Russian Federation: Selected Issues
Author: International Monetary Fund
Publication Date:
03 Aug 2012
eISBN:
9781475505047
Language:
English
Keywords:
ISCR; CR; GDP; exchange rate; Russia; central bank; USD volatility; financial market; FX asset position; FX assets; exchange rate volatility; Loans; Oil prices; Exchange rates; Capital adequacy requirements; Global
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The Selected Issues paper on the Russian Federation discusses the economic growth and future growth potential of the country. After almost a decade of impressive growth performance, Russia suffered a sharp contraction in 2009 with GDP falling by 8 percent. This paper gives an overview of the conceptual issues regarding potential growth and the analytical framework based on an exogenous growth model; growth accounting results for Russia in the past decade; and importance of structural reforms to achieve sustained high growth.

Abstract

The Selected Issues paper on the Russian Federation discusses the economic growth and future growth potential of the country. After almost a decade of impressive growth performance, Russia suffered a sharp contraction in 2009 with GDP falling by 8 percent. This paper gives an overview of the conceptual issues regarding potential growth and the analytical framework based on an exogenous growth model; growth accounting results for Russia in the past decade; and importance of structural reforms to achieve sustained high growth.

III. Banking Sector and Financial Market Conditions1

A. Recent Developments

Financial Market Developments

1. Russian financial markets have been volatile in line with global financial and commodity markets. Russian equities, sovereign bonds, and the exchange rate largely follow oil prices. Asset prices have been deteriorating since end 2011 in the context of renewed distress in euro area, and oil price volatility; however, they are still well above the trough recorded in 2008/09 when oil prices declined to $40 levels.

Figure III.1.
Figure III.1.

Financial Markets

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Liquidity Conditions

2. The global market turbulence in 2008/09 triggered a systemic liquidity squeeze among Russian banks and corporate. The systemic liquidity squeeze in global funding markets and oil price declines hit Russian private sector hard. The sharp oil price declines and contraction in global trade reduced cash inflows to the economy. While Russian corporate and banks’ external debts are mostly medium-and long-term Eurobonds, the sharp increases in the Libor triggered sudden repayment needs because these bonds are usually issued with embedded options that allow creditors to request early repayment when underlining interest rate exceeds a certain threshold (Figure 2).2 In addition, bank deposits declined by about 8½ percent, leading to a decrease in the deposit-to-GDP ratio in 2008; some banks experienced about 20 percent declines in household deposits in a matter of 1–2 months (Figure 2). Russian interbank market also exhibited systemic liquidity squeeze with sharp increases in rates, bid-ask spreads, and interest rate volatility (Figure 2).

Figure III.2.
Figure III.2.
Figure III.2.

Liquidity, Official Funding, and Banks’ External Positions

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

3. The emergency official liquidity injection and government commitment to continue providing emergency liquidity if needed successfully limited the impact of the systemic liquidity shock in 2008/09. The CBR provided liquidity amounting to 10 percent of GDP (Figure 2) by easing existing monetary instruments, introducing new instruments, and helping reduce counterparty risk in the interbank market.3 Its initial efforts to maintain Ruble value through intervention also eased the FX liquidity need for banks and corporate. The government also supported liquidity conditions by placing its deposit in commercial banks (Figure 2). Going forward, the CBR has made the emergency liquidity assistance a permanent feature of its institutional framework.

4. In contrast to 2008/09, banks have weathered the distress in global market since end-2011 well. The magnitude of external shocks has been moderate so far with smaller declines in oil prices than in 2008/09 (Figure 1) and moderate funding market distress that is more concentrated in euro area (Figure 2, Libor-OIS spread). At the same time, banks have reduced external funding liquidity risks as well: the stock of foreign borrowing has remained subdued since the last crisis time and banks are now a net foreign creditor (Figure 2). Banks also maintains net FX asset position and their FX assets are mostly liquid assets with less than 1 year maturity and held vis-à-vis counterparties located in major financial centers (Figure 2). In addition, solid customer deposit growth continued, raising deposit-to-GDP ratio (Figure 2) and interbank market liquidity was broadly maintained with both bid-ask spreads for interbank rates and interest rate volatility remaining at low levels.4,5

5. The official liquidity support in late 2011 mostly aimed at providing sufficient liquidity to the corporate sector through the banking sector. Liquidity conditions for Russian non-financial corporate sector tightened in the context of lower oil prices and closure of external funding markets, which made them turn to domestic bank credit instead. As banks’ deposit-credit balance tightened through the course of 2011 at the back of strong credit growth (see the next section) and excess liquidity in the system was reduced, the CBR and the government provided liquidity to the banks, which helped ensure financing for the corporate sector.

Credit Growth and its Funding

6. Credit growth and bank balance sheet expansion have been strong in 2011. Nominal credit to the non-financial private sector grew by 25 percent (Figure 3) in 2011 (20 percent in real terms), though the increase in the credit-to-GDP ratio (2 percentage points to 47 percent) appeared less alarming (Figure 3) and the pace was still below the pre-crisis peak of about 40 percent (year on year). 6 The total asset of banks also grew strongly by 23 percent in 2011, indicating that credit grew in tandem with overall balance sheet expansion, rather than asset substitution away from other types of investment, such as securities (Table 1).

Figure III.3.
Figure III.3.

Credit Growth and its Funding

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Table III.1.

Russia Financial Soundness Indicators of Banks, 2007–12

article image
Source: Central Bank of Russia.

7. Growth has been particularly strong in the household segment, though from a low base. Household credit growth continued to accelerate to over nominal 40 percent (yearon-year) in the first months of 2012, though this segment is still small, amounting to 11 percent of GDP (Figure 3). Within household credit, about 20 percent is mortgage and the credit growth has been equally strong in both mortgages and other types of consumer loans (Table 1). Corporate loans grew at more modest rate of nominal 24 percent in 2011, and a significant part of this growth appears to reflect substitution away from foreign funding. Exposures to the commercial real estate segments (construction) are small at about 6 percent of total loans (Table 1), although some market participants consider higher exposure (15–20 percent) once on-lending is considered.7

8. The strong credit growth is mostly funded by deposits, though the reliance on central bank funding is rising at the margin. Household and corporate deposits are over 60 percent of banks’ balance sheets, while customer loans amount to 56 percent of the balance sheet (Table 1). Solid deposit growth since the 2008/09 crisis has supported bank funding, but loan-to-deposit ratios started to rise in 2011, comparing less favorable to Russia’s peers (Figure 3). Therefore, Russian banks are becoming more dependent on non-deposit funding, especially central bank funding (3.1 percent of the balance sheet in March 2012) at the margin (Table 1).8 Russia’s liquidity indicator scores favorably to other EMs but the banks’ maturity gap is marginally rising, reflecting the increasing reliance on the central bank funding (Figure 3).

Financial Soundness of the Banking Sector

9. Russian banks regained their strong profitability and the NPL ratio has declined noticeably since the 2008/09 crisis (Figure 4, Table 1). Return on assets (ROA) recovered to over 2 percent in 2011. While this is still lower than before the crisis, it is the highest among comparator9 countries10,11 The NPL ratio declined from over 10 percent in 2009 to below 7 percent in 2011. However, this decline is due to rapid credit growth, and the amount of overdue and nonperforming loans have not been reduced. Russia’s NPL ratio also remains one of the highest among the peer group. In addition, the NPL ratio itself could be underreported due to (i) overvaluation of the foreclosed assets on bank balance sheets, (ii) the transfer of distressed assets to affiliated off-balance sheet entities that are not subject to consolidated supervision, 12 and (iii) doubtful quality of restructured loans.

Figure III.4.
Figure III.4.

Financial Soundness Indicators for Banks

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

10. Based on reported data, the provision coverage for NPLs appears reasonable, though it may fall short if reporting weaknesses are accounted for. The total provisions (including those set aside for performing loans) exceeds NPLs, and NPL ratio net of provisions to capital is about 10 percent (median in the peer group). Provision coverage for each of loss and problem loans has also improved slightly. However, as indicated by 2011 FSAP, there is notable uncertainly over the adequacy of provisions owing to substantial discretions allowed to banks regarding the provisioning ratio and the widely varying quality of collateral.13

11. Rapid credit growth is weighing on capital adequacy. The regulatory capital ratio for the system declined to 14.7 percent from the peak of above 20 percent in 2009 right after state capital injection. The decline is larger for state-owned banks and foreign banks, with about 4 percentage points decline each in a year since end 2010 (Table 2). The stock of capital remained constant (Figure 4) and the declines are owing to rapid expansion of credit and some tightening of risk weights. This is just about the median of the peer group, but the quality of capital is relatively weak compared to the peers and the core capital ratio is 9.2 percent (Table 1). The introduction of Basel 2.5 and Basel III framework starting in 2013 is expected to reduce capital adequacy further as risk weights will be tightened and the definition of capital will become stricter. Since the minimum total capital ratio will continue to be set at 10 percent, 14 the changes will effectively raise minimum capital ratio requirements.

Table III.2.

Russia Financial Soundness Indicators Across Banks, end 2011

article image
Sources: Central Bank of Russia and IMF staff estimates.

Large borrowers are those with loans exceeding 5 percent of regulatory capital.

B. Economic Risks and Resilience Going Forward

Oil Prices: Major Risk

12. Volatile external conditions, especially in oil prices, continue to be the main source of risks for Russian banks. The Russian economy and asset prices are largely driven by oil prices. Declines in oil prices (to US$50–70) with corresponding sharp declines in the GDP growth rate were the main stress scenario considered in the stress testing exercises for the 2011 FSAP. Credit risks are the key risk factors for Russian banks, and oil prices and the exchange rate (which is highly correlated with oil prices (Box 1) are the key drivers for credit quality (Figure 5). According to the results of the tests, the system was broadly resilient with overall capital ratio declining from 18.1 percent to 14.1 percent. However, given the reduced levels of current capital ratio at 14.7 percent (Table 1), the similar magnitude of shocks could make larger number of banks undercapitalized.

Figure III.5:
Figure III.5:

Elasticities of NPL ratio vis-à-vis Macro Risk Factors

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Exchange Rate: Manageable Risk

13. Russia’s exchange rate volatility has risen appreciably since the global financial crisis. The RUB/USD volatility is highly correlated with economic fundamentals for Russia because oil prices are denominated in U. S. dollars (Box 1). This implies that, as long as the oil market remains volatile, ruble exchange rate volatility is likely to stay at a high level. In addition, the change in CBR’s policy framework away from exchange rate targeting could allow more volatility, which would provide the economy an important instrument for absorbing macroeconomic and external shocks.

uA03fig01

Selected EM: Net Open FX Position to Capital 2011 1/

(In percent)

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Sources: IMF FSI database.1/ (FX assets - FX liabilities)/Capital

14. However, Russian banks appear to be well prepared for the direct impact of higher exchange rate volatility. Russian banks’ net open FX position to capital is extremely small at 0.6 percent of capital; and moreover, the banks are now net FX creditors (Figure 2). This means ruble depreciation, on aggregate, is beneficial to banks.

15. Indirect impact through credit quality does not appear higher than for ruble loans. Exchange rate movement could have an impact on banks through its indirect effects: NPL ratio might rise if borrowers obtain FX loans without corresponding FX income.

  • About a quarter of total loans are denominated in FX. Most of these loans are to nonresident borrowers, including corporations, banks, and individuals. Resident corporations and financial institutions borrow about 20 percent of their loans in FX, but many Russian corporations have matching FX income. Resident individuals are least likely to have matching FX income, but only 5 percent of their loans are denominated in FX. All loans for the Russian government and government agencies are in rubles (text chart: share of FX loans by borrower type).

  • Overdue loan ratios by currency indicate a relatively better credit quality of FX loans, despite the increased exchange rate volatility in recent periods. The overdue loan ratio is lower for FX loans for all types of borrowers except for individuals. However, FX lending to individuals (resident and nonresident) are just one percent of total loans.

uA03fig02

Russia: Share of FX loans by borrower type

(In percent, as of March 2012)

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Sources: CBR
uA03fig03

Russia: Overdue loan ratio by borrower type and currency

(In percent, as of March 2012)

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Sources: CBR

Potential Contagion from Exposures to Europe: Manageable

16. While overseas investments by Russian banks are rising, the majority of the exposures are vis-à-vis entities that are ultimately Russian, limiting risks from direct spillovers. Overseas and nonresident investments amount to 14 percent of total assets. Out of this, roughly 40 percent is interbank exposures, 30 percent is loans to nonresident corporations, 14 percent is in cash, and 13 percent is in securities.

uA03fig04

Geographical distribution of interbank exposures: Foreign-owned banks

(In percent)

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Sources: CBR

  • Interbank exposures: The country destination of interbank loans by group of banks (Table 2) indicates that (1) most of the exposures are concentrated in state-owned, foreign and large private banks and in major financial centers (U.K. in particular); (2) apart from exposures to banks in London financial center, state-owned banks’ exposures appear to be concentrated in Cyprus, where one of the major banks has its subsidiary; (3) and foreign banks’ exposures seem to pickup those vis-à-vis their group companies (Austria and Italy in particular). 15 There is little evidence that foreign banks in Russia are shipping more liquidity abroad: share of interbank exposures within Russia for foreign-owned banks broadly remained constant, although these banks now have larger exposures in Italy and Austria by reducing exposures in U.K., Germany, and other countries.

  • Securities exposures: The CBR estimates that about 60 percent of the exposures are vis-à-vis ultimately Russian entities. These exposures are in securities issued by entities incorporated in Luxembourg, Ireland, and Cyprus where many Russian banks and corporate establish SPVs for the purpose of issuing Eurobonds.

Monetary Tightening in Russia: Manageable

17. Risks from higher interest rates appear manageable. The latest stress test for the top 17 banks (65 percent of the system by assets) conducted in April 2012 indicates that potential losses from higher interest rates are very small compared to capital. In addition, the CBR and market participants see relatively little transmission from policy rates to other interest rates, limiting the impact of higher costs of central bank funding (which is relatively small, at 3 percent of liabilities, Table 1).

What Drives Ruble Exchange Rate Volatility?

The ruble exchange rate volatility has evolved, apparently in line with massive market pressures during the 2008-09 crisis time and changes in the CBR’s exchange rate policy.1

  • RUB/EUR volatility was fairly high in early 2000 but then it declined appreciably towards the mid 2000s and remained at much lower levels from 2004 up to the crisis.

  • At the same time, RUB/USD volatility was kept at very low levels in early 2000 in the context of exchange rate targeting framework, but then it rose somewhat in mid 2000.

  • During the 2008–09 crisis times, the CBR initially raised exchange rate and intervened in FX market substantially in order to defend the exchange rate. However, as the crisis deepened, the exchange rate was let go, the policy rate was cut down, and the CBR pumped liquidity in the banking system. As a result, volatility jumped enormously; 3–5 times of the pre-crisis averages (these differences are strongly statistically significant). The difference between the post-crisis period and pre-crisis period is significant only for RUB/USD volatility, though.

uA03fig05

Volatilities of annualized monthly changes in ruble exchange rates

(standard deviation in percent 1/)

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Sources: Bloomberg and Staff Calculation1/ Volatility is estimated by applying GARCH(1,1) without exogenous variables.2/ Crisis time is defined as July 2008-April 2009.

In addition to the changes in policy framework, fundamentals, such as oil price movement, also contribute to exchange rate volatility, particularly for RUB/USD.

  • The RUB/USD volatility is closely linked to oil price volatilities. A simple empirical model indicates that oil price volatility is closely related to RUB/USD volatility. Oil price volatility dominates the impact of other variables proxying for global risk appetite and financial market distresses (such as stock index volatility indices and Euribor-OIS spreads).2

  • Overall, the model (with crisis period dummy) explains over 80 percent of the movement of RUB/USD volatility. Much of the pickup in exchange rate volatility is indeed in line with the higher volatility of fundamentals (oil price volatility).

  • On the other hand, the oil price volatility plays only a small role in explaining RUB/EUR volatility. Indeed, EUR/USD volatility contributes most to RUB/EUR movement throughout all periods, explaining 30 percent of the total movement. This indicates that, in Russia, RUB/USD variability primarily reflects economic fundamentals and RUB/EUR rate movement picks up the residual volatility in line with EUR/USD.

For both RUB/USD and RUB/EUR, the unexplained residual seems to becoming more volatile, implying that exchange rates have been increasingly driven by factors other than fundamentals or global currency market trends since the global financial crisis. This could be consistent with an interpretation that, among other things, the CBR has become more tolerant for exchange rate volatilities since the crisis.

uA03fig06

Volatilities of monthly changes in Ruble - USD exchange rate

(standard deviation in percent)

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Sources: Bloomberg and Staff Estimation1/ Estimated by regressing actual volatility for monthly exchange rate changes (estimated using simple GARCH (1,1) without exogenous variables) on oil price volatility, with period dummies for 2000–04, 05-June 08, July 08-April 09, and May 09-May 2012.
uA03fig07

Volatilities of monthly changes in RublEeUR exchange

(standard deviation in percent)

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A003

Sources: Bloomberg and Staff Estimation1/ Estimated by regressing actual volatility for monthly exchange rate changes (estimated using simple GARCH (1,1) without exogenous variables) on oil price volatility, Eur-oU SD level and volatility, Euribo-rOIS spread, and implied volatility for stock index with with period dummies for 2000–04, 05-June 08, July 08-April 09, and May 09-May 2012.
1/ Volatility is estimated by applying GARCH(1,1) process without any exogenous variables to monthly changes in exchange rate. The GARCH estimates capture time-varying nature of volatility more effectively than rolling-window standard deviations.2/ The short-term changes in Ruble exchange rate are close to random walk, as is typically the case with other exchange rates, and it is hard to establish reasonable empirical relationship with macroeconomic variables. On the other hand, the second moment (volatility) tends to exhibit more sensible empirical relationship with other macroeconomic and financial variables.
1

Prepared by Hiroko Oura.

2

The spread between the (unsecured) U.S. dollar Libor and euribor and the secured rate (overnight index swap –OIS– rate) is a standard measure of interbank funding distress. It increases when concerns over counterparty risks rise, even with global top-tier financial institutions.

3

The CBR expanded the list of assets useable as collateral on the Lombard list, including lower-rated securities, non-resident securities, shares, non-marketable assets (loans), and guarantees. The CBR also provided unsecured liquidity and partial guarantee of losses on interbank transactions if the license of the counterparty was revoked during the crisis. The Technical Note on Crisis Management and Crisis Preparedness Frameworks for 2011 FSAP provides more details.

4

The authorities indicated there were some pressures in interbank money market that were not picked up by the Bloomberg data. However, these pressures were minor compared to the 2008/09 stresses.

5

The rise in interbank market rate to the middle of CBR’s policy rates corridor reflects structural changes in CBR’s monetary policy framework away from foreign exchange targeting and effects from fiscal balances, rather than systemic liquidity shortages in the interbank market.

6

In 2011, the real GDP growth rate was 4.3 percent, average CPI inflation was 8.4 percent, and the GDP deflator growth rate was 15.4 percent.

7

Sectoral credit distribution data could be biased as the lack of strict consolidated supervision and monitoring of related party lending could mask the nature of ultimate borrowers.

8

The main source of wholesale funding is interbank transactions (10 percent of balance sheet). However, interbank liabilities are mostly offset by interbank claims on the asset side, leaving the net borrowing from interbank sources at 1 percent of the assets (Table 2).

9

Comparator countries include Brazil, China, India, Turkey, South Africa, Hungary, Czech Republic and Poland.

10

Return on equity is 18 percent, about median of the range observed for Russia’s peers (13–21 percent, excluding Hungary with negative profits), because some countries have more equity capital relative to assets and hence higher capital adequacy ratio.

11

Strong profitability is the major source for strengthening capital for Russian banks as they have rather limited room for issuing new capital in markets because of state-ownership and limited capital market development. With 2.4 percent ROA, Russian banks can increase their total and core capital ratios by 2.7 percentage points every year, assuming zero dividend payout. Russian banks tend to pay small dividends and have limited pressures for payout due to state-ownership or concentrated ownership.

12

See 2011 FSAP’s Financial System Stability Assessment for details. The FSAP pointed major deficiencies with Russia’s practice of consolidated supervision mainly because the definition of consolidated entities is not comprehensive enough.

13

The CBR requests all banks to report both on local GAAP and IFRS basis, although regulatory ratios are based on local GAAP.

14

In emerging and developing economies, minimum capital requirements are often set much higher than Basel requirement (8 percent) partly in order to compensate for larger economic and financial volatilities (NPL ratios in these economies tend to show much larger jumps than those in advanced economies) and for regulatory and supervisory weakness.

15

There are over 100 foreign owned banks in Russia, which collectively hold 17 percent of the system's assets (Table 2). However, each bank has very small share of assets. The largest foreign banks include Unicredit (2 percent by assets), Raiffeisen Bank (1.8 percent by assets), and Citibank (0.7 percent by assets).

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Cover IMF Staff Country Reports
Russian Federation: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2012: Issue 218
Publisher:
International Monetary Fund
ISBN:
9781475505047
ISSN:
1934-7685
Pages:
58
DOI:
https://doi.org/10.5089/9781475505047.002

Financial Markets

Liquidity, Official Funding, and Banks’ External Positions

Liquidity, Official Funding, and Banks’ External Positions

Credit Growth and its Funding

Financial Soundness Indicators for Banks

Elasticities of NPL ratio vis-à-vis Macro Risk Factors

Selected EM: Net Open FX Position to Capital 2011 1/

(In percent)

Russia: Share of FX loans by borrower type

(In percent, as of March 2012)

Russia: Overdue loan ratio by borrower type and currency

(In percent, as of March 2012)

Geographical distribution of interbank exposures: Foreign-owned banks

(In percent)

Volatilities of annualized monthly changes in ruble exchange rates

(standard deviation in percent 1/)

Volatilities of monthly changes in Ruble - USD exchange rate

(standard deviation in percent)

Volatilities of monthly changes in RublEeUR exchange

(standard deviation in percent)