STABLE BANKING REGIME

Despite the relative stabilization of the market and active regulatory reforms, the Azerbaijani banking sector is still exposed to crisis. However expected, the bankruptcy of one of the country's oldest and largest banks, DemirBank OJSC, at the end of 2017 has added a definite dose of alarms to the overall negative situation.

However, local and international experts are quite optimistic and are waiting for positive changes this year.

Results of the last year

Statistical indicators of Azerbaijan’s banking sector for 2017 published in February clearly show the priorities that the bankers chose to restore their market positions and tame the crisis. For example, last year total assets of the banking system of Azerbaijan decreased by 11.2%, but at the same time their total capitalization grew almost twice reaching ₼3.7b. The fact that banks were willing to “sacrifice” other indicators for the sake of capitalization is understandable. Apparently, the shortage of capital funds was the main reason for the closure of more than 10 local banks in the last two years. According to the requirements of the Central Bank effective since January 1, 2014, the minimum aggregate capital of banks should be at least ₼50m. The goal of this decision was to leave strong players in the market, forcing the weak to consolidate finances or to leave. The devaluation of manat in 2015 and the following banking crisis have accelerated this process. The decrease in the volume of assets, unprofitable activity (only in 2016 total net losses of Azerbaijani banks reached ₼1.7b), as well as the need to channel considerable funds to maintain bank reserves eventually shattered even the banks that seemed to be “healthy”.

Also, the banks have become extremely cautious about lending to the economy: in 2017, their loan portfolio for customers in Baku and the regions decreased by 30.2% and 18.9%, respectively compared to 2016. This was due to the tightening of requirements concerning potential borrowers and the decrease in the number of borrowers expecting the growth in interest rates. According to CBA, at the end of 2017, the average rate on loans in national and foreign currencies was 13.2% (12.05% in 2016) and 8.6% (9.76% in 2016), respectively.

As for the deposits, the customers have become cautious after the bankruptcy of several banks that risked accumulating the deposits, which exceeded the limits guaranteed by the Azerbaijan Deposit Insurance Fund (ADIF). Since March 1, 2016, ADIF has guaranteed insurance for the deposits placed at 12% in the national currency and 3% in foreign currency. Accordingly, the average interest rate of banks for individuals in 2017 was 11.59% (10.31% in 2016) for deposits in national currency and 3.66% (5.44% in 2016) in foreign currency.

Dollarization persists

Despite an almost fourfold difference between the average rates in favor of manat, the dollarization of public bank deposits in Azerbaijan still remains high (66.5%). Last year this segment showed positive changes because 79.6% of depositors wished to place their deposits in dollars a year earlier. According to CBA experts, the decrease in dollarization and the reduction of inflationary expectations contributed to the increased supply in the currency market, and the Azerbaijani manat has strengthened by 4% since the beginning of 2018, although manat’s rate was expected rise under a flexible exchange rate policy manat effective after the second quarter of 2017. In short, if manat is able to maintain a relative stability of exchange rate, we can expect a certain balance in the future.

However, according to CBA, the flexible exchange rate of manat will be preserved at least this year. “The central bank can intervene in small and limited amounts in the foreign exchange market in order to prevent short-term changes in the national currency rate,” says the CBA statement on the main directions of the monetary policy for 2018 and the medium-term period. The Central Bank notes that stability in the currency market of Azerbaijan in 2018 will be provided due to the projected transfers of the State Oil Fund and the balance of payments.

“We do not buy or sell currency at auctions, but we do not want to allow a sharp reduction in manat’s exchange rate. This can lead to a number of undesirable macro and microeconomic risks. Therefore, we are currently implementing an “interim” policy that is an integral part of the full transition to the floating exchange rate regime of the national currency. We have three goals: a stable rate with low volatility, cheap currency and low inflation. All these goals are equally important,” said the CBA Chairman of Board Elman Rustamov.

Incidentally, this stability to a certain extent has influenced some growth of public confidence in banks. Either way, the public bank deposits in Azerbaijan increased by 1.5% in 2017 reaching ₼7.6b. In other words, despite obvious problems in the sector, the population has not turned its back on banks completely and still entrusts their money to the banks.

As to statistical figures of the banking sector over the past year, it is necessary to specify one more indicator: after more than ₼1.5b in losses in 2016, last year the banks managed to reach the total net profit of ₼883.6m.

Thus, the banking sector of Azerbaijan was actively stabilized in the past year, according to market actors. According to the Chairman of Pasha Bank Taleh Kazimov, “the implementation of a balanced monetary policy, strengthened control over the risk management system, as well as actions aimed at increasing the capitalization of the banking sector and improving prudential norms had their effect and influenced the recovery of the market.”

The program of reforms

Amidst more or less positive results, not only the local experts note quite optimistic forecasts for the near future.

Fitch Ratings outlook for 2018 predicts the revival of lending in the banking sector of Azerbaijan. “The banking sector of Azerbaijan remains very vulnerable. But we expect that in 2018 lending will grow after the fall in 2016-2017,” states the agency. Fitch estimates that the completion of restructuring of the external obligations ($2.3b) of the country's largest bank, the International Bank (IBA), helped restore the capital positions and the quality of the bank's assets. “The next step is to privatize the IBA and close a significant open currency position of the bank,” stated the agency.

Another rating giant, S&P Global Ratings, published a similar statement. “We believe that most of the risks for Azerbaijan due to the weak banking system have already materialized. Despite the fact that the financial system of Azerbaijan remains weak, we predict that it will gradually strengthen thanks to the economic growth of the country,” said the agency.

S&P is positive about the recent changes, which have vested additional supervisory powers to the regulator of the financial and banking system, Financial Market Supervision Chamber (FMSC).

The agency notes that the stability of the Azerbaijani banking sector will gradually improve. However, the agency estimates the share of non-performing loans at 20%.

“The effectiveness of monetary policy of Azerbaijan remains limited due to weak internal banking system, underdeveloped capital markets, high level of dollarization of the banking sector,” believe the agency's experts.

However, market regulators are determined to continue the reforms and offer completely new mechanisms for restructuring the banking sector. “The restructuring should be supported by complementary measures to regulate non-performing debts. Therefore, special mechanisms based on international experience, as well as the features and limitations of the country should be prepared. This integrated approach will strengthen the capital position of banks, expand healthy lending, increase credit activity and ensure economic growth,” says the CBA statement.

It is also necessary to continue eliminating existing restrictions and reducing risks. In addition to the mentioned factors, CBA believes it is necessary to create conditions for lending existing financial resources at levels that allow the risk-sensitive banking sector to accept them.

The market participants prepare a number of new proposals, including new funds with the asset insurance function, credit bureaus, and expansion of the powers of the bank ombudsman to the financial one, etc. The ultimate goal is to improve the quality of the market, preferably keeping the quantitative composition at current level. After the liquidation of DemirBank, the number of remaining banks in Azerbaijan dropped to 30, half of which operate with foreign capital.

The main factors are intention and desire available to all of the interested parties.