Russia's Central Bank Governor Elvira Nabiullina. REUTERS/Sergei Karpukhin The Russian central bank is encouraging the country's ailing banks to accept losses on foreign currency mortgages in a bid to stop ruble falls from further weakening the sector.

In a letter to banks dated January 23 the Bank of Russia wrote (emphasis added):

"Due to the increased levels of credit and currency risks in financial markets, the Bank of Russia recommends credit institutions consider restructuring mortgage loans (including fines and penalties) to individuals in foreign currencies, including the conversion of these loans into Russian rubles."

Most interestingly, the central bank recommends that the banks do not use current foreign exchange rates but instead "use the official exchange rate of foreign currency...as determined by the Bank of Russia as of 10.01.2014".

With the ruble relatively stable in recent years the appeal of lower interest rates that came with foreign-currency loans had increased for Russian borrowers. The collapse in the value of Russia's currency over recent months, however, has sent the cost of those debts soaring in ruble terms.

In October last year the exchange rate was 39 rubles to the dollar and 50 rubles to the euro, but the collapse in global oil prices and Western sanctions over Russia's role in the Ukraine crisis have meant that today the equivalent rates are 67.8 rubles to the dollar and 77 rubles to the euro.

Converting the loans into rubles at October 2014 rates would effectively mean taking mark-to-market losses of over 40% — but that might be seen as preferable to even larger losses in the case of Russian borrowers defaulting on their obligations. In effect, the central bank is asking Russian banks to impose losses now rather than allowing the situation to gradually deteriorate.

As Standard & Poor's ratings agency explained of its decision to downgrade Russia's sovereign debt rating to junk earlier this week:

S&P on Russia. Standard & Poor's



In recent weeks the central bank has moved to make it easier for financial firms to swap loans on their books for cash. In December the central bank announced that banks would no longer have to mark their assets to market and could use the average exchange rate from the previous quarter to assess how much foreign capital they require to cover foreign-currency denominated debt repayments. In essence, the central bank is allowing the banking sector to indulge in a bit of balance sheet fiction during a time of stress.

Bank of Russia emergency measures for Russian companies. Bank of Russia



These measures come on the back of large scale bank recapitalisations by the state. Last month the government was forced to inject $2.4 billion into financial institutions, including state-owned lenders VTB and Gazprombank. That bill is expected to rise with analysts suggesting that bailouts could cost the government a further $40 billion this year.