Title Page
INTERNATIONAL MONETARY FUND
MIDDLE EAST AND CENTRAL ASIA DEPARTMENT
DEPARTMENTAL PAPER
Managing Financial Sector Risks from the COVID-19 Crisis in the Caucasus and Central Asia
Prepared by Iulia Ruxandra Teodoru and Klakow Akepanidtaworn
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Copyright ©2022 International Monetary Fund
Cataloging-in-Publication Data IMF Library
Names: Teodoru, Iulia, author. | Akepanidtaworn, Klakow, author. | International Monetary Fund. Middle East and Central Asia Department, issuing body. | International Monetary Fund, publisher.
Title: Managing financial sector risks from the COVID-19 crisis in the Caucasus and Central Asia / prepared by Iulia Ruxandra Teodoru and Klakow Akepanidtaworn.
Other titles: Departmental Papers (International Monetary Fund). Description: Washington, DC : International Monetary Fund, 2022. | March 2022. | DP/2022/005. | Departmental paper series. | Includes bibliographical references.
Identifiers: ISBN 9798400201189 (paper)
Subjects: LCSH: Financial risk management -- Asia, Central. | Financial risk management -- Caucasus. | COVID-19 (Disease). | Banks and banking.
Classification: LCC HD61.T46 2022
Prepared by Iulia Ruxandra Teodoru and Klakow Akepanidtaworn, with contributions by Yizhi Xu, under the guidance of Nicolas Blancher and Nathan Porter, and approved by Subir Lall. This paper benefitted from comments from CCA region country teams and IMF departments, as well as research assistance by Amine Yaaqoubi and production assistance by Liliya Nigmatullina and Branden Laumann.
The Departmental Paper Series presents research by IMF staff on issues of broad regional or crosscountry interest. The views expressed in this paper are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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Contents
Executive Summary
1. Introduction
2. Key Macro-Financial Risk Factors in the CCA Region
A. CCA Banking Systems—Key Features
B. Credit Risk
C. Currency Risk
D. Dollarization Risk
D. Interest Rate Risk
3. Quantifying Financial Stability Risks
4. Near-Term Challenges and Lessons from Earlier Crises in the CCA Region
5. Conclusions and Policy Recommendations
A. Supervisory Frameworks
B. Macroprudential Perspective
C. Bank Resolution Frameworks and Insolvency Regimes
D. Broader Structural Reforms
Annex 1. Methodology and Assumptions for Stress Tests
Annex 2. Pre-COVID Financial Soundness Indicators
References
BOXES
Box 1. CCA Countries: Macro-Financial Measures Taken by Regional Central Banks
Box 2. Georgia and Armenia: Policies Suppor ting Balance Sheet Recovery
Box 3. Georgia: Resolving Insolvency.
FIGURES
Figure 1. CCA Countries: Real, Fiscal, and External Effects of the COVID-19 Pandemic
Figure 2. CCA Countries: Characteristics of Banking Systems, 2020
Figure 3. CCA Countries: Asset Quality, Credit Gaps, Dollarization, and Loan-to-Deposit Ratios, 2020
Figure 4. NPLs and CARs under Stress Scenarios
Figure 5. Sensitivity to Exchange Rate Shocks
Figure 6. Impact of Stress Testing on Liquidity
Figure 7. Stock Prices of Georgian and Kazakh Banks
Figure 8. Nonperforming Loans, 2006–18
Figure 9. Credit to the Private Sector, 2008–18
TABLES
Table 1. Financial Soundness Indicators
Executive Summary
The COVID-19 crisis raises the risk of renewed financial sector pressures in the Caucasus and Central Asia (CCA) region in the period ahead. Bank distress and its economic and fiscal fallout have been recurring features of many CCA countries, as seen after the global financial crisis and the 2014–15 oil price shock. Strong policy responses have delayed the full impact of the COVID crisis so far, but financial sector risks will increase once public support is phased out. If these risks are not preemptively addressed, banks’ ability to lend during the recovery phase could be impaired and there may be a need for costly public interventions, as in the past.
The crisis impact will exacerbate longstanding vulnerabilities in CCA banking systems. CCA banking systems are relatively small and concentrated, leading to high costs of finance and low levels of financial inclusion. A legacy of problem loans and large credit cycles could magnify systemic risks in some countries. In addition, persistently high dollarization may pose indirect foreign exchange (FX) credit risks, and high loan-to-deposit ratios and reliance on FX funding contribute to liquidity risks.
Stress test analysis allows identifying the most significant risk factors in the region’s financial systems at this juncture, especially FX risks. Under adverse macroeconomic scenarios, CCA bank’s capital adequacy ratios could drop significantly but would likely remain above regulatory minimums. However, vulnerabilities due to FX exposures appear substantial: FX-induced credit risk could severely impact bank capitalization, and half of the banks in the region could become illiquid under acute FX funding stress. In addition, a simultaneous realization of these risks would have compounded effects, and the largest and state-owned banks seem to be the most vulnerable.
A range of policies are needed to preemptively address these risks, building on best international practices and lessons from past experience in CCA countries. Supervisory policy should be based on in-depth risk diagnostics. Macroprudential policy frameworks should continue to be upgraded to build up resilience across credit cycles. Stronger bank resolution and insolvency regimes are needed to support swift balance sheet repair. In the longer term, reducing the role of the state and promoting competition in banking systems, and diversifying financing sources, including through capital market and fintech development, will help promote safe and sustainable credit growth and financial inclusion. Lessons from the 2014–15 crisis in the region confirm that appropriate policy responses, such as strengthened prudential regulation or decisive measures to rebuild capital, can help maintain market confidence and restore buffers without incurring large fiscal costs.