RUSSIAN Debt Crisis

Hi, welcome back to Joe Blogs. In today's episode, I want to talk to you about what's happening in the Russian economy and specifically to talk about a recent report where Russian banks are now concerned that the level of risk is rising, bad debts are rising, and there is a potential for bad debts to increase significantly over the course of the next 12 months.

So it was reported on Bloomberg that Russian banks are fearing a debt crisis as the war continues to strain the Russian economy. The report said that the Russian economy faces a worsening outlook that is graver than publicly acknowledged with a credible risk of a systemic banking crisis in the next 12 months. Russian banks are increasingly concerned about the level of bad debts on their balance sheet. According to officials and documents seen by Bloomberg News, they have privately raised the alarm about the number of corporate and retail clients who are failing to make loan payments as they struggle with high interest rates.

So, we've talked about this a lot on the channel. Russia's interest rates are currently sitting at 20%. So that means that every single year if you take out a loan of $100,000, you're having to pay back $20,000 every year just for the interest. So obviously if you had that loan for a period of 5 years, you'd be paying back double the amount that you'd borrowed. So what we're hearing now is that corporates and individuals in Russia are unable to make these payments. So they're missing payments, which obviously means that the risk of those borrowers not actually repaying the banks is increasing.

Official figures may mask the true magnitude of the debt problem. Borrowers are deferring payments, meaning that while public data on late payments doesn't yet suggest a serious problem. The reality is that many more loans are not being repaid as planned. Banks have estimated that their debt, their bad debts currently run to trillions of rubles and are taking steps to manage the increased risk leading to early signs of a credit crunch. One estimate showed that the corporate portfolio of Russian banks in the first two months of 2025 decreased by 1.5 trillion rubles, around $19 billion. So basically what that means isn't that those loans, those $19 billion worth of loans were repaid, they were actually written off. So when your loan book suddenly drops by 19 billion, it means that you've acknowledged that you're never going to get the money back. So what we're seeing here is a credit crunch starting to form in Russia.

And I've had lots of messages recently from people saying, "When will we start seeing the evidence of the strain on the Russian economy?" Well, I think this is the first sign. And one of the reasons why this is happening is because of the war economy that's been put into place. We've talked about this a lot on the channel, the fact that over the last 18 months, lots of companies in Russia have been commandeered to support the war effort. So, they're being sponsored by the state. So, those businesses are continuing to do well. They're performing well. They're being paid guaranteed revenue for making things. But the problem is that that's not a sustainable business model because those sales are not coming from the rest of the world. They're not commercial sales. They're basically coming from the National Wealth Fund. Russia is using its savings to keep that war going. And at some point, the wheels are going to come off in terms of that wartime economy.

And I thought this chart was really interesting because it shows the year-on-year change in output from Russian companies in various sectors between January and April 2025. And what we've got here is a scale across the bottom of minus 20% on the left through to plus 20% on the right and zero is in the middle. And as you can see just at first glance, the majority of the sectors that we're looking at here are to the left of the zero line. So that means that they're seeing year-on-year falls in output. So if we if we just run down this list at the top, we've got leather goods and there's a fall of almost 20% year on year in leather goods. And leather goods I think is an interesting barometer because when people are doing well then they will buy more clothing and and furniture like sofas that maybe are covered in leather. Um, they'll buy more cars that are using leather seats. So leather I think is seen to be a sort of luxury item. If you want to go for the most expensive option when leather is available it tends to be right up there in pricing. So you can buy a normal sofa that'll just be covered in standard material or you can go for the leather option. So what we're seeing is a big cut back in leather goods which indicates that Russian consumers are pulling back on those luxury items. They're not spending as much if they don't have to. They're going for cheaper alternatives.

The next biggest fall is in transport and trailers. So once again, this tells us that industry is pulling back from its expenditure. If you're trying to reduce your transport costs and you're not paying as much for moving things, firstly that shows strain on the budget. But secondly, it also shows that there is less business happening because things need to be moved. So if there's less transport happening, then that means there's less business happening. And then we've got a variety of other sectors that are falling by more than 5%. So we've got non-metallic mineral products, beverages, metals, and then we've got a whole host of other product sectors that are in negative territory, rubber and plastics, furniture, machinery and equipment, wood products, books and paper products, and food products. So 2/3 of the categories on this chart are in negative territory.

Now if we have a look at what sectors have been growing in the January to April period year on year, electrical equipment was up slightly. Coke and petroleum is up. So that's basically a year-on-year increase in the usage of those products. Tobacco products which will be being sent to Ukraine. um, the the army and all the people who are fighting will be provided with tobacco products, textiles which indicates a lot of the clothing and the equipment that's being sent over to Ukraine, chemical products, no no definition of what that is. And then medicines are up by around 17% year on year. And obviously there's a lot of treatment going on for people who are wounded in Ukraine. But the overall takeaway I think of this chart is that the vast majority of the sectors are seeing a year-on-year fall and this is why concern is now rising because that tells us that those sectors are now struggling and if they've got debt they will be struggling to repay that interest of 20%.

And if we have a look at this chart which compares Russian industries that are tied to the state with Russian industries that are not. So the black line shows those that are being sponsored by the state. The yellow line shows the commercial entities. You can see that following the middle of from the middle of 2022 onwards, there has been a sharp increase in the year-on-year output for these companies that are tied to the state. So it's actually gone from the index of 100 in the middle of 2022 to over 175%. That's a massive increase and that's basically because all those companies are having a heyday being paid by the Kremlin. If you look at the yellow line, you can see that there was virtually no movement at all in 2022, 23, and 24. We then saw an increase towards the end of 2024, but that was soon reversed and we're now back down to this flatline situation. So there isn't really any growth happening in any industries outside of those that are being sponsored by the Kremlin.

And a central bank report in May warned of vulnerabilities of the financial sector, including credit risk and concentration risk in corporate lending, as well as a deteriorating loan performance in consumer lending. 13 of Russia's largest 30 78 companies were unable to service their debt, double the number a year previously. So this is an official Russian bank report that is saying that around about 20% of the largest companies in Russia can't afford to pay their debt. And that's the largest companies. So obviously if you were looking at the smaller end of the market, the situation would be worse than that. But also we've got deteriorating loan performance in consumer lending. So that's lending to individuals. So this is all looking like some form of credit crisis that's building in Russia.

And Russia's rating agency, ACRA, has also provided a report in May that highlighted the deterioration in the quality of loan debt and said around 20% of the entire banking industry's capital is accounted for by borrowers whose creditworthiness is in danger of significantly decreasing due to high interest rates. Now, we'll have a look at that in a bit more detail in a moment, but another paper in the same month by the Center for Macroeconomic Analysis and Short-Term Forecasting, which is a think tank with close ties to the Kremlin. So, again, an official body here. This isn't somebody in Ukraine that's basically throwing shade over what's happening in Russia. This is coming out of Russia itself. And that paper found a moderate probability of a systemic banking crisis by April 26. So less than 12 months ago. They are saying that Russia could be in the midst of a banking crisis. And it warned that the risk could rise if there continue to be a decline in the issuance of new lending and a further increase in poorly performing loans. So what they're saying is that the bank should pull back on the amount of lending that they're giving out. The problem with that is that that will prevent the economy from growing because companies in Russia need to have more funding to invest into their businesses to expand to increase their output and to grow. If you're cutting the amount of debt that's available, then that's going to restrict that growth and therefore restrict the growth of the Russian economy.

Now, if we have a look at some of the findings from the ACRA report, this is the official regulator in Russia. They've said that the regulators restrictive policy coupled with a reduced buffer to absorb unexpected losses among banking industry leaders will lead to a decrease in risk appetite and capital accumulation in the next 12 months. So that's basically saying that if the banks do start losing money and the bad debt starts growing rapidly then they won't want to provide any more lending and that will accelerate the slowdown in the Russian economy because if they cut off the supply of cash to all of the companies then the companies won't be able to keep paying the interest and so it could become a really vicious circle quite quickly. He went on to say in the previous two years bank capital adequacy has been steadily declining due to business growth dividend payments by the larger single players significant players and a gradual increase in risk waiting when calculated credential capitalization standards. So that's basically saying that the bank's risk is rising their capital adequacy is going down. They've said the adequacy of core and total capital at the end of 2024 decreased to 10.3 and 12.5 respectively.

So if we have a look at what they're talking about here, this chart shows the capital adequacy for the Russian banking sector and what we've got here are two different colored lines. We've got core capital which is shown by the light green section and we've got basic capital which is shown by the dark green section. So um, basically what capital adequacy is for banks is that they have to have some cash set aside to cover them for the risk of not getting repaid. So if we're looking at this it's it's somewhere in the region of 11 10 between 10 and 11%. So what that means is for every 100,000 that the bank is providing in loans, it has to have around 10,000 set aside just to cover that 1 in 10 risk of not getting repaid. So what we're seeing here is that we've got five different years, 21, 22, 23, 24. Um, well 24 split into two, so we've got four years, sorry. Um, and back in 2021, the core capital adequacy was 11% and then the basic was 13.7. So that meant that for every $100 that the banks were lending, they had $13.7 broadly and then 11 as a core base. So basically saying we've got 11 in every single circumstance. Now if we look at what happened in 2022, it increased from 11 to 12% went up. Great. But since that time, we've seen it coming back down. And in 2024, it was down to 10.3. But if you look at the split, you can see that in the first half of the year, it was at 11%, by the second half, it was down to 10.2. So that 10.3, which is a weighted average, the trend is that it's going down. So that means that the banks have less capital set aside, less savings to cover them for any additional losses. And obviously that is a risk.

And if we look at this chart, which shows the position for a variety of different Russian banks, if you're any good at reading Russian, you can see what the name of all of these banks is at the bottom. There's 1 2 3 4 5 6 7 8 nine banks represented here. My Russian isn't that great, so I'm not going to try to pronounce them or even tell you which the banks are, but these are the nine biggest banks in Russia. And you can see we've got three different years here. 23 is shown by the um, the light green section. We've then got the first half of 24 in dark green and then second off in blue. And what you can see is that for the vast majority of these banks there has been a significant reduction over the last two years and the blue section for the majority of these banks is the lowest point. So that tells us that the risk is rising in the banking sector.

And one of the points that was mentioned in the report is that one of the reasons why the banks have got less cash set aside for its capital is because they've been paying increasing dividends. And this chart shows the dividends that have been paid in 22,23 and 24 by Russian banks on average. And you can see that in 2022 it was 1.4%. So pretty low. And obviously 2022 is the year that the war in Ukraine started and so a lot of Russian banks were thrown into chaos. There was a big dip in the economy and so not a lot of dividends were paid. In 2023 that increased to 20.6%. And then in the first half of 2024 it was maintained at that level and then we saw an increase to 22.6%. So they're fairly substantial dividends. If you think about if you own stock in a bank in the west, you might get a dividend of 3% 2 3 4% maybe if you're lucky might even be as low as 1%. You certainly won't be getting a dividend of 22.6% which is what the Russian banks are paying and the problem with that is they have to fund that from somewhere and the fund they get from cash which is cutting their capital adequacy.

And if we go on to look at that point that was raised in the report, it's saying significant dividend payments around 1.2 2 trillion rubles more than half of which came from Spur Bank PJSC which is the biggest lender and other part one-time factors influenced the size of the largest bank's equity capital significantly and slowed capital growth despite the continued profitability in the banking sector including taking account of all of the income that they're getting. This is increasing the risk. So what we're hearing here from the Russian regulator is that risk is rising and capital adequacy is falling.

So what's the summary and conclusion today? Well, I wanted to post this video because I think what's happening in the Russian economy is really quite interesting. We've been talking for a long time about the pressure that is building on Russia in terms of the sanctions. We've had multiple rounds of sanctions applied by the West. So Russia is finding it difficult to make sales and also to acquire goods. And so as a result of that, we've seen a switch to this wartime economy whereby the state is sponsoring lots of businesses. So on at face value, it looks like the Russian economy is doing okay because lots of these companies are still reporting revenue and profits and they're employing people. So it all looks good when you just look at the numbers. But when you take a deeper look, when you look under the bonnet to see exactly what's going on, many of these companies are making things that are being used for the war in Ukraine. Now, that obviously doesn't provide any long-term returns. You're not seeing something that you're selling and there'll be repeat business from all of these customers that you're building up and all of that type of thing. What you're seeing is one-off purchases by the state that obviously are continuing for a long period of time. So this war has been going on for almost three and a half years. So anybody that's being paid by the Kremlin is having a great time right now. But the problem that these companies have is that if that war was to stop tomorrow, then all of those orders would be stopped immediately and then that would throw those companies into chaos.

But what it's also caused in the Russian economy is high inflation because the companies that are being paid by the state are offering high wages to attract in staff. That's increasing wages across the board in Russia. So that's pushing up people's free disposable income. So they've got more money. So they're spending more money and therefore inflation is going up. But also inflation is being driven by the fact that imports are now more expensive because of the sanctions. So that's pushed up prices as well. And all of this is putting immense pressure onto the companies that are not being sponsored by the state. They're still having to fend for themselves. They're still having to find buyers for their products. And the problem that they're having is that the sanctions are really hurting the export market. So most Russian companies are no longer exporting products to the west. They're not able to. So they're having to find new markets. They're trying to sell things into the Russian market which is more difficult as well. So these companies are coming under financial strain. And at the same time as that's happening because of the high inflation, interest rates are now at 20%. So that's increased the debt interest for any company that's borrowed money in the last few years. And all of this is increasing the pressure on these companies.

And what we're hearing today is that both Russian bank officials and the official rating agency in Russia have said that the risk has increased. The capital adequacy that the banks are setting aside to cover themselves in the event of non-payment of debts, bad debts, is going down. That's increasing the risk of a credit crunch and it's potentially one year away now. We are less than 12 months away from seeing some sort of credit event happening in Russia. And this will again further increase the pressure on the Bank of Russia to reduce interest rates because one of the factors in this equation is the 20% interest rates. But the problem that that will cause for Russia is that if you start reducing interest rates, it means that people may start spending more. They may have more disposable income. That could therefore drive up inflation, which is already sitting at 9.9% against the target rate of 4%. So interest rates come down, inflation starts going up, and if the economy doesn't take off, if it doesn't start booming, which it's unlikely to do, Russia could find itself very quickly in a situation called stagflation, where you've got a stagnant economy with inflation, and that is very difficult to shake off.

So that's one scenario. But the other alternative scenario if the bad bad debts do start ramping up and the banks start losing lots of money is that the banks will then withdraw all of their new loan products. So nobody will be able to borrow any money anyway because the banks don't have any enough enough capital to give out more lending. That would reduce the amount of cash that both individuals and companies in Russia have. So therefore they would spend less. So that would bring down demand and you would see a slump in the economy and potentially a recession. So either way, whichever way you look at it, this current situation in Russia does not look good. And over the course of the next 12 months, it could get significantly worse, particularly if we start to see the bad debts exploding as the Russian authorities have said could potentially happen.

So hopefully you've enjoyed today's video, you found it useful, informative, and thoughtprovoking. If you've liked what I've said, then please give me a thumbs up. Thank you for watching this video all the way through to the end. And thank you so much to everyone that's supporting me. If you've bought me a coffee or sent me YouTube, super thanks. Really appreciate that. Thank you so much. And if you're a long-term supporter, either through Patreon or YouTube membership or buy me a coffee membership, thank you. Your support really helps to keep me motivated. And here's something to put a smile on your face.