Finance Risk Estimation and Modeling in Emerging Markets
This paper determines the optimal volume of international currency reserves of the Bank of Russia to prevent harmful fluctuations of the Russian ruble exchange rate causing a threat to financial stability.
We create a system of models, taking into account the linkage between the dynamics of the exchange rate and the behavior of economic agents – households, non-financial industries and banks. The evaluation includes the initial effects of stress, both in the internal foreign exchange market and in the global oil market. We also shed some light on the effects of the spread of these shocks through changes in the demand for currency, from economic agents and its consequences for the ruble exchange rate. The most important task in this study is the development of an iterative approach for stress testing the banking system, in the situation of excessive volatility in the internal foreign exchange market. The stress testing procedure considers the “fire sales” effect for the securities of banks, which means that these securities can be sold if a bank faces a liquidity or capital shortage, due to an imbalance of currency assets and liabilities.
The results of the stress testing allows us to conclude that, with the occurrence of the most severe stress and the immediate provisions of currency liquidity by the Bank of Russia, the current volume of international reserves will be sufficient to eliminate its consequences. However, in case of late provisions of currency liquidity, the volume of highly liquid reserves will not be enough, and the Bank of Russia will have to sell the significant volume of foreign government securities. It can lead to a devaluation of these securities.
In this connection, the Bank of Russia should change the structure of the currency international reserves in favor of highly liquid assets, by reducing the share of securities and increasing the share of short-term deposits in foreign banks with high credit ratings. As for the volume of international currency reserves for Russia (including less liquid components), it is sufficient to overcome the maximum possible stress in the foreign exchange market and to subsequently maintain the solvency of the Russian economy.