Banks: Looking for More Fiscal Spending and Lower Interest Rates

In the current situation, prospects for an economic revival are largely tied to the banking sector’s capacity to finance a recovery. Risks associated with mounting bad loans push Russian banks push to move in the opposite direction. Since the onset of the crisis, most private banks reduced their corporate lending portfolios, while state banks had to compensate for this constriction of credit. However, reports suggest that in June even Sberbank and VTB were reducing their corporate portfolios. On the retail side, unsurprisingly, since the beginning of the crisis bank portfolios have deteriorated at a much faster pace — year-to-date, they have decreased by 7 percent. As expectations of continued distress in household incomes and the prospect of unemployment loom, bankers are motivated to reduce lending and households adjust downward their demand for consumer purchases. Our assessment is that the decline in retail lending alone contributed approximately 3 ppts to the drop of consumption for the first half of 2009.

That being said, in late June Prime minister Vladimir Putin called upon state bankers to continue lending and to provide at least RUB400-500bn of new loans to the economy (through September). But it is quite clear that banking sector problems are treated with great care, and the need to prevent uncontrolled growth of bad loans is understood and accepted at the highest level. The system is already highly burdened with bad loans. The figures currently stand at 4.6 percent of total banks’ lending portfolios by Russian accounting standards, though in reality by international accounting standards the figure should be at least twice as high.

Previous crises have shown that the best way to address the problem of bad loans is to create a bank in which bad assets may be set aside, in order to clean up overall bank balance sheets. Unfortunately, this mechanism has been deemed as unacceptable because of the difficulties in the valuing of bad assets. Consequently, it has been decided to recapitalize the banking system. The government has designed a 3 to 1 subordinated debt program providing banks with an injection three times the size of the injections they are able to attract on their own. Another mechanism to be utilized is the recently approved recapitalization of banks via state bonds, which is applicable to about the 60 largest banks.

However, even though new capital is necessary for the stability of the banks, new injections are still not a good reason for that capital to be wasted.  We believe that under the current circumstances the government needs to increase fiscal spending. We have already seen some acceleration in fiscal spending in June and believe that this pattern will continue. State funds should provide financial support for enterprises, and through this vehicle improve the lending quality of banks. It will also help stabilize the funding base of the Russian banking system with cheap money on corporate accounts (which have been very vulnerable recently). For the coming months we also anticipate that the Russian Central Bank will continue gradually cutting its interest rates and reducing banks’ costs of funding.  All in all, this will eventually push down lending rates. And even though we do not expect banks to resume lending growth in the near-run, we see fiscal and monetary weakening as keys to the recovery of the financial system.