Restrictive risk weighting is required but not sufficient to fight overheating. In our view, consumer lenders are increasingly reliant on insurance fees normally charged upfront at loan origination and added to the loan principal but not recognised as part of the disclosed APR (see also Russian Consumer Finance Banks – Profits and losses demystified). This effectively means that the CBR might impose risk weights based on incomplete APR calculation.
Still, what if proper capital charges were introduced? Slower growth is generally perceived as credit-positive for the sector. Benefits become less obvious, however, given the potential impact on individual banks' profitability and capital. NIMs in consumer lending are usually in the 16-17% range (TCS Bank is an exception due to its policy to book part of its fees and commissions as interest income). This might not be sufficient to absorb elevated impairment losses, especially if – like Russian Standard Bank in 1H13 – consumer lenders report a cost of risk significantly above 10%, and, under the pressure from the CBR, they have to re-allocate capital to the lower-APR segments. As a result, risk-adjusted NIM might drop to breakeven and the banks' profits would depend on indirect revenues such as insurance fees. The CBR's decision to force all indirect fees into APR is a question of time, in our view, because otherwise banks would have an incentive to repackage their income from retail lending into non-interest revenues.
Capital vs. liquidity – what's more important? Lower profitability or even losses do not necessarily affect the banks’ liquidity: Russian consumer finance banks are largely deposit-funded, mitigating refinancing risks, and their loan books are usually short-term and granular. Pressure on capital adequacy is increasingly important, however, as banks do not look overcapitalised anymore. HCFB and AKBHC are to publish their 1H13 financials in the next few weeks – if they confirm that the issue of deteriorating asset quality and weaker capital adequacy is sector-wide, we think it could trigger rating reviews or downgrades.