Elvira Nabiullina: Bank of Russia's strategic objectives and plans
for the next five years
Speech by Ms Elvira Nabiullina, Governor of the Bank of Russia, at the International Financial
Congress, Moscow, 13 July 2017.
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I would like to speak about the Bank of Russia's strategic objectives and plans for the next five
years. The present situation suggests that we focus on the planning horizon and determine the
overall strategy for financial market development because the Russian economy currently stands
on the cusp of a new cycle.
The economy has rebounded to deliver positive growth rates although, in truth, they remain low.
This year we expect growth of 1.3-1.8%. The agenda of stabilisation and adaptation to external
shocks, which has dominated in recent years, has naturally transformed into discussion on how
to start up the engine of economic development. That is why the theme of this year's congress is
"Finance for Development". I expect that the two days at the Congress will help us gain a greater
understanding of the changes occurring in both the Russian and global financial system.
I will start by addressing global economic development. This year marks ten years since the
onset of the financial crisis.
Contending with the onslaught of the crisis - like waves crashing in one after another for many
years - and the economic consequences thereof, the central banks of many countries were
forced to take unprecedented steps to stabilise and reverse course. It is only now, ten years
later, that they are taking steps to move away from these measures.
What is everyone afraid of? That growth will remain rather low and unstable.
Indeed, after a long period of crises and stagnation, the global economy is entering a new cycle.
But what is the aftermath?
First. A higher debt load than in 2007. In developed economies, the primary problem is
government debt, whereas many countries with emerging markets struggle with corporate debt.
Second. Developed economies are contending with exceedingly low inflation and even deflation.
Moreover, there are bubbles in individual markets that threaten to grow owing, among other
things, to the effects of long-term soft monetary policy.
Fourth. Low growth rates in productivity and investment. This not only limits opportunities for
development but also hampers growth due to increased debt burden.
Fifth. Developed countries are seeing increased inequality in the face of stagnating middle-class
incomes, a trend observed over the past 30-40 years and often labelled the result of
globalisation. It is clear, however, that unequal access to the opportunities afforded by new
technologies also played a role. In this regard, the digital revolution and the new wave of job
automation, which changes the traditional profile of the labour market in a number of professions
and sectors, bring about significant social risks. As a result, we are observing an upswing of
populism in politics, which in itself generates new economic risks and harbours continued
financial market volatility.
Sixth. An important point for us. The global economy is entering its new cycle at a low phase of
the commodity (primarily oil) super cycle. So far, there has been no truth to the predictions that
low commodity prices will have a positive impact on global growth thanks to the positive
momentum enjoyed by raw material-importing countries exceeding the negative impact on
exporting countries. However, it is important to note the technological progress in the oil industry
both in terms of supply (e.g. the development of shale technologies; incidentally, the decreased
investment in shale oil in the face of low oil prices has once again begun to grow) and in terms of
demand (the development of the electric car and alternative green energy markets). In fact, in the
medium term the balance of these factors remains highly uncertain. Therefore, the markets are
constantly shifting their expectations about medium-term trends (almost every quarter) and thus
the oil market remains relatively volatile.
Lastly. The global economy is entering a new cycle with growing cyber-risks capable of
threatening both the stability of financial systems and economic growth.
Positive developments include the financial technological revolution (fintech and the cost cutting,
increased financial service penetration, and the improvements to their quality it entails), and the
financial markets' increased stability in the face of various shocks. This stability has been
repeatedly tested over the past year and a half, a period not lacking in political surprises. It
appears, the reforms jointly developed and implemented by regulators in the major countries
after the global financial crisis truly bolstered the financial system.
The very structure of the global financial markets has undergone dramatic changes over the past
decade. The role of global banks and cross-border lending by banks has taken a downward turn.
Moreover, capital raising markets (stock markets) saw stagnation and even company delisting.
The role of market lending (bond markets) and asset managers, i.e. the markets impacted by
regulatory reforms to a lesser extent, has increased. These markets could potentially become
more volatile, however.
In broad terms, what does all this mean for global growth? In our view, it will not be stable.
Average growth rates will be lower than in the early 2000s.
The main trend we will see in the coming years will be slow economic recovery and the leading
central banks taking a tighter policy stance. This will include increased interest rates and
curtailed balances.
For financial markets, these dynamics bring about two contradictory trends. On the one hand,
economic growth has a positive impact on financial markets and risk appetite. On the other hand,
increased interest rates are cooling the markets. Therefore, despite the overall stabilisation, there
is a high probability of financial market volatility.
What does all this mean for the Russian economy?
Our economy will be bolstered by external demand to a lesser extent and will be sensitive to
external volatility.
Although, as recent years have shown, our economy has learned to adapt to external shocks,
there are nevertheless a host of internal factors that leave us rather exposed.
These include low economic diversification, insufficient flexibility of institutions and rules, a weak
competitive environment (where new companies find it hard to enter the market and those
lagging behind economically continue to do so for a long time). As a result, even given the
potential for growth (which, as you know, the Central Bank estimates at 1.5-2%) there will
potentially be significant fluctuations in output in the coming years. Therefore, there is an urgent
need for structural changes that will raise the bar of potential growth above 1.5-2% and make it
sustainable. The financial sphere is also in need of such structural changes.
What policy response are we seeing in the face of these challenges in the financial sphere?
Above all, focus should be on maximum flexibility. Certainly, the floating rate should be upheld. It
is crucial to adjust and constantly re-adjust regulation in established and new spheres based on
the principles of proportionality to risks. Since rules quickly become outdated, it is important to
gradually transition from management guided by rules to management by principles.
Greater attention should be paid to systemic problems and risks, not just to the stability of
individual institutions. Adopting the principle of countercyclicality, using macroprudential tools.
Early warning of problems both in the system as a whole and in individual institutions.
Greater transparency in the financial sphere. This means transparency of sources of capital and
combatting instances of financial institution owners financing their businesses.
Rejecting dogmas. For example, the dogma that banking regulation is neutral and is aimed at
mere risk management. We are starting to gradually transition towards incentive-based
regulation.
Supporting new technology: focusing on that with greater protection from cyber risks.
I will now discuss the Bank of Russia's main areas of activity in more detail.
The first area is monetary policy. Its role is sustaining low macroeconomic risks, thus creating a
framework where banks, business, and the public can enjoy an increased planning horizon,
create long-term money and realise long-term projects.
Over the next five years, the focus of our policy will gradually shift from achieving the inflation
target and lowering inflation expectations to keeping inflation close to the target level and
maintaining inflation expectations at a low and, importantly, anchored level.
However, while transitioning to a policy of fine tuning, there are a number of challenges we must
face.
Ultimately, inflation is clearly a monetary phenomenon and, if we look to the medium term, the
average inflation rate depends first and foremost on monetary policy. Average inflation will near
4%. However, it will naturally fluctuate. Meanwhile, inflation fluctuations around the average level
can vary in nature, affect inflation expectations in different ways and therefore have an impact on
monetary inflation.
As our experience has shown, during times of high volatility it is crucial to avoid rash responses
to shocks (shocks being any big changes, both positive and negative). This policy suggests that
rushed decisions should be avoided. For example, if at the beginning of the year we had lowered
the rate at a faster pace, as many wanted us to, we might very well have faced the need to
sharply increase it again shortly thereafter.
However, there are clearly also shocks such as those in 2014 that require a more decisive
response.
However, it is important to contend with both the consequences of shocks on inflation as well as
the reasons behind them. These reasons are often beyond the Central Bank's control but this
does not mean it is impossible to hit upon suitable state policy measures on the whole.
This primarily concerns the dynamics of food inflation and regulated prices and rates. The state
policy of developing infrastructure, logistics, market competition (primarily food markets), and the
regulation of natural monopolies' rates can go a long way to reduce price volatility and thus lead
to a faster reduction in inflation expectations. This, in turn, will allow the Central Bank to draw the
key rate closer to the equilibrium-neutral level faster (I would like to reiterate that, in our
estimation, it stands at 2.5-3% in real terms or 6.5-7% in nominal terms). We will discuss these
matters in more detail at one of the upcoming sessions with Minister of Economic Development
Maxim Oreshkin.
The second area of ??our activity is maintaining financial stability. Here, our focus is also shifting:
from reversing the negative consequences from earlier risks to preventing new systemic risks.
On this, I would like to highlight three main points:
First. The systematisation of macroprudential regulation. We already have experience in cooling
the consumer lending market and staving off bubbles (in 2013), in driving a shift away from bank
balances in foreign currency, and implementing de-dollarisation. However, we typically
introduced such measures by way of changes to our standard regulatory acts. We are planning
to prepare stand-alone regulation as early as this year, encompassing all macroprudential policy
measures. In our opinion, this will allow us to streamline the system, foster a countercyclical
approach, and make it clearer and more transparent for the market to use these tools.
Second. The introduction of the "payment-to-income" ratio in order to influence the consumer
lending market more effectively. The corresponding advisory report we published has already
been discussed with the market. We will soon produce solid proposals.
Third. The new regulations related to the credit history bureau. It is the credit history bureau that
comprises the key infrastructure for collecting information on borrowers' aggregate debt. Here
there is a fork in the road. Our main objective is to entrust several strategic credit bureaus with
the imperative to aggregate information on aggregate debt payments. These offices will be
subject to greater regulation, primarily concerning data protection. If the market cannot come to
an agreement, we will have to take an alternative route and create a single integrator.
Furthermore, we plan to eliminate certain issues with regulation. These include the collection of
credit histories in cases of securitisation, license revocation or bank resolution.
Furthermore, in recent years financial regulation has been advanced by adding further objectives
that are completed using this regulation. Therefore, alongside the main objective of ensuring the
stability of individual banks and financial institutions, ensuring financial stability now falls within
the remit. In our opinion, there is currently room for one more addition. Let me explain.
The aim of financial regulation has conventionally been seen solely as risk limitation. Attempts to
put in place differentiated regulation that would curtail one area of business but stimulate other,
higher-priority ones, have always been met with outcry. But proportional regulation, for example,
which we started to develop, stimulates small business lending. This was one of the goals for its
introduction. Another example: the discouragement of unsecured consumer lending forced banks
to cultivate mortgage lending, among other things.
For example, a large share of bank lending is currently used for mergers and acquisitions. This
creates risks for banks, is unlikely to significantly benefit the country, does not create additional
gross product or new jobs, and simply facilitates the redistribution of property. Meanwhile, our
economy requires more lending for companies' operations and investment.
Moving forward, we must understand which issues can be solved through regulation and for
which it would be the way. This should never, under any circumstances, be pursued by reducing
risk protection. We need to strike a balance between limiting risk in some sectors and stimulating
others. This is a major conceptual challenge with no unambiguous answer. We will be
discussing it here at the congress.
Before addressing the objectives we set ourselves in individual sectors, I would like to say a few
words about the most fundamental prerequisite for development - healthy competition.
Encouraging competition is our unequivocal priority.
What are we doing to promote competition?
First. Thorough market cleansing. In our opinion, low-quality competition is just as bad as none at
all. Honest business should not have to compete with fraudulent market players. Our duty as the
financial market's supervisory body is providing an environment where effective and stable
financial institutions reap the benefit. This means ridding the market of dishonest players.
Second. Proportional regulation. It levels out the competitive playing field for players of different
sizes, and helps the market cultivate niches where different types of financial institutions tie in
with different types of clients and their needs. A year ago, in this hall we announced that we were
planning to transition to proportional regulation in the banking sector.
For most of the year, we have worked on elaborating the details of this approach. What is more,
Mr Aksakov has already announced that the Duma has adopted the necessary changes to the
legislation in the current session, and within a year and a half the banks will be able to choose the
type of license they will work under, and subsequently, what regulation will be applied to them.
We expect that banks with a basic license will mostly work with small businesses and household
finances. Moreover, we are now working on and support the idea of ??introducing small business
insurance in banks to bolster entrepreneurs' confidence in small banks.
Third. Encouraging competition. This involves developing the capital market, which can offer
alternative or complementary products to bank lending. With the development of equity financing
and the bond market, private investors will enjoy a wider range of financial investment
instruments. Thus, product competition will benefit both real sector enterprises as well as
various investors.
I would now like to address the objectives that we set for ourselves in the banking sector.
We are seeing positive trends in the banking sector. In June, both assets and lending to the
economy continued to grow, consumer loans increased significantly, and mortgage lending saw
rapid growth. Household deposits also rose. Typically, the share of household deposits in bank
liabilities exceeded that of corporate funding.
Looking at the results of the first half of the year as a whole, banking sector assets increased by
2.2% (adjusted for the impact of exchange rate); lending to the economy rose by 1.8%. The
share of overdue loans has stabilised and is starting to decrease.
Banking sector profit in the first half-year stood at 770 billion rubles (this is double that recorded
in the same period in the previous year). This is the source of capital growth of the banking
system.
These trends show that the banking system is successfully recovering. Lending is already on the
rise and will continue to expand.
What objectives have we set ourselves in order to develop the banking sector?
An active supervisory policy and tightening regulation allowed us to boost the health of the
financial system. This ensured the stability of the financial system despite the external shocks.
We have largely removed banks whose business was built on illegal transactions and those
considered chronically unsustainable.
To achieve this, we had to uproot unfair business practices, and force banks to abandon the
instruments they used to conceal the real state of affairs or siphon off assets. A whole host of
unscrupulous practices, previously considered the norm, have been consigned to history.
Certainly, there is still a great deal of work ahead.
Now, with most improvements to the banking system already complete, our regulation and
supervision will be more focused on development and stimulation.
By introducing proportional regulation, we envision that it will stabilise small banks and enhance
the solvency of their business models. I would like to highlight that while proportional regulation
limits the risks that small banks can take on, but they will be subject to simpler regulation. This
will ensure a fairer competitive environment.
The second innovation we also announced a year ago here at the congress is the transition to a
new bank resolution mechanism and the creation of a fund for banking sector consolidation. We
are now ready, both from a legal point of view and in terms of management, to apply the new
bank resolution mechanism. We hope that, as the market progressively clears and there is
improved early detection of problems, there will be more cases where it is more beneficial to try
to recover banks' solvency than simply revoke their license. Moreover, the new bank resolution
mechanism itself could promote the development of competition in the banking sector:
consolidation will allow relatively large banks to return to the market. We are currently observing
the lowest competition rate among the largest banks. Thus, we have made progress in two of the
three major objectives we announced at last year's congress. The third objective we spoke about
last year was establishing qualitative supervision over financial groups - we have prepared a
draft bill that is being discussed in the government. We hope this innovation will be introduced
next year.
I would now like to address the objectives that we are yet to complete.
The most pressing problem is lending to business owners. The standard N25 restricting
financing of one's own projects was introduced this year but is still only applied in a preferential
mode.
Lending to owners is dangerous for two reasons. First, the bank will turn a blind eye to risks
linked to its own company when issuing it a loan i.e. the risk of non-return. Second, our practice
has shown that if the owner's project really experiences difficulties the last place it returns money
is the affiliated bank. These are not marketable loans but loans extended by unwritten rules.
Banks cannot refinance or resell them.
In the end, this is the cause of bankruptcy for many banks. It is one of the factors that led to the
collapse of relatively large banks, whose licenses we revoked. We want the banking community
to know that our intentions in this field are serious and we will continue to take a tighter stance.
Therefore, I advise those whose business model is built on lending to owners to seriously
consider finding alternatives.
Yet another problem is the quality of banks' capital. We need to be confident that our banks have
real, not borrowed, capital. Therefore, as of this year we will be introducing tighter regulation on
the quality of capital. When calculating a bank's capital, we will not take funds from
nontransparent sources into account.
There is another whole host of problems associated with collateral. Let me clarify.
In the Russian banking system, a significant proportion of lending is secured lending. On the one
hand, collateral is a good way to motivate borrowers to repay loans. However, we are witnessing
the fact that many banks, when issuing loans, are immediately factoring the collateral in as part
of the loan repayment. In some cases, loans are issued to enterprises on the verge of
bankruptcy in view of the quality of their collateral.
This is fundamentally wrong because the source of loan repayment should be the borrower's
operating profit, not their collateral. Should the latter be the case, the banking system would turn
into a mere big pawnshop.
This problem is further complicated by the fact that collateral value can be used to lower potential
loss reserves. A lot of collateral is also low liquid. Moreover, in Russia, the value of collateral is
often overestimated.
Problems arise when, just prior to a crash, assets are withdrawn as collateral. Despite the
restrictions and injunctions imposed on banks, managers and owners can still withdraw assets
through collateral agreements. The regulator currently only has the right to limit or prohibit
banking operations. It has no jurisdiction over transactions with collateral or other property.
Therefore, the Central Bank will seek the right to limit transactions with collateral alongside other
banking operations within its framework of supervisory measures.
Otherwise, this is what happens. We lower the required reserves due to collateral taken into
account. When this collateral is easily withdrawn, the quality of the loan drops sharply. In cases
where the bank's license is revoked, the bankruptcy estate receives nothing. The rights of
depositors and creditors are compromised. In our opinion, collateral should only be taken into
account when calculating reserves if the Central Bank has the right to impose a moratorium on
operations with it.
Similarly, bankruptcy law must undergo improvement allowing honest creditors faster access to
collateral acquired under a contract or other assets by court decision.
I would like to reiterate that the regulator is of the firm belief that secured lending should not
dominate the lending profile. This is precisely how the banking system will contribute to
economic development.
Lombard loans should not establish themselves as the mainstay of banking business. Banks
need to work with clients and examine their business models rather than expect to acquire their
assets.
I would like to address our priorities in supervision. Over the course of the year, the Bank of
Russia reengineered its supervisory activities: it established a risk analysis service (which
assesses the quality of loans and the values of securities and derivatives, as well as collateral).
We are already seeing certain results.
We are now centralising supervision - we have created an ongoing banking supervision service
in order to accelerate the use of supervisory response measures and establish a uniform
supervisory practice in Russia.
We call the model we are pursuing advisory supervision. Advisory supervision allows us to
identify problems at an early stage and help the bank's owners develop a plan for their solution.
However, to achieve this, banks must also take responsibility: working transparently with the
regulator. In fact, we tend to have friendlier interactions with banks if they are willing to provide
reliable and complete information about their operations. This is because advisory supervision
instruments are built around banks' internal procedures: internal stress testing, internal capital
adequacy assessment procedures, and risk management. Be aware that if a bank has already
violated standards, we will not hesitate to adopt supervisory measures over simply advising
them. Advisory supervision involves joint work in the early stages of problem identification.
The Bank of Russia will also seek the right to motivated judgment to ensure supervision is
proactive and that the instruments we develop to facilitate extensive analysis of the situation in
banks and provide early detection of problems are effective.
Considering there is a great number of situations, for example those that involve proving the
relatedness of parties, it is impractical to rely on formal rules alone. Unfortunately, this reliance is
often the case: when the Bank of Russia's supervision has detected that the bank was
experiencing problems but, without the right to professional judgment, wasted time collecting
formal evidence, which may result in bank owners receiving the time to siphon off assets.
Last week, the Bank of Russia produced a report for public discussion. It outlines our approach
to applying professional judgment within the supervision process (incidentally, not restricted to
banking supervision alone). I hope that following discussion with the professional community and
legislative bodies, the necessary changes will be made.
I would now like to address the development of other sectors of the financial market.
Starting with what, in our opinion, is the key area - creating sources of long-term money in the
financial system e.g. the funded pension system, investment of insurance reserves and various
forms of investment (primarily collective).
We are putting a great deal of effort into preserving the funded pension market. Accounting for
demographic trends, the funded component is the only way to ensure a reasonable pension
level. This is extremely important for broadening the horizon of investment in the economy.
We have fully corporatised non-state pension funds.
Now, all funds concerned with compulsory pension insurance are participants of a guarantee
system. The financial stability of non-state pension funds continues to increase thanks to strict
admission to the guarantee system, constant monitoring of non-state pension funds, as well as
initiating stress tests. We will be overseeing this progress.
To assure future pensioners of their income, we plan to introduce fiduciary responsibility for
NPFs. To broaden the horizon of their investment, we will change the remuneration system to
fend off the false motivation behind recording income for a short period of time.
These measures are the groundwork for ensuring that NPFs are stable and work to benefit their
clients. But it is not enough. In our opinion, a convenient, large-scale voluntary funded pension
system is needed to preserve the funded pension market given the expected long-term freezing
of the funded component of pensions.
In conjunction with the Ministry of Finance, we have spent a lot of time developing the Individual
Pension Capital system. This involves voluntary pension deductions via automatic subscription.
In our opinion, it is crucial to establish centralised administration of the system. It will provide a
single window for customer service, and standardise and automate work, providing the public
with a convenient service. Incidentally, we believe that having centralised administration would
reduce the number of incidents where the public's rights are infringed when transitioning from
one non-state pension fund to another. As we see it, the draft bill is currently nearing completion.
The government is working on removing disagreements and, all being well, the draft bill will soon
be submitted to the Duma.
Moving on to the insurance market.
It is demonstrating growth and is, on the whole, marked by positive trends. However, there are
problematic segments: mainly OSAGO. Resolving the issues linked to OSAGO is one of our
near-term objectives. As of this year, it is mandatory for insurance companies to sell the OSAGO
policy in electronic form. This helped provide access to the policy in problematic regions. In the
first half of the year, seven times the number of electronic policies were issued than over the
course of the whole previous year. The priority of repairs over payments, introduced in April, is
intended to remove unscrupulous agents from the market. We expect that these measures will
stabilise the situation.
The strategic objectives to develop the insurance market are aimed at ensuring the long-term
sustainability of insurance companies and protecting the rights of policyholders.
There is also another gap in legislation. Unlike in the banking sector, there is no legal mechanism
for the resolution of insurers. We plan to introduce one in the near future. The corresponding
draft bill has been developed and is being discussed.
The Bank of Russia's priority objectives in the long-term include introducing Solvency II principles
to the risk-oriented approach to regulating financial stability and the solvency of insurers.
Microfinance is a financial service that carries great social significance. Notably, those who turn
to microfinance organisations are mostly poor people and the use of microloans arises in very
difficult situations (literally, when the cash will not last them until their pay day). Therefore, the
Bank of Russia's policy in this market is primarily aimed at protecting consumer rights. The first
objective is reducing borrowers' debt burden and limiting the marginal cost of the loan. The limits
we introduced have already significantly lowered the cost of microloans but we plan to reduce it
further.
Another of our areas of focus is combatting illegal, so-called "black" creditors. In this field,
legislation has been adopted that ensures the prosecution and responsibility of illegal creditors.
We are working together with law enforcement agencies and are now focusing on public
awareness. About a month ago, we launched a joint project with Yandex - the microfinance
organisations on our register are marked with a special symbol in the search results so that it is
easier to understand whether a given microfinance institution is legal or not.
Moreover, this year saw Mir cards issued on a large scale. In Russia, they are accepted by all
payment terminals and ATMs. The issue is proceeding at a good pace: over 10.6 million cards
have already been issued. In the last month and a half alone, over 2 million cards were issued.
Mir is a competitive system and offers all the services on the domestic market that the public are
used to after using international payment systems.
Our strategic objective in the coming years is ensuring Mir cards are accepted internationally,
firstly within the Eurasian Economic Union.
We are making progress in this area with our partners in the Eurasian Economic Union. Last
week, the first cross-border transactions using Mir cards were carried out with Armenia's ArCa
payment system. This is the first project we have undertaken to organise equal intersystem
interaction. (I believe the citizens of the two countries will benefit from new financial opportunities.
I would like to express my gratitude to the Central Bank of Armenia and the management team of
the ArCa payment system for their incredibly effective collaboration and promotion of this
project).
Moving on to developing financial technologies
Technology has an increasingly large impact on the financial sector. Russia is progressing in line
with global trends. In some cases, we are even ahead of some of these trends: for example,
Russian banks already offer cutting-edge mobile applications. According to Ernst & Young, the
Russian market is currently in third place globally in terms of financial technology development.
It would be foo