On July 26, the Central Bank raised the key rate to 18% per annum while simultaneously signaling a possible increase to 20%, sending the average maximum deposit interest rate offered by the top 10 Russian banks up another 0.17%, to 17.28% in the first ten days of August. The maximum possible yield is now between 18.5% and 19%. Invest Foresight asked Alexander Abramov, Head of the Laboratory for Analysis of Institutions and Financial Markets at the Russian Presidential Academy of National Economy and Public Administration, how long the “deposit rally” will go on, and whether there are other financial instruments that could compete with bank deposits in terms of yield?
– So, the average maximum deposit interest has increased to 17.28%. What is your forecast: would you rather expect it to grow further or to decline?
– I think that banks may offer a little higher interest in response to what may – or should – happen in September, which is another Central Bank key rate hike.
Well, in general, banks are in anticipation of a time when the Central Bank will start to lower the key rate. At the same time, lenders have many ways of cutting your interest even below the current 18% rate.
– Why would they do that?
– Well, banks are always playing at this. On the one hand, the interest they offer must be high enough because their clients are looking for best deals. But at the same time, they always want to pay the account holder less, because this affects the bank’s margin.
Have you noticed what happens when your time deposit account is renewed for another term, or how banks behave with passive investors? For example, my deposit expired in April, but I had no way to actually contact them. The bank eventually sent me a notice saying the term was extended at 12%. There are other ways to cut interest. When you look at your renewed deposit and your new interest rate, you have no way of knowing when you have actually opened that depositin the first place.
What I’m saying is that banks have quite many ways of “playing” with their depositors.
If you look at how the interest rate works using the Central Bank calculator, it becomes clear that bank interest is adjusted almost individually depending on many things. It depends on whether you have just opened your time deposit or renewed it, and if so, if you have added more money. In a word, there are quite a lot of different policies that allow banks to cut your current interest rate.
– Which is more preferable for banks today – to attract client money or to lend? Surely no one wants loans at these interest rates?
– There are different departments within a bank that are responsible for attracting deposits and issuing loans. They have entirely different tasks. One is interested in attracting money at the lowest possible interest rate; the other, in “selling” money at the highest price.
Their problems are surely understandable – with the key rate at 18%, it is next to impossible to find a profitable use for money.
– And that causes the excess liquidity problem.
– Yes, well, this problem certainly exists. But I can’t say that it is growing. Still, there is a good side: OFZ federal bonds, for example, are placed at 17%. The Central Bank accepts deposits from banks at about the same rate. In a word, a very peculiar game is underway. Banks are forced to raise the rate, while there are no normal projects for investment on the market. And the Ministry of Finance is raising the OFZ coupon rates, and the Central Bank is raising interest on its deposits for banks.
The same happened with another type of government securities, the GKO bonds, in the past, creating a financial pyramid. Market participants wanted a high interest, so the government raised funds by floating GKOs. Inflation accelerated, so the interest rates had to be raised again, and so was the GKOs rate.
If the rate rose to 30% or 50% now, we would see an OFZ pyramid build itself before your eyes.
Banks are largely compensated with OFZs issued by the Ministry of Finance and the Central Bank’s deposits.
– So deposits do remain the most profitable financial vehicle?
– The most important indicator of a bank’s performance is the bank margin, or net interest margin. It is a measure of the difference between interest paid and interest received. Have you ever found any information about this margin? I don’t think so.
I tried to calculate it once, six months ago. And it was actually negative!
However, I suppose that the banking community has ways to turn negative values into positive ones. One of the ways is to appeal to the Ministry of Finance to float OFZs at an astronomical interest of 17%. Plus, there are all sorts of corporate bonds with unimaginable yields.
So far, the fact is that these losses are partially recouped. They can use repo transactions in the interbank lending market; this actually works. Another thing is that this has nothing to do with real production.
– In case we want to augment our capital rather than save it, what financial instruments are best to use today?
– If we talk about bonds, market participants are torn between papers with a floating coupon yield and fixed-coupon securities. It is a game where the result depends on what you believe: whether the key rate will go up or down in the future.
It’s difficult to provide an exact answer to this question at the moment. However, assuming a typical scenario where the Central Bank successfully controls inflation and conditions for lowering rates arise in the first half of next year, it could be wise to invest in money market funds during this period. These funds are the least affected by rate hikes and are likely to offer a relatively high yield.
Once the turning point arrives and it becomes clear that interest rates will start to decrease, it will be necessary to shift focus to bonds, both long-term and corporate, as well as government bonds.
In principle, the bond market and money market funds offer opportunities for growth, not just preservation of capital. However, currently, the simplest option is short-term deposits, as rates for long-term deposits continue to decline. The stock market is unlikely to be a strong performer at this time. While it may see some recovery with falling interest rates, there don’t appear to be any strong long-term drivers for significant gains at the moment.