BALANCE OF RISKS AND GROWTH

In the context of ongoing volatility in the global economy, geopolitical turbulence and mounting pressure on the financial systems of developing countries, the stability of national banking and insurance sectors is becoming a key factor in macroeconomic stability. Interest rate hikes in leading economies, fluctuations in commodity and debt markets, and structural changes in global trade are creating new challenges for countries, forcing them to strike a balance between stimulating growth and managing financial risks.

In these conditions, Azerbaijan is demonstrating a balanced approach to ensuring financial stability. By combining the recovery of investment activity, growth in the construction sector and prudent management of banking risks, the country continues to strengthen the position of its financial sector. The Central Bank of Azerbaijan's (CBA) semi-annual financial stability report for 2025 corroborates this trend.

Banking sector stable

According to the CBA, the banking system demonstrated robust capital adequacy and liquidity ratios during the reporting period, significantly exceeding the minimum regulatory requirements. The capital adequacy ratio for the sector was 18% against a standard of 10%, and the aggregate liquidity coverage ratio reached 180%, exceeding the minimum level by 1.8 times. It should be noted that a 1 percentage point increase in the interest rate leads to a 0.9 percentage point decrease in the capital adequacy ratio, which does not pose a threat to the financial stability of the banking system.

Positive dynamics have also been maintained in terms of profitability: the banking sector's net profit for the first six months of 2025 exceeded ₼0.5 billion, with a return on assets of 2.1% and a return on equity of 18.5%.

Concurrently, the sector has experienced a decline in profitability, which the Central Bank attributes to rising interest and non-interest expenses. This is occurring against the backdrop of a slight increase in interest rates on deposits by banks, as well as an increase in operating expenses, which have increased by 55% and 16%, respectively.

Further to my previous message, I would like to reiterate the point about banking sector stability. It is worth noting that the weakening of dollarisation trends and the stable level of non-performing loans in the portfolio are evidence of sound risk management and effective supervision by the regulator. By June 2025, the dollarisation level of the business portfolio had decreased by 2.3 percentage points to 26.1%. A particularly notable reduction was observed in the construction and information and communication technology sectors.

Furthermore, following a period of intensive strengthening of capital positions and liquidity, banks transitioned to a more active phase of business lending, while maintaining a cautious approach to risk assessment and asset quality. According to the Central Bank, banks' business portfolios grew by 9.3% over the year, while nominal GDP grew by 4.3%. In the first half of 2025, lending growth was recorded in almost all sectors, with the exception of industry; the strongest growth was observed in the construction and transport sectors, where large infrastructure projects are being actively implemented.

A substantial proportion of the portfolio is made up of investment loans. As of June 2025, approximately 25% of all loans issued to the real sector were directed towards the formation of fixed capital, including construction, reconstruction, modernisation of production facilities and the purchase of equipment. Such loans contribute to the structural modernisation of the economy and strengthen its long-term potential.

The non-performing loan ratio in the business portfolio increased slightly, from 2.5% to 2.8%. According to the CBA's assessment, an in-depth analysis covering 56% of the business portfolio confirms that risks to non-financial organisations are under control and that the quality of credit assets as a whole is satisfactory.

Growth in non-performing loans

Following a period of consistent growth in the business portfolio and an expansion of the banking sector in the real economy, there has been a natural focus on asset quality. The increase in lending volumes, particularly in the consumer and mortgage loan segments, necessitates a more sophisticated risk management system. For this reason, the Central Bank maintains its course of preventive supervision and targeted regulation, seeking to maintain a balance between stimulating lending activity and controlling potential risks.

As of 1 July 2025, non-performing loans (NPLs) amounted to ₼787 million, representing a 20.1% increase since the beginning of the year. The primary growth was observed in the consumer loans, business loans and mortgage loans sectors.

At the same time, the level of reserves remains more than sufficient to cover potential losses. Target reserves for loans reached ₼1.7 billion, which is twice the volume of the non-performing portfolio. For consumer loans alone, the amount set aside as reserves was ₼1.23 billion, which is approximately 3.8 times higher than the corresponding NPLs. This indicator demonstrates the banking sector's ability to absorb potential losses without compromising the stability of the system.

During the first six months of 2025, banks wrote off bad loans amounting to ₼56.7 million, of which 61% were consumer loans and 39% were business loans. Despite this process, the level of non-performing loans in the business segment remains moderate at 2.8% of the total portfolio. The increase in non-performing loans (NPLs) compared to the end of last year is primarily due to isolated cases in the construction sector and is not indicative of a systemic issue.

The consumer segment, which is generally more sensitive to fluctuations in household income, remains under close scrutiny by the regulator. In the first half of 2025, NPLs in this segment grew by 30% to ₼321 million, and the non-performing loan ratio increased to 3.6%. At the same time, the debt burden remains significant: 38% of the consumer portfolio consists of loans with a debt-to-income ratio (DTI) above 45%.

In order to limit potential risks, the CBA is implementing a responsible lending policy. The new regulations establish a stringent upper limit on the debt-to-income ratio of 70% and impose more rigorous requirements for reserving loans with high debt burdens. These measures are designed to reinforce discipline among both banks and borrowers, thereby mitigating the risks associated with the consumer segment.

Concurrently, there has been a gradual reduction in restructured loans, with their total volume decreasing by 3.6% to ₼1.07 billion. The main decline was in the business portfolio, while the consumer segment saw a moderate increase in restructurings. There have been virtually no changes in mortgage loans.

All these factors confirm that credit risks in Azerbaijan's banking sector remain under control and that regulatory policy provides sufficient resilience to maintain financial stability, even in times of global turbulence.

Debt burden and interest rate risks

Following a thorough analysis of the dynamics of non-performing loans and an assessment of the overall stability of the banking sector, the question of the financial situation of the population naturally arises. Given that households form the basis of domestic demand and determine the stability of consumer lending, it is important to consider how balanced the financial situation of the population is.

The debt burden of the population in Azerbaijan remains manageable, but there are indications of a gradual increase in the trend. Despite steady growth in disposable income, an increasing portion of it is being directed towards servicing loans. In comparison with the end of last year, the ratio of total debt burden to disposable income has increased by 0.5 percentage points, reaching 18.5%. This indicator remains moderate and shows no signs of financial overheating, but requires careful monitoring against the backdrop of active growth in consumer lending.

The results of a survey conducted by the CBA among commercial banks confirm the ambiguity of the current dynamics. Therefore, 49% of participants by market share reported that the level of household debt had remained unchanged, while 50% noted a moderate increase.

Atakhan Hasanov, Director of the Financial Stability Department at the CBA, noted that the share of assets with a maturity of up to one year is 51%, and liabilities are 81%. This ensures a balanced structure and minimal impact on banks' capital.

The CBA representative emphasised that the mismatch between the maturities of assets and liabilities has a minimal impact on capital and does not pose a threat to the stability of the banking sector.

In the context of stable interest rate risks, there has been an increase in public confidence in the banking system, with more and more citizens opting to place their savings in term deposits, indicating an increase in financial discipline and long-term expectations. In the first half of 2025, the number of unique depositors with active term deposits grew by 11.7%, exceeding 168,000 people. This growth was a direct result of the introduction of new monetary and macroprudential instruments, as well as the active promotion of digital banking services, according to the CBA.

When compared with the previous year, the dynamics appear even more impressive: in 2024, the number of unique depositors increased by 41%, reaching 150,500 people. The growth of the deposit base of individuals strengthened the stability of banks' financial sources, even against the backdrop of a decline in corporate sector deposits.

Therefore, in the first half of 2025, corporate deposits decreased by 4.7% to ₼22.3 billion, while individual deposits increased by 5.3% to ₼15.1 billion. Consequently, the proportion of corporate deposits in liabilities fell to 44.8%, while the proportion of household deposits increased to 30.2%.

According to the CBA's assessment, the growth in deposits from individuals was primarily driven by an increase in term deposits. Conversely, the decline in corporate deposits was attributable to a decrease in both term and current balances, predominantly from large enterprises in the oil and gas sector.

Insurance sector: decline in profits

According to the report, the liquidity of Azerbaijan's insurance sector remains high, with the sector's liquidity ratio reaching 304%, significantly exceeding the standard set by the International Association of Insurance Supervisors. In terms of segments, the indicator was 271% for life insurance and 374% for non-life insurance, which indicates the strong financial position of the insurance market.

The total volume of highly liquid assets of insurance companies reached ₼1.4 billion, of which 816 million are attributable to life insurance and 537 million to non-life insurance. Maintaining a significant volume of high-quality liquid assets provides insurers with high resistance to three-month liquidity fluctuations and allows them to effectively fulfil their obligations to customers, even in periods of instability.

However, in the context of stable liquidity, the insurance sector's net profit declined by 17% to ₼81 million. The primary cause of this was an increase in the loss ratio, which reached 85%. The compulsory motor third-party liability insurance segment had a particularly significant impact, with the aggregate loss ratio rising to 109%. This is indicative of an increase in the number of insurance claims and claims payments.

In the first half of 2025, the insurance sector demonstrated its ability to adapt to changing market conditions: total capital decreased by 12% to ₼333 million, mainly due to the payment of dividends. Notwithstanding, this indicator continues to surpass the established prudential requirements, thereby ensuring the sector's stability remains at a satisfactory level.

CBA Director General Shahin Mahmudzade emphasised that insurance companies are committed to leveraging the full potential of financial market instruments at their disposal. They proactively engage in repo transactions, assuming the role of the party providing funds, thereby enhancing the efficiency of liquidity management.

Today, the investment portfolio accounts for 92% of the assets of life insurance companies and 73% of the assets of non-life insurance companies. The portfolio is based on government bonds and bank deposits. Income from investment activities for January-June reached ₼55 million, which is 7.15% of the sector's total income.

Investment market: new trends

In terms of the investment market, there are mixed dynamics at play. In light of the Ministry of Finance's decrease in new issues, the total value of government securities in circulation experienced a decline of 11%, amounting to ₼8.5 billion. This was due to a more measured issuance policy and a partial redistribution of investment flows towards the private sector and foreign markets.

Concurrently, activity on external brokerage platforms has grown significantly. Client assets of investment companies increased by 23% to ₼2.4 billion, of which ₼2.1 billion were attributable to brokerage services abroad. This trend indicates an increased interest among Azerbaijani investors in international financial instruments and a tendency towards diversification of investment behaviour.

However, not all indicators demonstrated positive dynamics. Despite an increase in client activity, the net profit of investment companies decreased by 67%, amounting to ₼1.5 million against ₼2.9 million a year earlier. The decline in profits can be attributed to several key factors, including an increase in fees and commissions, higher payroll and social security costs, and higher administrative expenses.

At the same time, the capital stability of the sector remains at a satisfactory level. As at the end of the first half of 2025, the total capital of investment companies amounted to ₼52.8 million, with the required minimum capital level being ₼7.4 million. This provides companies with a sufficient capital buffer for further development and increased competitiveness in a changing market environment.

The country's investment market is therefore entering a period of structural change, with a reduction in the domestic supply of government securities offset by growth in international investment activity. This reflects the gradual integration of the Azerbaijani financial sector into global capital markets.