A new inflation targeting framework, efforts to improve the supply of credit and the implementation of Basel III all pose challenges for the Bank of Russia, as well as opportunities to modernise the country's financial system.

The Bank of Russia’s monetary policy goal is to ensure the stability of the rouble by maintaining price stability, thereby forming the conditions for balanced and sustainable economic growth. The Bank of Russia pursues monetary policy considering the current development and future prospects of the Russian economy and taking into account global economic trends.

In 2013, monetary policy has been implemented against a backdrop of high inflation, which exceeds the existing target of 5% to 6%, and slowing economic growth caused by lower investment and external demand. In the second half of the year, inflation is expected to decrease provided there are no negative shocks in the food market.

Inflation targeting

The Bank of Russia is considering setting itself the task of bringing inflation down to 4.5% (December on December of the previous year) in 2014 and 2015, and to 4% in 2016. The medium-term horizon for the inflation target provides the Bank of Russia with the required flexibility necessary to withstand different shocks that occur in the economy and enables monetary policy to provide the required support for economic growth without coming into conflict with the inflation targets.

By 2015, the Bank of Russia plans to complete the transition to the inflation-targeting regime. The medium-term inflation target will be determined jointly by the Bank of Russia and the Russian government, taking into account the macroeconomic forecast.

The transition to the new operating mode requires the implementation of a set of measures that will affect exchange rate policy, the system of monetary policy instruments, the mechanisms of the Bank of Russia’s interaction with the Russian government, and communication with the public.

One of the preconditions for switching to inflation targeting is agreement between the Bank of Russia and the Russian government on pursuing a coordinated macroeconomic policy. The Bank of Russia attaches great importance to the development of mechanisms of interaction with the government in the following areas: the setting of an inflation target, the management of budget funds allocated to accounts with the Bank of Russia, and the replenishment and use of the sovereign reserve fund. The Bank of Russia continues to increase exchange rate flexibility and plans to switch to a free-floating exchange rate regime from 2015.

Public understanding of the Bank of Russia’s role in inflation targeting is key to the successful implementation of monetary policy, so it will seek maximum information transparency. The action plan for improving communication stipulates an increase in information disclosure via different channels taking account of the target groups – the business community, government authorities and general population.

As the reduction of inflation will be a priority task, the Bank of Russia’s decision making will be determined by the need to obtain a balance between curbing inflation, ensuring the sustainability of economic growth and maintaining financial stability. In the long-term, financial stability and price stability are the mutually supportive goals of monetary policy, while efficient monetary and macroprudential policies may strengthen and supplement each other.

New policy tools

Interest rate policy will be key in the implementation of monetary policy and the Bank of Russia may, if necessary, introduce unconventional monetary policy measures. With the aim of enhancing the efficiency of the interest rate policy and anchoring market participants’ expectations, the Bank of Russia introduced the key rate as an operational indicator of its monetary policy. The interest rate band remains the basis of the existing system of Bank of Russia instruments and is formed by the rates on overnight standing facilities. Control over banking sector liquidity is supposed to be exercised mainly through one-week auction transactions.

Currently, the Russian banking system has a significant structural liquidity deficit. Credit institutions receive about $9.3bn on average through central bank repurchase transactions at daily auctions and about $46.4bn at weekly auctions. The banking sector needs long-term money and the Bank of Russia intends to encourage credit institutions to use mostly longer term instruments.

With the aim of mitigating the problem of collateral shortfall for certain market participants, the Bank of Russia conducts its operations with different types of assets in addition to government securities, including foreign currency, precious metals and credit claims. Instruments with maturities of up to one year are used. Recently, the Bank of Russia started to execute longer term operations in the form of auctions with a floating interest rate so as to minimise their distortive influence on the market yield curve. The introduction of a new instrument in June 2013 – auctions of loans secured with non-marketable assets and securities at a floating interest rate – has become the first step in this direction. The rate on these loans is linked to the key rate. Starting in October 2013, the bank plans to conduct three-month auctions of this type on a regular basis.

Improving credit supply

Increasing bank loan accessibility for the economy is one of the pressing problems of Russian banking sector development. Interest rates on loans are affected by a set of factors, many of which are beyond the sphere of Bank of Russia regulation. In particular, credit risks remain high, including those related to the shortage of information on borrowers’ financial standing. This is especially true for small and medium-sized businesses. Alternative financial instruments to reduce reliance on bank loans are not yet sufficiently popular among potential borrowers.

Interest rates on loans are also influenced by inflation, banks’ own capital resources and the level of competition in the banking services market. To reduce the cost of lending, the Russian government and the Bank of Russia are jointly implementing a gradual set of measures to develop competition in the banking sector, reduce the costs of credit institutions and strengthen their capital base.

Although overall credit growth has slowed recently, it has been excessive, posing a threat to financial stability. To address this problem, the Bank of Russia has adopted a number of measures requiring banks to hold additional capital against unsecured consumer loans issued after July 1, 2013, that carry a high effective interest rate.

New supervision

Following Financial Stability Board and G-20 recommendations, the Bank of Russia pays close attention to maintaining the stability of national systemically important credit institutions and defining approaches to the regulation of their activities. The Bank of Russia took the decision to establish from October 2013 a department responsible for the supervision of Russia’s systemically important credit institutions. The major areas of its activities include consolidated supervision and improving risk assessment using mathematical models. To understand risk profiles correctly, credit institutions will be stress-tested based on macroeconomic scenarios. The Bank of Russia intends to develop the system of supervision of systemically important financial institutions, not only in the banking sector but also in other segments of the financial market.

A top priority for the Bank of Russia is the alignment of banking regulation with international standards such as Basel II and III. The expected introduction of Basel III provisions into Russian banking practices (starting from January 1, 2014) is a subject of discussion between the Bank of Russia and Russia’s banking community. In the opinion of chief executives of the largest Russian banks and some experts, Basel III implementation will require a lot of additional equity capital, thus slowing growth in bank lending and reducing the competitiveness of the banking sector.

However, according to Bank of Russia’s estimates, the implementation of Basel III requirements will not be difficult for Russian banks and, specifically, will not worsen their lending dynamics. On the whole, the introduction of Basel III will have a positive impact on the solvency of Russian banks as it will make them pursue more weighted growth strategies and more conservative policies with respect to equity capital.

The Bank of Russia plans to start ongoing monitoring of bank financial reporting based on Basel III requirements, to calculate bank equity capital projections in compliance with Basel III for the period of 2014 to 2015, and to start evaluating the impact of deductions related to the schemes used for raising capital.

Financial markets role

From September 1, 2013, the functions of regulation, control and supervision of the financial markets have been transferred from the Federal Financial Markets Service, which was liquidated, to the Bank of Russia. The purpose of the Financial Markets Service within the central bank is to ensure the development and stability of Russia’s financial market, including the prompt identification of crisis situations and adoption of anti-crisis measures.

One of its major tasks is the analysis of the current situation and development of financial markets and in particular the analysis and regulation of non-credit financial institutions. In addition, the Bank of Russia Financial Markets Service’s efforts will be concentrated on the protection of rights and lawful interests of shareholders and investors in the financial markets, and also of insurers and participants in the compulsory and private pension systems.

Elvira Nabiullina is the governor of the Bank of Russia, the country's central bank.

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