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Financial Markets and Financial Institutes lios yield were shrinking. When investing in a 7-year portfolio of the worst-case scenario, which the investor reaches with investments in the RTS index, is positive, equal to 1% per annum, the average yield on this portfolio is 27% per annum. This means that only when investing in the RTS index for 7 years and more investors would be faced with the fact of reducing the market value of the portfolio. It is for this reason that the minimum reasonable term of investment in a diversified portfolio of stocks in the Russian market should be 7 years or more. Herewith, as seen in Fig. 50, the dotted curves, showing assessments for a similar portfolio for the period preceding the crisis of 2008-2009, practically coincide with the curves, showing the crisis impact. This suggests that the current crisis did not affect the minimum requirements for the term of investments in the Russian market and the key indicators of profitability of long-term portfolios.

Average Min Max Average Min prior to crisis Max prior to crisis 66 56 57 56 25 26 27 24 -0 --29 -2 1 year 2 years 3 years 4 years 5 years 6 years 7 years 8 years 9 years 10 years ---Portfolio lifespan Minimum period for share portfolio -Source: Estimates of RTS.

Fig. 50. Yield (% per annum) portfolios of "RTS Index" of different maturity for the period from September 1995 to February Unfortunately, the benefits of long-term investment in the Russian stock market remains virtually out of demand. The bulk of investors are guided by relatively short-term strategy.

When entering into agreements with financial intermediaries, using brokerage services and asset management in the securities market the minimum acceptable timeframes for individual investors to invest in instruments with high market risk are not taken into account.

Fig.51 demonstrates available data on the number of accounts of individual investors with brokers and the number of personal accounts in registries of Privatization Investment Funds (PIF). Unfortunately, currently the National League does not disclose the number of marketbased mutual PIF shareholders. However, if we assume that the number of shareholders of PIFs in 2009-2010 has not significantly decreased as compared with 2008, then we can assume that the number of individual investors who trade in securities directly or through collective investments in 2010 reached one million. Herewith, 2010 is distinguished by a mani portfolio yield, % per annum RUSSIAN ECONOMY IN trends and outlooks fested trend of reduction of the number of brokers clients registered in the MICEX trading system. If in 2009 the growth in the number of registered customers during the year amounted to 112.2 thousand persons, the relevant figure in 2010 was only 42.8 thousand. The number of active clients and brokers declined from 114.1 thousand to 113.7 thousand. This may reflect the fact that the model to attract customers to the Russian stock market, effective up to now, begins to exhaust itself. The number of people involved in the stock exchange speculation in any country is limited. The new growth model requires the involvement in the market the long-term investors, which cannot be done without an effective system of retirement savings and restructuring the model of service delivery by financial institutions.

800 PIF shareholders, persons 671 700 000 Brokers clients, persons 600 000 Active brokers clients, persons 559 480 500 * PIF shareholders: 2007-2008- estimates;

2008-2009 data is not available 417 400 342 300 198 200 114 133 217 63 95 82 74 100 64 29 519 29 11 6 082 6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 jan Source: estimates based on the MICEX, National Securities Market Participants and National League.

Fig. 51. Number of market-based retail customers of management companies and brokers 3.9. Banking System in the Russian Federation 3.9.1. Key Macroeconomic Figures which had an Impact on the Russian Banking Sector in The year 2010 was of paramount importance for recovery and qualitative transformation in the Russian banking system following the financial crisis and economic downturn. In 2010, owing to a favorable foreign economic situation and gradual recovery of the domestic demand, Russian banks resumed lending to the real sector as the quality of credit institutions assets improved. The problem of liquid assets deficit in the banking sector was overcome in the previous year: deposits of the Central Bank of Russia decreased rapidly in the banking sector as corporate and retail deposits increased. It is the growth in the real household disposable income, recovery processes in the production sector and retail sale that can be attributed Section 3.

Financial Markets and Financial Institutes to the key macroeconomic preconditions which governed the recovery dynamics in the banking business. Growth rates in the construction industry and dynamics of investments in fixed assets contributed as much to recovery in non-financial institutions demand for borrowings.

It is worth mentioning briefly the values of the macroeconomic indicators which had an impact on the development of the banking sector in the past year.

According to the data published by the Federal State Statistics Service (Rosstat), real household disposable income increased by 4.3% as of 2010 year-end, which, on the one hand, promoted decrease in overdue accounts under previous loans and the number of new credit products sold by banks in the past year, and, on the other hand, increase in retail deposits.

Industrial production increased at a level of 108.2% in 2010 against 2009. Enterprises of the processing industry contributed most, 11.8%, in annual terms. Recovery of the processing industry had a great impact from the point of view of diversification of the corporate credit portfolio at banks. According to the data published by the Central Bank of Russia, as of January 1, 2011, ruble-denominated loans issued by banks to companies in the processing industry accounted for 19.7%. This category of business activities was ranked number one in terms of weight in the industrial production sector (e.g., enterprises operating in the mineral extraction industry and production and distribution of gas and water accounted for mere 2.1 % and 4.2% of the portfolio, respectively) and number two in terms of aggregate corporate credit portfolio after retail sales companies which accounted for 23.5% of the ruble-denominated loans issued by banks to the real sector (as % of the aggregate ruble-denominated corporate portfolio of the banking system with due account of loans from VEB (Vnesheconombank).

Retail turnover, which governs directly the need of households for short-term loans and sales companies for working assets, increased by 4.4% in 2010 against the figures reported in 2009 which was hit by recession.

Fixed capital expenditures create the demand for long loans in the banking sector. Bank loans accounted for 9.1% of the structure of capital investments of non-financial institutions in January September 2010. Fixed capital investments at the 9-month period-end was reported to grow at a level of 3.7% y-o-y. It is noteworthy that large banks, which can borrow inexpensive assets in international markets, continued to grant most of investment loans.

Before proceeding with analysis of banking aggregates in the past year-end, lets describe most remarkable events which in our opinion had a material effect on the development of the sector in 2010.

The regulator reduced intensively the refinancing rate. Throughout the entire 2010 the Bank of Russia made four decisions on reduction of the refinancing rate which finally decreased to a historical minimum of 7.75%.

From July 1, 2010 the Central Bank of Russia abolished recession-related benefits for creation of provisions for losses while maintained the moratorium on excluding banks from the deposit insurance system.

Following the Central Bank of Russia, banks began to intensively reduce deposit rates.

In 2010 the Bank of Russia intensively rolled back the recession counter package designed to support the banking system. The following events can be regarded as most remarkable.

First, unsecured loans for a period of more five weeks decreased in volumes; second, the Lombard list of securities which the Central Bank of Russia accepts as security for loans was shortened.

From January 1, 2010, the minimum capital requirements to credit organizations were increased up to RUB 90 mln, which, however, failed to result in any visible reduction in the RUSSIAN ECONOMY IN trends and outlooks number of existing banks. From 2012 the requirements are expected to be strengthened once again, up to RUB 180 mln, whereby promoting a trend towards consolidation in the Russian banking sector.

Upcoming partial privatization of the largest banks in which the state holds an interest, through sale of a part of the block of shares held in VTB and Sberbank, can be regarded as a remarkable event of the past year.

3.9.2. Analysis of Annual Data on the Banking System: Balance Sheet According to the data published by the Central Bank of Russia, the assets of the Russian banking system increased by 14.9% in 2010, thus exceeding the most optimistic expert expectations. However, the structure and quality of the increase was found to be very heterogeneous. Banks increased volumes of corporate lending, which contributed most to the growth of assets in the banking system in 2010. The corporate credit portfolio increased by RUB 1,5 tln in nominal terms during the same year, thereby resulting in a 34.8% cumulative growth in assets. A share of corporate lending in the assets decreased by 1 p.p., from 42.6 to 41.6%, in the past year-end. It is an intensive growth in bank investments in securities in 2010, that was most responsible for reduction in loans to non-financial institutions amidst remaining high credit risks, this type of investing in the banking system of Russia became the second, in order of importance, in terms of promoting annual growth in the assets. According to the published data, the banks portfolio of investments in securities increased by RUB 1,5 tln in 2010. Investments in bonds developed most intensively. Increase in the bond portfolio resulted in an annual growth of 23.8% in the assets of Russian banks. Retail lending was the third in order of importance driver of growth in the assets of the banking system in 2010, which developed at outstripping growth rates against corporate lending: 14% against 7.2% as of 2010 year-end. However, the portfolio of loans to individuals was found to contribute much less, a mere 12%, to a total growth in the assets in terms of volumes. Dynamics of the assets in the banking system in 2010 are shown in Fig. 52.

7 000 35 33 34 6 Investments in 33 4 securities 5 000 5 32 Loans to individuals 4 3 4 08531 2 726 Loans to legal entities 30 3 2 29 2 000 Assets, right scale 29 28 1 27 - 26 Data Source: the Central Bank of Russia.

Fig 52. Dynamics of assets in the banking system of the Russian Federation, bln RUB Jul-Jan-Jun-Oct-Apr-Feb-Sep-Dec-Dec-Aug-Nov-Mar-May-Section 3.

Financial Markets and Financial Institutes Foreign exchange structure of the corporate and retail credit portfolios changed insignificantly in 2010. In both cases, banks increased ruble-denominated retail and corporate loans by 2,5 and 1,3 p.p. respectively. Foreign exchange loans decreased for the two basic reasons: due to negative revaluation of the foreign exchange portfolio as a result of strengthening of the Russian ruble against other currencies (the RUB average weighted exchange rate decreased against the dual currency basket from RUB 35.96 to 35.16 in 2010) and low demand for foreign currencies from the private sector due to uncertainty of currency risks that might arise in the post-recession economy (Fig. 53).

Data Source: the Central Bank of Russia.

Fig. 53. Structure of corporate and retail credit portfolios denominated in foreign currencies and rubles Bank lending also differed in intensity in the sectoral structure. Traditional lending drivers fuel and energy and metal mining industries showed no substantial demand for credit resources yet, which, on the one hand, can be explained by the ongoing cost optimization policy, and, on the other hand, growth in prices of primary commodities.

The chemical, food production, metallurgical, pulp and paper industries, as well as public utilities sector (including power engineering) are the most active borrowers. The processing industry, though it is ready to show demand for credit resources, has no high credit potential due to unstable growth and low profitability (Fig. 54).

In 2010, the Government of the Russian Federation also linked the decrease in retail lending to the recovery of mortgage lending. The remaining credit risks and lack of acceptable interest rates on long money borrowings, whose principal source was the international money market prior to the recession, became the key factors which constrained returning to the prerecession growth rates in mortgage lending in 2010. As of 2010 year-end, however, the average weighted mortgage rate decreased from 14.6% as of January 1, 2010 to 13.4% as of December 31, 2010.

In 2010 the issue of insufficient liquidity in the banking sector ceased to be relevant. Bank borrowings obtained from individuals, corporate customers and interbank market were sufficient to cover lending transactions. In addition, investment of borrowings in alternative sources given the remaining credit risks in the real sector, became a relevant issue. The ratio RUSSIAN ECONOMY IN trends and outlooks of loans to investments in the banking system of Russia in 2010 (Fig. 55) is shown in the figure below.

2,4% Automobile production 2,3% 25,0% Trade industry 23,5% 9,5% Construction industry 9,1% 4,5% Food production 4,9% 8,1% Agricultural industry 8,3% 3,1% Metallurgical production 3,1% 1,1% Chemical production 01.01.1,4% 01.01.2,3% Production of fuel and energy natural resources.

2,1% Data Source : the Central Bank of Russia.

Fig. 54. Specific types of business activity in the RUB corporate credit portfolio of the Russian banking system with due regard to loans issued by VEB, % Investments/borrowings, % 100% 98% 98,2% 96% 94% 92% 93,9% 90% 88% 89,3% 86% 84% 01.01.2010 01.07.2010 01.01.Data Source: the Central Bank of Russia.

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