THE SPARK FOR FUTURE REFORM

Azerbaijan's  financial sector was shaken this month by news of the possible closure of half of the country's banks.  Or, to be more precise, of halving the number of banks by takeovers of the smaller players in the banking market.

Naturally, the news came as a shock to the market.  The questions arose of what would happen to deposit savings, whether or not they would be returned in full, whether or not it was worth the customers' while to keep their money in a bank at all, which banks are trustworthy today and so forth.  Some of the Azerbaijani media added fuel to the flames when they published a list of banks to be "scrapped", claiming that their information was accurate.  All this forced the country's Central Bank to make a new statement contradicting the earlier one - that the issue of closing down banks was not under discussion at present.

However, a different factor makes all this interesting:  The Central Bank of Azerbaijan skilfully forecasts and analyzes financial processes, not only within the country, but also internationally. This, in large part, is precisely what made it possible to avert detrimental effects from the global economic crisis. But it was found unable to foresee the fire its initial statement would start.  What then, was the need for all this fuss?

There are statements and there are statements

So, the Central Bank of Azerbaijan's statement, which was made by Alim Quliyev, first deputy chairman of the Board, was quite straightforward and did not allow for any ambiguity.  "At present, 46 banks operate in the country, and we believe that this is an excessive number for a country like Azerbaijan.  This is why one of the main objectives for the Central Bank in 2010 is to prepare a strategy of consolidation and optimization of the banking system," he said, speaking before the camcorders from news programmes of all the republic's leading TV channels.

At present, in A. Quliyev's opinion, a considerable number of banks are not system-forming in terms of their main financial indicators.  "This is why we think that 15-20 banks is the optimum number for Azerbaijan.  In this connection, the Central Bank will conduct an optimization of the banking network in 2010, and this process might take more than 1 year," said the first deputy chairman of the bank.  He added that the Central Bank would start implementing the strategy of consolidation of banks this year.  At present, the details are nailed down, but the process of implementation would be long-term, he said.

"The banks have three options:  banks which are not system-forming in terms of their assets and transaction turnover, will have to either merge into one major bank by combining their sound assets, or transform themselves into non-banking credit organizations; and the weak banks will be liquidated," Mr. Quliyev concluded his clear statement in quite unambiguous manner.

In principle, the plans for the consolidation of local banks which do not function efficiently have been voiced by the Central Bank more than once.  But hardly anyone expected that the process would be of such a sweeping nature or would start in the near future.  Immediately after the statement was made, a panic of sorts set in at the banks themselves - the specialists who work there began to predict imminent significant layoffs.  In addition, this created quite unpleasant publicity for the bankers:  no sooner had the practice of keeping savings in bank deposits gained popularity in Azerbaijan than the issue of bankruptcies, bank closures and reforms arose.  For many ordinary customers this means losing trust in the banking system.  Naturally, some of them might not want to keep their deposit accounts and, in general, will be more cautious about dealing with the banks, despite the existence of the banking accounts insurance fund, which involves 42 of the 46 banks operating in the country.

Of course, the most interesting question for everyone in this context was which particular banks would be affected by the reform.  Some of the Azerbaijani media rushed to supply an answer and published a list of banks which were to be closed down, although the source of the list remained unclear.

The Central Bank reacted to these media reports with another official statement, which practically contradicted its first statement:  that the closing of banks was not currently under discussion and no decision had been made on it.  "Azerbaijani banks continue to operate in normal mode, and there are no risks which could have a negative effect on their financial situation or potential."

Support and approval

Overall, no particular objections were raised to the Central Bank's plans to consolidate the domestic banking market:  it is no secret that some banks had tough times during the crisis and, without the Central Bank's assistance, they would be unlikely to exist today.  And the Central Bank's potential is not unlimited, which bank managers realize, so the prospect of continuing their work by merging with their "colleagues" is like a straw for a drowning man today.

However, Eldar Ismayilov, head of the Association of the Banks of Azerbaijan (ABA), argues that this process should unfold in a natural manner, that is to say, the process of the country's economic development will make it clear which banks and non-banking credit organizations will "survive" the competition and which of them will have to merge or simply disappear.  "In 1994, there were more than 230 commercial banks in Azerbaijan, and now there are only 46, of which some opened later, and some were opened in recent years.  That some banks opened and other banks disappeared from the market was a natural, evolution-like process," he noted.  In Mr. Ismayilov's opinion, the Central Bank must continue to monitor the banks' compliance with the letter and the spirit of the law:  "The economy cannot be served only by system-forming banks.  International experience shows that there are 10-12 ordinary, 'non-system-forming' banks for every system-forming bank.  This is why the policy of Azerbaijan's Central Bank should imply an equally positive attitude towards all banks: large ones and medium- and small-size banks."

Let us note that the plans to upsize banks were immediately approved by two international financial institutions at the same time: the International Monetary Fund and the European Bank for Reconstruction and Development.  For example, Nienke Oomes, head of the IMF mission in Azerbaijan, said that reducing the number of banks would make competition fiercer, simplify monitoring for the Central Bank and help to reduce interest rates, which remain quite high.  "Considering the recent slowing down in the rate of inflation, these measures should help reduce interest rates and bridge the gap between the interest rates on loans and deposits," she said.  The mission head said that tightening prudential requirements helped to create a sound banking system in the country, and this is a widely used practice elsewhere in the world.

The EBRD President Thomas Mirow said during his visit to Baku that the European Bank was even ready to provide appropriate assistance in the process of consolidation in the Azerbaijani banking market.  "If an individual approach to every bank is exercised, we will be able to determine, using initial assessments, how to help every bank in the consolidation process," said Mr. Mirow.  He noted that liquidity is not a big problem for Azerbaijani banks at present.  "There are other problems, like management of assets quality and evaluation of credit portfolios.  And consolidation will help to address these problems successfully," he stressed.  Let us remind our readers that in the past, the EBRD helped the Promtekhbank and MBank merge into UniBank.

Looking to the future

Summarizing all of the above, let us repeat:  the Central Bank's statement on consolidation attracted attention, not for its content, but for its form and proposed time table.  Simply speaking, why did the Central Bank need to cause a public stir by voicing its plans and then retracting its statement to end the panic?  Could the Central Bank analysts not predict the effects of Mr. Quliyev's statement?

Two conclusions can be drawn here:  either the situation in the banking market in general is quite serious but this is being kept secret from the public, or the statements were aimed at achieving some purpose of the Central Bank and were "testing the ground" for future decisions.

Of course, as already mentioned, the Azerbaijani banks did experience some difficulties during the crisis, but this does not mean at all that the market has lost stability or that the banks are on the verge of bankruptcy.  There are specific statistical data and published rankings with full descriptions of the situation in every bank.  And these testify that the banks showed growth in all financial indicators in 2009.  Last year assets increased by 13.5%, credit portfolios increased by 17.4% and individual deposits increased by 22.5%.  The total capital held in banks increased by 17.6%.

However, there are some negative indicators of banks' profitability.  For example, in January the number of banks which were profitable was 33, down by 2 compared to January 2009 and by 6 compared to December 2009.  The total profits of the banking system fell by a factor of three compared to January 2009, to AZN15.66 million.  The number of unprofitable banks has increased by six since the beginning of 2010 and by 2 compared to January 2009.  As a result, the losses of 13 banks reached AZN12.42 million, which is 55% more than in January 2009.

These statistics are bound to alarm the Central Bank.  At the same time, it is known that the key factor in the reduced profitability was excess liquidity, that is to say, to put it differently, the banks continue to open new accounts, but they also continue to pursue a very cautious lending policy, because of the burdens of "problematic" loans, which disturbs the balance of the two banking portfolios.  The banks have money, but that money is "dead," so to speak.

"The lessons of the crisis show that every loan should be issued very carefully.  Today, banks loan mainly to reliable, solvent clients but, on the other hand, the population increasingly keeps its savings in the banks," said the same Mr. Quliyev.

When the inflation rate is low, individual customers prefer to keep their financial resources in the bank rather than investing it in business, Mr. Quliyev added.  From this point of view, banks are busy today attracting deposits; high interest rates on deposit accounts and the banks' problems with investing the money attracted result in lower profits.

The Central Bank statement might easily trigger a withdrawal of deposits from banks and "lighten" their liquidity.  A number of experts have proposed this, at first sight absurd, explanation for the two mutually contradictory statements by the Central Bank, and it has the right to exist.  It was for a reason that the Central Bank also made a statement very recently about plans to stimulate a fall in interest rates on both deposit accounts and loans, which was aimed at restoring the balance of the banking portfolios.

On the one hand, these statements act as a disincentive to the population, who will now be more cautious about banks which do not have the reputation of being stable institutions.  And this will eventually translate into the natural evolutionary process of a consolidation of the entire market which Mr. Ismayilov mentioned above.

One way or another, the Central Bank apparently had quite a good idea of the possible consequences of its statements, so let us hope that it will achieve the intended results for the benefit of the entire banking system of Azerbaijan.