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. Last Updated: 07/27/2016

Government Moves to Bail Out Banks

The Central Bank started to bail out Russia's ailing banking industry Friday, pouring more than 1 trillion rubles ($222 million) into financial markets shaken by low liquidity and a loss of confidence which brought currency trading to a virtual standstill.

Trading remained frozen on the interbank market Friday, after grinding to a halt Thursday when around 10 banks were unable to repay their debts to other market players.

Since then, bankers and economists have alternately tagged the event as the beginning of a long-awaited shake-down among Russian banks notorious for making bad loans, or a momentary crisis in a young market that would return to normal early next week.

Under the government's plan, the Central Bank purchased a total of 1 trillion rubles worth of T-bills Friday in addition to 600 billion rubles worth of the securities Thursday to increase the banking sector's liquidity, acting bank chairwoman Tatyana Paramonova told a joint press conference with First Deputy Prime Minister Anatoly Chubais.

The bank will also issue 300 billion rubles ($68 million) in seven-day credits to Russia's largest and healthiest banks, she said.

The Bank bought $56 million in trading on the Moscow Interbank Currency Exchange on Friday, preventing the ruble from rising too fast as banks sold $89 million to raise rubles. The ruble ended trading six points higher at 4,422 to the dollar.

Paramonova also said the Central Bank was considering cutting Russia's refinancing rate and altering unpopular reserve requirements. In addition, she said, the banks plans to change the rules on trade in state securities so sellers can receive funds on the day of the sale, rather than the next day.

"By the middle of (Friday) the situation was resolved," Chubais said. "Banks have sufficient funds."

On Thursday, interest rates on overnight loans had zoomed up to 1,000 percent from 30 percent on Monday.

In the wake of the upheaval, Central Bank officials blamed media reports for inciting panic and the banks themselves for failing to request credits before things got out of control.

Current regulations allow the Central Bank to grant credits worth up to 25 percent of a commercial bank's compulsory reserves for up to seven days.

With more than 2,500 banks in Russia, many experts feel the sector is overloaded and in dire need of weeding out. High interest rates lead many troubled companies to avoid taking out loans until they are practically insolvent, leaving many banks with portfolios filled with loans that cannot be recovered.

Banking sector difficulties are common in markets such as Russia's which are undergoing severe stabilization measures, said Charles Blitzer, chief economist for the World Bank.

Opinions of other economists varied, some saying the short-term nature of the bank's ruble injections would prevent inflation, and others arguing the reverse.

Mikhail Delyagin, the president's economic adviser, dubbed the crisis "a healthy process" which will "improve the situation in the banking community."

"The Central Bank has to support only healthy banks," said Sergei Balagansky, a dealer with Stolichny Bank. "The bankrupt banks simply have to be closed."

One economist argued that had the Central Bank chosen to weed out small, unstable banks by increasing charter capital requirements instead of reserve requirements, a gradual trend toward bank mergers would have resulted and Thursday's fiasco would have been avoided.

Instead, banks are strapped for cash and cannot extend lines of credit, said Liam Halligan, an economist with the Center for Economic Performance.Bankers caught in Thursday's mass case of financial stage-fright seemed to agree.

"This year the overall unhealthy situation in the Russian bank system was burdened by the Central Bank's requirements to increase reserves and pay taxes on them," said Boris Sergeyev. "Theoretically everything is correct but in reality it's all wrong. These measures were untimely."

However, despite the harbingers of doom who said the crisis would cause deep, structural problems not only in the banking sector but in society, other voices were more optimistic.

A Western banker said he expected everything to be normalized by early next week, and considered the entire episode a natural step for a maturing financial sector.

"This is simply a learning phase, and the big professional banks will learn from this that they should not react too blindly to problems," said Maarten Pronk, general manager of ING Bank in Moscow.