ON THE SAFE SIDE

The availability of financial resources is a prerequisite for the development of the real sector of the economy. Concurrently, all countries have established explicit frameworks and conditions for bank lending, implemented by both regulators and financial institutions.

A recent study by international think tanks has revealed that while banks have been reducing lending in response to monetary tightening, non-bank credit institutions (NBCIs) have been increasing lending. The study highlights the crucial role of NBCIs in providing a vital support mechanism for the private sector and consumers, functioning as a reliable backup option.

In Azerbaijan, the NBCI sector is undergoing a period of dynamic development, marked by fluctuations in turnover and the number of market participants. However, since last year, the Central Bank of the country has taken significant steps to reform this sector as well.

International Experience

According to international analysts, the growth of non-bank lending during periods of monetary tightening partially mitigates the effect of credit contraction by banks. However, this substitution is incomplete, as credit is in fact shrinking at the level of the whole economy. Nevertheless, the non-bank lending market has the potential to create significant economic benefits by providing long-term financing to corporate borrowers, who tend to be smaller and more indebted than bank borrowers. However, this renders such companies particularly vulnerable to rising interest rates and recessions, and non-bank loans are thus riskier.

Banks, in contrast to non-bank intermediaries, depend on short-term funding sources, including deposits. In contrast, non-bank intermediaries rely on long-term debt and long-term funding, which they increase during periods of monetary tightening.

While rising interest rates generally lead to higher profitability for credit institutions, non-bank intermediaries tend to demonstrate higher levels of profitability compared to banks. Monetary tightening has been found to further widen this gap: profits have been shown to rise for both banks and non-banks, but the latter have been found to be more profitable - and this effect has persisted for several years after a rate hike. Consequently, non-bank intermediaries in the competitive market of long-term debt may be regarded as borrowers of higher quality, according to analysts.

Reforms in Azerbaijan

In Azerbaijan, the non-bank lending market is underdeveloped, with non-bank loans accounting for less than 2% of the total loan portfolio, despite there being more than twice as many non-bank entities as operating banks. As of the end of last year, there were 57 NBCIs operating in the country (banks 22). Despite these statistics, the role of NBCIs in the country's financial sector is very important in terms of providing access to finance in the regions. This is particularly relevant in areas where the banking sector is underdeveloped. NBCIs have made significant progress in this area, with a current network of over 300 branches in regional areas. Until recently, NBCIs were not required to assess borrowers' credit histories, simplifying the loan application process. This was despite the relatively high interest rates charged.

However, since last year, the Central Bank has introduced several innovations in this sector, which may have a significant impact on both the number of market participants and lending conditions. For instance, in November 2024, the Central Bank approved the "Rules for Prudential Regulation of Non-Bank Credit Institutions," which significantly raised the capital requirements for NBCIs. The minimum capital requirements for NBCIs representing commercial legal entities were raised from ₼300,000 to ₼1 million, and for NBCIs established in the form of non-commercial legal entities (currently there are no such organisations in Azerbaijan) - from ₼30,000 to ₼100,000. Market participants were given a three-month deadline to meet the new capital requirement, which was due to be fulfilled by March.

As a result of these changes, NBCIs were granted rights such as opening accounts and issuing credit cards to provide loans to customers.

New Impulse

These innovations have been met with a positive outlook by Jalal Aliyev, Chairman of the Supervisory Board of the Azerbaijan Microfinance Association. He anticipates that these changes will pave the way for the emergence of novel financial instruments in Azerbaijan. As a result, by the end of 2024, NBCI's assets had reached ₼1 billion, which is more than three times higher than in 2020 and 24% more than last year. The new rules are expected to drive even greater growth in 2025.

He also highlighted that NBCI's authorised capital increased from ₼141.4 million in 2020 to ₼456.4 million by the end of 2024. The sector's net profit totalled ₼231 million and the total volume of loans issued exceeded ₼800 million.

Regarding the potential for card issuance, J. Aliyev noted that NBCIs had previously used "co-branded" cards issued on the basis of agreements with banks, but these were issued without names. The mechanism for new opportunities to issue own cards is still under development, but the interest of market participants in this area is high.

"Changes in the regulation of NBCIs will play an important role in expanding the availability of financial services, opening new opportunities for providing additional services and developing innovative credit products," J. Aliyev emphasised.

It should also be noted that among the innovations are the CBA's rules of prudential regulation and credit risk management for NBCIs, which are designed to increase the stability of organisations, improve corporate governance and improve the quality of lending.

The CBA intends, among other things, to establish requirements for external audits and the application of corporate governance standards for NBCIs.

In summary, the NBCI market is expected to undergo significant changes this year. The potential for further growth in its share of the country's financial sector is contingent on its ability to adapt to these changes in a timely and effective manner.