VTB BANK 
By On the face of it, Russia's central bank has been acting tough. To clamp down on inflation it has recently hiked interest rates - in stark contrast with the ultra-loose monetary policies seen in western economies.
But while Russia has tightened the monetary screws with one hand, it has been opening the flood gates with the other.
"They are sending conflicting signals," said Natalia Orlova, chief economist at Alfa Bank. "They are raising interest rates ... and at the same time they continue to fund loan growth."
Total credit extended by the central bank has mushroomed to 2.5 trillion roubles ($80 billion) as of November 1 from negligible levels in mid-2011, and is approaching levels seen at the height of the 2008-9 financial shock.
And the central bank's role in financing banks looks set to keep growing as Russia's authorities endeavor to halt a possible slide in bank lending that would deepen an economic slowdown and undermine support for President Vladimir Putin.
At least in theory, more central bank funding for banks is a way to prop up the economy by encouraging banks to lend, supporting spending by companies and consumers.
FUNDING SQUEEZE
At the root of the central bank's growing lending is an intensifying squeeze on banks' market funding. Overnight interbank lending rates have risen steadily from below 3 percent at the start of 2011 to around 6 percent today.
Many bankers blame the central bank. Last month German Gref, the head of Russia's largest bank Sberbank (>> Sberbank Rossii OAO), criticized its September rate hike, arguing that higher borrowing costs would crimp lending and damage economic growth.
But the deeper roots of the funding shortage lie in Russian banks' own behavior.
"The cause of the problem is that the banks have deployed more liquidity than they have attracted in the form of customer funding," said Yaroslav Sovgyra, associate managing director at credit rating agency Moody's in Moscow.
In the first 10 months of this year, total lending by Russian banks grew by 15 percent, outpacing the 9.4 percent increase in client deposits, according to the central bank's monthly banking sector review.
The shortfall means that banks are instead turning to the central bank to fill the gap. Moody's predicts that the share of central bank funding in banks' liabilities, now some 6 percent, will reach 15 percent by the end of next year.
Under pressure from banks, the central bank has promised to accept a wider range of collateral in future, and extend the maximum duration of central bank refinancing operations from the present three months to up to one year.
That raises concerns that what began as an emergency measure is rapidly becoming the new norm.
"Banks generally should resort to central bank funding in a difficult situation, when you need liquidity as a matter of extraordinary support," said Sovgyra. "But not during the normal course of business to finance loans."
INFLATION OVERSHOOT
The central bank's monetary injections may help to explain disconcertingly high inflation, which is set to overshoot the central bank's 6 percent inflation target for the year.
"Without these injections core inflation would be much lower -- it's quite obvious," said Alfa's Orlova, who predicted that the central bank would also miss its 6 percent target next year due to political and economic pressure to support banks.
Analysts are also worried that the expansion in central bank credits will dilute asset quality, both of the central bank itself and of the banks it is lending to.
They point out that growth in retail lending -- the riskiest segment of the market -- has recently accelerated to over 40 percent, notwithstanding the recent hike in central bank rates.
Concerned by the rapid increase, the central bank is now tightening regulations to damp down the riskiest retail lending. But it seems less inclined to rein in corporate lending, the main cause of Russian banks' troubles in the 2008-9 crunch.
Leading bankers see the situation differently.
"If you look at penetration of loans in the economy it still significantly lags emerging market peers, and is obviously far away from the developed economies," said Herbert Moos, chief financial officer of VTB Bank (>> Bank VTB OAO), Russia's No.2 lender.
The ratio of loans to GDP, around 45 percent, compares with 55 percent in Poland and 150 percent in the European Union - suggesting that Russia is a long way from the kind of debt crisis now plaguing western economies. Retail loans represent just 10 percent of GDP.
But some Russian bankers paint a less reassuring picture.
"A lot of banks are involved in speculation, because the central bank provides a big volume of resources," said Andrei Larkin, deputy chairman of mid-size Absolut Bank.
"Banks take a big risk of a liquidity gap. In general the money is short-term, and the assets are long-term."
Leading bankers acknowledge the latter problem, but argue that the solution is for Russia to go even further in copying the quantitative easing policies seen in the West by providing multi-year financing.
"It's not only about inflation and monetary stability," said VTB's Moos. "If Russia wants to support growth of its own economy, it needs to provide improved longer-term financing."
Sceptics say that Russia can hardly be compared to western countries, which are resorting to highly unorthodox measures to revive stagnant lending and avert a deflationary debt spiral.
"Obviously that might be necessary if you have a problem effectively with loan growth - like you have in the U.S. or euro zone - but that's not a problem here," said Clemens Grafe, chief economist at Goldman Sachs in Moscow.
"You can't fund your loan growth with short-term repos (central bank loans), and you shouldn't fund it with long-term repos either, because that is essentially printing money."
($1 = 31.1612 Russian roubles)
(Editing by Douglas Busvine/Jeremy Gaunt; Graphic by Vincent Flasseur)
By Jason Bush
