MONEY MAKES MONEY

It seems that the world will be dreaming of financial stability for a long time - trust in this area over the past two years has been undermined so much that without fundamental changes in the system, it is unlikely to restore its image. "Fortunately", the regular "collapses" and bankruptcies of some companies, in which well-known banks are invariably involved, constantly fuel the negative public sentiment about the sustainability of existing economic and financial models.

Azerbaijan completed 2009 without any losses in the financial sector, but it would be wrong to say that the world situation had absolutely no impact on the domestic market. Yes, the Central Bank has done much and continues to make every effort to keep the situation within acceptable standards, but we should admit that it is quite difficult and expensive, although the CBA says that, despite everything, the measures in this direction will continue in the future. "The main objective of the Central Bank of Azerbaijan (CBA) for 2010 is to maintain inflation at a low level, to ensure the stability of the manat, to deepen the stability of the financial and banking sector and to meet the economy's demand for cash," the CBA said in a statement on the main aspects of its monetary policy in 2010.

Organization and stability

Thus, the efforts of the CBA were not in vain - now the situation in the banking system of Azerbaijan is that neither a sharp drop in economic growth, nor significant fall in real estate prices, nor the full repayment of the current debt portfolio will create problems for it. And all is thanks to the availability of appropriate financial reserves to overcome such shocks. According to the director-general of the Central Bank of Azerbaijan, Xaqani Abdullayev, the stress tests conducted by the CBA Research Department allow us not to doubt these assertions.

Sceptics would say: what will happen if the reserves run out? The use of substantial resources to maintain the stability of the financial situation reduces the possibilities of the CBA, and therefore, it can create a dangerous situation in the future if the crisis in the world is not overcome completely. However, in this case, we can object: first, we are not talking only about financial injections into the banking sector - it is just one of the measures. It must be remembered that at the beginning of the crisis, the Central Bank began to limit the use of foreign borrowings by local banks in a timely manner, and imposed certain regulations on the compulsory reserve ratio and the volume of loans involved. "The active dialogue with the banks reduced the financial risks and increased the liquidity of banks and their resilience to possible shocks. The Central Bank tightened the requirements for capitalization and for the quality of the loan portfolio. All these measures helped to ensure the stability of the banking sector during the recession on the world market," said Abdullayev.

If at the beginning of the global financial crisis, foreign borrowings by Azerbaijani banks accounted for 20-22 per cent of their total liabilities, in one year they repaid loans of approximately $900 million and in two years - $2 billion, he said. The Central Bank prepared a schedule of payments on external liabilities and possible volumes of resources used by Azerbaijani banks for a period of about 9-10 months. "This allows us to individually analyze the liquidity situation of each bank," he said. "Due to the fact that in recent years banks have borrowed more resources from domestic sources, they were not faced with a lack of liquidity."

Thus, currently, the instantaneous liquidity of the banking sector in the country is 80 per cent, while overdue loans comprise only 4 per cent of the total loan portfolio. Indicators of the capital adequacy of Azerbaijan's banking sector are also at a high enough level. According to a CBA survey "On financial stability", in comparison with the beginning of the year the total capital of banks increased by 14.7 per cent or 219.4 million manats, reaching 1,711.1 million manats. The increase in the total capital of banks occurred due to an increase in Tier 1 capital, which rose by 194.7 million manats or 17.8 per cent and amounted to 1,286.5 million manats. In the structure of Tier 1 capital, the proportion of undivided profits and reserve capital increased. The adequacy of the banking sector's capital amounted to 19.4 per cent against 19.6 per cent on 1 January. The preservation of capital adequacy during the year at a high level is due to the fact that the growth rate of capital (from the beginning of the year by 14.7 per cent) was adequate to the growth rate of risky assets. As a result, the adequacy of capital in the sector significantly (by 12 per cent) exceeded the minimum standard of the CBA. The current level of this index shows the presence of a sufficient level of capital reserves at banks.

In other words, the CBA's policy of adaptive risk management in the banking system makes it possible to keep the financial system "afloat" on a long-term basis. In any case, this year should also see no concerns in this area. The CBA statement says that to achieve all the goals, banking supervision tools will be improved, primary alert systems will be integrated and the introduction of new prudential reporting will begin. At the same time, the CBA intends to develop methods of consolidated banking supervision, standardizing stress tests and establishing a single model.

Consolidation and restructuring

Naturally, the crisis or the post-crisis period require a more careful approach to so-called institutional arrangements in the banking sector, in particular, to the acceleration of the consolidation of small banks and the restructuring of systemically important banks. It must be noted that at present there are 46 banks in Azerbaijan, and 23 of them involve foreign capital.

In principle, all previous measures in this area have shown the effectiveness of the chosen path, but the process is not yet complete and many experts agree that the number of banks in Azerbaijan could be completely reduced, which will only enhance the viability of the system. Thus, the president and chairman of the board of VTB Bank (Azerbaijan), Oleg Krasnozhon, believes that the development of the banking system in Azerbaijan is rather high in terms of legislation and the banks themselves, but their number is slightly higher than the local economy needs, and eventually there is a need for consolidation and amalgamation, "because the development of business requires a stronger financial structure". Today, in his opinion, the first 15-20 banks in Azerbaijan are working well and efficiently.

The need to consolidate banks was recently announced by the first deputy chairman of the CBA, Alim Quliyev, in connection with which the Central Bank intends to intensify its work in 2010. "Although the banks that do not meet the CBA's minimum requirements for capitalization have little market share, in 2010 we intend to include in the agenda the issue of merging banks or phasing out the banks that do not meet the requirements," Quliyev said. He said that after the introduction of the law on non-bank credit organizations, which is expected to be adopted by the country's parliament by the end of the year, this category of banks will be asked to change their form of ownership to non-banking credit organizations (NBCO). "Next year, the banks that do not settle for consolidation with the aim of enlarging their capital will be invited to transform into NBCO," Quliyev said.

Today, four banks do not comply with the minimum authorized capital requirement, which is defined at 10 million manats. According to CBA statistics, by the end of October 2009, the capital of 41 banks exceeded 10 million manats against 43 banks at the beginning of the year. Accordingly, the share of this category of banks in the total capital of all banks fell from 98.6 to 97.8 per cent.

Presumably, it is the CBA's constant and competent control of the situation on the banking market that keeps foreign investors interested in entering the banking sector of Azerbaijan, and this is very significant during the crisis period.

Inflation and competitiveness

The regulation of the banking market and the maintenance of financial stability in the country allow us to hope for long-term sustainability of the economy as a whole, especially as the CBA is also "responsible" for such an important macroeconomic indicator as inflation. In 2010, the Central Bank, using its mandate, will provide support to maintain the average annual inflation rate of the official projection - 3 per cent, but this projection can be further refined during the year, depending on the impact of global economic recovery on domestic inflation. "During the discussion of the draft budget for 2010, the average annual inflation rate was set at 3 per cent, and the Central Bank aims to maintain this level of inflation. Of course, this forecast could change if economic growth in the country exceeds expectations and aggregate demand channels expand even more rapidly as a result of growth in individual consumption, investment and public demand. Under such economic activity, the forecast of inflation in the country may be revised," Abdullayev said.

The Central Bank in 2010 also intends to ensure competitiveness in the country, he said. "Some economists have advocated a devaluation of the currency this year, and believe that it could become a factor that boosts competitiveness. However, studies show that even if higher inflation occurs after the devaluation, it could further aggravate the development of competitiveness in the country," he said.

According to Abdullayev, to date, the most generalized index of competitiveness for Azerbaijan is the real effective exchange rate of the manat against the currencies of the country's trading partners, which is changing in favour of Azerbaijan. "Today that figure in relation to the currencies of all the country's trading partners since the beginning of the year is 6 per cent lower. And in 2010, we intend to support this process at least at a neutral level," said the director-general.

During 2009, the rate of the Azerbaijani manat for the dollar remained stable, and in the third quarter it fell against the dollar by 0.05 per cent and for the euro - by 4.8 per cent. The Central Bank believes that the main causes of the cheapening of the manat at the beginning of the year (in February) were certain changes in the rates of the world's leading currencies under the impact of the financial crisis and the psychological influence of the devaluation observed in neighbouring countries. "Despite this, the Central Bank, through intervention in the market, was able to maintain the stability of the exchange rate of the manat," says the survey. "As a result of uncertainty about the rate from the very beginning, legal and natural persons have been interested in buying foreign currency, but as the rate of the manat stabilized in the last two quarters, demand for foreign currency fell."

According to Abdullayev, in 2010 the CBA will pursue policies aimed at reducing bank interest rates and maintaining the stability of the manat. The fundamental basis for maintaining a stable exchange rate of the manat is the forecast on a surplus in the country's balance of payments even despite the conservative forecast on oil prices. During the conduct of the exchange rate policy, the preservation of the country's international competitiveness will also be considered.

In other words, according to the CBA, the Azerbaijani economy, and in particular, the financial sector will also see no major upheavals in 2010, and if the world situation tends to improve, we may be talking about long-term sustainable development.