Financial Systems of Caucasus, Central Asia Are Particularly Vulnerable to Shocks
IMF Blog, March 10, 2022
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- Authors: Rayah Al-Farah, Klakow Akepanidtaworn, Sanan Mirzayev
- Published: March 10, 2022
Overview / Exposure
- Heavily reliant on commodity exports, remittances and tourism, the economies of the Caucasus and Central Asia (CCA) and their financial systems are vulnerable to volatile external shocks.
- The Chart of the Week highlights how exposed countries in the region are to such disruptions, which in the past have caused economic downturns and financial distress.
- Although the situation remains uncertain, the ongoing pandemic and the conflict in Ukraine could also have a substantial impact.
Drivers of vulnerability in regional banking systems
- Dollarization in CCA economies is well above emerging market peers.
- Banking sectors are:
- small,
- concentrated,
- often largely state-owned.
- Gaps in banking regulation and supervision have contributed to:
- weak quality of bank loan portfolios,
- weak capitalization.
Historical shocks and financial-sector consequences
- Favorable external conditions have at times spurred large credit expansions and raised systemic risks; these booms have sometimes been followed by busts.
- Adverse external shocks cited:
- the global financial crisis,
- the 2014-15 oil price shock.
- Consequences observed after these shocks included:
- sharp contractions in credit and asset prices,
- a legacy of problem loans,
- costly public interventions to bail out banks.
Pandemic, sanctions, and recent risks
- The pandemic has hit CCA economies hard in the past two years, but its impact on financial sectors has remained limited, helped by emergency measures to support households, businesses, and banks.
- The COVID shock is now compounded by the implications of international sanctions imposed on Russia, a country with sizable economic and financial linkages with CCA countries.
Policy recommendations and resilience building
- Strengthen macroprudential policy frameworks to:
- increase financial sector resilience,
- mitigate the impact of large financial cycles and external shocks.
- As experience in a few countries shows, strong macroprudential policy frameworks can:
- moderate credit and asset price booms,
- build larger buffers in bank balance sheets against adverse shocks,
- reduce risks from common exposures and interlinkages between financial institutions.
- Enhance regulatory and legal frameworks for bank resolution and insolvency to limit risks to financial stability and the public sector.
- Implement reforms that reduce the role of the state and promote competition to support:
- greater financial inclusion,
- more sustainable credit and economic growth.
Rayah Al-Farah, Klakow Akepanidtaworn, Sanan Mirzayev; March 10, 2022. —Ezequiel Cabezon, Padamja Khandelwal and Iulia Teodoru contributed to this blog.