Russian financial system: out of crisis, still far from normal.
Since March 2016, no new crises befell the Russian financial system. But has it regained the stability seen in 2011-2013? Let the ACRA Financial Stress Index (ACRA FSI) tell its story.
The Russian economy has almost overcome the recession in 2016, when real GDP shed just 0.2%, while in 2017, we expect it to grow 0.5%. But this does not mean that Russia's financial system has also plunged out of the crisis. We are used to gauging financial stability of the Russian economy looking at oil price or ruble volatility. Indeed, the recent years saw these indicators assume a forefront role in measuring stability of the Russian financial system, although they reflect only part of economic phenomena, while the ACRA FSI describes the condition of the financial system as a whole. Based on a wide range of financial and economic indicators, the FSI provides for accounting for the widest possible array of potentially new sources of financial stress. Such a comprehensive assessment may be useful not only to investors and researchers, but to the general public as well.
Which of the two crises borne more stress, the latest one that befell in 2014-2015, or its predecessor that dates back to 2008-2009? The latter and the earlier one lasted 208 days and boasted an index average of 4.4 pts, while the recent crisis had 137 days of running time, with the index standing at 2.9 pts, thus implying less damage compared to its predecessor.
Russia's financial system has been running stable for more than a year by now. The ACRA FSI last exceeded the 2.5 pts threshold on April 24, 2015. Early in 2016, tracking the oil price slump below USD 28/bbl, the index came close to the line by reaching 2.3 pts, but never crossed it.
The stress level in the Russian financial system is still above the pre-crisis mark of 2010-2013. In 1Q2017, the index averaged 0.86 pts versus some 0.65 pts in 2010-2013. Due to one of clearly pronounced manifestations of stress – i.e. to lack of information about other investor actions and expectations – the financial system is still unable to regain pre-crisis stability, although it has indeed come close to it.
What is the ACRA FSI?
The ACRA Financial Stress Index (ACRA FSI) shows how close the Russian financial system is to the crisis, and how far it is from the pre-crisis period. The index also allows to gauge whether the crisis of 2008-2009 was more or less stressful compared to the one seen in 2014-2015. The Index is updated daily at 17.00 Moscow time and published on the ACRA website https://www.acra-ratings.com/research/index. It has been normalized to range between 0 and 10 pts, but in future it may well go beyond these boundaries. The value 1 was attributed to the index as of January 11. 2006, while the maximum setting corresponds to January 28, 2009, which points to a maximum stress the Russian financial system sustained throughout the entire period observed. We attribute its values of above 2.5 pts to indications of a financial crisis.
The ACRA FSI is calculated based on economic indicators (inflation, exchange rate, oil prices, etc.) and financial parameters (interest rates on corporate bonds, money market rates, stock market volatility, etc.), whose increase or decrease reveals growth of one or more manifestations of financial stress. A crisis is defined by five signs of financial stress:
– Uncertainty around fundamental prices for financial assets or commodities;
– Lack of information about the motivation and current mood of other market participants;
– Information asymmetry regarding quality of assets (the seller knows more) or borrowers (borrower knows more);
– "Flight to quality": less profitable and less risky investments are of preference;
– "Flight to liquidity": more liquid assets are of preference.
In February, the index attained its pre-crisis averages, but this positive trend broke on March 8 after the US Department of Energy unveiled statistics on oil inventories. The following 5 pps slump in oil prices has pushed the ACRA FSI by as much as 0.3 pts up and above the 1 pts threshold for the first time since February, thus marking the most stressful event since the start of the year.
Further index’s trends are hard to predict, especially in view of uncertainty around political events that may potentially bring about a crisis. However, economic factors are more predictable, and we highlight those that may jeopardize Russia’s financial stability going further.
The Russian financial system is traditionally susceptible to oil price shocks. The latter hinge upon potential fluctuations in the U.S. inventories and a possibility of OPEC discontinuing the production quotation agreement. Moreover, Saudi Arabia may start disclosing its oil reserves prior to Saudi Aramco’s IPO, which may lead to financial instability if the actual numbers are much higher or lower than market participants expect. That said, the latter factor is likely to cause a short-lived effect.
Figure 1. ACRA Financial Stress Index
Another possible instability source is an increase in overdue bank loans on the back of harsher investment environment. In case of an unexpected exogenous shock, this may increase the probability of a financial crisis in the economy plunging, although by itself overdue loans are incapable of such effect. The trend of overdue loans piling up stems from the ongoing adjustment of the economy to a new balance of payments structure, with the latter manifesting itself in lower real household incomes and a recession accompanied by climbing import prices. Most borrowers suffer from persistently depressed credit quality, and some borrower groups still see this indicator declining. By ACRA’s estimates, in 2017, the share of problem loans will fall compared to the previous from 15% to less than 14%, but is still likely to be high enough. We expect bank asset quality to remain a key risk on the 3 to 4-year horizon.
The structural liquidity surplus may by itself increase the likelihood of instability in the event of external shocks and no retaliatory actions by the Bank of Russia. However, so far, the regulator has been trying to create sufficient incentives to promote investments in its risk-free instruments through a tight monetary policy, which leads to positive real short-term interest rates. We expect this policy, which reduces the probability of a new financial crisis, to continue in the next few years.