Banking sector of Azerbaijan: Results of 2010

Analysis Materials 5 January 2011 12:09 (UTC +04:00)

The level of development of the country's banking sector is one indicator defining the development of Azerbaijan's economy as a whole. The banking system faces a difficult task - in the future it will become the main source of lending to the economy, and a catalyst for accelerating development of Azerbaijan's non-oil sector. Despite the fact that overall growth in the banking sector is ahead of the main macroeconomic indicators of the country, its current potential is still far behind the needs of the country's economy.

Results of the 2010 fiscal year once again confirmed that Azerbaijan's banking sector has entered into a crisis well prepared. This is as the result of the preventive regulatory measures taken by the country's Central Bank, which serves to control excessive external borrowing. In order to motivate banks to exercise more restrained behavior in the market, and significantly improve risk management and corporate governance, timely requirements for the quality of assets and collateral loans were tightened.

However, these requirements of the Central Bank were directed not only to tightening. The banking sector received active assistance through the mitigation of monetary policy of the CBA and a reduction in the discount rate several times. This also include a reduction of reserve norms to attract domestic sources, the issuance of special loans to banks, and fivefold increase in the amount of state-insured deposits. All these activities played a role in stabilizing the situation in general.

Thanks to these activities Azerbaijan's banking sector avoided bankruptcy cases or the closure of banks during the crisis. However, this year the Central Bank launched the implementation of a strategy to consolidate and optimize the banking system, part of which is also the removal of weak banks from the market. After a two-year pause, the ranks in banking began to thin again, and showed depletion by the end of 2010.

On the first day of December, the Central Bank announced its decision to annul the licenses of two banks - Debutbank (operated since 1994) and Kovsarbank (in operation since 1992). This decision was due to failures to fulfill requirements of the minimum aggregate capital, violation of requirements of banking laws, including the non-implementation of management and current activity in a safe and prudent order. These banks also systematically neglected to fulfill the instructions of the Central Bank.

Recent reductions in the market occurred in 2008, as a result of the cancellation of licenses of Poctbank, which was practically inactive, and Atlantbank - due to non-fulfillment of requirements on capitalization. But then the number of banks increased by as much - permits for banking activity were granted to JSC Nakhchivanbank and Azfinans Bank (currently AFB Bank). However, this year, the Central Bank issued (in late March) a license to a bank with the Azerbaijani capital - BTB Bank. At present, the country's banking sector comprises 45 banks.

In future, reduction in the number of banks will be inevitable, taking into account the strategic goals of the CBA, which involves the enlargement of banks and an increase in the capitalization of the banking system. Although for several years the minimum requirement for capitalization (10 million manat) of banks remains unchanged, the government however exempted a part of profits, directed to capital rise, for three years to stimulate this process.

Azerbaijan needs large and medium-sized banks. Today the country's dynamic economy requires an increase in the active participation of banks, especially when taking into account the high demand for financial resources and the distribution of financial flows within of the country's economy. In this regard, banks show a significant growth potential.

Meanwhile, due to the fact that at present the risks are increasing, banks should once again assess the market, and this takes some time. Banks have enough money for lending, but they must ensure that funds will be returned in time.

If the share of problem loans exceeds 10 percent then it is considered at a risk level in world banking practice. According to the CBA, since March last year, the share of overdue loans in the total loan portfolio of the country's banks hit only 3.8 percent, but from early 2010 their share increased, and reached 5.01 percent as of Nov.1.

Growth in delays do not speak about the presence of a large number of debtors in Azerbaijani banks, as the growth in problem loans are due to big loans. As a result enterprises faced problems in connection with a reduction in business as a result of the crisis in the world economy.

Perhaps this contributed to the reorientation of the banking business in the direction of service, which was especially observed during this year. Providing retail banking services to the public is becoming a promising sphere of banks' activity, especially outside the capital, in the regions where the market is poorly developed, and the potential of the population's solvency is growing. Retail banking services are one of the most profitable businesses types for banks.

The attractiveness of the retail services is due to the fact that corporate clients are already covered by banking services. In addition, stiff competition in this market segment has developed quite speedily. Deposit transactions with the population contribute to the constant flow of resources, and its lending provides bank with a high level of income and diversification of credit risks by differentiating the credit services on terms and customers.

Banks, forecasting this trend, reorient its development strategy to increasing lending in other segments of the market - loans to physical entities and enterprises of small and medium-sized businesses. The share of loans to the population already accounts for 21.3 percent of total assets of the banking sector.

One of the positive trends of the banking market of the country was also a significant reduction in interest rates, as well as dynamic growth in the figure of the population's deposits. For a year deposits of physical entities rose by 35.8 percent to 2.9 billion manat. A reduction in the maximum limit of interest rates on deposits from June 1 (on which insurance coverage are provided by the Azerbaijani Deposit Insurance Fund)(ADIF) to 12 percent led to a reduction of interest rates on deposits. Deposits attracted by banks over this rate are not insured by the Fund, and payment of compensation for them is not envisaged. During the year the average interest rate on deposits in manat was reduced by roughly two percent.
Despite the reduction in the number of profitable banks (31 banks compared to 36 a year earlier), in general the country's banking sector is now stable enough to the point that banks do not face big problems. The country's banks have a 60-70 percent financial liquidity with the existing norm at 30 percent, and repay foreign commitments in time.

As a result of previous measures the share of banks in the country's economy hits 27.9 percent (the ratio of credit investments to GDP), whereas earlier this figure didn't exceed 20 percent. Balance sheet assets of the banking system each month pierce its historic maximum, and as of Nov. 1 they reached 12.768 billion manat, increasing within ten months by 9.5 percent.

Given such a growth rate, it is necessary to improve the effectiveness of supervision in the country's banking sector. Hence the Central Bank's goals,  after the crisis developed, include the introduction of a system emphasizing a firmer approach to the regulation of the banking system, which can a source of risks in the banking sector. The Central Bank is also going to introduce a new regulatory framework in three directions - on regulating capital adequately, liquidity management and financial backup.

In recent years, positive trends indicate an effectiveness of the implemented reforms. In particular, competition among the leading banks seriously tightened. This factor should be observed against the background that 2009 was a year of tests of survival for many financial organizations, while 2010 became the year of entry into the post-crisis period, which affected all the world's nations negatively.