Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.

Russia: Key Findings and Recommendations of the 2011 Stability Module Under the Financial Sector Assessment Program (FSAP)

April 12, 2011

The Russian authorities maintained financial stability at home in the face of a major global shock. Although the recent global financial crisis hit the Russian economy hard, the authorities succeeded in shielding to a large extent the financial sector from its impact. The economy and the financial system are now recovering: the performance of financial institutions began to improve already in 2010, and the emergency anti-crisis measures have been unwound. Now it is the time to draw lessons and build a framework that will make the financial system even more resilient in the future.

What worked well. The success in maintaining financial stability in the face of this major systemic threat reflected mainly three factors: the decisive and broad-based policy response by the government, the CBR, and the DIA; the frequent and close cooperation between them during the crisis; and the decision to grant emergency powers and expand significantly the range of tools available to these agencies, supported by strongly countercyclical fiscal and monetary policies. These are important lessons for the future and apply not only to Russia but also to other countries.

The financial system is still fragile. Economic activity is projected to grow at a modest pace in the coming years, and given the structure of the Russian economy, the financial system will continue to be exposed to significant risks from fluctuations in international commodity prices and capital flows. These factors will create a difficult environment for the financial system in the near term. In addition, in the banking sector, the heart of the financial system, loan quality may be overestimated while the level of provisions is still lower than it should be. For this reason, although financial soundness indicators are strong and stress tests suggest that the sector can withstand sizeable macroeconomic and financial shocks without extra help by the government or the CBR, increased vigilance is required. Non-bank financial sectors are small and not systemically important. But the insurance sector is struggling: profitability and return on assets is low, many insurers are in distress, and many will not be able to meet the increased minimum capital requirements in 2012.

The crisis has set back progress toward a strong, competitive financial system for the future. Competition has declined, as the post-crisis consolidation has strengthened mainly large, state-owned banks, whose share in deposits has risen after the gradual decline of recent years. Moral hazard has increased as a result of the emergency measures to maintain stability, which inevitably benefited systemically important institutions.

In addition, the system continues to suffer from weak governance, highlighted by sometimes non-transparent ownership structures, deficiencies in financial reporting, and endemic perceptions of corruption in the Russian economy. The authorities’ medium-term strategy for the development of the banking system provides a clear vision for the future, which will require tackling these challenges.

Banking supervision. Despite progress in recent years, the regulatory and supervisory framework for banking has gaps and weaknesses. Key among these is the lack of authority for the CBR to supervise bank holding companies and broadly-defined related parties; issue binding guidance on risk management by banks; use professional judgment (with appropriate legal protection for individual supervisors) in applying laws and regulations to individual banks; and share without restrictions information with other supervisors. Most of these shortcomings would be addressed by pending legislation at the State Duma; but until this is implemented, Russia will continue to score poorly in compliance with accepted international standards on banking supervision. Providing greater discretion to supervisors to use their professional judgment will allow the CBR to move toward risk-based supervision and reduce the burden on banks of ever-multiplying recommendations and requirements. The CBR should also adopt a transparent framework for prompt remedial action, with a clearly delineated set of mandatory measures that escalate as a bank’s financial situation deteriorates.

Supervision on non-bank financial institutions. The recent decision to move insurance supervision to the FSFM can generate significant benefits by giving supervisors a comprehensive view of the market, harmonizing supervisory approaches and requirements, and realizing economies of scale. But for these benefits to materialize, the framework currently under preparation for the new, expanded FSFM should provide the agency with the power to issue secondary regulation and industry-wide binding norms and ensure its independence and adequate resources. It is also imperative to finalize the new framework as quickly as possible, since the decision to unify insurance and securities supervision was taken without adequate preparation, creating a temporary vacuum in oversight, especially in the insurance sector.

Systemic risk monitoring and macroprudential policy. The establishment of an inter-agency working group under the Presidential Council and the creation of a special department at the CBR in charge of macroprudential analysis are important steps in developing mechanisms for systemic risk monitoring and management. Given the dominant position of banking in the domestic financial sector, the CBR will inevitably have the lion’s share of the responsibility for assessing systemic risk and developing tools to mitigate it. Closer supervision of systemically important banks, including the ability to maintain permanent supervisory presence on-site, would be a key component of this new framework. Other policy instruments, tailored to the Russian environment, may also be developed. At the same time, close cooperation and information-exchange between all supervisory agencies, the government, and the DIA is crucial. In this context, the DIA should be a member of the inter-agency working group.

Liquidity management and transparency of monetary policy. Over the past 7-8 years, the CBR has made major progress in enhancing the transparency of its monetary policy: based on the factual update of the 2003 assessment, the CBR today complies with all criteria under the Code of Monetary and Financial Policy Transparency. More can be done to provide clearer signals of the direction of monetary policy. To improve the effectiveness of monetary policy and the management of liquidity in the banking system, the functioning of the interbank market should be improved by requiring repo transactions to take place using central counterparty clearing and setting limits in the concentration of collateral. The CBR’s emergency liquidity assistance proved effective during the crisis, but the framework could be strengthened further—and the risks to the central bank’s balance sheet reduced—by requiring the government to guarantee any loan that is unsecured or backed by non-marketable assets or guarantees.

Crisis prevention and resolution. The framework for deposit insurance is well-structured and effective, as attested by the experience during the crisis. There are a few relatively minor features of the deposit insurance framework which warrant reconsideration, such as the need to revisit the ban on accepting household deposits by banks which are not making profits for six consecutive months (which is temporary suspended until July 2011), as there may be occasions when viable banks temporarily make losses. The framework for bank resolution, on the other hand, needs to be unified into a single regime for all banks, with broad authority for the administrator to assume all powers of decision-making bodies of the bank; override the preemptive rights of existing shareholders; write down capital; restructure debt; undertake purchase & assumption; and arrange mergers. “Open bank assistance” tools, however, such as loans to investors, recapitalization using public funds, or nationalization should be reserved only for situations of systemic crisis and be deployed after a decision by the government. There should also be prompt and early communication of information between the CBR and the DIA on problem banks.

Moscow as an international financial center. This ambitious vision can indeed become reality. But it will not happen overnight. It will require establishing a track record of macroeconomic stability. It will also require steady steps over several years to address the challenges identified in the government’s plan and in this FSAP and, more broadly, improve infrastructure and governance beyond the financial sector. The reforms already underway or pending are critical first steps in this direction.

The key recommendations of the mission are prioritized in the attached table.


Table. Russia: Key FSAP Recommendations


Recommendations

Short term (implementation within 12 months)

Empower the CBR to use professional judgment in interpreting laws and regulations, issuing enforceable risk management guidance, and applying it to individual banks.

Approve pending amendments to expand CBR supervisory authority over bank holding companies and related parties, and eliminate restrictions on information-sharing with other domestic and foreign supervisors.

Allow the CBR to sanction individual directors and key managers, raise capital requirements on individual institutions, and impose restrictions on transactions between affiliates.

Ensure the unified securities and insurance supervisor (FSFM) has the power to issue secondary regulation to interpret the law, as well as industry-wide binding norms.

Empower the FSFM to require insurers to have in place internal controls and risk management systems commensurate with for the complexity of their business.

Apply fit and proper requirements to directors and key management of insurers on an ongoing basis.

Make home-host notifications and cross-border cooperation in insurance mandatory for the FSFM.

Adopt pending legislation that empowers the FSFM to appoint a provisional administrator, freeze assets, and wind down distressed securities firms.

 

Medium term (implementation in 1-3 years)

Adopt a prompt remedial action framework for banks.

Give the chairman and key members of FSFM fixed-term appointments.

Require government guarantee for all CBR loans that are unsecured or not backed by marketable collateral or guarantees.

Require repo transactions to take place using central counterparty clearing.

Set limits on concentration of collateral in the repo market.

Introduce a unified administration regime for all banks (systemic or otherwise) with broad powers for the administrator, including P&A.

Open-bank assistance such as loans, capital injections, nationalization by the DIA should be restricted to systemic situations.



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