MICROFINANCING FOR MACRO GOALS

The last two years have been remarkably successful for the development of Azerbaijan's microfinance sector and the profitability growth of non-bank credit organisations (NBCOs). The primary objective of the Central Bank of Azerbaijan (CBA) is to elevate the domestic microfinance market to a qualitatively higher level of development by diversifying financial instruments and expanding the range of products to better meet the needs of small and micro businesses. To achieve this goal, the CBA is updating prudential regulations for the microcredit sector and accelerating digitalization processes. The recent conference titled "Innovative Solutions for Sustainable Microfinance," held in Baku, was dedicated to discussing these matters.

From Stagnation To Surge

Microfinance represents a flexible alternative to traditional bank loans, enabling individuals to easily initiate businesses without needing start-up capital or a credit history, and without requiring registered collateral. Essentially, these are small loans with short repayment periods. Obtaining these loans is generally easier than securing a bank loan; however, the interest rates on such loans tend to be significantly higher. The conditions imposed by commercial banks are often unaffordable for entrepreneurs, particularly concerning collateral. Additionally, small financial transactions are not always appealing to banks. Global trends indicate that microfinance institutions are predominantly found in regions where banking services are not readily available. Furthermore, alongside classical NBCOs, various structures such as credit and agricultural consumer cooperatives, housing savings cooperatives, and pawnshops operate under similar models in Asia, Africa, South America, and the post-Soviet space.

These issues are also pertinent to Azerbaijan, where despite excess liquidity, the banking sector has not become a primary donor for entrepreneurs. Challenges include difficulties in accessing loan capital without reliable collateral, relatively high interest rates, and significant perceived risks associated with lending to microbusinesses, especially in the agricultural sector. From the late 1990s until the energy crisis of 2014, the microfinance sector experienced robust growth, driven by strong market demand, particularly in Azerbaijan's regions.

However, the devaluation in 2015, the subsequent default crisis, and a series of bankruptcies adversely impacted all segments of the financial market, causing substantial harm to NBCOs' operations. Given that most microfinance structures rely on foreign donors, the level of dollarization in the sector was notably high. Consequently, demand for micro-loans in the country plummeted, leading to a contraction of both the loan portfolio and the number of borrowers. Over the past decade, the number of NBCOs has decreased from 150 to just over fifty. The microcredit sector was also severely impacted by the forced inactivity of microbusinesses—particularly trade and service enterprises—as well as catering facilities during the coronavirus pandemic.

In contrast, favourable conditions over the past few years have led to a rapid recovery of Azerbaijan's microfinance market. Last year, the 54 NBCOs operating in the country achieved a threefold increase in profitability owing to higher interest income from their expanding loan portfolios and improved operational efficiency among small credit institutions. These positive trends have continued into the current year. Microcredit volumes rose by 33%, and as of October 1, 2024, NBCO's portfolio was estimated at ₼630 million. Over the past three quarters, the net profit of microcredit organizations reached ₼149.2 million—2.5 times more than during the same period last year.

"It is anticipated that by the end of next year, the assets of domestic non-bank credit organisations will double and surpass ₼1 billion. The branch network of NBCOs is expanding, collectively increasing to 302 structures, while the number of employees has grown to 3,500 and the customer base exceeds 700,000 borrowers," stated Khayyam Ismayilov, Head of Division at the CBA's Credit Organisations Supervision Department during the conference.

According to the new Financial Sector Development Strategy 2024-2026, the Central Bank aims to significantly broaden access to microcredit in collaboration with the Azerbaijan Microfinance Association (AMFA) and the Small and Medium Business Development Agency (KOBİA). This will ensure greater access to loan capital for small businesses and individual entrepreneurs. To enhance industry competitiveness, plans include creating a new microfinance model, implementing international best practices, developing effective legal and regulatory mechanisms, and simplifying access to loan capital.

"The Central Bank has developed new rules for credit risk management. A key priority is strengthening the institutional capacity of microfinance organizations. In this regard, prudential regulations have been updated; requirements for corporate governance and external audits are being reinforced; and regulations concerning outsourcing by NBCOs are being improved," CBA Director General Toghrul Aliyev told attendees at the conference. He noted that regulatory and legal documents have already been discussed with AMFA and market participants and will be adopted soon.

New initiatives

Among other developments, new financial consumer protection initiatives will be launched to promote inclusiveness and enhance risk management within microfinance institutions. These initiatives will facilitate money transfers and currency exchanges without necessitating an account with an NBCO. Conditions and mechanisms for regulating online lending within the microcredit sector have also been established. Additionally, there are plans to broaden the use of alternative monetary instruments through the introduction of an OpenBanking platform and fintech solutions. Granting non-bank credit organizations access to various payment systems and e-platforms will positively influence their operations while simplifying processes for clients. Concurrently, new information security requirements have been developed for the microfinance sector. The CBA strategy outlines a separate action plan focused on digital financial initiatives encompassing special regulations, digital identification, and cybersecurity measures.

"Innovations and digitalization within the microfinance sector enhance the quality, scale, and efficiency of financial services while elevating client relations to a qualitatively new level," remarked AMFA Chairman Jalal Aliyev during the forum. He emphasized that widespread internet use and mobile communications have created new opportunities for delivering financial services through alternative channels. Social networks with extensive audiences offer platforms that enable direct access to loans.

The innovations and digitalization processes in the microfinance sector are crucial for improving service quality and efficiency—a sentiment fully supported by AMFA.

The CBA and AMFA also recognize an important task: addressing NBCOs' need for low-interest liquidity primarily in national currency. This is vital for sustainably meeting rising market demand for borrowed resources from small and micro-businesses. Historically, a significant portion of funding for microcredit organizations originated from abroad; however, in recent years, CBA policies have aimed at reducing dollar reliance within the financial market, resulting in comparatively less external donor support. Unfortunately, strategies aimed at providing cheaper manat liquidity for banks or NBCOs face various challenges. Primarily absent in Azerbaijan are financial instruments such as unit investment funds, pension funds, mortgage accumulation funds, along with suitable mechanisms in the securities market that could facilitate low-interest long-term financing.

"Microfinance organisations in Azerbaijan impose high interest rates due to elevated operational costs," stated Orkhan Mammadov, Chairman of KOBİA's Board during the conference. "However, businesses require loans on more favourable terms with lower interest rates." He emphasised that it is crucial to enhance cooperation between state entities and relevant financial institutions. Mammadov asserted that banks and non-bank credit organizations should make loans more accessible to small and medium-sized enterprises, particularly in regional areas. KOBİA has partnered with the Entrepreneurship Development Fund (SIF) to launch a new mechanism aimed at providing entrepreneurs access to small soft loans. Under this initiative, 914 loans totalling ₼5.7 million have been issued—514 amounting to ₼3 million during this year's first three quarters—designed to improve access to finance in regional areas while reducing risks for banks.

Osman Khaliyev, Chairman of SIF's Board of Directors who participated in the conference, also indicated his readiness to further support the microcredit segment. He noted plans for more efficient and timely provision of favourable loans to business entities in coming years, emphasizing that cooperation with authorized credit institutions—including microfinance organizations—will need to deepen significantly.