The Russian authorities maintained financial stability in the face of a major global shock. This success reflects three factors, among others: 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 to these agencies, supported by countercyclical fiscal and monetary policies.

The financial system is still in a process of balance sheet repair. Given the structure of the Russian economy, the financial system is exposed to significant risks from fluctuations in international commodity prices and capital flows. Although the banking system is recovering well and profitability has improved, banks’ balance sheets are still burdened from the impact of the crisis and increased vigilance is warranted in the period ahead. Non-bank financial sectors are small and do not appear to pose systemic issues. That said, the insurance sector is struggling: profitability and return on assets is low and some insurers are in distress.

The crisis has also set back progress toward a strong, competitive financial system. Competition has declined and moral hazard has increased, as the emergency measures and post-crisis consolidation inevitably benefited systemically important institutions, which are mainly large, state-owned banks. In addition, the system would benefit from stronger governance and better financial reporting. The authorities’ Strategy for Banking Sector Development through 2015 provides a clear vision for the future, which will involve tackling these challenges.

Financial sector supervision

• Despite progress in recent years, key weaknesses of the supervisory framework include the lack of authority for the CBR to supervise on a consolidated basis bank holding companies; issue binding guidance on risk management by banks; and use professional judgment in applying laws and regulations to individual banks. Most of these shortcomings would be addressed by pending legislation currently at the State Duma; but until this is implemented, Russia will continue to fall short of accepted international standards.

• The recent decision to move insurance supervision to the FSFM can generate significant benefits by giving supervisors a comprehensive view of the market and realizing economies of scale. But for these benefits to materialize, the framework under preparation for the new, expanded FSFM should ensure its independence, adequate resources, and the power to issue and enforce secondary regulation.

• The establishment of an inter-agency working group under the Presidential Council and the creation of a macroprudential department at the CBR are important steps in developing mechanisms for systemic risk monitoring. 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. Close cooperation and information-exchange between all supervisory agencies, the government, and the DIA is also crucial.

Crisis prevention and resolution. The framework for bank resolution 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 and undertake different forms of restructuring, such as purchase & assumption. However, tools such as direct loans to investors, recapitalization using public funds, or nationalization should be reserved for situations of systemic crisis and only be deployed after a decision by the government.

Moscow as an international financial center. This ambitious vision can indeed become reality, although it will not happen overnight. It will require establishing a track record of macroeconomic and financial 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 to improve the business environment more broadly.