CBA STEPS IN

As the risks associated with inflation have been progressively reduced, the Central Bank of Azerbaijan (CBA) has pursued a consistent easing of its monetary policy since the previous autumn. This objective is justified, particularly given the prevailing excess liquidity in the country's financial market during the preceding period. According to the CBA, the total volume of credit investments in the Azerbaijani economy increased by 12.6% during the first half of 2024, accompanied by a corresponding rise in the volume of business loans. Meanwhile, the majority of loans in the portfolio are consumer loans, while bank investments in the real sector of the economy remain insignificant.

Weak Transmission

The stability of the credit market is contingent upon the equilibrium of basic macroeconomic parameters, with the monetary factor being of particular importance. In contrast to numerous trading partners, Azerbaijan has succeeded in maintaining the manat-dollar exchange rate for the eighth consecutive year. These factors contribute to the resilience of the banking sector to external and internal stresses.

The impact of the regulator's efforts to reduce the discount rate on the debt capital market is variable. Since the beginning of this year, there has been an increase in banks' lending activity. As evidenced by the CBA data for 1 July 2024, the volume of credit investments in the Azerbaijani economy has reached ₼27 billion, representing a 12.6% increase compared to the beginning of 2024. Furthermore, when comparing year-on-year (i.e. with indicators as of 1 July 2023), when the volume of credit investments of banks reached ₼21.966 billion, the dynamics are even more impressive, with an increase of 22.9%.

With regard to the level of interest rates on bank loans, it can be observed that since the beginning of the year there has been only a slight decrease (at a number of banks) in comparison with the indicators of the previous period. It is evident that the transmission of the refinancing rate to the credit market remains considerably weak. It is important to note that domestic banks have limited access to favourable long-term financing. Indeed, the market of pension or unit investment funds with their "cheap" capital is not developed in Azerbaijan. Furthermore, due to the comparative narrowness of the insurance market, this segment is unable to provide the required amount of affordable funds for refinancing for banks. It should be recalled that local insurance companies are closely affiliated with the banking sector and often provide the latter with liquidity.

In the wake of the 2015 devaluation and the ensuing severe bank default crisis, the CBA's policy has been to restrict foreign currency loans from abroad, placing its bet on the dedollarisation of the country's financial system. Furthermore, it is important to consider that the rise in inflation has compelled local banks to maintain a relatively high (in comparison to the global average) level of interest rates on household deposits. Despite the CBA's new policy on the discount rate, interest on deposits remains unchanged. This leaves local banks with limited flexibility in adjusting lending rates, which should typically be higher than interest on deposits. Consequently, despite the ample liquidity in the country's financial sector, banks are compelled to reduce their margins (the difference between purchase and sale prices of money) to manage liquidity and generate income.

These issues are of an objective nature and their impact on banking institutions has been observed for a considerable period of time. Consequently, it is challenging to anticipate a qualitative shift in the circumstances solely as a result of alterations to the CBA policy on the discount rate.

Consumption Loans

The regulator's statistics indicate that the volume of lending in Azerbaijan has exhibited a pattern of gradual growth throughout the current year. However, this growth has been accompanied by the emergence of notable imbalances in the composition of the banking sector's portfolio. Accordingly, as of 31 May 2024, the Central Bank's calculations indicate that the majority of bank loans issued in the country (56.9%) were directed towards households, specifically consumer lending. Although this figure is slightly lower than that observed in the first five months of the previous year (58.8% in January-May 2023), it remains relatively high in comparison to the typical distribution of loan capital. The volume of loans extended to households exhibited a 22% increase on a year-on-year basis. Furthermore, individuals, particularly the younger demographic, remain undeterred by relatively elevated interest rates associated with this category of financial services. The prevailing interest rates in the national currency are maintained at a level of 22-25%.

From one perspective, the intensification of banks' lending to households has the effect of promoting the development of the credit system, simultaneously stimulating trade demand and helping to increase the production of goods and the supply of services. Conversely, an expansion in the proportion of consumer lending and the resulting "overheating" of the monetary system give rise to an elevated risk of credit default in the event of unforeseen circumstances, thereby contributing to inflationary pressures.

Ten years ago, Azerbaijan, like almost all oil-producing countries, was confronted with the collapse of the energy market and the subsequent devaluation of the national currency, which resulted in a severe default crisis. Consequently, the number of local banks declined from 45 to 25. These harsh experiences were duly internalised by the domestic financial market. In recent years, the CBA has made significant contributions towards reducing the dominance of the US dollar in the domestic lending system, enhancing the stability of the monetary system and strengthening the regulatory framework governing lending practices and compliance with prudential norms in the banking sector.

For the Real Sector

Nevertheless, banks continue to apply high interest rates on loans due to the inherent risks associated with financing the real sector of the economy. The typical loan term of three to four years is unsuitable for financing the industrial sector, where the payback period and profitability of projects are considerably longer. The situation with regard to lending to the agricultural sector is even more problematic. The elevated risks associated with crop production, the absence of readily liquidisable collateral, and the inadequate coverage of small farms by agricultural insurance collectively impede banks' capacity to expand their involvement in financing the agro-industrial complex.

The relatively high level of consumer lending observed recently should not be taken as an indication of stability. This is particularly notable in light of the observed decline in the proportion of lending directed towards other sectors of the economy.

According to the Central Bank of Argentina (CBA), the proportion of loans allocated to the energy, chemicals and natural resources sectors within the overall banking portfolio declined from 3.27% during the period between January and May 2023 to 3.2% during the first five months of 2024. A corresponding decline was observed in the respective shares, from 2.3% to 1.7% in agriculture, from 5.23% to 4.4% in construction, and from 15.78% to 14.5% in trade and services.

Concurrently, lending to industry and production has exhibited a notable expansion over the course of the current year, with an investment of ₼2 billion directed towards this sector. In comparison to the figures recorded last year, which stood at 4.9%, the proportion of the industry within the bank portfolio has increased to 7.5%. A similar positive dynamic is observed in the transport and communications sector, where over ₼1.7 billion was invested in the first five months of 2024. This resulted in an increase in the share parameters from 4% to 6.4%.

These achievements are not fortuitous, as since last year the Central Bank, in collaboration with the Ministry of Economy and banking institutions, has invested considerable effort into developing a novel strategy for the advancement of the financial sector. This strategy prioritises the enhancement of banks' role in providing credit to the real economy. The strategy encompasses a range of measures designed to address existing imbalances in the supply and demand dynamics, enhance the accessibility of credit for economic agents, and streamline the credit access process. In order to achieve this objective, the CBA has implemented regulatory amendments with the intention of optimising the process of lending. In accordance with the amendments, bank loans for large project financing will be regarded as fully secured, with the frequency of interest payments on these loans aligned with the maturity of the project in question. In consequence, the reserve load on project finance loans has been adjusted and will henceforth be excluded from the concentration limit on unsecured loans. Furthermore, regulatory requirements for borrowers with environmentally friendly vehicles have been streamlined, and the stipulations for production, commercial, and other specialised equipment serving as collateral for business loans have been eased.

Furthermore, considerable measures are being implemented to facilitate the provision of credit to industrial and agricultural enterprises within the Garabagh region. These include the availability of state-backed guarantees and subsidised loans for businesses. Up to 90% of the loan amount, up to ₼5 million, is guaranteed, with an annual interest rate of up to 15% and a term of up to 7 years. The state provides a subsidy of 10% of the annual interest rates on these loans for a period of up to 36 months. It is anticipated that by the conclusion of the current fiscal year, the Ministry of Economy will have completed the process of establishing a framework for providing entrepreneurs with access to additional financing, including the utilisation of resources from the Entrepreneurship Development Fund and the Azerbaijan Investment Company. An additional option would be to provide a state guarantee for loans until January 1, 2028, with the guarantee being funded by the banks' own resources. This would be for business entities that have committed to producing food wheat and purchasing economical irrigation systems.

These and other promising measures and commitments in the domain of entrepreneurial support are designed to motivate financial institutions to extend financing to the real economy, with the objective of significantly augmenting the proportion of this sector within their portfolios in the forthcoming years.