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. Last Updated: 07/27/2016

Banks Head Into 2nd Debt Swap

The Central Bank intends Friday to conduct for a second time a massive interbank payment scheme aimed at unclogging the frozen system of settlements between Russian banks.

Last week the operation cleared a large amount of overdue debt between banks and to the federal and regional budgets and depositors. The Central Bank allowed commercial banks to take funds from their required reserves to make payments. The Central Bank plans to refill the reserves with freshly minted rubles swapped for the banks' worthless treasury bills.

Industry analysts warned Thursday that the scheme may not start the sector's lifeblood flowing again because many banks were refusing to participate due to the sheer size of their outstanding debts. Acknowledging those debts would be like admitting how far a bank had fallen, they said.

The process also may spark inflation as the Central Bank pumps more rubles into the money supply, analysts said. As a result of last week's swap, for instance, the amount of money in circulation increased by 900 million rubles ($58 million at Friday's official rate).

The Central Bank, while conceding the potential economic danger of its scheme, is trying to limit any damage.

"Our wish is to emit as little money as possible while unblocking the maximum number [of payments]," Andrei Kozlov, first deputy chairman of the Central Bank, said earlier this week. "We naturally are going to limit emissions by all possible means."

The scheme is nonetheless the first step in normalizing interbank relations.

"Any idea to break the deadlock is good," said Holger Mueller, banking analyst at Flemings/UCB, who stressed that an economy stops functioning when its banking system cannot operate.

But not everyone is convinced. An official from a top 10 Russian bank said the entire process did little for the industry. "Banks are afraid because if they participate they need to show their losses," the official said.

On Friday, however, banks will not have a choice. Kozlov said all banks from five regions f Moscow, the Moscow region, Samara, St. Petersburg, and Yekaterinburg f must submit debt documents Friday morning. Other regional banks may be allowed to join.

The scheme works in the following way: At the start of the day, all participating banks submit to the Central Bank a list of their debts. Settlements are facilitated through a correspondent account at the Central Bank.

If need be, a bank is allowed to dip into its mandatory reserves with the Central Bank to avoid a liquidity problem. Banks can use up to 30 percent of those reserves.

Last Friday, banks submitted 508,000 outstanding payment documents, according to the Central Bank. Among Moscow banks alone, total debts amounted to 20 billion rubles ($1.3 billion). However, only 312,000 payments were made equaling 9.5 billion rubles.

Out of the debt paid, 6 billion rubles f or almost two-thirds of all payments f went to the federal and regional budgets, the Pension Fund and several other nonbudgetary funds.

Banks last Friday needed only 3.3 billion rubles, or 13 percent, of total reserves at the Central Bank to meet their obligations. The positive outstanding balance of all banks at the Central Bank increased by 900 million rubles f the sum of the effective emission.

Banks that made an overdraft must replenish their reserves before Dec. 1 by selling the Central Bank their frozen treasury bills, which have been worthless since the government defaulted on them and suspended the market Aug. 17.

The Central Bank estimates that total outstanding payments between banks had amounted to 30 billion rubles before the initial run. The debt now stands at 20 billion rubles.

Kozlov said he hoped that by forcing all banks to participate in the payment process the Central Bank would be able to restore the Moscow's banking system.