The Crisis of the Ideology
of Monetary Regulation

Herald of the Russian Academy of Sciences
2014, Vol. 84, No. 1, pp. 52-57
ISSN 1019-3316

Original Russian Text,
published in Vestnik Rossiiskoi Akademii Nauk,
2014, Vol. 84, No. 2, pp. 159-165.

© Vladimir V. Martynenko, 2014

Âåñòíèê ÐÀÍ, Òîì 84, No 2, 2014

In the opinion of the author of this article,
the lack of noticeable success in overcoming negative phenomena in the monetary-financial and economic spheres reflects a crisis of the mainstream ideology of monetary and financial regulation and testifies to the use of socially unsubstantiated methods in the struggle against inflation and of an inadequate mechanism of banking supervision and deposit insurance. Overall, this causes large-scale abuse of the law and power and worsens the conditions for the development of full-fledged credit relations.

The Crisis of the Ideology
of Monetary Regulation

Vladimir V. Martynenko *

The monetary policy and activity of the Bank of Russia prior to the change in its management had been sharply criticized by businesspeople, parliamentarians, and academic circles. They emphasized the negative impact of the high interest rate, viewed by the Central Bank of the Russia Federation as an effective method of combating inflation, on the state of the Russian economy and the insufficient attention of the authorities to the problems of economic development and employment. It appears that the Bank of Russia has ignored all criticism by confirming its adherence to the ideology of financial and monetary regulation. It still proclaims that decreasing inflation is the most important condition of economic growth. This is why inflation is proclaimed to be the main concern of the Bank of Russia, which justifies preserving the hardline monetary and credit policy and a sufficiently high bank rate, whose decrease is believed to be inexpedient under low economic growth rates. At the same time, it is recognized that, at present, inflation largely depends on nonmonetary factors; i.e., its dynamics is not controlled by the Central Bank of the Russian Federation.

The inconsistency in the statements about the necessity to preserve the high discount rate of the Bank of Russia is sufficiently obvious. However, as opposed to developed countries, the value of the discount rate of the Central Bank in Russia has no significant effect on the conditions of economic development, on the volumes of monetary emission, or on inflation rates. The point is that, in our country, only a narrow circle of banks, which are closely related to the government, local authorities, and the Bank of Russia itself, can count on credit support on the part of the Central Bank. Moreover, the Bank of Russia refinances (according to the Lombard List) only loans (including investments in securities) issued by commercial banks to the government, local authorities, and oil-and-gas and other export-oriented companies, as well as to a small group of privileged banks. Owing to the possibility of using temporary free budget funds, these banks have substantial credit and financial support even without loans from the Central Bank. This circumstance is a factor related to various abuses and machinations, decreased market discipline, and the irrational use of credit and financial resources. Such abuses, rather than the possibility to be credited by the Bank of Russia, leads to inflationary fallout. Since the Central Bank of the Russian Federation refuses to credit the main bulk of Russian banks even in critical situations, thus decreasing the level of reliability of the entire banking system, the bank rate established by it has no significant effect on the general level of bank interests and bank loan volumes. Its value is reduced to calculating the value of legislatively established and to delay damages and penalties anchored to it.

Note that, as such, the idea of refinancing in the form of supplying secured credits by central banks or of buying a certain group of commercial banks’ assets reflects the inertia of economic thinking. At the dawn of the existence of central banks, when they could not control commercial banks, their credits in the form of purchases of promissory notes of a certain group of issuers with reliable reputations could be viewed as a justified policy. Today the situation is different: with account for the current possibilities to control the activity of commercial banks on the part of central banks, there exist no reasons that could explain why commercial banks should secure credits: this violates the principles of economic competition because banks supply loans to a certain group of companies. However, while, for example, the United States largely compensates for the above negative consequences by the fact that commercial banks have the right to secure loans by practically all types of their assets, this is impossible in Russia because of the limited list of such assets preset by the Bank of Russia. To receive a loan from the Central Bank of the Russian Federation, banks should first provide credit for the government, local authorities, or related companies and banks.

The fact that the Bank of Russia refinances state and equated securities is like supplying loans to the government, which can prompt inflation if government officials waste these loans. The currently popular private-public partnerships allow officials to escape responsibility for privatizing the powers of authority and abusing taxpayers’ money. An inevitable social result of this situation is the growth of corruption and monopolistic pressure on the economy.

It is also noteworthy that all creditors and depositors in banks with state participation can be equated to the holders of state debt securities, and the banks themselves, to the instruments of extending the size of state debt growth, unregulated by any legislative norms. In fact, the refinancing of such banks by the Bank of Russia is equivalent to the government and local authorities having the possibility to finance their activity at the expense of emission, which, as a rule, is of an inflationary nature. In addition, the current policy favors the conservation of the current raw material structure of the Russian economy and has an adverse effect on the development of small and medium businesses.

Money supply generation. The current mainstream ideology of monetary and banking regulation inevitably leads to a situation in which banks and the banking system as a whole turn out to be unable to fulfill their main socioeconomic function. Moreover, this hinders adequate understanding of the social role of commercial banks in generating an economically substantiated amount of money supply that ensures the development of full-fledged credit relations. Society still has an extremely superficial idea about money, which it views as notes and coins emitted by the Bank of Russia.

The provision of the Russian Constitution that “monetary emission shall be the exclusive responsibility of the Central Bank of the Russian Federation” has an adverse effect. The idea that the emission of money (although it would be more correct to call it the emission of notes as legal tender) shall be the exclusive responsibility of the Bank of Russia leads to warped judgments, particularly, to the opinion that the functions of commercial banks are limited to accumulating the monetary resources of physical and legal entities and investing them in the real sector of the economy [1]. On the one hand, the monetary funds of banks’ customers are regarded as the main source of long-term credits to producers and investments in production; on the other, the blame for the real sector’s current deficit of long-term credits and investments is laid on banks instead of explaining it by the fact that their customers have no ready assets to deposit for the long term. However, the main problem lies not even in the contradictory requirements on the banking sector. If we presume that monetary emission is the exclusive responsibility of the Bank of Russia, while commercial banks only accumulate the funds of individuals and companies, it is unclear from where the customers take money: there are no direct relations between them and the Central Bank of the Russian Federation. Another question in this context is the following: if the Bank of Russia has no direct relations with the representatives of the real sector and with the producers and consumers of goods and services, how can it determine the economy’s real need for monetary funds and the amount of monetary emission necessary to implement the country’s socioeconomic potential?

All cash that individuals or companies have on hand can only come from commercial banks. Of course, the banks can withdraw it from their accounts in the Bank of Russia, but only within the amount of money on these accounts, placed by the founders or supplied by the customers. In other words, all other things being equal, companies and individuals take cash from commercial banks, and the banks themselves can give them only the money previously received from them. Thus, the circle closes, and there is no place in it for the monetary emission of the Bank of Russia. The circle can be broken by understanding the mechanism of the two-level banking system, implying the active role of commercial banks in monetary emission, which, in turn, should be supported by credits of the Central Bank.

The possibility for commercial banks to participate in the formation of money supply is determined by the fact that they provide both crediting and settlement services for the representatives of the real sector of the economy. When they credit from the funds deposited on their clients’ current accounts, then, on the one hand, those who have taken loans receive additional cash and, on the other, the funds on the customers’ accounts of those from which these funds have been taken do not decrease. This mechanism of monetary- credit emission can work effectively only if commercial banks receive credit support from the Central Bank in all extraordinary situations to execute their current obligations before their customers. The volumes of credits supplied by the Central Bank determine the amount of its monetary emission. The Central Bank should exercise control and supervision to prevent inflationary fallout related to commercial banks’ possible irrational credit policy that results in supplying credits to entities whose activity does not lead to an increase in the amount of goods and services necessary for consumers.

The problem is that the above mechanism of forming money supply practically does not work in Russia. This is because amendments were introduced to the Law On the Bank of Russia in 1995, which removed its obligation to support commercial banks by exercising its legal function as the lender of last resort. Since that time, all issues concerning refinancing commercial banks have been decided by the Central Bank itself, which rejects the above responsibility. The result was not long in coming, and in August 1995 a banking crisis happened in Russia, which became a harbinger of the economic crisis of 1998 [2].

At present, the Bank of Russia, first, credits only a small group of commercial banks closely related to the government or the Bank of Russia itself. Second, it refinances credits supplied by the above banks to a very limited circle of political and economic entities. Thus, refinancing by the Central Bank of the Russian Federation does not exert a noticeable effect on the volumes of monetary emission in the country, and the possibility of commercial banks to participate in money supply generation is minimized. The monetary policy of the monetary authorities and the volumes of monetary emission are determined with no account for the real needs of the national economy and cannot correspond to the full implementation of the country’s existing socioeconomic and scientific–technological potential.

For almost two decades, the Bank of Russia has been “printing” rubles by means of buying foreign currency from exporters through the intermediary of commercial banks. This indicates that, unlike the central banks of the leading countries of the world that try to shield their domestic money emission from the influence of foreign currency that comes into the disposal of exporters and commercial banks, the Bank of Russia does not pursue an independent national monetary policy. Under such a mechanism of monetary emission, the size of emission can only partially meet the interests of export-oriented industries but cannot meet the interests of Russia’s economic restructuring, implement the country’s scientific–engineering potential, or ensure its balanced socioeconomic development.

Another point is that the Bank of Russia exchanges rubles for foreign currency in amounts that allow it to preserve the larger part of the currency earnings as reserves in the form of foreign government securities or deposits with foreign banks. The Bank of Russia’s currency reserves characterize the amount of credits that the Russian economy lends to foreign economies. Such a monetary policy has led to a situation in which Russian exporters, including state-owned companies and banks owned by them have to borrow from foreign banks amounts that almost equal the currency reserves of the Central Bank of the Russian Federation. Since the interest rate on such loans is an order of magnitude higher than that for which the Bank of Russia and the government deposit their foreign currency reserves, the Russian economy annually suffers great losses which hardly differ from those caused by imposed contributions. If such monetary payment remains, a quite reasonable question may arise about the expediency of preserving ruble emission and the existence of the Central Bank of Russia.

“Sterilization” of the money supply. An indicator and a manifestation of the crisis of the current mainstream ideology in monetary regulation is the dissemination of the concept that it is necessary to “sterilize” surplus money supply as the main instrument of inflation control. Money supply is seen as an abstract mac- roeconomic category, disengaging its sociolegal meaning, that money supply reflects the aggregate rights of social agents to purchase goods and services that have been made to date or that will be made in the foreseeable future. In this context, the sterilization of money supply, in fact, means the forced liquidation and/or redistribution of the above rights of social agents. At present the main amount of money supply in all countries (about 90–95% in developed countries) represents cash on the accounts of commercial banks that act as the main social institutions that fix and make possible the implementation of the corresponding rights of social agents (physical and legal entities). In this situation, the policy of money-supply sterilization inevitably leads to measures that freeze or limit the bank account transactions of companies and individuals, as well as cause the bankruptcy of banks and other financial institutions.

As the recent events in Cyprus have shown, the idea of the struggle against the laundering of criminal money by banks may serve as justification or ideological support for such measures. Symptomatic is the fact that the United States is striving to lead the global struggle against money laundering because the use of its national currency as the main means of international settlements is currently under severe criticism due to the colossal scale of the US internal debt.

This struggle occurred in Russia, too, having led to large-scale cash losses among the law-abiding customers, lenders, and depositors of liquidated banks. Meanwhile, linking the activities of commercial banks with the possibility of money laundering, which is now practically unquestioned, is far from being as simple and obvious as it may seem at first sight. Ifwe translate the term money laundering into legal language, it means the legitimation of the rights of the owners of this money. Consequently, only the government has the real ability to launder criminal money but only in the case that it amnesties or legitimates this way of obtaining cash. In all other cases we have not money laundering but a change in the ownership of dirty money. If, for example, someone is interested (for the purposes of tax avoidance, paying bribes and kickbacks, etc.) in turning one’s legally obtained incomes into unaccounted cash, this someone makes a fraudulent deal with the owner of the dirty money, for example, a noncash transfer of “clean” money for fictitious services rendered, goods sold, etc., in exchange for the unaccounted transfer of the dirty money. In addition, the former owner of the dirty money formally acquires a legally obtained income on which he can pay taxes and other mandatory payments, and his counteragent becomes the holder of the dirty money. It is clear that such transactions need banks that fix (since money is accounted for on client accounts) and exercise the rights of noncash clean-money holders. However, banks become guilty, as a rule, only in not executing their additional police functions of identifying dirty-money holders.

At the same time, the very fact of vesting commercial banks with such functions increases their dependence on the political authorities and on the representatives of law enforcement agencies and generates additional sociopolitical problems related to the possible abuse of law and power. It is no coincidence that the former head of the Bank of Russia, upon leaving his post, made a guess about the existence of a certain well-organized and uncontrollable group that deals with illegal banking transactions [3]. Therefore, an efficient solution to the problem of dirty money is possible only if the representatives of power are really interested in eliminating the conditions of coming into dirty money and in struggling against the causes and not against the effects. Otherwise, the efficiency of such a struggle, as practice shows, will be low and side effects associated with the possible interests of the monetary authorities in sterilizing money supply will have an extremely negative effect on the conditions of socioeconomic development and on the sociopolitical situation both in individual countries and in the world at large.

The amount of money supply may decrease, but the processes of money depreciation may gain momentum. The point is that money depreciation can be either explicit or implicit, for example, as a drop in production and a deficit of goods and services, including those that should be provided for by government bodies (social, transport, and industrial infrastructures). Latent inflation is typical of situations where the state starts to regulate the exchange rate and prices for goods and services and, consequently, the incomes from various economic activities administratively. As a rule, such measures do not affect the incomes of the representatives ofvarious monopolistic structures, i.e., people who hinder the extension of the production of goods and services. This leads to increased incentives in society toward activities that are one way or another based on violence rather than on the production of goods and services marketed on the conditions of voluntary exchange, thus deforming the conditions necessary for the full-fledged functioning of money and socioeconomic development.

Liquidation of banks as a crisis economic phenomenon. The negative effect produced by the uncritical use of recommendations that have been developed over the past decades by the Basel Committee on Banking Supervision has also been significant. The financial crisis in Cyprus has revealed major defects in the methods of regulating banking and exchange activities adopted by the member countries of the International Monetary Fund (including Russia). When such recommendations are followed thoughtlessly and are complemented by the inadequate interpretation of the conditions of their use, by the absence of an adequate insurance system and an effective mechanism of refinancing commercial banks, and by linking money emission to the amount of foreign currency coming into the country, which we currently observe in Russia, the risk of serious socioeconomic and political disturbances increases. From the formal point of view, the measures proposed by the Basel Committee on Banking Supervision that envisage the need for banks to increase their capital are aimed at improving the reliability of banking activity. At the same time, they allow the monetary authorities to simplify the solution of the sterilization of money supply by liquidating banks and financial companies.

It is characteristic that the process of reducing the number of credit organizations was observed simultaneously with the requirements to increase the amount of banking capital in practically all countries of the world. The developed countries adopted measures aimed at increasing the amount of insurance indemnity of bank deposits that would partially cut down the diffusion of crisis phenomena in the economy related to the liquidation of banks. At present the minimum insurance indemnity in the United States that is paid, as a rule, to all customers (physical and legal entities) the next day after the closure of the liquidated bank is $250 000. The opposite picture was observed in Russia: the Bank of Russia started to increase the requirements on the capital of commercial banks around the 1990s, which led to a reduction in Russian banks by about five times. At the same time, a law that would allow people to receive at least partial compensation for their losses in the closed banks was adopted only at the end of 2003, i.e., after the majority of them had ceased to exist. The size of insurance indemnity in Russia is 700000 rubles, which is about 10 times less than the US insurance indemnity. Unlike the United States, in Russia funds on the accounts of legal entities are not insured and the periods of repayment of insurance indemnity are several months after the closure of the liquidated bank.

By the scale of reduction of banks, Russia occupies almost the first place in the world, although Russia is far behind the developed countries by the number of banks and their specific weight per capita: today fewer than 1000 banks function in Russia. If we compare, the EU countries overall have about 8000 credit organizations (including the countries of the Eurozone with their 6000 banks) [4]; the United States, more than 7000 commercial and savings-and-loan banks [5] and about 7000 cooperative banks (credit unions). In the past, it was the development of small cooperative banks in towns and rural areas that largely strengthened agricultural production and local industries in many European countries and in the United States.

If we take into account the fact that more than half of the overall number of Russian banks are located in Moscow and that no more than three banks function on the territories of the 38 Russian constituent members [6], the underdevelopment of the Russian banking sector is more than obvious. It is safe to say that without a substantial increase in the number of banks in the Russian regions, as well as without a change in the conditions of their operation, it is hard to count on noticeable positive shifts in the country’s economy. At the same time, the probability of a significant increase in the number of banks that meet the minimum capital requirements in the Russian regions that are not related to incomes from the export of raw materials is practically zero. There are no grounds that allow us to hope for the emergence of the necessary number of branches of Moscow banks in the regions.

It appears that Russia’s monetary authorities have little interest in these problems. The necessity of increasing the capital requirements for banks regardless of the opportunities truly existing is justified by the purposes of enhancing their reliability. But it is possible to link the amount of a bank’s capital with its reliability only if the amount of loans given does not exceed the size of its equity capital. However, there is no sense in the existence of commercial banks under such conditions. In reality, the reliability of any individual bank and of a banking system in general depends on the possibility to receive timely credit support from the Bank of Russia. To improve the reliability and efficiency of the banking system, it is necessary to detach and delimit the functions of commercial, investment, and savings-and-loan (including mortgage) banks, which simultaneously implies the use of various methods of the regulation and insurance of their activities [7].

In the context of monetary regulation, the size of capital is an indicator that should be used to establish the limits on participation of a commercial bank in the process of money-and-credit emission. The possible bankruptcy and liquidation of a commercial bank should be accompanied by measures that would guarantee its customers the possibility of uninterrupted use of their cash assets and that would secure the socioeconomic function of commercial banks. This means that the size of insurance indemnity, first, should cover all the current liabilities of commercial banks before the representatives of the real sector of the economy. Second, payback periods should be reduced to several days. A possible inflation surge should be inhibited by the funds of the bank owners and similar people, as well as by the insurance and reserve funds of the banking system. The above funds should be formed and replenished by the profits of all commercial banks and the Bank of Russia. The latter, issuing banking licenses, approving bank managers, and receiving profits on its authorities in monetary regulation, should be responsible before creditors and depositors on par with commercial banks.

Measures to control the activities of commercial banks. For the purposes of reducing the inflation risk related to possible abuses and irrational credit policies by commercial banks, their activities should be reoriented to provide for short-term (up to one year) loans to the real sector of the economy. These loans should be aimed at supporting entrepreneurs who extend and change the structure of goods and services rendered. In addition, it is important to exclude the distribution of invalid credit relations that were generated by the monopolization of the monetary sphere. An indicator of this invalidity may be the giving of a loan disregarding the real abilities of the borrower to repay the loan through the production and/or marketing of goods and services depending on the amount of the collateral that the borrower can give to the lender.

To this end, the volumes of consumer loans provided by commercial banks require tight control. Consumer, including mortgage, loans should be lent only by those credit institutions that have no right to deal with settlement and cash services and, consequently, that are excluded from the formation of money supply. Such credit organizations may be distinguished as a separate group of savings-and-loan banks whose functions are limited to the mobilization and redistribution of temporarily free assets of physical and legal entities.

Still stricter limits should be imposed on the transactions of commercial banks in the securities market, including loans to investment companies and funds, as well as to any person who deals with the purchase and sale of securities. The opportunities of using the resources of commercial banks to stimulate the stock market should be reduced to the minimum. Thanks to the stock market, investors, transferring their assets to various companies for long-term or unlimited use, have the opportunity to return them at any time by selling the shares or bonds bought. Without this opportunity, the majority of investors would not put their assets at risk and companies would lose one of their main sources of attracting capital. This condition is ensured by professional players in financial markets, who are ready at any moment to buy securities from investors. This readiness means that the professional players have to take sufficiently high risks that they naturally try to mitigate by attracting to stock market transactions as many potentials buyers and sellers as possible, more precisely, nonprofessional speculators who would be ready to take on some of the risks. Such players are attracted by demonstrating to them the prospects of high profits from transactions related to the reselling of securities, which is achieved by artificial manipulation with securities rates using the long- known mechanism of creating financial pyramids.

The time frames of financial pyramids depend on the number of potential players who may be attracted to the pyramid “construction.” Therefore, the last “attracted” players pay, suffering losses, for the high incomes received by their forerunners. However, the main problem is that losses are incurred not only on market players who expected to receive speculatively high incomes. The chief negative socioeconomic consequences arise when commercial banks participate in this, for example, by crediting the unlucky players of exchange trade. The losses of banks that lead to their insolvency, which also covers their unwitting customers, and cause the breaking of long-established economic relations, as well as the general curtailing of credit relations, destroy the conditions necessary for the support and development of economic activities. At the same time, if the goal is the full elimination of the conditions for financial pyramids, its implementation may lead to the impossibility for financial markets to perform their main function of providing entrepreneurs with investment resources.

It turns out that, on the one hand, the market would not provide entrepreneurs with the necessary investment resources without stock speculators and financial pyramids, and, on the other hand, the absence of economic limits, which restrain the scale of pyramid construction, hinders financial markets to perform their main function and harmfully affect the conditions of socioeconomic development in general. In this connection, the establishment of strict control over the investment transactions of commercial banks is a major and necessary instrument of reducing the scale of financial pyramids and destructive socioeconomic consequences when these pyramids collapse.

Thus, to change the negative trends and phenomena in the Russian economy and society we have to abandon the currently dominant ideology of monetary regulation and change cardinally the principles of monetary emission, as well as the organization and conditions of the functioning of the banking sector. The policy of the monetary authorities can be recognized as socially justified and nationally oriented only if it is aimed at the development of full-fledged credit relations in society and at stringent countermeasures to any monopolization of banking activity.


Vladimir Vladimirovich Martynenko, Dr. Sci. (Polit.), is chief researcher at the RAS Institute of Sociopolitical Research.

A.L. Kudrin’s address to the meeting of the Russian government on the banking sector’s development strategy until 2015. January 1, 2011.

V.V. Martynenko, The Unknown Policy of the Bank of Russia. (Izd. ISPI RAN, Moscow, 2004) [in Russian].

S. Ignat’ev, “11 % of organizations pay no taxes,” Vedomosti, Feb. 20 (2012).

Number of monetary financial institutions (MFIs): Euro area. European Central Bank.

Note on the number of active credit organizations and their branches as of March 1, 2013. Central Bank of the Russian Federation.

V.V. Martynenko, Compendium of Sociopolitical Thought (Akademiya, Moscow, 2011) [in Russian].