BANKS FOR “TREATMENT”

"Instability" and "underdevelopment" of the banking system are one of the factors determining the poor ratings of Azerbaijan by international agencies and institutions. The country's leadership is also dissatisfied with the banks. President Ilham Aliyev has repeatedly criticised the banks, urging them to participate more actively in the real sector of the economy.

Nevertheless, the year of 2020 promises to become rich in banking reforms - the 'new old' market regulator, the Central Bank of Azerbaijan (CBA), has begun to solve problems actively in order to reconcile the banks with businesses.

Weak links

"We have conducted a comprehensive audit in all the banks of Azerbaijan and already have specific data. In general, the banking sector is showing positive dynamics, but there are a number of the so-called pinpoint problems," Elman Rustamov, the head of CBA said. He added that the regulator has prepared a set of specific proposals to submit to the Financial Stability Board.

In fact, the annual statistical indicators of the banking sector are really positive. The sector demonstrated an impressive growth in terms of all major parameters. The total assets of banks increased by 10.9%, loan portfolio - by 18%, total capitalisation - by 12.6%, total net profit - by 92.2%. In other words, the banking sector has not only fully recovered from the 2015-2016 crisis, but has also become stronger.

Then what is the reason for the government's dissatisfaction? What are the pinpoint problems that so negatively affect the overall picture?

As of December 31, 2019, thirty banks had a license to operate in Azerbaijan. Fourteen of these banks had foreign capital. These are the banks that have managed to stay in the sector after the well-known devaluation crisis of 2015-2016. But right now the situation in at least three-five banks causes serious concern for analysts.

The situation with the local AtaBank has been widely covered in the media. It became known that the bank refused to return time deposits to customers, referring to a lack of liquidity. It was a serious call for the market and a cause for speculations about the expected bankruptcy of the bank. In response, CBA issued a statement on serious problems in the bank related to "liquidity and financial stability".

AtaBank’s problems, despite all its seriousness, are quite common. Like the other 'weak links' of the banking chain, it has issued a large number of high-risk loans, which would later turn into an intolerable debt burden for the bank itself. "No risk management has not been carried out. This was during a period of problems in the financial market and, as a result, led to a deterioration in the bank’s position," E. Rustamov noted, adding that he hopes that the situation with AtaBank becomes clear soon at the Financial Stability Board.

However, if the fate of bank is considered hopeless even after last year’s attempts to solve the problem of bad loans under the relevant presidential decree, it is unlikely that it will recover. But again, only the Financial Stability Board is authorised to decide... Either way, the bank’s depositors should not worry about their deposits, since AtaBank is the member of the Azerbaijan Deposit Insurance Fund, which means that the insured deposits will be returned. The management of the bank was recommended "to personally contact each depositor who did not insure the deposit and inform them that they can do this in the near future."

Most likely, the regulator will deal with other 'weak links' in the banking sector. After all, Mr. Rustamov promised that "the recovery of the banking sector will end in the first half of the year".

Consumer loan virus

As already noted above, after the banks were "cleared" of the load of bad loans, the situation in the sector was supposed to change for the better. Recall that the decree mentioned above provided for reimbursement within three months of the difference in the principal debt of individuals on loans in foreign currencies in the amount of up to $10 thousand resulting from devaluations at the expense of the state budget. And within the framework of this document, last year ₼645 million was paid in compensation, loans of 135,000 citizens worth more than ₼269 million were restructured.

However, the sector did not seem to learn lessons from the crises of past years and is still exposed to the 'consumer loan' virus, which has not been cured for years. "Since the beginning of 2019, credit investments increased by 16.1% due to the increase in consumer lending by 21%. As a result, the share of consumer loans is 50.4%," CBA reported on the main directions of monetary policy and financial stability for 2020 and the medium term.

In fact, this is one of the main factors that casts doubt on the stability of the entire banking sector. "I was informed that banks increased consumer lending again. A few years ago, this was the cause of the banking crisis. If you continue, in a few years we are going to face the same problems again," President Ilham Aliyev said in October 2019.

Recently, during the conference dedicated to the results of the first year of implementation of the State Program for the Socio-Economic Development of the Regions of Azerbaijan in 2019-2023, president once again underlined the need to expand lending to small and medium enterprises, as this is important for increasing the country's GDP. "The advantage should be given to business loans, not consumer loans. Private banks should lower rates on business loans. In 2019, CBA lowered the discount rate, and this trend continues in 2020. Therefore, banks must reduce interest rates on loans. The state creates conditions for them. Therefore, banks should be more responsible and promote economic growth," Ilham Aliyev said.

The situation in the regions of Azerbaijan is even worse. According to CBA, as of January 1, 2020, the volume of loans issued by banks in Baku is 80.2% of all loan investments of banks in the country. In general, the average annual rate of loans is 11.1% in Azerbaijan and 9.3% in Baku. According to Rustamov, in 2018-2019, business loans amounted for 11% of all the loans, which is another 5 points less than in previous years.

But in the regions, the problem is not only higher interest rates but the terms under which the loans, particularly business loans, are issued. "Particularly, this applies to regions where banks require property in Baku as collateral for loans. This is unacceptable," president said commenting on collaterals as one of main barriers to obtaining loans.

"Of course, for some banks, consumer loans are a more profitable and easier way to generate income, but business loans are more important for the Azerbaijan's economy. A decrease in the discount rate should reduce interest rates on loans, making them closer to the rates on soft loans issued through the Ministry of Economy," Ilham Aliyev said.

Insurance model

One of the first things that CBA did in 2020 was lowering the discount rate by 0.25%, bringing it to 7.25%. The rate on loans of the Entrepreneurship Development Fund (EDF) is 5%. The gap between private banks is significant.

But at the same time, banks are commercial entities, and the regulator cannot instruct them to issue risky loans. There are several ways out: first is to start improving the financial literacy of business entities, teaching them how to develop appropriate business plans that meet risk indicators.

On the other hand, Mr. Rustamov believes that it is necessary for the Mortgage and Loan Guarantee Fund to intensify efforts regarding the business loans and to reduce the risks of banks as part of the loan guarantee mechanism.

As for CBA, it cannot actually influence the process, since the bank does not issue loans to commercial banks. "CBA gives money to banks for short-term liquidity in order to avoid discontent among economic entities. Recently, we have increased the money supply by four times, but these resources do not flow into the economy in entirety," Rustamov added.

Either way, banks receive state support, which also ensures a stable macroeconomic environment, national currency exchange rate and full insurance of population deposits. The latter, however, will change as public confidence in banks increases and the market improves. As said above, the insurance system has been applied to the entire amount of public deposits (up to ₼30,000 before) since March 4, 2016 provided that the interest on the deposit should not be higher than the limits set by ADIF. So, public deposits in national and foreign currencies at annual rates above 10% and 2.5%, respectively, are not covered by the insurance. This rule expires on March 1, 2020.

At the same time, banking experts and bank managers have repeatedly noted that this insurance system in the current conditions is not entirely effective. Apparently, the regulator also adheres to the same position. "We are currently working on a new deposit insurance model. We believe that it will have to be implemented smoothly and in stages. The current system was introduced during the crisis to stop the outflow of deposits. Now confidence in banks is recovering, and the situation in the sector is improving, but only after solving all the problems can we talk about changing the model of deposit insurance," Rustamov said.

So, it seems the existing problems will be solved soon, i.e. until the end of the first half of the year...