Falling rates expose lack of borrowers for Russian banks

The recent public disagreement between Sberbank Chief, Herman Gref, and Finance Minister, Aleksey Kudrin, has opened up debate about the effect falling interest rates are having on the banking system.

The 25 basis point cut of the Russian refinancing rate in late May gave rise to the unusual sight of a public disagreement between Finance Minister Aleksey Kudrin, and former Minister for economic Development, and now Sberbank CEO, Herman Gref.

The nub of their disagreement revolved around the level of risk implied with refinancing rates at 7.75% with the CEO bank chief, now of the view they had become too low, and the Finance Minister referring to the continued fall in inflationary pressures.

Analysts say that Gref’s comments reflect two key issues, with tightening margins and a paucity of suitable borrowers to take advantage of the low rates.

Vladimir Savov, Otkritie FC’s Head of Research, says Russian banks, with Sberbank being the best example are facing a market where the economic rebound hasn’t yet filtered through strongly in terms of generating quality new borrowers, and need to tread warily in the marketplace.

“There is one big problem for Russia’s banking system – a lack of “quality” borrowers, who can later pay back the loan granted today at a low rate. The banks have enough liquidity but they can’t give it away carelessly as otherwise they will simply “kill” their profitability. Generally speaking, I think, that they should be careful with the interest rate during a so-called “transition period", when the economy hasn’t recovered completely.”

Clemens Grafe, Chief economist at UBS in Moscow says this feeds through to the bank’s bottom line, when they place their liquidity with the central bank and it reduces rates.

“Sberbank has a large surplus of deposits compared to its loans and is investing this into CBR deposits and state securities. Therefore lower interest rates lead to lower interest income for Sberbank, while interest rates on current accounts are essentially fixed at zero, so Sberbank's margin is declining.”

Grafe also notes that whereas banks generally benefit from lower central bank rates, in the case of Russia the relative lack of long term lending means they aren’t getting the benefit they would in other economies.

“In principle banks like low short rates and high long rates because they tend to lend long term while they borrow short term. So they like policy rates to fall typically. In Russia, that is somehow a bit less relevant because there is little long term lending.”

Igor Nikolaev, Partner and Director of Strategic Analysis at FBK says that the falls in refinancing rates are overstated in terms of their effect on the economy, and don’t reflect the borrowing costs they face. He says that it’s possible that the refinancing rate could be trimmed again but that this will not address the real issue as far as banks in the system are concerned.

“I think, the refinancing rate could gown down another time, but it will have very little economic basis. In, fact it’s artificially understated. And, what’s amazing, its importance as an economic indicator in Russia is overestimated. The thing that really reflects the situation in the economy, and namely in the credit market, is the credit rate for non financial institutions. It shows the price for credit resources for Russia’s real sector and is calculated by the banks themselves, reflecting their economic risks. Today it goes almost separately from the refinancing rate and about 3.5% higher. There is virtually no straightforward correlation between the two, which is bad and makes all effort from the Government to stabilize the economy by means of manipulations with the refinancing rate null and void.”

Vladimir Savov says that the Central Bank could trim rates again with the continued fall in inflation opening up room.

“Credit activity recovers really slowly in Russia, so lower interest rates don’t give the desired effect. But, I think, one more rate cut is quite possible, as inflation in Russia – the main rate driver – remains low.”

Clemens Grafe also believes rate could be cut by a further 50 basis points, or half a percent, but that this could force banks in the system to search for more effective uses for excess liquidity than keeping it with the Central Bank.

“Banks remain reluctant to lend and are hoarding liquidity with the CBR. The lower the rates, the less attractive it is for the banks to keep deposits with the CBR and the more they are forced to do something useful with the deposits like lending to the real economy. At the margin lower rates will also help to discourage hot money inflows.”