DIGITALISATION IS INEVITABLE

it is been almost a year that the Azerbaijani banks have stoically withstood the shocks of global changes in external markets. "Azerbaijan’s banking sector has remained more resilient to macroeconomic challenges than expected in recent years. Asset quality pressure is decreasing," a recent S&P report noted.

On the one hand, banks have to defend themselves against the negative effects of pandemics, geopolitical conflicts, and inflationary processes in partner countries, and on the other hand they have to respond to equally important challenges, such as maintaining the quantity and quality of assets. The rapidly digitising world also dictates its own conditions in the financial sector, which makes it necessary to adjust to new requirements in the short term. Thus, at the 6th International Banking Forum held in Baku, the Central Bank of Azerbaijan (CBA) announced its preparing a package of policy documents to boost the next wave of reforms in the sector.

Progressive dynamics

According to the Azerbaijani bankers, despite all the difficulties of recent years there has been rapid growth in the sector. Here is some statistical data for the last year: the growth of bank assets – by 26% (up to ₼43.6b), of loan portfolio – by 23% (up to ₼19.2b), including business loans – by 20% (up to ₼10.8b). "Individual deposits in banks increased by 27% to ₼11b, which is the highest growth rate. The level of dollarization on deposits reduced to 39,2%", President of the Association of Banks of Azerbaijan (ABA) Zakir Nuriyev said at the forum. Thus, the balance capital of banks reached ₼5.3b (+10%), with their total profit close to ₼1b and net profit at ₼683m.

The volume of liquidity also shows progressive dynamics. The situation is very favourable in this area. In the passing year alone, the volume of banks’ cash, deposits in correspondent accounts and financial institutions increased by 25% to ₼15,8b, which is roughly 36% of total assets. According to Vusal Gasimly, executive director of the Center for Analysis of Economic Reforms and Communications, the level of capitalization and liquidity of the banking sector exceeds the normal level twice.

On the one hand, this is an excellent indicator of the sustainability of local banks. But on the other hand, economists constantly point to the need to tap excess liquidity in the real economy. In other words, money should work, be in circulation, and not stored in treasuries. It has been repeatedly suggested that banks should review their lending policies to businesses.

Orkhan Mammadov, chairman of the board of the Agency for Small and Medium Business Development under the Ministry of Economy, said one of the main problems in this area is the issue of collaterals. "There is a special working group. I believe that we will soon be able to move in this direction. Bank owners are also entrepreneurs, the state protects their interests as well. Therefore, the issue of financing must be resolved in accordance with the interests of both entrepreneurs and banks," Mammadov said.

Despite a fairly good performance, bankers believe that the pace of development in the banking sector will shift to a more moderate development trend as early as next year. This is also due to the need for innovation to support growth in the sector, and a more in-depth approach to the use of modern technologies and products, which require additional investment in digitalisation. New challenges also impose obligations on the regulator (CBA) to carry out additional reforms to update the legal framework and program points for the development of the sector. And CBA seems to be ready to undertake this mission.

New strategy and reforms

Taleh Kazymov, head of the Central Bank of Azerbaijan, said at the forum that they had been working on a new strategy for the development of the financial sector. "Starting from January 2023, we want to present a new three-year strategy for the development of the financial sector," Kazymov said.

The strategy will consist of two parts: transformation of both the CBA and the sector. Kazymov believes that as a regulator CBA should make more efforts to actively and widely implement modern IT technologies to develop the market. Therefore, it is expected to adopt a new law on payment systems, where the level of influence of IT is particularly high. "This will be a great achievement in terms of legislation for the financial sector. We also expect the changes to the Central Bank Act to be approved in a few months. There are plans to introduce a special CBA regulatory regime, Sandbox, which will allow us to test all startup applications in a test mode," Kazymov said.

Chairman of the Parliamentary Commission on Economic Policy Tahir Mirkishili expressed his concerns about the problems in the sector, particularly noting that financial institutions increasingly evade taxation and negatively affect the market due to own advertising campaigns. "Together with the CBA, we will try to solve all the urgent problems," promised Mirkishili, urging banks to be more active in adopting the latest digital technologies. "You may think that your business is making a lot of profit currently and reforms are not needed. But believe me, if you do not change your approach to lending from consumers to the production segment, do not innovate, do not invest in developing digital services instead of opening new branch offices, do not use big data services instead of credit scoring, you will soon face quite unpleasant consequences in terms of your income," Mirkishili said.

Meanwhile, Kazymov does not believe the digitalisation of Azerbaijan's banking sector is at a low or unsatisfactory level. "Today 84% of local banks use mobile applications, 77% of  transactions are carried out electronically thanks to mobile and internet banking. As for Internet-banking, during 10 months of this year the volume of operations grew compared to the same period of last year by 55%, while the operations through mobile banking tripled. These are quite good indicators," Kazymov said. The volume of non-cash payments inside the country is also positive, increasing more than twice to ₼20b, while its share via payment cards exceeded 42% (+12 percentage points) compared to the last year.

However, according to Kazymov, an area that will continuously evolve in the current uncertain environment is IT, and the financial sector cannot develop without it. "We cannot implement our policies without IT," he said.

As part of this strategy, CBA is also developing a roadmap for Open Banking, which will cover the period until 2025. Sahib Hasanov, head of the CBA's IT Department, said that open banking will contribute to the development of both financial instruments and the economy as a whole. In addition, it is planned to develop open banking API standards based on international standards currently applied in 60 countries around the world.

All of these measures will ultimately require appropriate changes to Azerbaijan's legislation, as well as stronger cyber security measures within the banks.

Secure banking

CBA and the International Finance Corporation (IFC) are jointly developing the cybersecurity strategy for the financial sector. According to Kazymov, cyber security is an essential element of sustainable development of the financial sector in view of today's global challenges.

CBA Director General Farid Osmanov said that cyber security issues are in the focus of the Central Bank. The development of the three-year strategy will be completed this year. It will be applicable in 2023. "The development of regulatory and methodological framework for protecting information security and ensuring cybersecurity of the participants of financial market is ongoing. Banks have rules governing information security. We monitor the activities in this area. Our joint strategy with IFC will include issues of regulation and prevention of cyber threats," Osmanov said.

Apparently, there are problems in this area as well. It is particularly depressing that despite the availability of operational security centres, the cyber security system in most of even the leading banks of Azerbaijan is not functioning 24/7, which poses threats in terms of cyber attacks. Elvin Shahverdiyev, head of Information & Cyber Security Department of the Central Bank of Azerbaijan, said that according to the results of monitoring it was revealed that only 3 of 10 leading banks have security system operating 24/7. "This point will definitely be taken into account in our cyber security strategy," Shahverdiyev said.

In addition, the strategy will include certain measures to strengthen, improve, update and develop cyber security in the financial sector. According to Shahverdiyev, it initiates the establishment of FinCERT (Centre for Monitoring and Response to Computer Attacks in the Credit and Financial Sphere) in Azerbaijan and will focus on raising awareness of CERT (Computer Emergency Response Team). "We aim to increase the efficiency of interaction with government agencies. Our goal is to take the cooperation between the national CERT and the newly established FinCERT to a high level," said a CBA spokesperson.

Apparently, the main direction of the forthcoming reforms in Azerbaijan's banking sector will cover the deepening and development of digital services and the strengthening of IT security. This is the way to ensure the continued competitiveness and sustainability of local financial institutions amid rapidly changing global trends.