Troika Dialog in Moscow -

With all eyes on the US Federal Reserve and the European Central Bank to see if they are going to pump more money into the global system, Russia's Central Bank of Russia is well ahead of them and in the midst of its own "quantitative easing" to support growth and prop up the banking sector. The second wave of the crisis in Russia has already started but no one has noticed as the Central Bank of Russia (CBR) has enough money to prevent anyone from going bust.

During the 2008-2009 meltdown the Russian government spent a total of about $200bn into the economy to stave off total collapse. However, as the global economy stabilised the CBR chocked off lending after production bounced back from extreme lows.

Now a second wave of the financial imbroglio is threatening. The on going Eurozone crisis has pulled down industrial production across the Continent including Russia. The slow down is also reflected in the low level of investment and total lack of confidence amongst industrial companies. The upshot of all this pessimism is money is not flowing around the system and Russia banks have been caught in a slow moving train wreck as liquidity in the financial system has evaporated.

The main problem is that while corporate lending is sluggish, consumer lending is exploding. Retail loans are rising by 3-4% every month and up well over 40% on an annualised basis - far in excess of the 28% threshold the CBR says marks the beginning of "overheating". This lending is eating up banks' capital and is well above the rate of money supply and nominal GDP growth. To feed this consumer credit expansion, banks will soon need to be recapitalised - a problem that leading state-owned VTB Bank is already facing.

VTB CEO Andrei Kostin warned at the start of this year it would be difficult for the bank to achieve the 15-20% loan portfolio increase targeted this year and said that deposit rates were under pressure due to increasing competition. As banks have been forced to rely on deposit funding their ability to lend has been restricted and interest rates have risen. As the summer ends VTB's capital adequacy ratio - a key measure of any bank's health - fell to just below the mandatory minimum of 10%.

Kostin's fellow banking captain, Sberbank's CEO German Gref was even more explicit in June, saying: ""As for a short-term liquidity forecast, unfortunately, what we are seeing now is a liquidity crunch. So far, we do not see that the situation will improve and, consequently, a short-term rates forecast unfortunately indicates that the rates may rise further."

Low liquidity is a big problem for Russia's banking sector. As the top 30 banks do about 90% of the business and hold the lion's share of the deposits the other 900-odd banks in the sector are almost completely dependent on the inter-bank market for money. The game is a simple one: as a bank you can borrow on the inter-bank market more cheaply than in the open market, so companies set up banks to get cheap money. However, if that liquidity dries up then these "pocket banks" quickly become unstable and threaten the stability of the whole system.

As bne wrote in its September cover story Storm Clouds Gather Europe is in the middle of a slow moving crisis that could spin out of control. But even if Europe's politicians find a fudge that prevents a fresh meltdown (as appears to be case following the ECB meeting on September 6 that launches a new bond-buying programme) the stresses in the system are increasing thanks to the falling industrial production levels.

These problem are getting sufficiently serious that the CBR feels the need to step in and start offering cheap financing to banks that are no longer able to take care of themselves without CBR hand outs.

"In mid-2012, the Central Bank significantly expanded refinancing of commercial banks, not only via repo loans, but by providing loans against non-tradable collateral, less-liquid assets and various forms of guarantees," Troika Dialog's chief economist Evgeny Gavrilenkov said in a note in September, a repeat of the actions it took in the middle of the 2008 crisis - and on the same scale, Gavrilenkov adds.

The second wave of the crisis is already here

What this refinancing means is the second wave of the crisis is already here, if judged on the basis of what the CBR has been forced to do in order to prevent a systemic meltdown. However, the liquidity crunch will not caused any problems as all the banks have plenty of cheap money - except it is coming from the CBR instead of normal market operations or something as mundane as making profits.

This lending is the banking equivalent of playing with fire. The CBR can't just give crap banks money, so what it has done is to expand the list of assets it will accept as collateral. Troika says the stock of "poorly secured" loans the CBR is holding has built up to levels last seen in 2008. Not only could this debt turn toxic but this is also an extremely opaque way of going about a banking sector bail out.

"It is not entirely clear what has motivated the Central Bank to suddenly loosen monetary policy this time," says Gavrilenkov. "If the Central Bank accepts various forms of guarantees and lends money against some other collateral (beyond OFZs or corporate and municipal bonds), then it becomes virtually impossible to foresee the magnitude of potential refinancing activity of the Central Bank."

Even though the total consumer debt to GDP ratio remains at a reasonable 10% of GDP, overly aggressive lending by banks to consumers could become a problem for the system if there were a shock of the system - say a bank crisis in Europe or food price shock - that drove up the number of non-performing loans or caused a spike inflation - both of which are very much on the cards, as bne pointed out in its Storm Clouds Gather story.

To add to the other concerns, the Russian quantitative easing doesn't seem to be having an impact on economic growth. The point of issuing all-but-free cash is to stimulate the economy, however, economists agree that the Russian economy is likely to slow in the autumn. The only way to reduce the risks of lending lots of cash on the back of poor quality assets is to spark economic growth, but this is not happening. The reason is obvious: there are not enough real businesses in Russia and the lack of reform means money pumped into shoddy companies and banks is largely wasted.

Even if the second wave hasn't arrived yet, the state is clearly actively anticipating another crash. Last year it the government's rainy day Reserve Fund was replenished by an amount of foreign cash far exceeding the fiscal surplus (the latter was around $15bn, while the State Reserve Fund increased by around $35bn). And the current plan is the government is going to borrow heavily on the domestic market in rubles, convert the proceeds to foreign currency and stash the booty in the Reserve Fund - just in case. According to the proposed budget, the government is going to replenish the State Reserve Fund by more than $20bn in 2013.

Gavrilenkov argues that this is a very unhealthy thing to do and the upshot is to increase the capital outflow: "If the government can suck local liquidity out of the system and buy foreign cash, why should others behave differently." This action also feeds inflation, reduces money supply and exacerbates the liquidity shortage.

Everything now depends on what happens in western Europe. If there is no second wave and confidence begins to recover these problems will fade away as the Russian economy is still growing. If there is a mild shock then the money in the Reserve Fund (and the increasingly flexible exchange rate regime) will cushion the blow. But if there is a particularly nasty collapse in the rest of Europe some of these debts could become toxic and send the banking sector over the cliff (again). The bottom line is that the government is attempting to protect the economy with financial shenanigans, but the better solution is to make the economy much more robust through reform, diversification and promoting small- and medium-sized enterprise.