MACRO PROBLEMS OF MICRO-FINANCING

Micro-financing has advanced into one of the most effective instruments for the development of small businesses in Azerbaijan over the past two decades. The volume of microcredits lent in the country exceeds ₼20 billion. High profitability, organizational flexibility and coverage of more than half a million customers allowed non-bank credit institutions (NBCIs) to act more efficiently than many banks. However, the global energy crisis, which resulted in the devaluation of manat and economic decline in Azerbaijan, collapsed the microfinance market in two years, reducing the volume of lending by ten times. 

Obviously, the credit sector of Azerbaijan has suffered the greatest damage from economic upheavals of the last two and a half years. The realities of the post-oil era resulted in decline in production and trade in a number of industries (primarily, the construction and real estate sector, automotive and consumer markets), which were traditionally the main directions for the banks.

Devaluation of the national currency further aggravated the situation leading to a large-scale crisis of non-payments for consumer loans and negatively influenced all spheres of national financial sector. Deterioration in the structure of assets, narrowing of operating space and reduction of profits resulted in the closure of almost one-third of the banks operating in the country (from 45 to 31 banks in 2015).

However, thanks to the efforts of the Central Bank and the Chamber for Supervision of Financial Markets, the situation in the banking sector has stabilized. Unfortunately, a completely different situation developed in the microcredit market, where non-bank credit organizations had dominated throughout all these years.

Unlike banks, NBCIs remained aside from the programs of financial market sanitation implemented in the last two years. They needed help in no less degree than the banks, since the crisis of non-payments caused by the devaluation and the reduction of credit activity in the regions hit the NBCIs with a double force.

The scale of this problem was voiced during the 5^th Investment Fair "The Future of Microfinance in Azerbaijan: Challenges and Opportunities".

In 2015, the clientele of microfinance institutions (MFIs) exceeded 600 thousand people, and the loan portfolio reached ₼800 million. "However, the clientele decreased to 298 thousand people in 2016, and to 118 thousand people in 2017, while the aggregate loan portfolio decreased to ₼80.1 million," said the chairman of the Association of Microfinance of Azerbaijan (AMFA) Suleyman Kalashev.

The reason for such a difficult situation in microfinancing lies in the peculiarities of NBCIs activities. Firstly, non-payment of MFIs loans was much more acute than in the banking sector. Unlike banks, NBCIs operating mainly in the regions of Azerbaijan often provided microcredits without collateral. The main clients of MFIs are small family farm enterprises, small-scale trading businesses, small workshops, etc., which borrowed capital for relatively short periods (often for one or two months). Since majority of NBCIs operating in Azerbaijan represent branches of profile foreign companies attracting credits from abroad, loans to small entrepreneurs were issued in manats linked to the exchange rate, or directly in foreign currency.

As a rule, the repayment of such loans (on average from 500 to 5 thousand manats) during the period of stable manat rate was not difficult. However, after the devaluation, the return of microcredits has become an impossible task for a considerable number of participants in the microcredit market. Given the narrowness of the consumer market in the regions of the country, many borrowers were forced to significantly reduce, or even curtail their business activities.

As a consequence, the crisis processes led to a significant reduction in the number of microcredit organizations: if two years ago there were more than 150 NBCIs in Azerbaijan, today this number decreased to 123. The situation has gotten even worse as NBCIs, unlike banks, may not attract deposits and, accordingly, cannot use ADIF funds to repay borrowed funds.

"As a result, we witnessed a deterioration in the quality of microcredit portfolio, the sector worked at a loss, lost customers and assets. Since the beginning of the Chamber's activities, we have done a lot of work to improve the sector: a number of virtually non-functioning financial organizations that do not meet the regulator's requirements left the market. It is worth noting that the market today is working with a profit," said Deputy Chief Executive Officer of the Chamber of Financial Market Supervision Asim Zulfugarov.

According to Mr. Zulfugarov, the main challenge of the regulator is to ensure the stability of microfinance market, for which it is necessary to ensure stable activity of the sector and access to financial resources.

The first steps in this direction had a certain positive impact on the microcredit market. "To mitigate the negative effect caused by the devaluation and to ease the borrowers' situation, microfinance organizations were forced to restructure loans, write off penalties for late payments, and carried out a number of other activities," said AMFA Chairman Suleyman Kalyashev.

However, a number of urgent measures have to be taken in order to regain former positions and qualitative growth in microcredit market indicators. First and utmost, it is necessary to ensure access of MFIs to low-cost manat resources.

"The devaluation of the national currency led to a significant increase in the volume of unreturned loans in both the banking and microfinance sectors. Investors and creditors operating in the microfinance sector prefer a more cautious approach," believes AMFA Executive Director Zhala Hajiyeva, noting the important role of the Credit Guarantee Fund in facilitating entrepreneurs' access to financial resources.

The need for state support in providing access to manat resources is an extremely important issue, as after the devaluation, most borrowers in the consumption sector and entrepreneurs in the small and medium-sized businesses are cautious in attracting loans in foreign currency. However, under current circumstances, the policy of the Central Bank and the Chamber of Supervision of Financial Markets excludes a noticeable increase in the provision of resources in the national currency. On the contrary, in the past two years, the country has been pursuing a strict monetary policy: in particular, the CBA's discount rate has been increased several times, deposit auctions have been held to sterilize excess manat and maintain low inflation. Given the prevailing trends, it is difficult to expect a significant increase for MFI funding from the state.

Some non-bank credit institutions expand the issue of securities, raising the rate of return on bonds to increase manat resources. But this leads to a rise in the cost of borrowed resources, which reduces demand in the market under existing conditions.

At the same time, NBCIs may not attract deposits from the population, and therefore face certain difficulties in attracting foreign exchange credits from abroad.

According to S. Kalashev, several new foreign investors are ready to provide manat loans to microfinance organizations operating in Azerbaijan: "They show interest in the local microfinance market and are ready to issue loans in local currency by converting their dollar funds." However, in this issue, it is necessary to create mechanisms that minimize the risks of investors in the event of another crisis in the foreign exchange market.

To overcome this obstacle, the participants of the microfinance market of Azerbaijan advocate the creation of hedge funds in the country. "It was suggested to create a hedge fund to insure risks on dollar funds attracted from foreign investors and issue loans to local clients. This would help significantly expand lending by microfinance organizations," said AMFA board member, financial expert Jalal Aliyev.

The introduction of hedging instruments in Azerbaijan is envisaged in the strategic roadmap for the development of key sectors of the economy. They would significantly simplify the provision of loans in national currency by European banks and international financial corporations, says Angela Prigozhina, a leading expert of the World Bank (WB) in finance and the private sector in the South Caucasus.

Among other measures necessary to accelerate the development of the microfinance market, it is necessary to review the legislation on NBCIs and modernize the procedure for judicial decision to repay loans. In order to restore the microfinance market as soon as possible, AMFA experts suggest supporting NBCIs through providing a tax holiday for several years, in particular, for income tax.

One of the options for the development of microfinancing is the use of the tools provided by Islamic financing.

According to the executive director of the Center for Analysis and Economic Reforms and Communications Vusal Gasimli, microfinance organizations of Azerbaijan should expand the list of their services through microinsurance, microassemblies and transfers, etc. Also, microfinance institutions should actively use financial technologies in their work, such as the introduction of an online platform imitating direct contact with the consumer, including the functions of electronic financial advisors as an intermediary. Such mechanisms accelerate, simplify and reduce the cost of financial institutions.

"If microfinance institutions do not start using new financial technologies and tools, they will not be able to cut costs. Thus, their loans will no longer be attractive to businesses and households. The era of expensive loans is over. Today it is necessary to offer loans that will be attractive to customers," said V. Gasimli.

In short, the survival tools for the financial sector are available. It is important to catch the momentum and to be able to follow the market trends.