Azerbaijan's banking sector is broadly stable, Fitch Ratings said on March 6.
At the same time, structural issues continue to weigh on the sector's asset quality, profitability and capitalization, the report added.
"Azerbaijan's banks are now refocusing loan growth towards the retail segment to offset legacy impairment problems in corporate portfolios and improve returns on capital through wider margins," Fitch said. "Retail loan growth (44 percent in 2013) has been considerably faster than nominal household income growth (8 percent in 2013) resulting in a rapid increase in personal debt burdens."
Fitch also believes the quality of existing retail lending is reasonable and there is some further room for growth, given still modest penetration (retail loans to GDP equals only 11 percent at end-2013) and the potential inflow of currently under-banked people into the system.
In contrast, the corporate lending market is closer to saturation, reflected in the lack of good quality borrowers in the system.
"Corporate loan growth was 15 percent in 2013 after a 25-percent expansion in 2012," Fitch said.
Reported asset quality metrics suggest a recovery in loan arrears, as according to a survey of Fitch-rated banks, loans 90 days overdue fell to 9.6 percent at end-2013 from 13.1 percent at end-2012. However, Fitch believes underlying asset quality is somewhat weaker than indicated by headline numbers due to the untested quality of newly-originated corporate lending, potentially sizeable restructured loans and other legacy assets at some banks, and insufficient provisioning at some banks.
"Capital ratios have improved, with the system's aggregate total ratio reaching 18 percent at end-2013, as some larger banks received considerable equity injections from shareholders in 2013," Fitch said.
However, Fitch views the sector's capitalization as moderate in the context of significant unreserved problem loans (around 45 percent of end-2013 equity), modest additional loss absorption capacity, particularly at smaller privately-owned banks, and weak internal capital generation capacity. The latter is dampened by operating efficiency problems, a significant portion of low-margin directed lending and quite volatile impairment charges.
"Funding remains stable, underpinned by sticky state funding (24 percent of system liabilities) and a growing deposit base," Fitch said. "Foreign funding is a significant 19 percent of liabilities, but this was equal to a moderate 12 percent of sovereign FX reserves and is mostly concentrated at International Bank of Azerbaijan (BB/Stable). Banks maintain reasonable liquidity cushions on their balance sheets but in case of stress their liquidity may be vulnerable due to slow loan book amortization."