"CHEAP" MONEY

High interest rates on loans issued by Azerbaijani banks are considered to be a long-standing problem of the credit sector. The urgency of resolving this problem has long been included in the priorities of the Central Bank of Azerbaijan [CBA]. The market's tendency over the past few years aiming to lower interest rates this year has been underpinned by weighty arguments. These include the decision taken by the CBA in February to lower base financing rate, as well as lowered annual deposit rates guaranteed by the Azerbaijan Deposit Insurance Fund (ADIF) in August.

Causes and consequences

 The primary task of the government for the next decade is doubling the volume of non-oil GDP. To meet this objective the Cabinet of Ministers has drawn up a set of measures that envisage a stage-by-stage replacement of the state's current dominant role as a portfolio investor through the growth of the private sector in the industry's capitalisation. The non-oil sector entities will be mostly supported through expanded access to low-interest and long-term bank loans.

The bank community itself took certain measures to reduce the cost of credit due to the changed market demand. Strongly "overheated" in the pre-crisis period, the economy of the country was in need of excessive monetary fuel, while the high GDP growth rates and rapid turnover of funds involved in the economy allowed the companies to borrow money at relatively high interest rates, and easily absorb the associated risks. However, the marked decrease of the real economy's demand for "expensive money" observed in 2009-2010 forced domestic banks to begin a phased reduction in rates for different types of loans.

The statistics cited by the Central Bank of Azerbaijan clearly demonstrate these processes. By early September 2013 the average loan rate in national currency stood at 14,26 per cent, whereas the same figure for 2012 was 15,4 per cent. Comparing the current level with the figures of three or four years ago, when the average bank loan rate ranged between 18 and 20 per cent, one can clearly see the positive trend toward cheaper loans. 

"We must consider all factors that influence the growth of interest rates, since this matter requires a methodological approach. The business and consumer loans account for the majority of loans. The interest rate for both of them is not higher than the ones in Kazakhstan, Russia and other neighbouring countries," Alim Quliyev, the deputy chairman of the CBA, recently pointed out. In his opinion, recently bank resources have been becoming cheaper and the average loan rate of the Azerbaijani banks is in line with similar figures for the region's other countries. 

Difficult consumers

 The rate for consumer loans still remains quite high, for example, the rate for car loans averages 20 per cent. The urgency of this problem is quite high on the agenda, considering that consumer loans account for about half of the loan portfolio of the national banks. Therefore, the dominant trend for lowering interest rates remains topical, according to the CBA. Its experts had developed and from the beginning of this year began implementing a set of measures to this end, including lowering the base refinancing rate and the rates of insurance deposits, as well as administrative measures carried out in cooperation with commercial banks. 

The reason for the still relatively high interest rates, particularly in the consumer segment, has to do with some difficulties in the activities of banks in the financial market of the country. The banks are saddled with liquid assets at very low interest margins and assets that do not bring any interest because of their arrears and low quality.

Azerbaijani banks' lending standards are rather soft, as evidenced by not always high-quality assets, a high concentration of loan portfolios, very weak payments capabilities of borrowers, the inefficiency of the judicial system, especially in terms of foreclosure of the mortgaged property. All this creates a high risk in the retail credit segment, and the banks are trying to protect themselves from the hazards by keeping their interest rates high.

"It is quite obvious today that the consumer loans niche that the banks have been actively tapping into through the entire post-crisis period is close to saturation. Therefore, the interest rates for consumers are bound to fall with subsequent lowering of the profitability of the bank operations in this segment. This fact in the short term will prompt the banks to shift their focus on the overall market for financial services," the manager of the Baku Interbank Stock Exchange, Farhad Amirbayov, believes.

Margin decreases

 The reduction of interest rates is also clearly facilitated by the lowering of interest rates on deposits and bank accounts of the population, and a phased reduction of the margin between these basic parameters of the banking sector. For example, four years ago the average interest rate on bank deposits stood at the annual level of 16 per cent, and by September of this year fell to 9.45 per cent. As a result, the proportion of average annual interest rates between the bank deposits and issued loans dropped. Three or four years ago, the margin was correlated as one to two, and often to two and a half times, whereas today the gap between the average lending and deposit rate was reduced to less than 50 per cent. All of the above is largely due to the restructuring of loans, ensuring liquidity of bank assets at a lower percentage level.

This trend is further reinforced taking into account the fact that from 1 August this year the annual deposit rate guaranteed by the Azerbaijan Deposit Insurance Fund was reduced from 12 to 10 per cent. This decision will encourage domestic banks to further reduce interest rates on deposits. As a result, new opportunities will emerge to reduce the margin in the segment of consumer lending.

Today, with the significant growth of activities in the credit sector and high levels of liquidity the banks need to make additional efforts to further reduce the cost of borrowed funds. It is these motives that dictated the CBA decision to reduce the refinancing rate from 5 to 4.75 per cent effective 11 February. Of course, one should take into account that the change in Azerbaijan's refinancing rate for the most part plays an indicative role. Its adjustment is reflected in the financial markets and business indirectly, so the rate reduction is interesting, especially as the trend. This is a kind of CBA message to the financial market participants. In this way the Central Bank encourages lenders to direct available funds not into the currency market and the treasury bill market, but towards financing the real economy. Finally, the decrease in the discount rate, albeit indirectly, will have a positive impact on the market of securities and non-oil exports. In particular, the CBA's decision was designed to increase to some extent the demand for the securities, reducing the volume of supply and thereby increasing their market value. It was also expected that the decrease in the discount rate and, as a consequence, cheaper loans will encourage the development of export-oriented industries.

The policy of "cheap" money is often referred to as the "politics of inflationary lending" and, of course, with distorting the balance their pumping into the economy could trigger a rise in prices. However, with regard to the development of Azerbaijan, such a scenario is unlikely. First of all because of the very cautious macroeconomic policies CBA: the rate of inflation in January- September 2013 amounted to only 2.3 per cent. Based on this, we can rest assured that maintaining a low level of interest rates and reducing the cost of borrowing will become a long-term trend of the policy of the Central Bank.

Speaking of the mechanisms that aim to reduce the price of credit resources, we cannot fail to mention the ongoing measures that the CBA took in the last year to recapitalize the banking system, which can result in a serious reshuffle of the bank sector as early as 1 January 2014. About five or seven major banks with numerous free resources may form in the country. For the purpose of reinvestment of assets a group of such banks could bring down the interest rates on consumer loans (to a level of 5-10 per cent), "taking" this segment of the market for itself , including through refinancing loans from other banks.

In short, today it is difficult to judge what the situation on the banking market will be like in a year or two, but clearly in Azerbaijan, like in all developed countries, the gap between the level of loan and deposit rates gradually narrows, forcing every single credit organization to improve management efficiency and reduce operating costs.