The Chief Economist Of Russia's Largest Banking Group Warns Of 'A Full-Scale Banking Crisis'

Evgeny Gavrilenkov, the chief economist at the investment banking arm of Russia's largest lender Sberbank CIB, has warned that actions taken by the Russian authorities to bail out Russia's troubled banking sector could cause a "full-scale banking crisis".

"If the Central Bank of Russia continues to provide refinancing in exchange for non-marketable securities that banks can generate in almost unlimited amounts, the system will gradually ramp up to full-scale banking crisis," Gavrilenkov said.

That is, the emergency measures undertaken by the central bank to pump liquidity into the country's banking system in order to prevent widespread defaults could end up coming back to bite it. In essence he thinks that banks may prove unable to pay back loans from the central bank with interest rates now set at 17% and the collateral that they pledge in exchange for it may not be of sufficient quality to cover the losses.

He estimates that servicing over 7.3 trillion rubles of debt at current interest rates will cost the banks of the Russian Federation in the 1.2-1.3 trillion rubles ($20 billion) a year.

Last week Russian central bank head Elvira Nabiullina announced that "the Bank of Russia plans to consider the introduction of foreign currency lending on the security of non-marketable assets" is an effort to calm investor fears about the health of the country's banks. However, Gavrilenkov suggests that this move may increase risks in the system rather than alleviate them.

Indeed he pointed the finger for the plight of the ruble, which has fallen over 40% this year, squarely at the central bank and the Russian Finance Ministry for "pumping the economy with additional liquidity". In remarks that could be interpreted as highly critical of the government, he also said the unprecedented injections of liquidity had "coincided with a significant increase budget expenditures".

There are already clear signs of stress in the banking system. The interbank lending rate, the interest rate that banks charge to lend to each other, jumped to 27.3% yesterday, the highest rate since data started being collected in 2006 according to Bloomberg. The news suggests that confidence in the banking sector is quickly eroding and that banks are becoming concerned with the quality of their peers' balance sheets.

On Friday Russia's lower house of parliament rushed through a draft law to give the banking sector a capital boost of up to 1 trillion rubles ($16.5 billion), Reuters reports. The bill passed three draft readings in a day, a process that frequently takes weeks to complete, in a sign that the government is concerned about the financial sector.

In a note on Thursday Morgan Stanley warned that Russian banks are a major area of concern:

"In addition to margin pressures driven by CBR interest rate hikes, risk of corporate default poses an immediate threat to banks' earnings, in our view. Cost of risk has increased significantly in corporate portfolios over the past nine months and appears likely to accelerate from here."

These worries have already led to a significant easing of standards by the central bank. On Thursday it announced that banks would no longer have to mark their assets to market and could use the average exchange rate from the previous quarter to assess how much foreign capital they require to cover foreign-currency denominated debt repayments. In essence, the central bank is allowing the banking sector to indulge in a bit of balance sheet fiction during a time of stress.

Bank of RussiaBank of Russia emergency measures for Russian companies.

The question, however, is whether current balance sheet stress is predominantly related to the  ruble exchange rate (as in, it is a liquidity problem) or whether the problems are more fundamental (a solvency problem that could lead to default and collapse). As Morgan Stanley puts it, "the Russian banking sector looks to be a risk-absorption buffer between the CBR's policy and real economy, seemingly poised to bear the brunt of interest rate and depreciation-related adjustment".

For the Russian authorities the issue that must now be addressed is to what extent they can differentiate between banks under stress due to temporary factors and fundamentally damaged institutions. Supporting the latter could end up being an extremely costly and ultimately unrewarding enterprise for the Russian state.