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Source: The Central Bank of the Russian Federation and the IEP calculations Fig. 54. Borrowed funds of the corporate sector, billion Rb In 2009, in a situation where foreign markets were closed and bank lending was stagnant domestic bonds became the main channel for attraction of borrowed funds to the corporate sector. As a result, their share in the total volume of the corporate debt rose to 11% (16% on the domestic market). At present, the unit weight of the market borrowings in the total volume of attracted credit resources remains relatively stable. In the 20102011 period, the average growth rates of the volume of outstanding ruble-denominated bonds are almost similar to the growth rates of bank credit portfolios. Accordingly, their share in the domestic borrowings remains at the level of 14%16%.

It is to be noted that the aggregate investments of banks in corporate debt obligations do not exceed 35%40% of the market and amount to the mere 4%5% of the total volume of banks claims to industries and entities (loans and debt obligations). If in 2011 the growth rates of lending to corporate customers amount to about 22% banks investments in corporate bonds increase at a slower rate (16%). The outputs of the polls of large Russian banks show that the existing ratio between investments in securities and lending is quite stable. According to the polls of large banks1, over the two-thirds of the polled banks are not prepared to invest in bonds more than 10% of the aggregate portfolio of claims to corporate customers. Bonds do not became a real alternative to a bank loan either for borrowers or banks.

A. Vedev, S. Grigoryan. Development of the Russian Banking System in the Current Decade. The outputs of Polls of large Russian Banks (http://www.vedi.ru/bank_sys/bank5411_banks%20poll.pdf) Section Financial Markets and Financial Institutions Liquidity The banking sector entered the year 2011 with excessive liquidity. During the first quarter of 2011 (without taking into account the seasonal peak of January 1) the volume of excessive reserve assets of banks placed in deposits with the Bank of Russia and invested in its bonds amounted to Rb 1.1 trillion Rb 1.3 trillion or 3.5%4.0% of the banks aggregate assets.

Meant for lending to the real sector, that volume of resources could ensure growth of 30% in retail lending (which figure is comparable to the actual annual growth in 2011) or growth of 10% in corporate loans (nearly a half of the actual annual growth). With multiplicative factor taken into account, the aggregate volume of the reserve assets as of the end of the 1st quarter was sufficient enough to the banking sector to double the money supply (judged by the precrisis structure1 of the money multiplier and the decreased share of cash funds in the money supply).

However, a potential credit boom did not materialize due to changes both in the structure of assets of the non-financial sector and preferences of the banks. Households started to switch over to a credit model of consumption which situation deprived banks of the main institutional creditor. Starting from July, households borrowed more funds than placed in deposits.

In the first three quarters of 2011, the aggregate growth in loans to households (Rb 1,059bn with adjustment to revaluation of assets in foreign currency) turned out to be higher than the influx of households deposits to banks (Rb 1,002bn with a similar adjustment).

However, it was banks activities that contributed most to transformation of excessive liquidity into a liquidity squeeze, namely a withdrawal of liquid assets abroad from the Russian economy. So, in 2011 the net foreign assets of the banking sector rose by $24bn or more than Rb 740bn (over 60% of the excessive liquidity at the beginning of the year). On the basis of the results of the year, an excess of foreign assets over foreign liabilities amounted to the record-high level of $46bn, while foreign assets in foreign currency amounted to $185bn.The main channels of capital outflow were state banks and subsidiary banks of nonresidents. Out of $24bn of the net foreign assets growth, Sberbank and other state banks accounted for $15bn, while another $9.5bn was withdrawn by foreign banks. Thus, other private banks even ensured insignificant growth of about $ bn in the net inflow of capital.

In 2011, the specifics of the shrinkage of the bank liquidity consisted in its overall nature.

The ratio of liquid assets to the aggregate assets kept declining with all the groups of the banks (Fig. 55). However, state banks were still in a more advantageous situation. Only in that group of banks, a drop in liquidity did not amount to the pre-crisis minimum of 2.5% 3.0% having retained a small reserve for a further decline. As regards other groups of banks, liquidity amounted as a minimum to the pre-crisis level with a group of small banks and midsized banks being in the most disadvantageous situation. If in the 2007-2008 period liquidity of those banks did not fall below 9%10% (due to low diversification of the business small banks need higher liquidity to maintain normal activities) in autumn 2011 that index amounted to the level of 7%8%. Such a situation points to considerable liquidity shortages In this context, the structure of money multiplier means the aggregate of actual relations between individual components of the monetary base: cash funds, banks mandatory reserves, correspondent account balances with the Bank of Russia and respective components of the banks resource base. For mandatory reserves volumes of reserve liabilities, while for other reserve assets the aggregate depositary base of the banking sector.

Insignificant differences in data with Section 2.1.4 are justified by differences in calculating methods of the balance of payments and banks balance sheet.

RUSSIAN ECONOMY IN trends and outlooks and rising risk level in that group of banks. Due to a lower business diversification, smaller banks need to maintain a higher volume of reserve (liquid) assets for comfort business activities. A further drop in liquidity makes such banks critically dependent on access to refinancing of the Bank of Russia and the inter-bank market.

Source: The Central bank of the Russian Federation and the IEP calculations.

Fig. 55. Dynamics of the share of liquid assets in different groups of banks Table The structure of assets of the banking system of Russia (as of the end of the month), % of the total 12.05 12.06 12.07 12.08 12.09 06.10 12.10 03.11 06.11 09.11 12.Assets, billion Rb. 9696 13963 20125 28022 29430 30417 33805 34009 35237 38443 Cash funds and precious metals 2.7 2.6 2.5 3.0 2.7 2.1 2.7 2.2 2.2 2.3 2.Funds deposited with the Bank of 7.3 7.5 6.9 7.5 6.9 7.8 7.1 5.9 4.5 3.5 4.Russia Inter-bank operations 6.3 5.8 5.4 5.2 5.4 6.2 6.5 6.5 6.4 6.2 6.Foreign assets 9.1 9.9 9.8 13.8 14.1 12.7 13.4 13.6 13.8 14.6 14.Loans to households 12.1 14.7 16.1 15.5 13.1 13.0 13.0 13.3 14.0 14.2 14.Loans to the corporate sector 47.0 45.3 47.2 44.5 44.5 45.1 43.6 44.5 45.3 45.1 44.State 6.6 5.2 4.1 2.0 4.2 4.2 5.1 5.7 5.8 6.0 5.Property 2.4 2.4 2.2 1.9 2.7 2.7 2.6 2.6 2.5 2.4 2.Source: The Central Bank of the Russian Federation and the IEPs Center for Structural Research calculations.

3.9.6. Forecasts of Development of the Banking Sector In 2012, development of the banking sector in Russia will be determined by a number of factors. On one side, the dynamics of the macro indices which reflect the condition of banks main customers industries and households will have an effect on banks. On the other side, the situation will be determined by solution (or prevalence and aggravation) of acute structural problems inside the banking system.

According to the official forecasts (prepared by the Ministry of Economic Development of the Russian Federation), in 2012 a considerable decrease in the growth rates of the main macroeconomic indices is expected: real GDP (from 4.3% in 2011 to 3.7%), industrial production Section Financial Markets and Financial Institutions (from 4.7% to 3.6%), retail sales volume (from 7.2% to 5.5%). There is still a direct risk of investment activities being at a low level, but it is clear that growth in material assets will be the minimum (after soaring growth in 2011). The above factors will determine both the decrease in the growth rates of savings of the non-financial sector in the banking system and prevalence of the low demand in bank loans on the part of industries. In addition to the above, growth in households real disposable income (from 0.5% to 4.5%) which corresponds to growth in the retail sales volume is expected; implicitly, such a situation may result in a decrease in the demand in consumer credit. In general, in 2012 the expected macroeconomic situation in no way contributes to the speed-up of development of the banking sector.

In the second half of 2011, structural problems in the banking sector became more acute growth rates of the resource base kept consistently falling, while those of lending, increasing.

As a result, the Russian banking system turned out to be loaned up while expansion of assets and maintaining of the minimum required level of liquidity were carried out by means of refinancing and deposits of the Ministry of Finance.

Generally, it appears that in a situation of moderately positive or moderately negative (depending on expectations) macroeconomic conditions development of the banking sector will be determined by structural problems which prevailed late in 2011. Such problems are characterized by a growing gap between the resource base of the banking system and volumes of loans which are financed by means of loans of the Central Bank and deposits of the Ministry of Finance of the Russian Federation. It is to be noted that the liquidity shortage is aggravated by the segmentation of the banking system and its low capitalization. Generally, the situation may develop in accordance with the following three scenarios:

1. Prevalence of the existing trends. In such a case, the liquidity crisis is highly likely to occur in the banking sector as soon as February-March 2012. The crisis will be justified both by the short-term nature of deposits of the Ministry of Finance and problems related to refinancing of a large number of small and mid-sized banks. A relatively simple solution of the problem may consist in provision of another portion of state resources and modification of the system of refinancing (in order to ensure that an ever larger number of participants join it). Within the frameworks of that scenario with a simple solution of the problem, the situation will not radically change and the next large-scale aggravation of the liquidity crisis will take place early in autumn.

2. Expansion of external financing. The gap between the resources of the banking system and the volume of the extended loans can be covered by means of the external financing.

A similar process was observed in the 20062008 period; it is to be noted that that process was accompanied not only by a drop in the volumes of refinancing to the zero level, but also by the growth in the gross (not net) capital outflow. In other words, as seen from the experience of the past decade growth in the inflow of external resources to the Russian banking sector encourages not only further growth in lending to the non-financial sector, but also growth in excessive liquidity and capital outflow which factor points to existence of both system difficulties and structural problems in the banking system. Realization of that scenario is far from being clear due to the fact that an unstable situation, primarily, in the banking sector of the developed economies is highly likely to remain.

3. A drop in the growth rates of lending to the non-financial sector. Such a scenario is of a crisis nature for a number of reasons. First of all, a drop in the growth rates of lending is possible not only due to toughening of requirements to the borrower, but also due to growth in interest rates. With loans becoming more expensive, economic activities will RUSSIAN ECONOMY IN trends and outlooks decline, prices will go up and the number of debt service payments will increase. Then, the bad debts problem will get worse due to both more expensive refinancing of old debts and the effect of the base. The latter means that indices of problem debts aggravate purely statistically when growth rates or absolute volumes of the extended loans fall.

In case of implementation of any scenario listed above, the banking system of Russia will face instability in 2012. Apart from the fact that bank lending will not be able to be a factor behind the economic growth, the very feasibility that it will meet the adequate demand in loans on the part of the non-financial sector appears highly doubtful. An important observation of the development of the banking system in 2011 consists in the fact that no proper conclusions have been drawn from the 20082009 crisis, and as soon as the first evidence of stabilization appeared structural problems got aggravated again. It is quite clear that restructuring of the banking sector is badly needed to ensure sustained development. However, such an operation is related to high costs and risks in a situation of unstable recovery growth.

3.10. Market for Municipal and Sub-Federal Borrowings 3.10.1. Dynamic of Market Development By results of 2011, the consolidated regional budget and budgets of territorial state extrabudgetary funds had been executed with a deficit of Rb 14.2bn (0,03% of GDP). When compared with 2010, the amount of the deficit of the consolidated regional budget shrank in the shares of GDP equivalent nearly 7.5 times. Thus, the 2010 deficit of territorial budgets accounted for Rb. 99.3bn (0.22% of GDP).

In 2011, budgets of RF Subjects were executed with a deficit of Rb 20.4bn, budgets of urban okrugs with a deficit of Rb 31.1bn, budgets of intracity municipal entities of the city of Moscow and St. Petersburg with a surplus of Rb 0.8bn, budgets of urban and rural settlements with a surplus of Rb 1.8bn, balances of territorial public extrabudgetary funds with a surplus of Rb 20.9bn. In 2010, the RF Subjects budgets were executed with a deficit of Rb 88.1bn, budgets of urban okrugs with a deficit of Rb 15.1bn, budgets of intra-city municipal entities of the city of Moscow and St. Petersburg - with a deficit of Rb 0.1bn, budgets of municipal districts with a deficit of Rb 1.2bn, budgets of urban and rural settlements with a surplus of Rb 4.5bn.

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