Trend commentator: Pros and cons of CBA’s preventive measures

Trend commentator: Pros and cons of CBA’s preventive measures

Azerbaijan, Baku, Nov.1 / Trend /

Trend Deputy Director Ilaha Mammadli

Preventive measures within which the Central Bank of Azerbaijan raised discount rate by one percent to three percent came into force in Azerbaijan from today.  

Taking into account the conditions prevailing in the domestic market, discount rate should be increased. During January-September 2010, Azerbaijan's GDP grew by 4.1 percent or one billion manat compared to the same period of last year, amounting to 29.3 billion manat. These growth rates are the absolute upper limit for the past four months. True, the highest growth rate of the domestic economy was observed at 9.2 percent in January 2010.

The refinancing rate is percent that the Central Bank charges on loans allocated to commercial banks. The refinancing rate is an instrument of money-and-credit regulation with the help of which the Central Bank influences on the interbank market rate, as well as rates on loans and deposits, which are provided by lending institutions to legal and physical entities. Raising interest rates leads to a corresponding increase in interest on loans provided by banks and interest on deposits placed in these banks. Discount rate in general is increased to combat inflation, and decreased to stimulate economic growth.

According to the State Statistics Committee's forecast, the consumer price index can reach 5.5-5.6 percent as a result of this year. Even by increasing the discount rate, we cannot affect the rising global prices for oil, sugar and grain. Raising the discount rate is a tool to influence the market participants' psychology. Freezing the rates is an effective means of suppressing the expected inflation rate.

During the first 9 months inflation year-on-year rose by 5.2 percent. Raising interest rates would increase interest in manat investments and further stabilize the economy.

Raising interest rates can be a tool for raising short-term rates in the interbank market and decreasing the amount of the interbank lending.

Preventive measures taken by the Central Bank today once again confirm the fact that the crisis has passed.

CBA's main policy objectives during the crisis period included the provision of financial system with liquidity, support for aggregate demand, and maintenance of financial system's stability. A wide range of measures have been taken for these goals. Since late 2008, the Central Bank six times changed the rate of refinancing and limits of corridor for operations on the open market in the direction of reduction.

As a result, the refinancing rate fell from 15 percent in October 2008 to 2 percent to this day, the upper limit of the corridor - respectively from 20 to 7 percent, the CBA balance requirements for banks since early last year to this day has increased by 20 times. Mandatory backup norms on internal sources of fund attraction were reduced from 12 to 0.5 percent, and on external sources of fund attraction in general have been canceled.

Along with this, in order to reduce the burden of supporting the required reserves, the reporting averaging over compulsory reserve was lengthened from 15 days to a month.

As a result, in October 2008, the net amount of "injections" of liquidity into the economy amounted to about $ 2 billion. Of this amount, only by reducing the obligatory reservation, the banks received more than $730 million, and revitalization of the Central Bank's discount window was mainly aimed at maintaining the liquidity of strategic companies (e.g., the State Oil Company, Azeraluminium JSC) and banks (mainly for timely servicing the external debts).

Along with changes in the interest rates, since Nov. 1, 2010, the Central Bank has also introduced a mandatory reserve on foreign sources of attraction at a rate of 0.5 percent, which until October 2008 was five percent.

The Central Bank started in a timely manner to limit the foreign borrowing by local banks, and imposed certain regulations on compulsory reserve norms, the amount of international loans. If at the beginning of the global financial crisis, the foreign borrowings of Azerbaijani banks accounted for 20-22 percent of their total liabilities, during the year they repaid credits in amount of about $900 million, and for two years - $2 billion.
After the restoration of the situation on world financial markets, Azerbaijani banks began to increase the amount of attraction. For the first half of 2010, the banks have attracted $955.8 million foreign borrowings with an increase of 4.6 times compared to the same period of last year.

But even after stabilization of the situation on the external and internal markets, the effect of raising the norm of obligatory reservation on foreign loans will not be evident because the foreign market will remain attractive in terms of cost of borrowing. On the one hand, excessive dependence on external debt financing discourages development of its own financial system and increases its vulnerability to external shocks, as any crisis in the banking system in any way is associated with external borrowing, and imposing restrictive measures on them is desirable.

On the other hand, it would be more reasonable not to limit, but to create mechanisms that would make foreign loans less profitable than domestic. All options have their pros and cons, as preventive measures by the Central Banks have provided a high-level capital adequacy for banks, capable to cover potential losses.

The banks also have high liquidity, which in turn ensures the timely implementation of commitments, including repayment of external loans.
As of July 1, 2010, the rate of capital adequacy for the banking system amounted to 17.2 percent, and the current liquidity ratio is two to three times more than the standard set by the Central Bank.
According to the international rating agency Fitch Ratings, liquidity risk and refinancing in Azerbaijani banks are at the background, Moscow's Fitch Ratings banking analytical group head Vladimir Markelov told Trend. He said that Azerbaijani Central Bank actively assist in stabilizing the situation in the banking sector. It refinanced a number of banks with high external debt burden, thus allowing them to refinance foreign loans. According to the agency, liquidity risk and refinancing are at the background, since much of the external debt of the banks were repaid. The "liquidity cushion" of assets increased due to lower demand for credit in the economy and also due to tighter control of banks in respect of loan during crisis.

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