Kseniya Yudaeva’s speech at press conference: Financial Stability Review for 2021 Q2–Q3

Today, we present the new issue of the Financial Stability Review. I would like to remind you that these semi-annual reviews are meant to assess vulnerabilities and possible risks that might materialise in the Russian financial sector, on the one hand, and to estimate its resistance to these risks, the availability of buffers and policy tools to mitigate them, as well as the need in additional measures.

Last year, Russia’s economy and financial system had to face the coronavirus-induced risks and the economic consequences of the measures implemented to address the pandemic. Therefore, the financial stability reviews mostly focused on the stability of the financial sector in this environment. This year, the pandemic does not have a critical impact on the economy and the financial system. Hence, we have returned to the conventional structure of these reviews and discuss in detail the vulnerabilities of the financial sector.

First, I would like to speak on risks. The pandemic situation remains the key factor of uncertainty for both the Russian and global economies. It is the pandemic and differences in vaccination rates that are behind the uneven development of the global economy over the past six months. Nonetheless, most regulators expect that the pandemic situation will improve and the world economy will develop progressively.

One of the main risks is faster inflation, fuelled by demand considerably exceeding supply and shifts in the structure of demand, as well as the unprecedented growth of prices for energy commodities worldwide. Moreover, transitory factors affecting price movements might have longer-lasting secondary effects. Consequently, inflation might stay elevated for a longer period than expected before. This is true for both the Russian and global economies.

Many central banks in emerging market economies have already started a cycle of policy rate increases. Moreover, some of them are raising their policy rates quite aggressively. Regulators in advanced economies are beginning to taper their economy stimulus programmes. If it turns out that the market is not yet ready for this, changes in the policies of advanced economies’ central banks might reverse capital flows and spur volatility. Countries, companies, and households having high debt burden might face debt repayment problems.

Other factors of instability include a possible drastic revaluation of financial assets and growing global risks due to investment in digital currencies. In recent years, non-bank financial intermediaries have been playing a more important role in the global financial market. We have already noted this several times. As compared to banks, the regulation of such companies is much easier, whereas their response to the situation might entail more significant consequences as their actions might exacerbate market volatility.

Finally, geopolitical risk remains a considerable global risk factor for Russia.

The economic growth rate has returned to the pre-pandemic trend, except a small number of sectors, first of all oil and gas production which is still subject to the OPEC oil cuts. The economic recovery and high demand for Russian exports worldwide are positively influencing companies’ financial standing: for instance, major public companies’ debt to EBITDA ratio decreased from 2 as of the beginning of the year to 1.4 as of 1 July. As a result, credit risks in banking and the financial sector in general lowered. Owing to this, Russia was among the first countries to terminate the regulatory easing for the financial sector, and this was done smoothly.

Overall, the situation in Russia’s economy and financial sector is sufficiently stable as compared to other emerging market economies. Significant international reserves at the central bank, small public debt, and considerable capital cushions and high profits in the banking sector are the main buffers to counter potential shocks. The smooth functioning and better sustainability of the financial sector are one of the key objectives of the Bank of Russia. That is why we carry out continuous monitoring of vulnerabilities in the financial system.

Our assessment of vulnerabilities is based on the traffic light principle: significant risks are in the red zone, moderate risks are in the yellow zone, while the green zone means that there is no serious threat, but developments should be monitored. We watch closely all vulnerabilities and, where needed, employ various instruments to address them.

Currently, we have no ‘red’ vulnerabilities and are taking proactive measures in order to prevent them. According to our estimates, the vulnerability related to households’ growing debt burden and retail lending risks is in the bright yellow, or rather orange zone. At the macro-level, households’ debt burden edged up over 2021 H1 from 9.8% to 10.2% of their disposable income. The expansion of unsecured consumer lending is driven not by an inflow of customers into the banking sector, but rather by an increase in loan amounts, which involves systemic risks.

The Bank of Russia already raised the macroprudential capital requirements for banks in consumer lending on 1 July and 1 October. The higher is a borrower’s debt burden, the higher are capital requirements for banks. Furthermore, the procedure for measuring the debt service-to-income ratio for long-term (over four years) consumer loans will change since 1 February 2022. The draft law adopted yesterday entitles the Bank of Russia to establish macroprudential limits on consumer loans involving high risks. In the future, it will help influence the situation with households’ debt burden even more efficiently.

The climate problem is also in the orange zone, in our opinion. This vulnerability is rather considered to be a medium- and long-term risk. The global energy transition will impact multiple industries of Russia’s economy, from electric power to mining and quarrying. Transition risks might cause a decline in revenues and higher operating and capital expenses for energy-intensive companies, which will increase their debt to EBITDA ratio. Moreover, our analysis shows that very few enterprises in carbon-intensive industries have set quantitative targets for the reduction of the environmental impact. As Russian companies need capital to decrease emissions and are facing problems trying to raise funds abroad because global investors are greening up their portfolios, Russian banks’ portfolio might concentrate on the largest brown companies. In this regard, the Bank of Russia recommends that banks and other financial institutions should take into account climate transition risks in their risk assessments already now.

We believe that the yellow zone of moderate risk include the following vulnerabilities: the Russian market’s sensitivity to non-residents’ behaviour, a significant inflow of retail investors into the securities market, interest rate risk in the banking book, and risks associated with ecosystem development in the Russian financial market. I would like to focus on each of them a little more. First of all, I would speak on current vulnerabilities.

Foreign investors are still among the most active participants in the Russian financial market. This involves the risks of higher volatility as the discussions about new sanctions regularly become more active. There are still risks that investors might exit emerging market economies in response to the cycle of policy rate increases started by major central banks. It would be possible to reduce these risks if Russian investors having long-term investment strategies — pension and insurance funds and retail investors using long-term individual investment accounts — strengthen their market positions.

Overall, risks related to non-residents’ activity in the market are lower in Russia than in other emerging market economies. According to the National Settlement Depository, non-residents’ investment in federal government bonds reached 3.3 trillion rubles by the end of Q3, which is a record high (currently — 3.2 trillion rubles). However, the situation in the Russian market is more favourable than in other countries both in absolute terms and in terms of the market share. (By way of comparison, foreigners account for 20.3% in Russia, whereas in South Africa, Malaysia and Peru, these figures reach 30%, 26% and 44%, respectively.) In the FX swap market, non-residents increased the demand for carry trade. Their short foreign currency position reached 30 billion US dollars, while dropping slightly in recent weeks (on average, their position totalled 26 billion US dollars in November). However, non-residents continue to divest from Russian shares amid high demand for these assets demonstrated by Russian private investors and growing stock indices.

In the medium and long term, individuals’ massive investment in securities will make their financial standing more dependent on fluctuations in the securities market. High activity of retail investors with similar strategies might intensify market volatility. Nevertheless, the concentration of individuals’ investment is currently moderate, and the related indicators of systemic risks are in the moderate zone. People have expanded their foreign investment. This has slightly increased the portion of foreign currency in household savings by the moment, specifically from 21.0% as of early 2021 to 21.6% as of 1 October 2021.

The risks associated with Russians’ investment in digital currencies are growing as well. According to a number of indirect assessments, Russian investors are among the most active participants in the digital currency market. In this regard, I would like to reiterate that digital currencies are money substitutes not backed by any assets. Therefore, a person might totally lose investments as a result of both volatility and fraud or cyber threats. The stability of the so-called stablecoins is also highly questionable. In practice, it turns out that they are often not backed by sufficient assets and are also exposed to fraud risks.

By the moment, growing interest rates in the economy have not yet caused a decrease in the banking sector’s net interest income. However, interest rate risk might materialise to a greater extent in the future as liabilities are revaluated faster than assets due to a large portion of short-term liabilities and as a result of a gradual movement of funds into more expensive time deposits. Nevertheless, if this risk materialises, banks will not suffer any significant consequences owing to a considerable rise in their profit in 2021.

New contagion channels in the Russian financial market emerge due to the development of ecosystems by banks expanding their non-core business and partnerships with technology companies. If the development of ecosystems is not controlled properly, this will increase step-in risks for these banks as they will be forced to support this business. In view of the above, the Bank of Russia is studying the issue of tightening the regulation of banks’ investment in non-core assets and the introduction of differentiated capital buffers for banks developing ecosystems. At the same time, it is essential to pay attention to the growing interest of large technology companies, the so-called BigTechs, in the integration with the financial market. Technology companies have not only been acquiring their own banks, but also extensively offering their financial products (in the first place, instalment services) in partnership with financial institutions. This entails the risks of fragmentation of the financial market and the risks of regulatory arbitrage in credit markets.

Now, I would like to say a few words about the vulnerabilities we focused on in our previous reviews that have slightly stabilised. As regards mortgage lending and the housing market, after the tightening of the government subsidised mortgage lending programme beginning from 1 July 2021 and the increase in the key rate and the macroprudential buffers for mortgage loans with a low down payment, the growth in mortgage lending returned to more moderate rates. However, prices in the real estate market are still rising rather fast, and therefore it would be too early to forget about this risk.

Owing to the economic rebound and the termination of the regulatory easing, we consider that risks in corporate lending are minor (the green zone). Of course, there are certain companies facing hardships, but the situation in general is stable. The recovery of economic activity in 2021 is accompanied by the growth of corporate lending. As of 1 October 2021, outstanding debt increased by 11.2% in annualised terms. Companies have been efficiently addressing the aftermath of the pandemic and adjusting to the current market environment. This is promoted by economic growth and higher prices in commodity markets. Companies have restored their financial position, which has improved the quality of banks’ loan portfolio in general.

In conclusion, I would like to focus on the issue I addressed at the beginning. The pandemic persists, and this is the main risk for the Russian and global economies. It is hard to predict how the pandemic situation might change, and the gaps caused by the coronavirus are still considerable. It would be too early now to talk about a post-coronavirus world, and the Bank of Russia takes into account this factor in its policy. The banking sector is sufficiently resilient to potential risks. Specifically, as of 1 October, the macroprudential buffers amounted to 710 billion rubles already (as compared to about 630 billion rubles before the outbreak of the pandemic). Despite a rather favourable situation, it would be better for banks to remain prudent, factor in the current vulnerabilities, and ramp up their capital buffers amid record high profits.