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That has had a notable effect on the rise of the excess of forex-denominated assets over liabilities. The CBRs strategy of a freer oscillation of the Rb exchange rate in the frame of a gradual transition to inflation targeting proved an efficient move to constrain attractiveness of CT. In March and December 2011, the Central Bank announced broadening the trading band against dual-currency basket from Rb 4 to 5 and from Rb 5 to 6, respectively.

9 246,57,8 8,6,6 4,7 5,3,3,2,2,1,0 -1,--2,-1,-4,-6 -5,30,30,19,8 -8,9 19,-9,5,7,2 7,0 3,-10,4,3 5,-9 0,2,-7,-5,8 0,-12 -8,5 -6,8 -Excess (+); deficit (-) of the share of foreign assets over liabilities Change in the $ nominal exchange rate in Rb equivalent (right axis) Source: calculated by the CBR data.

Fig. 18. Excess (+) and Deficit (-) of Banks Forex-Denominated Assets over Liabilities (Proportion of the Value of Banks Assets (Liabilities) as %) 12 10,3,6,---11,2,-12 Net foreign assets to banks assets, as % (left axis) RR by COs liabilities to non-resident banks in the RF currency and in forex (right axis) RR by COsother liabilities in the RF currency and in forex (right axis) RR by forex-denominated liabilities before corporate non-residents (right axis) RR by liabilities before private individuals in the RF currency (right axis) RR by other forex-denominated liabilities (right axis) Source: calculated by the CBR data.

Fig. 19. Regulation of Carry Trading by the Bank of Russia, as of 1 January Bank default 1.8.Change in $ exchange rate, % liabilities % to banks assets as % of forex-denominated RUSSIAN ECONOMY IN trends and outlooks The 2011 restrictions on CT were exercised in tandem with the trend to discontinuation of deleverage of the banking system1, as shown in Fig. 20. In other words, the banking system saw renewal of the advanced increase in credit portfolio against the deposit base. We believe that the combination of the said tendencies generated problems with funding of banks, thus having become a critical factor behind exacerbation of the problem with bank liquidity in Hof the year. The other reason that aggravated the bank liquidity problem was a notable increase of the federal government borrowing on the domestic stock market in 2010 by issuing government bonds (for more details, see the section on the bond market).

20 246,5 19,3 17,8 13,11,9,1 8,8 7,6 7,5,3,0,-4,-2,9 -4,6 -7,0 -1,0 -1,-6,0 ----20 30,30,-19,8 19,5,-30 7,7,4,3 3,-7,4 0,1 0,-5,8 -8,5 -6,-5,2,-40 -Net claims to other sectors (deleverage) Changes in the $ nominal exchange rate in Rb equivalent (right axis) Source: calculated by the CBR data.

Fig. 20. Excess of Loans over Deposits Deleverage (as % of the Value of Banks Assets (Liabilities)) 3.3.2. Liquidity and the Current Stability of the Banking System As shown in Fig. 21, Russian banks entered 2011 with a sizeable surplus of short-term liquidity. In December 2011, their net claims to the Bank of Russia accounted for Rb 2.5 trillion, while those to public administration agencies Rb 0.8 trillion. But by end-November 2011, the said amounts of net claims shrank to Rb 0.5 trillion and 0.2 trillion, respectively.

That de facto meant that the size of short-term injections government and monetary authorities made in the banking system accounted for some Rb 2.6 trillion by the end of 2011, i.e. the value comparable to the one the banks received during the 2008 crisis. In December alone, thanks to a drastic increase in federal budget expenditure, as much as about Rb 2.0 trillion poured in the domestic market2. Bank deposits increased by roughly the same amount, while 2 grew from Rb 22.0 trillion up to Rb 24.5 trillion, or by 11.7%. Extra bank liquidity was sterilized thanks to the amount of banks net claims to the Bank of Russia being up to Rb 1.trillion and those to public administration agencies up to Rb 1.0 trillion.

Index of costs of banks net claims to residents and businesses relative to banks aggregate assets.

According to Mr. A. Siluanov, the RF Minister of Finance, in December 2011 the federal budget spending was set to increase 2-fold vs. the average size of budget expenditures over the year and account for a. Rb 2 trillion.

(Sapozhkov . The 2012 budget overhang exceeds a usual size 2012. Kommersant, 7 December 2011).

Changes in the $ exchange rate.

.Section Financial Markets and Financial Institutions 3 2 2 1 1 -2008 2009 2010 -1 -1 -2 Net claims to the Bank of Russia, total Net claims to public administration agencies, total Source: by data of the Bank of Russias review of credit organizations.

Fig. 21. An Estimate of Amount of Support to Banks, as Rb bn Fig. 22 displays findings of an analysis of forms of the CBRs support of banks during the 2008-09 crisis and in the year under review. During the crisis, it was non-collateral loans, whose disbursement kicked off on 20 October 2009, which became a major form of credit support to banks. Various bank support programs at the expense of centralized lending have been practically stopped since September 2010. However, once the liquidity crisis exacerbated in H2 2011, the Bank of Russia began to vehemently disburse loans to banks in the form of direct repo operations, the debt on which is displayed in the graph in the form of debts on other loans. According to a CBR spokesperson, had the liquidity crisis intensified, the monetary authorities were ready to consider a renewal of non-collateral lending to banks1.

While attracting borrowed funds from the Bank of Russia and the Ministry of Finance, in the period of exacerbation of the situation with bank liquidity it was state-owned banks that found themselves in an advantageous position. According to Fitch Rating, they consumed 84% of the total volume of placed funds, while their proportion in the aggregate volume of the banking sectors assets accounts for some 55%2.

A traditional method of the Bank of Russias influence on stability of the banking system is lending to banks by means of direct repo transactions. Fig. 23 displays two periods in development of Russias banking system depending on prevalence of different sources of maintaining bank liquidity. The first period - between 2004 and July 2008- was the heyday of the carry trading strategy, with banks enjoying the opportunity to raise cheap money on foreign markets. In the period of increasing liquidity, the Bank of Russia resorted to direct repo only occasionally and in a relatively moderate scale. The second period encompasses the 2008 crisis and the subsequent recovery of the market. During the acute phase, direct repo deals were increasingly in use to stabilize the interbank lending market. They were carried out on a regular basis, and their volumes surged drastically vis--vis the pre-crisis figures. The stabilization of the situation with short-term liquidity in banks in 2010 drove the interbank lending rates Dementyeva S. Money is served. Kommersant, 28 October 2011.

Public funds have been dispersed across state owned banks. Kommersant, 2 December 2011.

2 2 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 -------jul jul jul jul jan oct -jan -oct jan oct jan oct -feb jun feb jun feb jun feb jun apr apr apr apr --sep sep sep sep dec dec dec dec aug aug aug aug nov nov nov nov mar mar mar mar may may may may ------------1 -1 -1 -1 -1 -1 -1 RUSSIAN ECONOMY IN trends and outlooks down to the pre-crisis level, while the Bank of Russia discontinued an active use of direct repo. However, once the situation with liquidity aggravated in H2 2011, repo deals became a principal means for the CBR to provide lending to banks. In a number of cases their volume in 2011 was in excess of maximum volumes of lending to banks with the use of repo deals at the peak of the 2008 crisis.

3 000 2 500 2 000 1 500 1 000 500 Volume by other loans Lombard loans Arrears by overnight loans Volume of intra-day loans Volume by other loans Source: by the Bank of Russias data.

Fig. 22. The Bank of Russias Lending to Banks, as Rb mn.

Liquidity problems The period of rising liquidity 35 and carry trading Crisis and recovery 0 Cash balances on corresponding accounts and deposits with CBR Repo IBL interest rates for the term of 2-7 days Interest on loans in the form of Repo Source: by the Bank of Russias data.

Fig. 23. Use of the Repo Mechanism for Regulation of Bank Liquidity between 2003 and December bn % annualized Financial Markets and Financial Institutions 3.3.3. Lending on the Rise The instability of the resource of funding of banks in 2011, which manifested itself in a limited employment of Carry trading, a slower pace of expansion of the deposit base, a compelled attraction of short-term resources from the Bank of Russia and public administration bodies, did not hamper the renewal of banks lending activity nonetheless (Fig. 24).

While in 2010 the volume of lending to the non-banking sector was up 12.8% and loans to the population up 14.3%, at year-end 2011, the increase in the said credit portfolios accounted for 39.3% and 54.0%. That was lower than the average growth rates of the credit portfolio over the pre-crisis 20002007 which accounted for 47.3% for the non-banking sector and 81.3% for private residents, but far greater than an annual 25% growth rate which is considered internationally to be a pace sufficient for a normal, without overheating, advancement of the banking sector.

Loans to businesses Loans to private residents Source: by data of the Bank of Russias Review of Credit Organizations.

Fig. 24. Russia: the Volume of Credit Disbursed, billion of Rb as of 1 January So, in 2011, despite the reinvigoration of lending activity, the banking sector, whose proportion in the overall volume of Russian financial organizations assets stands at a. 95%, has thus far failed to find resources sufficient to ensure its sustainable progress. Its funding to a significant degree remains reliant on the Bank of Russia and public administration agencies short-term financial resources, which generates substantial risks for the financial system.

3.4. Governmentalization of the market for Rb-Denominated Bonds 3.4.1. An Adanced Growth of Placement of Government Bonds The government notably increased its role on the domestic bond market in 2011, primarily in its capacity of one of key operators on the market in question. That manifested itself in an accelerated rise in public borrowing on the domestic market, a greater impact the state has on the exchange infrastructure, the Bank of Russia and public structures growing activity with regard to trading in bonds, prevalence of state-owned corporations in their capacity of bor ECONOMY IN trends and outlooks rowers on the market for corporate bonds and a growing activity of state-owned banks in the segment of investment and banking services. As well, the year of 2011 witnessed adoption of the document entitled The fundamental objectives of the public debt policy of Russian Federation for 201220141. The document holds that, development of the debt market is regarded as an absolute priority of the public debt policy in the medium term. The MinFin plans that the federal budget deficit would be met at 90% at the expense of domestic public borrowing. We believe this means a domestic bond markets growing dependence on risks engendered by an imbalanced state budget.

The data dispalyed in Fig. 25 evidences that in 2011 the aggregate volume of placement of government bonds posted a higher pace of growth than the aggregate volume of placement of corporate bonds. While in 2010 the volume of placement of government papers worth a total of Rb 861bn was just slightly above the volume of issued corporate bonds, which accounted for Rb 855bn, in 2011 the value of new issues of government papers hit the mark of Rb 1,374bn, a way up vs. a Rb 855bn- worth aggregate value of placed corporate bonds. However, at this point, we should make a reservation that the estimate of the 2011 volume of the government bonds issuance was made with account of the value of the issue of 15-year OFZ bonds worth a total of Rb 295 bn, which the MinFin placed by way of a closed subscription in the frame of a Bank of Russias rehabilitation program, the control stake in which was acquired by VTB. That said, the development testifies that MinFins need in attraction of funds on the debt market are on the rise, and in 2011 it was in many ways associated with the RF Governments decision to employ resources attracted by issuing government papers on the domestic market, rather than resources spent out of the Reserve Fund, as a source of meeting the Pension Funds budget deficit. The decision in question enabled the MinFin to transfer some Rb 1.0 trillion of oil-and-gas revenues to the Reserve Fund in early 2012 and compensate for those funds by boosting up borrowings on the bond market.

2 500 2 1 1 1 500 141 - 11 163 - 4 15 79 112 GKO-OFZ-GSO Regional bonds Corporate bonds Source: MICEX-RTS and IMF data.

Fig. 25. Volume of Placement of Rb-Denominated Bonds Posted on the MinFin web-site.

Rb bn Section Financial Markets and Financial Institutions The MinFin plans an increase in placement of government bonds in 2012, too. According to a preliminary schedule of auctions on placement of OFZ for Q1 2012, it is planned to raise Rb 285bn, or nearly 8-fold above the figure reported in the same period of the previous year.

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