PLAN FOR FIVE YEARS

In recent years, the high dynamics of economic development in Azerbaijan, the rapid growth of the financial system and the volatile and complex global economic environment have created new challenges for the Central Bank.

It order to respond effectively to these challenges, the CBA has identified new priorities for strategic activities aimed at increasing support for economic development, as well as human capital, bringing institutional governance in line with current practices, maintaining macroeconomic stability and the financial stability of the banking system and modernizing the functions that serve the main mission of the CBA.

The new action plan, designed for 2011-2014 and presented by the Central Bank chief Elman Rustamov on 21 July, sets nine strategic objectives that will enable the CBA to become an important government institution which supports macroeconomic stability and sustainable development in the country.

CBA strengthens supervision

It was during the global financial crisis, as well as the post-crisis period that the improvement of banking supervision became a subject of heated discussion in the international arena. These processes were closely monitored by the Central Bank of Azerbaijan. In order to amplify the activities of the CBA in improving banking supervision, several innovations are being prepared.

The innovations are expected in three directions - in strengthening supervision related to risks, improving corporate governance and risk management in banks, as well as introducing counter-cyclical supervision.

Regarding the first point, we should note that in order to secure safe management of capital, liquidity and credit risks, the CBA once again restored the "leverage" norm (a tool that links the growth of assets to capital growth) this year, but in a more rigid form. The "leverage" norm will limit the strong growth of banks. It must be noted that the decision to use this norm of 8 per cent was made in late 2010. In this regard, banks should observe a correlation between balance capital and assets plus balance-sheet assets. A similar practice has already been used in the banking sector of Azerbaijan, but the effect of this norm with a coefficient of 6 per cent was suspended in 2003.

With respect to two other points of innovations, it should be noted that the Central Bank is currently preparing measures to improve the quality of bank management, which include issues of corporate governance and risk management. More detailed and qualitative rules have been prepared on risk management, as the previous rules on the development of corporate governance in banks were adopted in 2004 after the adoption of the law "On banks".

An interesting detail: one of the innovations in this direction will be the adoption of rules on compensation to bank managers. The Central Bank is holding consultations with banks on the issuance of bonuses to bank managers. This will help change bank managers' approach to management, as the high rate of return will help them receive large bonuses.

We must say that this issue is being actively discussed all over the world, in the G20 countries, the Basel Committee, as well as all other major platforms. And, perhaps, the CBA will be among the first in the world to introduce this tool, which is being discussed at such a global level today.

Currently, the CBA is also working to establish a system of macro-prudential supervision for assessing systemic risks and their management. To this end, a normative and methodological base is being formed, and this system will make it possible to supervise the entire banking system of Azerbaijan. At the same time, the CBA will be forming groups of banks. To this end, the Central Bank's internal criteria and new standards for short-term liquidity will be approved.

New counter-cyclical policy

The CBA is also currently discussing the possibility of using a new counter-cyclical policy and forming a model of caution policy on its basis. In particular, the banking system is currently using a model of statistical caution and redundancy is based on asset classification. The new model provides for the creation of reserves on the basis of economic cycles.

According to the head of the CBA Department for Supervision of Credit Institutions, Rasad Orucov, the counter-cyclical redundancy model has already been developed and "now we are thinking more about how to choose the right time to start its implementation. Depending on the situation, it may be decided to apply it not this year, but in 2012."

"In counter-cyclical redundancy, dynamic reserves are also added, which is due to the growth in banks. At the moment, with good asset quality, reserves are not being created, but as their quality deteriorates, there is a need to create large reserves," Orucov said.

The need to create additional reserves is due to the fact that the profitability of the banking sector is also affected by the overall economic situation in connection with the onset of another economic cycle, since it increases the pressure on banks from the supervisory authority to ensure the necessary profits and retain the capital adequacy ratio at the required level. The norm of capital adequacy, established by the Central Bank at 12 per cent, is considered high enough, as the regulatory requirement of the Basel Committee is 8 per cent.

The new model invites banks to create additional reserves regardless of the state of assets, i.e. even despite the good quality of assets, which will provide a solution to problems in the future.

Currently, the Central Bank is deciding on the timing of the implementation of this model. However, "we do not want to put additional pressure on banks". If this year banks demonstrate good performance in terms of profitability and growth, it will be possible to introduce a counter-cyclical redundancy model from 2011. Also today, various options for the introduction of factors are still being worked out, which will depend on the amount of bank loan portfolios for which additional reserves will be created," Orucov said.

Today, reserves are being created in relation to problem assets based on three indicators (30, 60 and 100 per cent). In this case, the total assets of Azerbaijani banks during the year grew by 7.8 per cent, reaching 12.97 billion manats by early June 2011, while the total volume of credit investments amounted to 8,750.4 million manats, 6.3 per cent of which is overdue. Last year, this figure was 4.4 per cent.

And finally. The main issue for the CBA after the crisis is to improve the liquidity management of banks. Currently, the stability of the banking sector is a magnet for speculative capital. In this connection, it is planned to develop tools that will limit the inflow of speculative capital.

Thus, the CBA has undertaken to solve the basic problems of the banking sector over the next five years, which is certainly important in terms of the need to develop the internal banking market and to protect it from exposure to negative developments on external markets.