Summary: The state-dominated financial sector confronts several critical challenges. Deep and long standing structural problems and negative external spillovers are creating distortions affecting the credit channel and overall financial stability. Financial sector contingent liabilities are on the rise accentuating an already weak fiscal situation. The government is directing a large proportion of loans from state-owned banks to unhedged state-owned corporates. A Development Bank (DB), created in 2011 to centralize such directed lending, has grown rapidly to assume systemic significance. External imbalances, combined with low international reserves and significant negative spillovers from Russia—the main trade and financial partner, have weakened corporates’ ability to service foreign-currency obligations.

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