EFFICIENCY INDICATOR

Over the past couple of years, the Central Bank of Azerbaijan (CBA) has undergone a series of revolutionary changes in its operations. It is thanks to their efforts that the country's financial sector has begun to adopt international instruments of regulation and management with greater frequency.

Among such innovations is the commencement of publication on the official website of the Central Bank of the Azerbaijan Interbank Rate (AZIR) indices from 1 May 2023. These indices reflect the weighted average interest rate on transactions in national currency between local banks in the unsecured market.

Two years later, the CBA issued an 'update' to this instrument, making minor changes to the approach of AZIR calculation.

Necessary for both the CBA and banking sector

The Central Bank of Azerbaijan announced the launch of a new instrument, AZIR indices, two years ago. At the time, it was explained that their calculation would use transactions concluded in national currency between the country's commercial banks operating on the Bloomberg trading platform. In addition to the interest indices, the CBA's website indicated the amounts and number of eligible transactions.

The Central Bank has stated that it will utilise these indices as a metric to assess the efficacy with which monetary policy goals are being achieved. Market participants can also use AZIR as a base interest rate when concluding various transactions on the financial market.

As the experts explained, such instruments are used today in many countries worldwide. They act as a determining factor in the conclusion of various financial contracts (credit, bond, derivative, etc.), and allow us to assess the effectiveness of monetary policy transmission carried out by central banks.

The CBA has observed that the dynamics of AZIR indices over the past two years indicate the existence of an active interbank unsecured money market and effective liquidity management in the banking sector.

"The AZIR index has been maintained close to the discount rate (7.25 per cent) for over a year now. Despite liquidity fluctuations since the beginning of the year, maintaining this rate of the index has enabled us to effectively control our operations," CBA Chairman Taleh Kazimov said. He added that this also demonstrates the stability of the exchange rate of the national currency of Azerbaijan.

Previously, decisions on quantitative parameters of monetary policy instruments were made on the basis of the 1-day AZIR index. Since November 2023, the 1-day AZIR index has been managed within the interest rate corridor, which, according to experts, indicates the strengthening of the interest rate channel in the transmission of monetary policy.

"Our analysis indicates that changes in AZIR indices have also begun to impact deposit and lending interest rates. This means that the groundwork has been laid for using AZIR as a reference interest rate for financial instruments, including loans and bonds," analysts at the country's Central Bank concluded.

Elchin Gulaliyev, deputy head of the CBA's monetary policy department, stated that a 1 percentage point change in AZIR affects interest rates on retail deposits by 0.14-0.27 percentage points.

Since November 2023, the 1D AZIR index has been formed within the interest rate corridor, indicating that the interest rate channel in the transmission of monetary policy has begun to function as intended. An assessment of the impact of the 1D AZIR on interest rates on loans is already underway.

A new approach

However, as with any useful tool, improvements can be made from time to time. As previously stated, this is a relatively new development, and during this period, market participants and the regulator itself may have questions or nuances to finalise.

In any case, the CBA, working closely with the experts of the European Bank for Reconstruction and Development (EBRD), has developed and approved new, more advanced rules for calculating the AZIR index. These regulations include several new provisions.

Therefore, in order to prevent unreasonable and sudden fluctuations of the index, the new methodology provides for the exclusion of 10 per cent of transactions concluded with interest rates that differ significantly from the market average from the calculation.

Contingency settlement plans are also in place to ensure the continuity of AZIR publication, even on days when transactions are not available in the volumes and quantities required by the new rules. The CBA has indicated that the changes are intended to eliminate interruptions in the publication of AZIR, with a view to furthering its use as a reference rate by money market participants.

The new rules also require the calculation and disclosure of compound interest rates for different periods. The new methodology will see AZIR rates with compound interest calculated for 30-, 90- and 180-day periods. These will be based on daily AZIRs disclosed for the relevant period. As these indices are calculated using interest rates announced daily for the last 30, 90 and 180 days, respectively, they provide statistical indicators of the average dynamics of AZIR for these periods. In addition, it is planned to announce a cumulative index of interest growth with the base date 01.11.2024 based on the daily announced AZIR rate. This index will thus allow market participants to calculate AZIR rates with cumulative interest for any non-standard reporting period.

"Among the key innovations is the introduction of additional indicators: the AZIR Compounded Rates for 30, 90 and 180 days, as well as the AZIR Compounded Index. This will expand the use of AZIR in cash and derivatives transactions," says Natalie Muravidze, Head of the EBRD's Country Office in Azerbaijan. It is her professional opinion that this initiative will strengthen the Azerbaijani manat market, promote the development of the interbank sector and strengthen the macroeconomic stability of the country.

To summarise, the introduction of a new methodology for calculating and publishing AZIR represents a significant stage in the chain of reforms aimed at boosting trade in the interbank market and improving the country's entire financial sector.