Dmitry Dmitriev of VTB Capital -

The Central Bank of Russia (CBR) once again - quite similar to what it did in 2004 - has had to resort to extraordinary measures to respond to the rising tensions in the interbank market. Within a very short period of time of writing this, it will inject about RUB1.8 trillion into the banking system, which we believe is adequate to safeguard the core part of the banking system and to prevent a bank run if these measures are properly exercised and publicised.

The total amount of funds to be injected into the banking system through various mechanisms is RUB1.8 trillion (net of the almost fully-used repo mechanism and lombard loans) which we can compare with the interbank exposure of Russian private banks that we estimate at RUB1.1 trillion to RUB 1.2 trillion, or with the total amount of interbank funding in Russian banks of RUB1.8 trillion (according to the CBR's most recent statistics).

We believe that the CBR's intention is not to save some highly leveraged investment banks blown by their leverage, but rather the core of the banking system. Also, contrary to 2004, the CBR is firing immediately from all the guns as opposed to waiting and gradually allowing the crisis to escalate into the real economy and/or provoke a "bank run."

In the short term, however, we expect the system to slow loan growth further as banks will have to shift the balance sheet mix towards liquid assets. Together with the global credit crunch, this may have a negative impact on economic growth in Russia. Given the capital outflow though, monetary policy easing now is unlikely to have a materially adverse impact on inflation.

We also note that Sberbank, Bank St Petersburg and Bank Vozrozhdenie have very limited exposure to the interbank market on both the asset and liabilities side of their balance sheets. Moreover, Sberbank is the direct receiver of the budget funds that the government plans to place with state-owned banks.

What the CBR has done

The CBR has taken sharp action to provide liquidity to the banking sector and effective from September 18 has lowered mandatory reserve requirements by 4% on all classes of liabilities subject to reservation, additionally raising the averaging coefficient to 0.6 up from 0.55. The head of the CBR, Sergei Ignatiev, expects that these measures will provide around RUB300bn of additional liquidity for the banking sector just from lowering the reserve requirement, with tens of billions of rubles to be freed up due to the averaging coefficient.

Reserve requirements will be gradually raised back to previous levels in two 2% increases on February 1 and March 1, 2009, as the CBR still has to battle inflation, although banking sector stability is obviously the top priority now.

The terms of the RUB1.127 trillion budget funds to be placed in the state banks have been increased from five weeks to three months and may now be carried over the year-end, which previously was not allowed. We believe that this factor will reduce the risk of one more shock to the banking system once the deposits are removed and will support banking sector liquidity in the turbulent times of the immediate short term.

Will the measures be sufficient?

We estimate that the total size of the interbank market is around RUB1.8 trillion, comparable to the liquidity injection of RUB1.8 trillion. According to Micex data, the amount of unsettled repo deals during September 8-15 is approximately RUB7.2bn (of which RUB7.0bn is due to KIT-Finance deals). KIT-Finance has already said that it is in the final stage of talks with Lider Asset Management Company to sell a controlling stake in the group.

At this stage, we believe that this will be enough to unwind the outstanding interbank transaction and to support the liquidity in the system. However, going forward the Russian banking system is yet to face $45bn in external debt repayments by the end of the year by Russian corporates, so the liquidity pillow should stay to help the banks adjust their strategies and lending activities to the "new order."

What else could the CBR do?

In our view, the CBR does not have much room for manoeuvre in terms of decreasing requirements or injecting any more cash into the market. As noted, the amount provided should be sufficient though in extreme cases the bank may enforce and even finance a bailout or troubled entity if its problems represent a systemic risk. But if further steps are required, the only thing the CBR can do is either extend the list of collateral for repo operations or add additional asset classes against which it will provide liquidity to the banking system.

Our universe's exposure

We have looked at the exposure that our coverage universe has for lending to financial services and investment companies, as well as the amount of outstanding repo transactions. As seen from the table below, only Bank of Moscow (BoM) has high exposure to the markets, but we believe that this does not present a significant risk for BoM's solvency given the bank's state ownership.

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