Unreliable Asset Quality Review Is a Key Problem of the Banking Sector

27 july 2017

The Money and Credit Magazine has published an article by the Analytical Center's experts Daniil Nametkin and Natalia Safina entitled "Ways to Refine Banks' Asset Quality Review Methodology to Improve Financial Stability in Russia". The experts analyze the Russian financial market and propose to introduce a unified principle of asset quality review.

According to the authors of the article, recent developments, i.e. Tatfondbank and Rosenergobank losing their licenses and the Central Bank putting Yugra Bank under temporary administration, have made it apparent that the Russian banking sector still has some structural problems despite the overall stabilization of the main macroeconomic indicators and a steady improvement in the financial performance of the banking system as a whole.

In many cases, such extreme regulatory measures are accompanied by statements of inadequate reporting of assets on the bank's balance sheets that helped conceal real problems, such as shortage of regulatory capital, allowing the bank to operate for a long time with these issues unnoticed. It is the present asset quality review methodology, which is based on accounting records evaluation and the current financial performance of the borrower, that allows the banks to operate like that.

In view of the above, the authors of the article focus on ways to improve the asset quality review methodology based on successful foreign experience, in particular that of the EU. Such as the ECB asset quality review principles that allow to obtain risk-weighted capital requirements based not only on the current financial performance of the borrower, but also taking into account the state of the business environment.

This way, the problems with capital that Russian banks are facing could be eased by the introduction of a unified methodology, describing risk assessment procedures for asset quality review, based on which a credit institution will be able to form an adequate capital structure. That would protect credit organizations to a large extent from market and external shocks, thereby minimizing potential losses and the need to create additional capital during the period of economic crisis.

The effectiveness of the proposed methodology, based on the principles of international rating agencies evaluation, has already been proved by the EU banking sector. For instance, in 2011-2012, there was a temporary decrease in the profitability of the EU banking sector, when the ECB obliged a number of banks to meet the minimum reserve requirements calculated based on new adapted risk assessment models. However, starting from 2013, the profitability of European banks began to recover as reserves from repaid loans started to be released. Moreover, by the end of 2016, the profitability of the European banking sector remained near maximum values, despite an increase in the volatility of the Euro and a parallel decrease in consumer and investment demand in a number of key European countries.

The article provides a detailed description of the methodological approaches that can have such a significant impact.

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