The growth of reserve requirements may adversely affect bank profitability

From 1 August, 2016, the Bank of Russia increases reserve requirements for all types of credit institutions’ liabilities in roubles and foreign currency by 0.75 percentage points.

In the current year, the regulator has already increased reserve requirements for banks’ liabilities in foreign currency twice (by 1 percentage point – starting from 1 April and 1 July), discouraging the growth of banks’ foreign currency liabilities. The current increase that also concerns the rouble part of banks’ liabilities, is aimed at absorbing the increasing liquidity surplus in the banking sector linked to financing the federal budget deficit at the expense of the Reserve Fund. Note that the regulator’ capabilities for liquidity surplus sterilization in a large-scale reduction of lending to the banking sector is limited. In this regard, the decision to raise reserve requirements on banks’ liabilities in roubles can empower the Russian Central Bank to manage money market rates, slowing the process of banking sector’s transition to the situation of liquidity surplus.

At the same time, the increase of reserve requirements may adversely affect the profitability of banking activities, increasing funding costs for banks by means of attracting deposits. This may lead to further reduction of deposit interest rates that are already being reduced due to liquidity surplus. Interest rates on rouble individual deposits of up to 1 year decreased from 8.53% per annum in January to 7.71% in March 2016, and interest rates on deposits in foreign currency dropped from 0.99% per annum in January to 0, 93% in March 2016. However, the reduction of deposit returns in real terms will be restrained in proportion to the slowing inflation and inflation expectations.

In general, the increase in reserve requirements is quite an effective measure that restricts the expansion of the monetary base. This decision will contribute to achieving the Russian Central Bank’s official inflation objective of 4% in 2017.

Alexandra Bozhechkova – head of the Monetary Policy Department