Russia’s banking system will resume growth in 2017. Following last year's record-breaking slump (a similar decline was last seen in 1998), the sector is expected to grow its assets 2% this year fueled by retail lending, particularly in the mortgage segment. Although interest rates are likely to shed 1-1.5 pps in 2017, demand for loans will be capped by projected decline in real disposable income and weak economic growth.
Past due loans passed their peak in 2016, but asset quality will remain a key risk for banks. In 2017, the proportion of problem loans will still stand strong at no less than 14% versus 15% recorded last year. Cost of risk is likely to be pushed up by lending expansion in the segment of less reliable borrowers and by the Bank of Russia tightening supervision over asset impairment level assessment.
The volatile profitability period is over for Russian banks. As the economy transitions to gradual recovery, banks will wee their financials stabilizing, while competition for liabilities combined with lower loan interest rates will put pressure on net interest margin. As a result, profitability of Russian banks will remain relatively low, with ROAA not exceeding 1.5%.
The deposit base should grow at a moderate pace in 2017, with private and corporate deposits climbing 9% and 12% respectively. The trend will be spurred by the Bank of Russia stimulating savings and recovering economic activity after a weak performance shown in 2016.
Regulation and supervision strengthening by the Bank of Russia will stiffen the operating environment for Russian banks. Thus, ACRA expects a decline in the number of credit institutions and a shift in operational requirements for smaller banks on the back of transition to proportional regulation.
Table 1. Key indicators of the Russian banking system for 2014–2020
 Funds and income
 1+ past due loans according to the Bank of Russia accounting standards
 Capital divided by total assets
Assets growth to be capped by weak demand for credit resources
Since February 2016, Russia's financial system has been stable, which contributes to banking sector recovery (see the ACRA report “Russia’s financial system is still experiencing a higher than pre-crisis level of stress”).
The forecast has been prepared in compliance with General Principles of Socioeconomic Indicators Forecasting.
ACRA expects Russian bank assets to show positive dynamics in 2017, although their growth will most likely be very weak – at around 2%. In 2016, bank assets squeezed 4% marking the worst result after the 1998 crisis, while their ratio to GDP retreated to 96% for the first time in years. The latter trend looks set to persist this year (see Figure 1), with a noticeable growth acceleration seeming probable starting 2018 the earliest and a return to pre-crisis growth rates hardly being attainable in four years. In 2018–2020, bank assets are unlikely to climb by more than 10% on average, but they will determine the projected average nominal GDP growth (around 6%).
Figure 1. Bank assets to GDP ratio to shrink further in 2017
Risk appetite to grow across the sector
On the backdrop of weak loan demand, banks are very likely to increase risk appetite by easing borrower requirements. The latter should primarily affect the mortgage lending segment, as it requires less provisioning. Growing risk appetite is likely to further stimulate demand for loans fueled by lower quality borrowers, but may result in higher loan loss provisions by end 2017.
ACRA forecasts that lending in 2017 will be still driven mainly by the mortgage segment, which provides for an optimal balance of profitability and cost of risk among key lending segments.
All retail lending segments are expected to return to positive growth rates in 2017, mainly thanks to the low base effect (in 2016, the retail loan portfolio net of mortgage loans shrank by 6%) and pent-up demand. Growth in unsecured consumer lending (cash loans, POS-loans, credit cards) will remain weak at 5–7%, partly capped by reversion to the high 110% level of the ratio accounting for unsecured loans used for calculation of risk-weighted assets.
In 2017, ACRA also expects an acceleration in the car loan segment, which should grow 8–10% as a result of increasing demand for cars assembled in Russia (an aging fleet effect), as well fueled by an expected decline in interest rates, prompted among other factors by government-run subsidy programs. That said, unsecured lending will still have a very limited growth potential due to a persisting households’ propensity to save.
The corporate lending segment will likely show uneven dynamics. Lending to large businesses should post a moderate 6–8% growth (vs a 9% fall in 2016) fueled by both inflation and an increased involvement of major banks in financing infrastructure projects. Lending to small and medium enterprises (SMEs) is also expected to return to positive growth rates, which, nevertheless, are likely to remain modest in 2017–2020. Besides, the segment showed the highest default level in 2014–2016 and grew largely unattractive for major banks. Its recovery is additionally restrained by a shrinking number of enterprises operating in full conformity with the law and by grey business schemes that grow increasingly popular in response to higher administrative pressures.
Figure 2. Loans to individuals to grow faster than loans to entities
Assets quality is the key medium-term risk
Cost of credit risk (provisions divided by the average gross loan portfolio) is expected to grow y-o-y across the system in 2017 from 0.3% to 1%. This growth will be supported by both the projected easing of borrower requirements (aimed at boosting demand by means of attracting less reliable borrowers) and the continued tightening of asset impairment supervision approaches by the Bank of Russia. In addition, cost of risk will be impacted by a sharp decline in provisioning recorded in 2016 and related to a one-off dissolution of provisions by several large banks late in the year.
ACRA believes that overdue loans passed their peak in all bank lending segments by end 2016, and their level on banks’ balance sheets will gradually decline as loan portfolios recover. However, we expect credit quality to recover and past due debt to return to pre-crisis levels not before 2020 (see Figure 3).
By ACRA’s forecasts, overdue debt will remain lowest in the mortgage lending segment. Although we expect the former to accelerate growth in 2017, its share in the latter’s total portfolio should not exceed 2.5% in the next four years. The highest overdue debt level of not less than 10% will likely be recorded by SME lending, and this is what will likely be one of restraints for this segment’s growth in the next two years. The current level of past due debt does not fully reflect the actual level of troubled assets (banks widely resort to loan restructuring), nor does it provide a clear view of the Bank of Russia’s approach to borrower credit quality assessment. ACRA estimates that in the segments of lending to individuals and SMEs the proportion of forced restructurings (i.e. those not associated with market changes) is relatively small, standing at around 5% of the portfolio, while in the segment of lending to large businesses this figure reached 10–12% (overdue debt equaled 6% early in 2017). Taking into account the liabilities of potentially troubled largest corporate borrowers, the total percentage of bad debt in the Russian banking sector amounted to about 15%4 at end 2016.
 This indicator is an ACRA expert assessment based on the analysis of management accounts of a representative sample of banks. ACRA denotes bad debt as a share of 90+ day overdue debt and troubled debt (impaired, but not past due debt with a high probability of servicing termination within the next 12–18 months; forcedly restructured debt, which, if not restructured, would run the borrower into difficulties with servicing its financial obligations) in the total loan portfolio of a bank (based on IFRS accounts).
Figure 3. Past due debt level to decline in five years
Income stabilization to stimulate gradual capital adequacy growth
By ACRA’s estimates, the period of dramatically volatile profitability in the Russian banking sector is almost over thanks to a reduction and subsequent stabilization of interest rates (driven in turn by lower inflation), and normalization of cost of risk after its significant growth in 2013–2015. The economy’s transition from recession to gradual recovery will be accompanied by stabilization of financial results.
In 2016, the banking system showed a sharp increase in ROA, which jumped to 1.1% from 0.4% recorded in 2015. However, net of Sberbank’s bottom line, the sector posted just 0.7% in ROA, which correctly reflects the real condition of an overwhelming majority of Russian banks. A considerable net income growth was caused by a one-off release of corporate loan loss provisions by largest banks in December 2016 (total provision shrank by more than RUB 276 bln that month, of which around RUB 174 bln was attributable, by ACRA’s estimates, to Sberbank, VTB and Gazprombank (AA(RU)). Net of provisions release, ROA would have run into 0.8%, with net income running into some RUB 654 bln across the sector (in December, the latter would have posted losses) and capital adequacy5 decreasing from 10.8% to 10.4% at year-end.
ACRA expects sector’s net interest margin to stabilize around 3.5% in the medium term, although it may well decline somewhat in 2017–2020. The latter may be caused by a rapid fall in loan interest rates compared to cost of funding, which in turn might be affected by increasing competition for liabilities among banks. A positive medium-term factor in terms of sector profitability may also be cost of risk settling at 0.5–1.0% of the total loan portfolio after a significant growth shown in 2013–2015.
Influenced by the factors mentioned above, ROA in the banking system will likely remain at 1.0% in 2017, while ROE should run into 9.1% and is expected to range 9–12% in the next three years with a trend to a gradual decline by the end of the period due to an outstripping capital growth.
 In this case ACRA denotes capital adequacy as capital (funds and income) divided by total assets.
Figure 4. Banking system income to stabilize starting 2017
ACRA expects improved internal capital generation to push capital adequacy in the banking system up to 11.3% in 2017, which would be much higher than the bottom level of 8.9% recorded in 2014, but should not exceed 12% before 2020. The base case scenario does not imply any substantial recapitalization of the banking system by shareholders over the next three to four years, so banking business is likely to retain its low investment potential. The Russian government also seems to be planning no new recapitalization stage for the sector, especially given the forthcoming transfer of the Deposit Insurance Agency (DIA) under Bank of Russia’s management.
Slow economic recovery to dampen deposit growth
In 2017 and in the medium term, ACRA expects bank funding to rely mainly on moderate growth of customer funds, in particular those of entities, while the banking system will continue its transition to structural liquidity surplus. However, maintaining liquidity in the segment of small and medium-sized banks will require a more proactive refinancing activity from the Bank of Russia.
The deposit base of Russian banks is expected to grow at a moderate pace this year, with private deposits presumably expanding 9% and corporate ones adding 12%. This will partly be a recovery after the weak 2016, which saw corporate deposits shrink 10.1% and private deposits climb merely 4.2%, which in both cases was partly due to ruble strengthening.
With gradual recovery of confidence in the banking system and further inflation reduction to the 4% per annum targeted by the Bank of Russia, private deposits are expected to grow longer and stimulate stronger competition between banks, which is likely to result in real interest rates remaining in the positive territory not only in 2017, but through 2019. That said, private deposits growth may well be restrained by further declining real household income projected by ACRA for 2017.
Corporate deposits and current accounts may slow down growth hampered by a very slow economic recovery after the recession seen in the second half of 2014 through end 2016, while interest rates will most likely follow a trend similar to the one private deposits are expected to show.
ACRA also expects the share of bank funds in the banking system liabilities to remain stable at around 16% in the medium term, heralding the interbank market swinging back to normal and accompanied by a moderate decline in interest rates.
Figure 5. Private and corporate deposit dynamics
Macroprudential regulation is aimed at keeping the national financial system stable and is the objective of the Bank of Russia as the financial market megaregulator.
Proportional bank regulation allows for simplified treatment of smaller banks with limited operational scope and basic banking licenses, while those holding general licenses will have to comply with heightened capital requirements and international regulatory standards being introduced.
Maintaining macroprudential regulation and control tightening by the Bank of Russia will result in stiffening of operating environment for Russian banks. In particular, the number of credit institutions is expected to shrink further, mainly due to revoking banking licenses from unscrupulous market players, and banks with unstable financial position. However, ACRA expects the pace of market cleanup to slow down and the number of purged banks and NBFIs not to exceed 10% of the total (see Figure 6).
Figure 6. The number of revoked licenses to decrease
Polarization of the Russian banking system will continue, with largest banks set to keep on building up their share. Currently, the 5 largest banks hold 56% of banking sector’s assets and 57% of its capital, while the figures for the top 200 credit institutions are 97,9% and 96% respectively. The system’s polarization will be somewhat backed by mergers and acquisitions (M&A), although ACRA expects their number to be minimal in 2017, one of the reasons to this being a very limited number of M&A objects boasting high-quality assets and priced below their cost of capital. Major banks, including those enjoying state support, are expected to retain dominant market positions, which will reflect upon their share in the total amount of new loans and funds received from customers, as well as on their income and profitability. Banks with foreign support will hardly see their market positions change dramatically.
Among other regulatory measures, a negative effect on small banks’ efficiency will most likely come from the proportional regulatory regime the Bank of Russia is planning to introduce in the banking sector. The new regime will require banks applying for general banking licenses to build up their capital to RUB 1 bln, while as of December 1, 2016, around half of Russian credit institutions were short of this amount. As a result, some of the smaller players will face an inevitable challenge of either opting for systemic restructuring or being squeezed out of the market.