How much does “softness” cost?

I constantly have clashes with former and current colleagues at the Central Bank and with representatives of the banking community on the following issue. I have always been and continue to be a supporter of “strict” banking supervision, which would not allow banks to hide their problems, and government agencies to pretend that these problems do not exist. That is, the bitter truth is better than a sweet lie. My opponents believe that if you give the problem time, it will resolve itself. And I am convinced that economic problems do not dissolve, but only accumulate their power. And sooner or later, you have to pay for their decision (no matter whether this decision occurred due to conscious actions or spontaneously). And here is a new reason to talk about how much “soft” banking supervision costs.

According to recently published statistical data, household deposits in Russian banks increased by almost 1.6 trillion rubles. from January 1, 2009 to January 1, 2010, and if we add deposits of legal entities to this, the increase amounted to almost 2.7 trillion rubles. (let’s leave aside the discussion about rubles/currency for now: in any case, during this time the ruble strengthened, i.e. foreign currency deposits dried up, therefore, the real influx of money on deposits was greater). Strictly speaking, this was not a strong revelation, since our population always turns out to be more economically literate than is commonly thought, and responded absolutely adequately to rising interest rates and falling inflation. And even to the next question, how do banks use these funds, I knew the answer in advance: they pay off their debts (external, internal, to the Central Bank). And statistics show this, and bankers say.

As a matter of fact, the next element of the puzzle lies on the surface: almost all this time, Russian banks have been steadily reducing the volume of loans provided to the economy and the population. Here, however, the peak value was on February 1, 2009: over 12 months, the total volume of the loan portfolio then decreased by 1.36 trillion rubles.

Look: the increase in deposits is accompanied by a decrease in loans, and the total delta is almost 4 trillion rubles, which is 10% of Russian GDP. And one of the basic theses of economic textbooks sounds like this: the banking system transforms savings into investments. In Russia, the opposite is true: savings are growing, but investments are falling.

Just don’t immediately rush to blame the “fat cats” – the bankers – for everything. As a matter of fact, they didn’t hide this money anywhere. Approximately 1.5 trillion rubles. Another 2.5 trillion rubles were spent on repaying external debts. -- to repay loans received from the Bank of Russia during the acute phase of the crisis. There are no questions about the first part: this is why there is a crisis of external debt in the Russian economy (this time corporate), so that for some time the economy will pay off previously acquired loans. Do not forget that as of the beginning of autumn 2008, the amount of bank and corporate debts subject to repayment by the end of 2009 was about $200 billion (12% of GDP). The amount is obviously unaffordable for the economy, so a massive corporate default on external debt is not someone’s invention, but an objectively determined reality. It’s worse for banks: for them, a default is tantamount to cessation of activity, and therefore they were ready to take money anywhere, at any interest, just to pay off their debts. And they paid. The banks paid their part, 4% of GDP. The corporation will pay the remaining 8%, as they say, later, if they find the money. Or, as a last resort, they will agree with creditors to change the repayment terms. What if they don’t find it and don’t come to an agreement? This means that it will be harder and more expensive for others to borrow money on foreign markets.

But let’s return to the remaining 2.5 trillion rubles, which banks used to repay loans received from the Bank of Russia. It is worth recalling that banks began receiving these loans in September 2008. True, it initially turned out that the Bank of Russia was not ready to issue loans to banks, and the function of lender of last resort was temporarily taken over by the Ministry of Finance, which began placing its deposits in banks. But gradually these deposits were returned by the banks as they were replaced with loans from the Bank of Russia. As many remember, banks used all the rubles they received to purchase foreign currency (see Vremya Novostei, October 17, 2008) , which led to a sharp drop in the level of gold and foreign exchange reserves, and later to what was called a “smooth devaluation.” Of course, the banks explained that these were requests from clients, but their balance sheets clearly show that they simply accumulated currency in their accounts, understanding better than the authorities that with falling oil prices, devaluation becomes inevitable.

Another circumstance pushed banks to such an intensive accumulation of foreign currency assets: for a long time, in their activities, banks proceeded from the fact that the ruble would strengthen, and therefore, it was commercially profitable for banks to borrow in dollars and issue loans in rubles. In this case, servicing foreign currency debts became cheaper in ruble terms, or, conversely, ruble loans brought foreign currency excess profits. Again, I don’t want to blame banks for anything: they are commercial organizations and must earn a profit. As a matter of fact, this is why banking supervision exists, to limit and control the risks that banks take on. After all, they operate with funds received from investors.

So this policy - borrowing in dollars, loans in rubles - is correct only if the ruble constantly strengthens against the dollar. In the event of a weakening of the ruble or a planned devaluation, banks could receive colossal losses from such a policy. To prevent this from happening, the world practice of banking supervision has developed a standard for an open currency position, i.e. the maximum permissible gap between the bank's assets and liabilities in one currency. In Russia, this standard is set at 10% of the bank’s capital, i.e. the difference between, for example, funds raised by a bank in dollars and issued dollar loans should not exceed 10% of capital (the amount of equity). If the bank complies with this standard, then even a 50% devaluation of the ruble against the dollar will lead to the bank losing only 5% of its capital. And if this capital is real and not fictitious (which is what the Bank of Russia must monitor), then nothing will threaten the stability of the bank.

Here we come to “hard” and “soft” banking supervision. If the Bank of Russia were a supporter of “strict” supervision, it would not allow Russian banks to violate the established standard. Whether it is a private bank, or a state-owned bank, a system-forming one with hundreds of offices, or a small regional one with one head office. But, as I have already said, the Bank of Russia is a supporter of “soft” supervision, which entirely fits into the well-known phrase: “The severity of Russian laws is offset by the non-binding nature of their implementation.” The standard for an open foreign exchange position in Russia has been established, but at the same time, banks are allowed to “compensate” for missing foreign exchange assets with assets, to put it mildly, of “second freshness”. For example, by concluding a forward contract for the purchase of dollars in the future, the seller of which is the offshore company “Horns and Hooves”. Externally, everything becomes great in the bank’s balance sheet after such an operation, and the reporting shows full compliance of the standard with the established value. True, if at the time of payment under such a contract the ruble weakens sharply, the offshore company will never pay.

According to the estimates of the first deputy chairman of the Bank of Russia, Alexei Ulyukaev, on the eve of the crisis, the real gap between foreign currency liabilities and assets in the Russian banking system was $100 billion, or about 80% of the total capital of the banking system. That is, banks violated the established standard eight (!) times. This means that the same smooth 40% devaluation of the ruble against the dollar would lead to the banking system losing more than 30% of its capital. Simply put, it would go completely bankrupt. Moreover, state banks would be at the head of this process.

In Russia it often happens that a feat is just retribution for someone’s stupidity. Later we will hear that the government, through “heroic efforts,” saved the banking system, although in fact the banks were only given rubles so that they could buy dollars and thereby bridge the gap that Alexey Ulyukaev spoke about. (If you want to laugh: one state bank in that situation decided to play the opposite game and violated this most unfortunate standard in the other direction, i.e. its currency position in rubles turned out to be unbalanced. Unfortunately for it, the ruble began to quickly strengthen, and... the bank suffered losses, after which he had to go to the state again for help. The state, of course, helped.)

The banks turned out to be “honest” and gradually returned almost all the loans received to the Bank of Russia. Only from the point of view of macroeconomics, it turned out that for this they used the savings generated in the economy in the amount of those same 2.5 trillion rubles, or more than 6% of GDP. Which otherwise would have to be transformed into investments. After all, this is the function of the banking system.

Well, of course, “a crisis is a crisis” and “you shouldn’t stir up the past,” if not for one “but.” The Bank of Russia continues its policy of “soft” banking supervision. Now this is manifested in his soft attitude towards assessing the quality of banks’ loan portfolios, in his reluctance to deal with what is called the “bad debt crisis.” But, as very recent events have shown, the “softness” of banking supervision will inevitably have to be paid for sooner or later. And the population always has to pay. Isn't it too expensive?

Sergei ALEXASHENKO, Director of Macroeconomic Research at the Higher School of Economics