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. Last Updated: 07/27/2016

Central Bank Scraps Increase in Reserve Rates

In a bid to inject some liquidity and confidence into Russia's embattled banking sector, the Central Bank decided Wednesday to scrap an increase in reserve requirements imposed just two weeks earlier.

Analysts said the cut in reserve requirements will give commercial banks a much-needed break.

"The banks have been experiencing a heavy strain" because of a lack of liquidity in the market, said Yaroslav Lissovolik, an economist with the Russian-European Center for Economic Policy. He said Wednesday's decision should "leave the banks some room for maneuver."

Lissovolik said the Central Bank had "chosen the lesser of two evils" by giving priority to stability in the banking sector, even if the decision could have a slightly inflationary effect.

The Central Bank decided to raise the reserves to shore up its defenses against inflation after the government last month ordered the bank to hand over 5 trillion rubles ($1 billion) of its 1994 profits to cover a budget shortfall.

Monthly inflation reached a post-reform low of 1.2 percent in June and is expected to fall below 1 percent this month.

By raising or lowering the percentage of commercial bank deposits that must be kept in reserve, the Central Bank can exercise some control over the amount of money in circulation and the rate of inflation.

The reduction in reserves was accompanied by a cut in the Central Bank's benchmark refinancing rate to 110 percent from 120 percent annually. The Central Bank does not lend money to the banks at this rate, which is higher than most market rates, but many official and private rates are directly linked to the refinancing rate.

The rate cut will have "a certain effect on the overall dynamic of interest rates," Lissovolik said, but added that the reduction is so small, it is unlikely to have any short-term impact on the economy.

The refinancing rate was last cut to 120 percent from 160 percent last February.

The Central Bank made the announcements against the backdrop of its decision this week to shut down troubled Tveruniversalbank, the country's 17th largest bank. Analysts have long predicted a shakeout in the country's overcrowded banking sector.

A spokesman for the Association of Russian Banks said the organization welcomes the Central Bank's decision to cut reserve requirements, but would like to see a further decrease.

"Reserves of 20 percent were justified some years ago, when annual inflation was 2,000 percent," said Alexander Zagryadsky, the association's press secretary. "Now we would like to see reserves of 10 to 15 percent."

By Aug. 1, the reserve requirements on ruble deposits of up to 30 days will be reduced from the current 20 percent to 18 percent, the Central Bank said in a statement Wednesday. The reserves for accounts in foreign currency will stay at 2.5 percent. The Central Bank decision to increase reserves last month brought loud complaints from commercial banks suffering from a drop in yields on treasury bills, in which they deal heavily, and a chronic nonpayment crisis among corporate clients.

"It came close to a confrontation," Zagryadsky said of the discussion between the bankers association and the Central Bank.

Despite the generally positive reception, bankers said the decision was unlikely to be a major boon for the sector as a whole.

"It is too insignificant to save banks that are really in trouble," said one banker, who did not wish to be identified.