brief practice in Russia has revealed that a spontaneous and unchecked offer of a large variety of instruments can result in disappointment on the part of customers (this is what actually happened with the boom in investment life insurance). Such a path that exploits lack of knowledge and inability of the part of consumers to assess risks undermines trust to the financial market in general. We need sales standards and standards for information disclosure to the customers.

What we have so far is conduct supervision tools for non-bank financial institutions, and the key role here belongs to the sales standards and self-regulatory organisations that control their enforcement.

But the banking sector, which is taking on the primary role, does not have self-regulation. The model of banking associations that we have at the moment does not empower associations to influence the conduct of their members, let alone punish them for any misconduct.

This scope of regulation will be fully covered once all the product selling entities comply with common standards. It raises the question of self-regulation in the banking sector.

There are two alternatives that we also want to discuss with the market. We would have to choose either of the options. We could have associations playing the role of self-regulatory organisations in producing the standards. But it will be the Central Bank that will control their enforcement. Or we must set up a fully functional self-regulatory institution where self-regulatory organisations will both produce standards and monitor their implementation.

In any case, we need to introduce legal amendments that would allow using self-regulation to control proper conduct in offering both banking and non-banking products by banks.

Streamlining regulatory burden

We understand that in a situation of low economic growth and tighter competition from fintech cutting costs is becoming a major factor in the resilience of the financial institutions’ business models.

As a regulator, we understand that action is need.

We are aware that one area where you can cut costs is administrative expenses in dealing with the regulator.

Financial organisations have been complaining about it all the time, and not without reason. We need to take action that will help cut regulation-related costs. Again, it is digitalisation that can offer the biggest potential in terms of cost management, and we will introduce RegTech and SupTech solutions.

The Government has launched the regulatory guillotine but I cannot say that it is fully applicable to the financial sector because our regulation emerged in a more modern period. There are not so many outdated provisions, and our reform to centralise supervision is largely focused on ensuring uniform standards in supervision. Still, our regulation does feature many provisions that are ineffective, obsolete, and excessive.

We are planning to establish a permanent contact with the market to streamline the regulatory burden.

We have decided to set up a working group that will register proposals on regulation adjustment from market players. We will adopt a new perspective whereby we will judge regulatory provisions by their de-facto impact, rather than by the expected impact from a pending rule. We take a regulation and assess its impact and whether the goals that were initially set have been achieved. Our key target will be to identify obsolete rules, overlapping provisions that may often lead to regulatory arbitrage.

But we want to start with older regulations. It is difficult to assess the de-facto impact from the rules that have been in place for some three years. The terms are not likely to have changed much. This is why we will start with older provisions.

On top of that, our shared goal, which we have been discussing for a long time now, is to cut the amount of reporting. We have promised to streamline the process many times. To be faster than we currently are we are planning an audit of the reporting and data volumes provided by organisations under regulation. There is a lot of room for streamlining, I am sure you will agree with me on that.

Furthermore, we have identified those provisions that we can repeal as excessive. For instance, we can cancel the N10.1 ratio in banking regulation that limits the total credit risk to a bank concerning all of the insiders. Following the introduction of N25, we believe the rule is no longer needed.

We are also likely to simplify supervisory assessment of the banks’ economic standing. There are quite many metrics, and some of them could be cut.

We hope to get into contact with market players on that.

In terms of future regulation, there is another question that market players ask all the time. They need time to implement the changes. As you remember, the general rule says there are ten days by default between the passing of a regulation and their taking effect. More often, we take measures with suspended entry into force and discuss all the options with the financial market players before adopting the regulation, but the deadline remains by default, and we understand it is too short a time, and we would be ready to extend the term.

Most importantly, we want to introduce all these changes in dialogue with you, and we call on you to be brave in voicing your concerns. It is our interest to identify bottlenecks and remove them, and we can only make it together.

Finally, we understand that it is difficult to operate in the financial sector. Both the current economic situation and the long-term trends indicate that every year competition will be getting tighter, your profit margin lower, and traditional business models will be disappearing fast, but I hope that new business models will come. I believe that our financial system has built up a sufficient cushion, and that is something that we have been working on together for a long time. If we do not dodge issues, acute problems, if the short-term gains will not prevail over long-term sustainability, we will be able to tackle these challenges and make a substantial contribution to the development of the Russian economy and improving the well-being of our citizens.

I wish you constructive work at the congress, and hope that the debates will be interesting and positive for you.

Thank you for your attention.