CONTROLLED RISKS

The Central Bank of Azerbaijan has established clear prudential norms for all market participants and conducts comprehensive monitoring of potential risks. Consequently, over the course of the first half of the year, 18 inspections were conducted and 47 control measures were implemented. Consequently, sanctions amounting to ₼135,600 were imposed, and stringent measures were taken against 37 entities, resulting in the revocation of licenses in some cases.

A comprehensive overview of the financial sector is provided in the CBA's H1 2024 Report.

Banking Sector Is Fundamental

The formation of this environment is influenced by a number of factors, including ongoing geopolitical tensions, expectations of interest rate cuts in Europe and the United States, and slowing global growth in commodity and raw material prices. As a consequence of the decline in demand, there is an increase in the risk of inflation, which requires additional attention to be paid to issues of stability. In light of these external challenges, the internal macroeconomic situation in Azerbaijan exhibits encouraging trends. The country's economy continues to expand, driven by the non-oil sector, while the real effective exchange rate of the national currency remains stable. Furthermore, an increase in employment and income for the population contributes to the strengthening of financial sustainability. "The positive balance of foreign trade and growth of strategic foreign exchange reserves create an additional margin of safety," stated CBA Director General Shahin Mahmudzade at the presentation of the Financial Stability Report.

He emphasized that during the initial six months of the present year, the stability of Azerbaijan's financial sector exhibited a modest increase. The banking sector, which constitutes 94.6% of the financial sector, continued to occupy a dominant position. Furthermore, it is characterised by low and medium levels of concentration. In accordance with the Herfindahl-Hirschman index, which is employed in international practice to evaluate the degree of concentration, the credit portfolio of banks exhibited a low level of concentration (1,196), the deposit portfolio demonstrated a medium level of concentration (1,604), and the assets exhibited a low level of concentration (1,484) during the initial six-month period of 2024.

Concurrently, the Central Bank has observed an expansion in the market share of banks from the top three institutions with regard to loan portfolios during the January to June period. In particular, their share increased by 1.4 percentage points, reaching 53.8% (an increase of 4 percentage points in 2023).

The foreign exchange position of the banking sector is also within the parameters set forth by prudential norms. The banks' open long foreign exchange position totalled ₼202 million, representing a ratio of 3.5%. In accordance with the regulations governing the establishment of limits on open currency positions in banking institutions, the maximum permissible ratio of the total open currency position in freely convertible currencies to the total capital of the banking institution is 20%. The CBA observed a stabilization of the dedollarisation process, with the dollarization of the sector's loan portfolio decreasing by 0.8 percentage points over a six-month period to reach a historical minimum of 18%, while the deposit portfolio increased by 0.3 percentage points to reach 38.7%.

Furthermore, Mahmudzadeh noted that Azerbaijan is taking steps to enhance its legal framework, with the aim of fostering a safer and more transparent environment for financial operations and reducing associated risks. This includes updating the rules governing interactions with individuals connected to banks. Moreover, amendments have been introduced to the credit risk management process, including the extension of life insurance coverage for consumer loans and the enhancement of risk monitoring in the loan approval phase. The third significant phase was the implementation of criteria to guarantee the security of information in banking and non-banking credit institutions. "The innovations should serve to reinforce data protection measures and to mitigate the risk of cybersecurity threats. A document outlining the implementation of sustainable finance principles has been approved. "The objective is to integrate sustainable development strategies into banks' corporate governance, enhance transparency in accounting and reporting, and implement effective risk management," summarized the CBA Director General.

Insurance: Growth in Assets and Profits

Insurers, as with other significant players in Azerbaijan's financial sector, demonstrated positive investment activity in the first half of the year, as reported by the CBA. Compared to the previous year, investments increased by 6% (₼94 million), reaching ₼1.6 billion. As indicated in the report, the expansion of investments was primarily attributable to state securities, amounting to ₼100 million. Concurrently, the sector generated revenue of ₼58 million, representing 8% of its total revenue.

In summary, the assets of Azerbaijan's insurance sector exhibited a 5% growth during the initial six-month period of the current year, reaching a total of ₼1.9 billion. Furthermore, 49% of assets are state securities, 21% are funds from banks, 8% are non-state securities, 7% are accounts receivable, and 15% are other assets.

With regard to the challenges currently facing the market, there has been a discernible trend among certain insurance companies to withdraw from the compulsory civil liability insurance market for motor vehicle owners. Consequently, the licenses of JSC "Azsigorta," "Ipek Yolu Sigorta," "A-Group Sigorta," and "Baku Sigorta," which had been previously issued on a voluntary basis, were subsequently limited in their validity by the cancellation of permits for compulsory motor insurance. Does this have an adverse effect on the sector as a whole?

As Sh. Mahmudzade observed, the CBA does not consider the specific insurance company that leaves the MTPL market to be a significant factor. "A company that provides services related to compulsory motor insurance should be prepared to offer clients hull insurance as well. It is not sufficient for an insurer to rely solely on compulsory motor insurance to guarantee its financial stability; it must also actively engage in the voluntary insurance market. The decision of an insurance company to withdraw from a particular market segment is ultimately driven by its commercial interests. If a company determines that a specific insurance product is unprofitable and that remaining in the market is not a viable financial strategy, it will exit the market. He stated that this is a typical phenomenon.

Furthermore, the CBA representative indicated that the advancement of hull insurance in Azerbaijan is contingent upon the age of vehicles. The average age of vehicles in Azerbaijan is relatively high, which results in a correspondingly high premium for hull insurance, making it challenging to collect. The CBA is committed to taking all possible measures to enhance the situation. "There are discernible trends in market development, and it is anticipated that this sector will experience a period of accelerated growth over the next three years," Mahmudzade stated.

Nevertheless, in light of the aforementioned circumstances, the CBA anticipates that the loss ratio (defined as the ratio of payments to collections) in CMTPL insurance will persist at the end of 2024. "At present, the highest loss ratio in the insurance sector is in CMTPL insurance, which is projected to reach approximately 80% by the end of this year. "This is an acceptable level and corresponds to global indicators," the CBA director general stated.

He also indicated that the Central Bank is engaged in efforts to foster the development of the compulsory insurance market for real estate, where current profitability levels are relatively low.

As indicated in the report, the loss ratio for CMTPL insurance during the initial six months of 2024 reached 71%, while that for compulsory insurance of immovable property stood at 7%.

Notwithstanding the aforementioned, the net profit of Azerbaijan's insurance sector reached ₼98 million, representing a 20% increase compared to the previous period. The profit of life insurance companies decreased by ₼5 million, reaching ₼41 million, whereas the profit of non-life insurance companies increased. The profit of AzRe Təkrarsığorta OJSC, the sole reinsurance company in Azerbaijan, increased by ₼12 million, reaching ₼15 million.

Similarly, investment companies are performing well. During the survey period, the assets of the aforementioned entities exhibited an 89 percent growth, reaching a total of ₼228 million. As indicated in the report, the sector's liabilities increased by 40% to ₼180m, while the balance sheet capital increased by 4% to ₼48m. The primary driver of the expansion in the assets and liabilities of investment companies was the growth in direct and reverse repo transactions. In comparison to the first half of 2023, the repo market demonstrated a significant increase in operations, with a more than twofold growth rate, as reported in the document.

Therefore, the stability of pivotal sectors within the financial domain is apparent, thereby ensuring the maintenance of an overall market environment that is risk-managed. This, in turn, serves to mitigate the potential for global negative impacts on the economy as a whole.

UPDATE

Azerbaijan is commemorating the 105th anniversary of the establishment of its central banking system. In order to advance the country's financial sector to a qualitatively new level of development, comprehensive reforms are being implemented. In a statement made at an event commemorating the 105th anniversary of the establishment of central banking in Azerbaijan, Chairman of the Central Bank of Azerbaijan (CBA) Taleh Kazimov asserted that...

As indicated in the press release of the CBA, the Central Bank is committed to facilitating the implementation of international initiatives that align with the objectives of our country. This is achieved through the establishment of the requisite infrastructure to organize the activities of the financial sector and promote the principles of sustainability.

In consideration of the most effective international practices, the Central Bank is developing a regulatory and supervisory framework that aligns with the challenges of the modern era, thereby fostering positive dynamics in the banking, insurance, capital markets, and payment systems. The initiatives currently being implemented are designed to enhance public confidence in the financial system. In essence, the objective is to augment financial inclusion through the deployment of cutting-edge technologies and capabilities, thereby reinforcing macroeconomic stability within the country and fortifying the sector's capacity to withstand potential disruptions.

In accordance with its mandate, the Central Bank will continue to pursue significant initiatives aimed at supporting economic progress, ensuring financial stability and a sustainable future, as stated in the press release.