The Russian banking sector is on course to earn in excess of RUB3 trillion ($32bn) this year, which would be its best result ever in both dollar and ruble terms, despite a 30% devaluation of the national currency this year.

Russia’s banking sector had another good month in September, reporting a net profit of RUB296bn ($3.2bn) (chart), representing an annualised return on equity of approximately 26%, the Central Bank of Russia (CBR) reported in its latest sector update. That brings the cumulative profit for the year to RUB2,668bn ($28.4bn), well ahead of every year since the 2014 crisis.

The recovery of profits is already enough to easily beat the previous high in 2021 in ruble terms, and probably will be enough to beat it in dollar terms by the end of December - especially if the ruble strengthens before the end of the year. Russian banks made a record RUB2.4 trillion ($31bn) of profit in 2021 before the war.

But the sector is far from booming. September’s result was a retreat in month-on-month terms and 16% down compared to the previous month's result of RUB353bn as banks profits are being affected by the ruble’s instability this year.

“The decline was primarily driven by reduced income from foreign currency revaluation, which amounted to RUB8bn, significantly lower than the RUB106bn recorded in August,” the CBR said. “Negative revaluation of long-term foreign currency-denominated securities, particularly in euros and Swiss francs, played a role in this decline, as the US dollar strengthened against these currencies.”

Furthermore, in September, the sector saw a 4% reduction in core revenues (net interest income and net fee and commission income) compared to August, the CBR reported.

“This decline was mainly attributed to the faster revaluation of liabilities compared to assets, driven by the higher proportion of current accounts and short-term deposits,” the CBR said.

On a positive note, the improving credit landscape saw banks able to reduce their provisions for bad loans, which frees up more capital that can be added to the bottom line: the sector saw a slight increase of 18% in its core profit, amounting to RUB264bn, due to reduced provisions, which decreased by 35%. The non-performing loans (NPLs) for September are not available yet, but in August the proportion of problem loans decreased across most segments, the CBR said.

The number of profitable banks in the sector also saw a slight decrease in September compared to August, with 248 banks (77% of the total) reporting profits, down from 263 banks (81%) in the previous month. Over the first nine months of 2023, there were 282 profitable banks, accounting for 87% of the total, and they represented 99% of the sector's assets.

Despite the banking sector reporting a profit of RUB296bn, the balance sheet capital is increasing more slowly as banks get buffered by war-related volatility; capital only increased by RUB152bn, reaching a total of RUB13.6 trillion.

“The difference was primarily influenced by negative revaluation of securities, valued through other comprehensive income (approximately RUB112bn), and dividend payments (around RUB21bn),” the CBR said.

According to preliminary results for September, the all-important capital adequacy ratio (CAR), the amount of cash banks retail to cover deposit withdrawals, saw a slight decrease of 0.04 percentage points, settling at 12.05%.

While that numbers remains comfortably above the 10% mandatory minimum, typically in emerging markets bankers like to maintain a CAR in the high teens to make sure they always have enough cash on hand to cope with large external shocks. Given Russia is at war and facing extreme sanctions, the 12% CAR margin leaves bankers a lot of less wiggle room to cope with any surprises.

“This decrease [in CAR] was attributed to the faster growth of Risk-Weighted Assets (RWAs) at 2.3% compared to capital growth at 1.9%,” the CBR said.

However, the CBR is working to shore up the stability of the sector. CBR governor Elvia Nabiullina has been fretting for months over the possible build-up of consumer loan and mortgage bubbles and has start to take action to cool the market.

While the corporate loan portfolio continues to grow strongly, after the CBR beefed up its macro-prudential regulation implemented from September 1, 2023 consumer lending has been slowing.

In September, the high pace of corporate lending growth persisted, with a 2.0% increase, equivalent to RUB1.4 trillion (up 1.7% in August). A significant portion of these loans was extended to companies in the mining and metallurgical, oil and gas, and energy sectors as part of  the war efforts. At the same time, preliminary data suggests that consumer lending significantly slowed in September, with a growth rate of 1.5%, compared to 2.4% in August.

“This deceleration can be attributed to several factors. On one hand, there has been a decrease in demand for loans due to higher interest rates, as well as a slight slowdown in consumer activity. On the other hand, banks may have reduced lending volumes due to the tightening of macroprudential regulation and the need to comply with macroprudential limits (MPL) from the third quarter of 2023,” the CBR said.

Corporate deposits are also rising, but not as fast as loans. In September, the funds of companies saw an increase of RUB332bn, representing a growth of 0.7%. This growth was primarily observed in the oil and gas, metallurgical, and energy sectors.

While consumer borrowing is slowing, the rate deposits are growing is increasing as the population switch from spending to saving, partly driven by the CBR’s recent large rate hikes. The growth of funds held by the population in September showed a slight acceleration compared to August, increasing by 1.0% from 0.8%.

“The growth was primarily seen in-denominated balances, which increased by RUB488bn, marking a 1.3% rise. Notably, there continued to be a shift of funds from current accounts (down RUB471bn, a decrease of 3.4%) to time deposits (up RUB959bn, a growth of 4.3%). Time deposits remained attractive due to rising interest rates, reaching 10.19% by the end of September compared to 9.66% at the end of August, following another round of key rate increases to 13% in mid-September.”

The improved profitability of the banking sector is underpinned by plenty of liquidity in the sector, which reached approximately RUB15.7 trillion in September according to the CBR.

“This sum is sufficient to cover 19% of all customer funds and 43% of individual customer funds held in rubles. However, it's important to note that the coverage ratio of customer funds has noticeably declined since the beginning of the year, decreasing by 6.6 percentage points from 26% on January 1, 2023. This decline is largely attributed to banks prioritising the maintenance of credit growth over the creation of an additional liquidity buffer,” the CBR said.

The liquidity in the banking sector is also important as it provides a pool of money the government can potentially tap by selling the Russian Finance Ministry’s OFZ treasury bills to cover any budget shortfall – and this pool is very large at the moment.

This year’s budget has pencilled in a 2% of GDP deficit, or a total of RUB2.9bn. Currently there is three-times this amount, or RUB6.8 trillion, in the liquid part of the National Welfare Fund (NWF) – enough to cover at least two years of 2% deficits. If things went very badly wrong, then the Ministry of Finance can tap an additional RUB15 trillion of banking sector liquidity by selling bonds and cover another five years of 2% of GDP deficits before it even needs to think about raising taxes.

“Additionally, banks have the capacity to attract another 9.9 trillion rubles (12% of customer funds) from the Central Bank of Russia, collateralised by non-market assets,” the CBR said.