ON THE CREST OF A WAVE

The key priorities of the financial sector development strategy formulated by the Central Bank of Azerbaijan (CBA) include the simplification of lending conditions and the increase of funding for small and micro businesses, particularly those operating in regions. It is planned to concentrate on non-bank credit organisations (NBCOs) for financing micro-businesses, a sector to which the CBA has recently devoted considerable attention. Currently, there are 54 NBCOs in the country: their assets have doubled over the past five years and their loan portfolio has increased by 25 per cent. The evolution of the microfinance market was a topic of discussion at the financial forum Achievements and Challenges held in Baku.

Credit history

Last year, CBA specialists collaborated with international consultants to enhance the capital market, payment systems, and digitalisation of all segments of the financial market. As per the Central Bank's strategy for the development of the financial sector, individual documents will be prepared for each of the sub-sectors - banking, insurance, capital markets and payment systems, as well as microfinance. Of course, these areas differ by their significance. CBA Chairman Taleh Kazimov noted that today 96% of the assets of Azerbaijan's financial sector are constituted by banks, while the remaining 4% are shared by insurance and investment companies, non-bank credit organisations.

The most crucial priorities of the new strategy are addressing the issues of credit structures, bolstering their collaboration with entrepreneurs who operate in the real sector of the economy, especially in peripheral regions and rural areas, in order to broaden the access of economic entities to financial resources.

Enhancing the access of business entities to financial and banking services is a long-term task. Admittedly, the banking sector has not been able to become a primary donor to entrepreneurs due to difficult access to loan capital, high interest rates, collateral problems, etc. Banks still maintain high interest rates on loans, which is due to significant (as the banks think) risks of financing the development of the real sector of the economy, particularly agriculture. In turn, the lack of liquid collateral and inadequate insurance coverage of small farms discourage banks from getting involved in financing rural producers and other areas of small and micro-entrepreneurship. As a result, Baku currently accounts for over three quarters of all bank lending.

Four billion in 20 years

What is the optimal solution in the medium and even longer term? According to the estimates of leading international financial organisations (IFIs), one of the most effective methods of capitalising small businesses could be the further development of microfinance. In fact, we have quite a lot of experience in this area. Dozens of NBCOs and credit unions, which have been functioning since the mid-1990s, mainly in agrarian regions, managed to become an effective instrument for financing SMEs and microbusinesses. IFIs acted as founders and donors of many microfinance structures, providing them with preferential liquidity, supporting them through technical programmes, and sharing their experience in institutional development. As a result, over 20 years, NBCOs and similar structures have been able to provide more than ₼4 billion in microcredit to SMEs. This is not surprising since, unlike banks, they are not constrained by complex prudential regulations, can issue microcredits without collateral, and the transaction itself is incomparably simpler - borrowers are not required to have a long credit history, etc.

Unfortunately, the domestic microfinance sector suffered tangibly during the global energy crisis of 2014-2017. The devaluation, a series of bankruptcies, and the country's economic slowdown inflicted significant damage on the activities of Non-Bank Credit Organisations (NBCOs). The demand for foreign currency denominated loans in the country fell dramatically. Given that most microfinance institutions are tied to foreign donors, the volume of foreign currency loans in this sector is quite substantial. Consequently, the number of such structures decreased by two-thirds, and both the loan portfolio and the number of borrowers more than halved.

However, the microfinance sector has seen consistent growth over the past few years. This is largely due to the support of the Central Bank of Azerbaijan (CBA), the Azerbaijan Microfinance Association (AMFA), and the Small and Medium Business Development Agency, which have aimed to expand microfinance (especially in the country's regions) to facilitate access to finance for Small and Medium-sized Enterprises (SMEs). Meanwhile, loans from NBCOs often serve as the only competitive alternative for microbusinesses in the face of a not always efficient banking system. According to a recent World Bank study, only about 9 per cent of domestic small companies systematically use bank loans. Simultaneously, state support for the microfinance market is a critical component of the development of SMEs and individual entrepreneurship. The latter is a strategic goal of the government. SMEs and microbusinesses account for over 97 per cent of all registered taxpayers, not to mention the fact that this sector employs about half of Azerbaijan's working-age population.

Non-banking innovations

These facts suggest that the development of the microfinance market will remain a focus of the financial regulator and other relevant government agencies for a long time to come. In particular, the CBA has recently sped up the process of issuing licenses for new microfinance institutions, the number of which has reached 54. Four more non-bank credit institutions already registered by the Tax Service under the Ministry of Economy are expected to be licensed in 2024.

In turn, NBCOs increase their authorised capital, place bonds at auctions of the Baku Stock Exchange, and amendments to legislation adopted in 2023 gave them the right to issue credit cards. These are part of all the innovations introduced last year in the amendments to the Law on Non-Bank Credit Organisations. From now on, NBCOs will be able to engage in payment intermediation services. Until recently, only banks and the national postal operator had this right. Another innovation for the NBCO segment is the change in prudential requirements to improve their financial stability. For microfinance entities, the maximum credit risk, as well as the minimum capital size, the ratio of liabilities to capital, etc. have been defined. In addition, legislative amendments defined the procedure for acquiring a significant share in the authorised (share) capital of NBCOs. All of the above steps contribute to the expansion of microfinance institutions' capitalisation, attracting investors and, ultimately, facilitating access to the much sought-after concessional sources of financing.

It is clear that favourable market conditions, optimisation of the regulatory framework, and support from the regulator are contributing to the rapid development of the microfinance sector. As highlighted by Zhala Hajiyeva, the Executive Director of AMFA, the recent enforcement of amendments to the NBCO law will bring about significant improvements. Notably, it will enhance the socio-economic conditions of the self-employed sector and increase the accessibility of borrowed resources for microbusinesses. According to her, by supporting self-employment and micro-entrepreneurship, the state reduces the burden of social security for those employed in this sector. Simplified access to finance is provided for groups of the population unable to use traditional banking services. A clear testament to the positive trends in the sector is the fact that last year saw a 25 per cent growth in the loan portfolio and a 10 per cent increase in the number of employees.

"By the end of the third quarter of 2023, the assets of non-bank credit organisations in Azerbaijan had doubled, reaching ₼682 million. Approximately 80 per cent of the assets of microcredit structures are loans. Thus, for the first three quarters of last year, the volume of loans issued to clients exceeded half a billion manats, which is twice the corresponding indicators of 2019," said Jalal Aliyev, Chairman of the Supervisory Board of AMFA, at the Azerbaijan Financial Forum. When discussing the efficiency of the microfinance sector, the AMFA head also mentioned the increase in tax payments through NBCO, the volume of which totalled ₼10.7 million in the first nine months of 2023.

Looking at the prospects for the microfinance sector in 2024 and beyond, the implementation of other provisions of the three-year Financial Sector Development Strategy should also be noted. Among other things, this document aims at the use of alternative monetary instruments. These include the introduction of the OpenBanking platform in the country for the widespread application of fintech solutions and expanding access to various payment systems. "Today, we are living in an era of digital financial services development, where artificial intelligence is expanding its scope of activity. The increased use of the internet and mobile devices has led to the emergence of a large number of platforms, including credit bureaus and easy finance platforms. Banks, NBCOs are actively interested in innovations and achievements in the field of digital technologies, and we are confident that this issue will become one of the most important in the future," J. Aliyev noted.

Another promising goal for the CBA and AMFA is to meet the needs of NBCOs for low-interest liquidity, primarily in the national currency. Access to "long and inexpensive" credit lines (including MFI resources) for NBCOs is crucial to sustainably meet the growing market demand for borrowing from SMEs and microbusinesses.