Banks’ Hidden Negative Capital Before and After the Senior Management Change at the Bank of Russia

Abstract

What was the size of hidden negative capital (HNC) in the Russian banking system before the Bank of Russia's senior management changed? Has the financial regulator's new, tougher, supervision policy launched in mid-2013 been productive in dealing with problems accumulated over recent years? This study attempts to provide first answers to these questions using Heckman selection models and solving a possible regulator's optimization problem using the data on Russian banks over the period from December 2009 to May 2017. The study results suggest that before the change of the Bank of Russia's senior management in mid-2013, the average level of HNC at banks operating in Russia was very high: 14% of the banking system's total assets on each specific date, and fairly permanent in time. But as early as half a year after the Bank of Russia's senior management changed, the overall size of HNC started contracting rapidly, coming close to to 4% by mid-2016. In the last 12 months of the time span under study the level of the HNC stabilized at 4%. These estimates point to the high effectiveness of the new senior management's supervision policy. The policy has produced a strong indirect positive effect: large part of fragile banks have started addressing their problems without waiting for the Central Bank's intervention. The effectiveness of the Bank of Russia's new policy cannot be attributed to other factors such as macroeconomic stabilization or improvement and/or rising profitability or bank operartions. Rather, when supervision policy was stepped up, these other factors were acting in the opposite direction.