CBR Deputy Governor Olga Polyakova: Many smaller banks have chosen a passive business model, we call them ‘dormant banks’
Olga Polyakova
Photo: The Central Bank of the Russian Federation
Banking supervision has faced challenges like no others during the pandemic: the Central Bank has had to monitor closely the financial strength of lenders, at times remotely, and come up with measures to support them very quickly in times of mass isolation and an economic slump. Olga Polyakova, a Central Bank deputy governor, told Interfax in an interview about how the financial system had emerged from crisis, how banks with basic licenses were faring and about banking supervision plans.
Question: Several years have passed since the Central Bank split banks into systemically important, universal and basic ones. There is an opinion that banks with a basic license have been unable to build a viable business model given their limited opportunities. Do you agree with this?
Answer: Our banking sector today consists of lenders of varying scale and with varying tasks. There are large banks with a lot of capital and opportunities to invest in technology, and there are small ones that cannot compete on equal terms with large high-tech banks.
We realized that it was necessary to create a market environment in which all participants could operate, regardless of their size, so we switched to proportional regulation - we made it easier for small banks, limiting them in return when conducting high-risk operations. Banks with a basic license, with capital of upwards of 300 million rubles, do not compile reports to International Financial Reporting Standards today and do not provide data in accordance with the internal capital adequacy assessment process (ICAAP). The expectation was that gradually these banks would be able to adapt to the new rules and continue lending to small and medium-sized businesses in accordance with their capital reserve, while retaining the ability to conduct settlement transactions and some transactions with securities.
The outcome differs somewhat from our expectations. Practice has shown that, unfortunately, more than a third of these banks have not yet decided on a business model. Perhaps the fact that this reform took place not long before the pandemic - banks with a basic license began to operate as institutions from late 2018-early 2019 - played a role, complicating the situation and conditions for development.
Unfortunately, we see many of the smaller banks adopting a passive business model. We call them ‘dormant banks’ because they do not act as financial intermediaries and do not lend. On the whole, banks with a basic license have average annual portfolio growth of less than 1%, despite a large capital reserve - for some banks, the capital adequacy level can reach 40%. Such banks invest their liquidity either in deposits with the Central Bank or in federal loan bonds. And too little risk appetite adversely affects their overall efficiency and profitability.
It is important for us as the supervisory body to understand the strategy of such banks and their future. A bank may continue to be dormant, and its owner, having not seen any prospects, may decide to give up the license and leave the market voluntarily, having paid off all depositors and creditors. This is a responsible position, there are such cases and, as you know, the licenses of nine credit institutions were canceled in 2020, and of six in 2021. Or, on the contrary, a bank may go off at a tangent, perform ‘scheme’ or illegal transactions which, unfortunately, we also sometimes see, and as a result we are forced to revoke the licenses of such banks.
At the same time, I would not make a final conclusion about the non-viability of banks with a basic license. The time horizon for issuing a verdict is clearly insufficient, especially since many banks with a basic license are still looking for a niche of their own in the current challenging circumstances.
Q.: What do you think about the initiative of the Association of Banks of Russia, which proposed including such banks in the system of measures to support SMEs? And giving them the corresponding status of SME? How much of an incentive would this be for them?
A.: We believe that the issue needs to be studied in detail before making such a decision: because a bank is a special institution that does not operate with its own money, but with the funds of customers - depositors and businesses - the bank also bears special responsibility for safe-keeping these funds. Therefore, we believe that the possibility of giving banks with a basic license the full range of rights that the law grants to SMEs should be approached with caution.
As for the possibility of support from state authorities and local governments that banks with a basic license could receive as SMEs, this issue is for the government to decide. In general, it remains open and is under discussion.
Q.: The Central Bank conducted an ICAAP analysis in 2021. What did the results show?
A.: We completed this analysis and reviewed the results of banks that are obliged to provide us with this information. Let me remind you that this requirement does not apply to banks with a basic license. We started our work on analyzing ICAAP with the largest banks, the assets of which exceed 500 billion rubles and, after fine-tuning approaches and forming an understanding of how the risk management system should be built, we extended this practice to all banks with universal licenses. ICAAP gives banks the ability to manage capital adequacy, determining the risk appetite for various types of assets so as not to step over the red line where risk limits are. This helps keep capital at a level that is sufficient for the normal existence of the bank and expansion of its potential lending.
The level of maturity of risk management in the banking sector is fairly high. With every year the largest banks develop and introduce more advanced approaches to assessing capital for significant risks. The list of potentially significant types of risks is expanding, increasing attention is devoted to cyber risks, and methods are being developed to assess new types of risks, including ESG and ecosystem risks.
Of course, there are banks with problems and shortcomings. For example, the main reasons for 'questionable' and 'unsatisfactory' assessments of the quality of ICAAP at certain banks were set limits being systematically exceeded, violations of statutory ratios, and the risk management system not conforming to the scale and nature of activities. If problems are found, we have the right, based on the results of ICAAP assessment, to require the bank to set an additional capital buffer.
Q.: Are there banks for which the CBR set additional capital adequacy buffers following the ICAAP analysis?
A.: There are such banks.
Q.: Banking sector statistics for 2021 indicate that banks will receive record profits. Does the Central Bank have a vision of how banks should distribute this profit? Will you have any communication with banks on this?
A.: Indeed, for 2021 profit should amount to about 2.5 trillion rubles. And the capital reserve right now is quite substantial - 6 trillion rubles, while the average adequacy ratio exceeds 12%. In other words, banks have accumulated a decent safety cushion.
And in cases where, by our estimates, payment of dividends could have a perceptible negative impact on the financial stability of a credit institution, the Bank of Russia will hold consultations with the owners and managers of banks in order to persuade them to refrain from paying dividends.
However, we understand, of course, that owners expect to get a “fair” payment for risk in the form of dividends. There cannot be any other approach to such investments, since the banking sector, while it is a singular form of activity, is nonetheless a business.
Q.: Do you already have a profit forecast for 2022?
A.: The CBR does not have a forecast for 2022 profits yet, banks are only drafting their business plans. But we believe that the banking sector's profit this year might be lower than in 2021 in conditions where the cost of raising client funds is growing and provisioning expenses are returning to the usual level.
Q.: How often does the Central Bank analyze the business plans of banks, and how does it act if it reveals weaknesses?
A.: We analyze not only a bank’s business plan, but also its business model. A business plan is information about the volume of the bank's loan portfolio, the pace at which it will grow, whether the bank will give preference to growth of the retail or corporate portfolio, what return the bank expects from investment in certain assets, what margin it will maintain, what profit it plans to end the year with, and so on. Of course, we discuss it in the period when banks approve such business plans, around the end of an outgoing year or at the beginning of a new year. Then, in the middle of a year, we return to the document in order to evaluate how fast a bank is moving, whether it is ahead of the business plan, or lagging behind, and together we discuss the reasons for the deviations. And then we meet again, at the end of one year and beginning of the next. So we discuss a bank’s business plan with a bank at least twice a year.
As for the business model, this describes the life of the bank: how the bank builds its business, what exactly it chooses as its main area of activity. Business model analysis has become an important part of the entire supervisory process. Thanks to this, we can detect risks, shortcomings and vulnerabilities in the activity of banks at an early stage.
This is for us the basis for dialogue with banks. It matters whether it will be a universal, retail or exclusively corporate bank, unrelated to requirements for individuals. Some banks bet exclusively on market risks and have big securities portfolios. Or a bank does not have any model and we have a dormant bank. It is important to recognize whether a bank model is captive or not.
Q.: Are there any captive banks left?
A.: Yes, we have these, too. In general, we have created a certain clustering in our work with the analysis of business models. I have mentioned several types, but in fact we have more. This work helps to assess the success or failure of the bank's business, to determine and quickly diagnose, to identify its problems both today and in the future.
Thanks to clustering, for example, we have identified business models where operating income is not sufficient to cover the administrative and economic expenses of banks. Another group shows a lack of income generated to form the required reserves.
Banks are grouped in each cluster according to various additional features. And if we identify significant distinctive dynamics in the activities of any bank, then we conduct a repeated unscheduled analysis of the bank's business model. Such analysis is carried out on an ongoing basis for some banks.
Q.: There is another term, the financial stability recovery plan (FSRP), which supervision rarely makes use of in full view. Should every bank have an FSRP and how effective a tool is this to resolve banking problems?
A.: This is an effective tool for crisis situations. But it is effective if the approach to compiling it was not formal, and the document itself contains entirely specific financial stability recovery measures and procedures over a certain period of time, including support from the owner and review of the bank's business strategy. We have been doing this work for a long time. As you know, Basel has made the FSRP requirement for systemically important banks mandatory. The Bank of Russia also has the right to require other banks to provide such a plan, if it sees a need for it. We use this tool in exceptional cases. Suffice it to say that as of the beginning of 2021, the Bank of Russia carried out such work with 14 banks. And such a supervisory measure is incomplete at just one bank.
If the ICAAP, as we have already said, helps to ensure that a bank does not approach ‘red zones’, then the FSRP is a list of measures in the event a bank does after all get into the red zone.
Letter N193-T was previously in effect at the Bank of Russia, then a Bank of Russia regulation establishing the requirements for the content of the FSRP came into effect. At the end of 2021, we published detailed recommendations for banks on the drafting an FSRP, where we systematized our knowledge and experience with banks on the preparation and evaluation of such plans - what aspects should receive attention, even the format of this document. A report was also published describing approaches to compiling FSRP in different countries.
An FSRP starts to work when a very serious situation arises, usually related to external factors. For example, a pandemic. This is a situation that cannot be foreseen, one which may develop according to a more negative scenario than expected. So banks, especially systemically important ones, their stability being important for banking sector stability, should develop their own FSRP. The document should include several likely stress scenarios, usually three.
Q.: What events, for example, might a bank factor into the scenario?
A.: Events should have a strong impact on fundamental factors for our economy, such as the exchange rate or the price of oil. For example, if a bank simulates a stress scenario according to the 2008 example and still maintains capital adequacy and liquidity, then we demand such a tough idiosyncratic scenario when it will nevertheless break capital adequacy ratios, when liquidity problems arise, and the bank can describe its actions to get out of this situation.
This is in fact a back-calculation. We have already come across scenarios in the calculations of some banks when only the fulfillment of a number of absolutely unrealistic conditions could lead to a violation of stability. I hope we never face such situations in practice.
Problems are overcome by those who are well prepared, so a financial stability recovery plan is needed. The plan should be clearly outlined: measures, speed of informing management, speed of decision-making, and so on. In fact, this is Plan B or Plan C for a bank, if Plan A has begun to falter.
For systemically important banks, we review the FSRP annually – this is submitted to the Banking Supervision Committee, where it is discussed, approved or sent back for revision. The supervisor may require an FSRP if it sees negative trends in the activities of a bank. The plan is then submitted to the Bank of Russia after approval by the bank’s board of directors and should contain information on how the bank will restore its stability, bolster capital adequacy, change the structure of assets, reduce investments in distressed assets and so on.
An FSRP is perhaps the best known, but not the only form of ‘scheduled’ measures against banks. Supervisory divisions also make active use of other forms, including participation plans, financial resolution plans and plan to restore equity. We decide whether to terminate such plans as the financial stability of banks recovers.
Q.: Why not make FSRP mandatory for large banks with a universal license, so they can also have a Plan B on their shelf?
A.: Good question. It can probably be extended to other banks in the future, not just systemically important ones. We need to think about it, and I do not rule out this option becoming mandatory for them at some stage.
Q.: You said in 2020 that the Bank of Russia had begun to use stress testing for supervisory purposes. What did the stress testing show and how do you use the results for supervisory purposes? Does the Central Bank have plans to expand this instrument?
A.: We have been using stress testing for a long time. There are two methods: top-down and bottom-up. Based on the results of stress testing by the bottom-up method [done by banks using internal data and models based on CBR scenarios], we select a number of banks and determine a stress scenario with our colleagues from the monetary policy department, send it to the banks, which then come back to us with the results of the stress test.
In 2020, in order to reduce the regulatory burden amid the pandemic, the CBR refrained from doing bottom-up stress tests and only did internal stress tests. In 2021, bottom-up stress tests were resumed and done with 30 banks. They included systemically important banks and a number of other major banks that together account for 82% of the sector's assets. As a result of this work we did not find serious problems in the financial position of these banks in the event of negative scenarios for the development of the economy and financial market being realized.
In past years we received these results, discussed them, then we began to apply them in practice in dialog with banks. When receiving their responses, we discuss the results with each bank, including the understanding of how a given loan portfolio will behave, what the level of losses will be in such a stress, to what extent the bank overestimates or underestimates returns, margins and so on.
In general I must say that the results are pretty good. Gradually building up competency and mastery, we will probably think about publishing the results of stress testing in future. Perhaps we'll start publishing in 2022 or in a year.
Q.: Like the Fed and some other central banks do?
A.: Yes. Some of them publish, some don’t.
Q.: Are you still using the results of stress testing in your dialogue with banks?
A.: Yes. The toolkit that we have - the opportunity to set an additional allowance based on the results of the ICAAP assessment - is sufficient for now. But, as stress testing develops, we will think about expanding the use of this tool for supervisory purposes.
It would probably be too soon to air specific details about this work. I’ll say only that the purpose of it is to establish that banks have a sufficient capital buffer to allow them to continue developing during stress period and crisis events.
Q.: What are the main problems the Central Bank is identifying at banks in supervision process? Has the nature of these challenges and risks changed as the banking business moves online?
A.: I’d say the situation has improved. The pandemic has been a serious test for the banking sector. You see that, fortunately, there has been no mass exodus from the market, as was the case after 2014-2015. This is partly because we did a lot of work beforehand to purge the banking sector of unscrupulous and weak players. The culture of risk management in banks is improving, and banks are becoming more transparent. The percentage of banks that had a lot of investments in business related to owners is decreasing.
Banks do of course have distressed assets as well. All enterprises are living organisms: one day they work well, and the next day something happens and a loan becomes a problem loan. But this is a natural process. The main thing is that the share of non-performing loans should not be too high, so that a bank has capital, and enough of it to absorb unforeseen losses.
An analysis of the performance of banks that have left the market indicates the prevalence of credit risk. The risk of concealing the true quality of assets and purpose of individual transactions from the market and the regulator should also be recognized as specific.
Now as well, unfortunately, we are seeing not always successful attempts to find additional sources of income, when selected banks begin to provide services to various companies to withdraw funds through electronic platforms. This is a serious problem, it is pressing. A number of licenses have already been revoked from both banks and non-bank credit institutions, which, unfortunately, have been involved in such operations.
Q.: Are you talking about banks associated with online casinos?
A.: Yes. We’ve seen a considerable increase in the volume and number of illegal transactions with online casinos and bookmakers, so-called ‘gambling’, and this was the reason for the withdrawal of licenses from a number of credit institutions by the Bank of Russia in 2021. But these are mostly small banks that are looking for a source of income, but in the wrong places.
Q.: How do you assess the state of banks after their exit from regulatory forbearance? Have all banks coped with additional provisioning? Banks have complained that the Central Bank did not extend all forbearance measures related to Ukraine and sanctions...
A.: We are not ignoring the banks’ appeals. I’ve said we have a fairly active dialogue with banks, and this had become even more substantive during the pandemic. You will recall that we reacted quickly, made the necessary decisions, issued information letters or recommendations on how banks should work during the lockdown period. We adapted quickly enough to enable both banks, and, above all their clients - both small and large businesses - and individuals to survive this difficult time. We decided on mortgage holidays and holidays on other retail loans; that banks, when restructuring loans, would not have to provision for them and not recognize such restructuring as a default, but, on the contrary, look at it as an opportunity to give a client respite, after which it would be possible to return to the normal operating routine.
Not all banks took advantage of our concessions, and those that asked for them did so in different ways. Some to the full extent, some to a greater or lesser extent. Why didn't they make use it? Because, in principle, banks had normal capital adequacy, and they have been heeding the level of risk while building their business. So they were able to survive a difficult period quite calmly and maintain their capital adequacy, although everyone had to adapt their business and go mostly online.
We have not heard any complaints that we abolished the concessions early. You may recall that we extended them several times, and effectively they came to an end in 2021. But we also see that banks came out if this regulatory forbearance with varying levels of financial stability. There are still loss-making banks, and some of them have been posting losses for a long time. We work closely with such banks, and we communicate with their owners so that they provide the necessary assistance to the bank. However, in general, the problems for banks, if they exist, are probably caused largely by the need to adjust their existing business model or even switch to a different model of market presence.
As for Ukraine, this norm was introduced in late 2014-early 2015, and was also extended, expiring back in 2020. They all coped.
Q.: Do I understand correctly that the Central Bank plans to extend the reserves concessions to sanctioned companies?
A.: Yes. For three years.
Q.: The Central Bank has said repeatedly that in its supervisory process it is switching to a data-centric approach. What other data would you like to receive from banks in order to make decisions quickly?
A.: We do of course need up-to-date data, and we want to receive it ‘here and now’. We receive reports with some regularity, but with a time lag. There are reports that are submitted to us at the end of the month following the reporting month, or at the end of the quarter following the reporting quarter. Can we talk about the relevance of these data in this sort of situation? Probably not. The times are such that we must understand the situation here and now, in extreme cases, in one or two days.
We spoke about our intention to move gradually towards a data-centric approach. I stress gradually, because this is a two-way process. On the one hand, we must set standards for banks to generate such data. On the other hand, banks must ensure the quality of the data. We understand that banks are complaining that we are asking for a lot of additional information. But we will not be able to go any further without this work and without accommodating each other.
As for additional data, the Bank of Russia needs above all more detailed information on the provisions made in accordance with IFRS 9 requirements, as they are more risk-sensitive. Analysis of provisions under IFRS 9 makes it possible to more accurately determine the risks and, accordingly, the prospects for change in the financial position of banks. Therefore, the Bank of Russia has already prepared a new reporting form, which will contain the main risk indicators used to calculate reserves under IFRS 9, broken down by loans to legal entities. There are plans to start gathering this data from banks in 2023.
The pandemic has demonstrated the need to obtain up-to-date data particularly clearly, because we had to understand what was happening at the present moment, and not just rely on reporting data a month old. So I want to say a thank you to the banks, they agreed to provide us with their management reporting or the necessary excerpts from it during the pandemic. And we have not lost the opportunity to monitor the situation, to evaluate it in time, how it might change and so on. This is what has given us the opportunity to make correct and timely decisions.
Q.: Was this a one-off campaign during the pandemic?
A.: In general, yes. True, we sometimes request things even now, and banks are not very happy when we do so. But on the whole, the work involved in improve reporting will take more than one year.
Q.: What does the Central Bank think about the idea of using ratings to determine the classification group of a bank and level of contributions to the deposit insurance system?
A.: There will always be differences in the methodological approaches of supervision and rating agencies. Supervision does not publish information about how we classify a particular bank based on the results of assessing its financial position, and supervisory information is not subject to disclosure. But in order to generate a supervisory assessment we also take information about a bank's ratings into account, since all external sources of information are important to us, providing an opportunity to obtain additional information about a bank, about the quality of its work.
In terms of assessing the economic situation of banks, we plan in 2022 to update comprehensively the approaches to the assessments. We will present the results to the banking community for discussion once we have completed work within the CBR.
Q.: The Central Bank has recently criticized banks for their disloyal policy regarding the pricing of deposits. Can you say what the regulator will be proposing at the legislative level?
A.: We don’t like the selective, differentiated approach of banks, which set interest rates depending on whether a customer brings ‘new’ money or not. You will not be able to move your funds from a previously opened bank deposit to another one with a higher interest rate until you bring new money to the bank, for example, having taken it out of another bank. Or, as a condition for a higher rate, a bank asks you to buy additional services or an investment product that you don’t particularly understand or need, but otherwise you cannot get the product that interests you. It is necessary to make setting the interest rate fairer, and to enable all depositors to get returns on the same terms. So we are now drafting amendments to the Law on Banks and Banking Activities to ban banks from using such loopholes and so that banks cannot rank a customer according to whether the money is ‘new’ or ‘old’ "new" or "old", or the method for depositing funds or the purchase of additional products.
Q.: At what stage is the idea of a deposit for people on low incomes? It is still unclear: who will subsidize the above-market rate for such a deposit - the banks themselves or the budget?
A.: We’ve stated the need to come up with such a deposit, this is a targeted product, and we are discussing its possible terms. It is obvious that some people may have difficulty finding the money for bare necessities due to difficult circumstances, but this does not mean that they should not be able to gradually save money in a savings account to overcome their problems in the future. And of course, such a deposit has to be appealing.
The deposit for people on low incomes would be limited to 100,000 rubles, the interest rate on it would be linked to the key rate, and a person would only be able to open one such deposit. Subsidies are a matter for discussion. If banks have high profits and can allocate more than 50% of those profits for dividends, then why should we subsidize interest rates? It is necessary to make calculations and evaluate the share of such deposits in the system, as well as how much of a burden those costs would be for banks. After all, many banks declare themselves to be socially responsible, the look to obtain ESG ratings. Well, we all know that the second letter of this abbreviation stands for - social. This is how banks can provide help to those who need it.
We would consider the social treasury system that the government is working on to be a source of information about people with low incomes, and we hope that it will be created in perhaps one year.