Insufficient Funds May Restrain Growth of Azerbaijani Banking System-Fitch

Azerbaijan, Baku, 25 April /corr. Trend I.Khalilova / The international agency Fitch Ratings support the rapid growth of Azerbaijani banking system despite of considerable difficulties, Agency reported.

Fitch Ratings says in a special report issued on 24 April that very rapid growth, considerable fragmentation among private-sector banks, balance sheet concentrations and weak corporate governance practices represent considerable challenges for the Azerbaijani banking system. However, Fitch also notes that asset quality has improved in recent years, reflecting the buoyant credit environment driven by high oil prices, and that growth has been from a low base, somewhat mitigating credit risks.

"The banking regulator has taken a number of steps to enhance the effectiveness of the supervisory framework," says Vladimir Markelov, Associate Director in Fitch's Financial Institutions group. "The regulator has stimulated consolidation by raising minimum capital requirements," he said.

The National Bank of Azerbaijan (NBA) introduced reporting standards broadly in line with IFRS and promoted the introduction of the deposit insurance system. At the same time, according to Markelov, the enforcement of prudential regulations has not been strong, shareholder structures are often less than transparent and corporate governance is loosely supervised

"Extremely rapid growth, significant sector and obligor concentrations and the still high level of dollarisation are of concern," says James Watson, Senior Director in Fitch's Financial Institutions group. "However, these are somewhat mitigated by the relatively low penetration level and improvements in NPL ratios on the back of a broadly favorable credit environment," he said.

The overall level of banking sector penetration (end-2007: credit/GDP ratio of 18%) lags markedly behind most other CIS countries. However, according to Fitch experts, the credit/GDP ratio should be considered in light of the low level of banking sector lending to the dominant oil and gas sector, which contributed 63% of 2007 GDP, and therefore higher penetration of the non-oil economy. Fitch expects the banking sector, especially the leading private players, to continue to grow rapidly, although this may be subject to funding constraints if access to international borrowings remains limited.

The report says that the system is concentrated at the top end with state-owned International Bank of Azerbaijan (IBA, 'BB+'/Outlook Stable), holding 39% of end-2007 system assets. However, the privately-owned sector is very fragmented, with no other bank holding more than 10% of system assets, making it difficult to achieve economies of scale and diversify risks. The number of banks, at 46, is also high in respect to the system's size, although branch networks are underdeveloped. The level of state participation is high, and privatization has been slow and lacking in transparency, with limited information about non-government beneficiaries at both IBA and Kapital Bank ('BB-' (BB minus)/Rating Watch Negative). Foreign ownership is moderate, although international financial institutions have taken minority stakes in four of the largest ten banks.

Profitability has been reasonable in recent years; however return on equity is not so strong when adjusted for inflation. Funding is primarily sourced from domestic deposits, which are short-term and potentially exposed to flight risk. Foreign borrowings are limited and mainly take the form of bank bilateral facilities, syndicated loans or club deals, the report says.

Capital adequacy ratios for the system as a whole have been broadly flat and comfortably in double digits since 2004. However, capitalization is under significant pressure from rapidly growing balance sheets and needs to be supported by regular equity injections. Fitch considers the level of system capitalization to be moderate in light of growth rates and concentrations.  The correspondent can be contacted at: [email protected]

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