Russian Financials - CBR Publishes Ecosystem Proposals

The CBR yesterday published a consultation paper that complements April's piece on ecosystem regulation. The paper outlines several regulatory approaches it is considering. Here are the key takeaways. > The dilemma. According to the CBR, the key risk for banks is the formation on their balance sheets of what it calls "immobilized assets" - effectively, investments in ecosystem companies and other non-core assets. Such exposures can reduce banks' ability to absorb losses, and if not adequately covered by capital, the risks that they could depreciate in value pose a threat to the financial stability of the bank, and consequently to the entire financial system.> Three regulatory options. The CBR sees a risk-based approach as the best way to regulate such investments. It is considering three options for regulation:> Institutional separation of banking and non-banking business (according to the CBR, this would be the strictest measure, beneficial to no one).> The introduction of a maximum risk-weight for such ecosystem assets (1,250%) or the deduction from a bank's capital of all new investments in ecosystem assets that create additional risks for creditors and depositors (the softest measure).> The introduction of risk-sensitive limits (RSL) as a percentage of capital for these investments (the most balanced and flexible approach, and the CBR's favored option).> Cap on ecosystem and non-core investments proposed at 30% of capital. The RSL would cap the maximum that a bank can invest in "immobilized assets" including ecosystem, real estate and other non-financial assets as a share of its total capital. The proposed limit would be 30%, and these assets would be subject to a coefficient multiple of 1 to 5 times, depending on their characteristics and perceived risk. Any investments above the 30% limit would be deducted from regulatory capital.> Proposed implementation steps. The CBR proposes three steps in terms of implementing the RSL approach:> Set up regulation for banks' investments in ecosystem assets, including those not related to participation in ecosystems.> Ensure the adequate assessment of ecosystem risks within the framework of banks' internal procedures to assess capital adequacy (ICAAP).> Increase capital requirements for banks developing large ecosystems, as detailed below.> Banks developing ecosystems could be classified as SIFIs, or face additional capital requirements. To minimize systemic risks, banks that develop large ecosystems or similar entities could be classified as systemically important (SIFIs), even if they do not meet the criteria in terms of scale of banking activities. In this case, they would be subject to the 1 pp SIFI capital ratio premium. This measure would not apply to banks that participate in ecosystems as subsidiaries of large technology companies. In some cases, when the risks of an ecosystem or a similar formation are especially high and may have implications for the stability of the whole financial system, the CBR could increase the capital adequacy ratio premium to more than 1 pp (depending on customer base, GMV, number of employees and other criteria). > Staged adoption through 2027. The CBR proposes implementing the RSL limits in stages. For example, over five years, the value of the limit could be progressively reduced from the initial 100% to the 30% target. In this case, the limit could begin to operate as early as 2023, and would be finalized in 2025-27.> CBR's aim: Allow bank ecosystems to develop while limiting risks. The CBR says its proposals would allow banks to develop ecosystems, contributing to technological progress and improving the customer experience while at the same time limiting the risks for lenders and depositors, as banks will need to back sizable investments with capital.> Bottom line for traded financials. The consultation paper refers to Sber, VTB and TCS as banks that are developing ecosystems. The main takeaway here is that capital requirements may well rise - for example, TCS could be classified as a SIFI, and banks operating the largest ecosystems could face higher minimum capital requirements. However, the devil will be in the details, in particular regarding the coefficient applied to ecosystem and other non-financial assets. Consultations with banks will be held until the start of September. There also appears to be a fairly long planned rollout.