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It´s time to end the bonanza with deposit certificates

The National Bank of Ukraine last week published a report on the results of the banking sector in 2022. The title of the report is a bit surprising: Banks Maintain Clients’ Trust, High Operational Efficiency, Profitability as War Drags On. The banking sector did have a good operating profit considering the state of war, but to call it efficiency is incorrect. We all know, and the NBU itself says in its reports, that an important role in the profitability of the banking sector in 2022 was played by devaluation and the exchange rate differential between the official and market exchange rates, as well as the income of banks from NBU certificates of deposit. In Figure 1, we see a significant effect from the revaluation of securities and currency in the summer of 2022, as well as significant income from buying and selling of currency. These revenues accounted for 17% of total operating income for 2022.

Figure 2 shows the rapid growth of income from deposit certificates. If in 2021 they accounted for 6% of total interest income, in November 2022 their share rose to 30% (on average for 11 months of 2022 - 15%).

Fig 1. Operating income components, UAH bn Fig 2. Components of interest income, UAH bn

Obtaining these revenues is not a sign of efficiency. This is passive income. And if income from currency revaluation has a logical explanation against the background of exchange rate fluctuations, the income from deposit certificates is an anomaly. In fact, the NBU pays banks for not doing their business, i.e. not lending to the economy. Where else will you find the opportunity to earn 23% return without doing anything? A real bonanza.

But the most unfortunate thing is that the budget of Ukraine does not receive this money. Because the profit of the NBU is transferred to the budget, not always in full, but it is an important source of financing of the budget deficit in wartime conditions. Therefore, the NBU's interest expenses on deposit certificates lead to the state budget not receiving these money, and the amount of such lost income is very significant. Over 11 months of 2022, banks' income (NBU expenses) from deposit certificates reached UAH 28 billion (Financial Stability Report). According to preliminary estimates, the annual volume may be between UAH 37 and 40 billion. This is 1.1 billion dollars, which could be used to buy 182 Bayraktars or something else useful.

In addition, by giving banks the opportunity to earn 23% on deposit certificates, the NBU actually takes away their incentive to lend to the economy and invest in government securities. As a result, by the end of 2022, we have UAH 457 billion in decertificates (this is $12.5 billion).

Question: why does the NBU find it acceptable to donate such money to banks at the expense of the state budget in the conditions of war and a tough situation with state finances? The NBU says that deposit certificates are a way to tie up excess liquidity. But there are other ways to tie up liquidity, without such unjustified costs. For example, increase reserve requirements or sell government bonds from the NBU's portfolio.

In December, the NBU finally began to move in this direction, announcing a 5% increase in reserve requirements for demand deposits and current accounts from February 11, and in January announced an additional increase for March. At the same time, the NBU enabled banks to cover up to 50% of the total required reserves with benchmark government bonds (OVDP).

The next step should be to reduce the deposit certificates interest rate to zero. In his article "Monetary policies that do not subsidize banks", Paul De Grauwe criticizes the practice of central banks rewarding the reserves of commercial banks. This practice actually emerged relatively recently: in the USA, for example, in 2008. Prior to that, liquidity reserves were not rewarded. A zero rate on liquidity is quite logical, argues De Grauwe, because banks themselves do not pay interest on current accounts. If no one in the economy earns interest on liquidity, why do banks? In Ukraine, this problem is exacerbated by the fact that these rates have now reached sky-high levels.

In addition, targeted measures can be taken to solve the problem of excess liquidity. For example, we know that budget payments to the military, which go mainly through state banks, make a significant contribution to excess liquidity. My colleague Artem Gergun, in the article "State Finances in the Conditions of War", suggests using the experience of the USA, which since the Second World War and still transfers a significant part of the salaries of the military to deferred consumption funds, which are aimed at improving housing conditions, medical care and educational services in in the future. The Ukrainian military would probably also not mind receiving part of the reward in the form of real estate investments.

In addition to real estate, we can think about other assets in which the military and other citizens can invest. Why do we encourage foreign investment and not our own? For example, we can create a development and innovation fund that will invest in Ukrainian enterprises and projects and offer all interested citizens to invest in its shares. I am preparing a separate article on this topic.

The money that the NBU will save on deposit certificates payments can be used to subsidize loans to the real sector (under the 5-7-9 program, for example). In this way, the banks will be able to earn interest income and the business will have the resources for reconstruction. Under the current policy of the NBU with an unreasonably high interest rate of 25%, business lending is practically impossible. But this is another well-known topic...

In summary, war requires a military monetary policy. At a minimum, this means that we cannot afford expensive gifts for the banks, and must be resourceful and use non-standard tools that meet the needs of wartime.


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