TODAY.AZ / Business

Banking sector of Azerbaijan: making the best of a crisis

30 July 2015 [16:36] - TODAY.AZ

/By AzerNews/

By Gulgiz Dadashova

The dramatic drop in the price of oil in mid 2014 has made Azerbaijan’s banking sector suffer the most, since banking capital is dependent on energy revenues.

Azerbaijan's booming economy almost solely relied on the oil and gas sector in the last decade, but in recent years, the government has made a concerted effort to diversify the economy. Realizing that the energy boom cannot last forever, the state began to direct its hydrocarbon revenues to grow the non-oil sector and efforts to boost the banking sector have become part of the state strategy.

Overall, banks operating in the country have been growing rapidly – aided by the government to overcome the 2008-2009 global financial crisis – with the Central Bank of Azerbaijan giving additional liquidity to banks that needed it. The country’s banks avoided serious damage and bankruptcy thanks to state support through banks for infrastructure projects, and direct state support for large borrowers with payment difficulties.

Later, the CBA set higher capital requirements for banks bringing the capital floor up to 50 million manats ($47.6 million) to force bank consolidation and reduce risks. Larger banks meant larger loans to support the development of the economy, especially by switching focus to financing retail and small and medium-sized enterprises (SME).

In general, the CBA has identified several development options for the banks: capitalization, consolidation, conversion into NBCOs, or ultimately going out of business.

Bank operations during cheap oil prices set from mid 2014 have proved that the steps taken by the CBA are working and show the urgency for a stronger banking sector. The slump in oil prices has put downward pressure on Azerbaijan's economy, given that the hydrocarbon sector accounted for close to 37 percent of nominal GDP at year-end 2014.

Azerbaijan saw a sharp decrease in energy revenues being that its oil price declined from about $140 to $50-$60 a barrel as a result of which the government was forced to decrease its support to the sector.

The red line for the government is $40 a barrel, when the declining revenues may adversely affect the state budget.

Economist Ogtay Hagvardiyev said if the budget is not executed, then the costs will be reduced, and as a result, the banking system of the country will suffer. Accordingly, a large number of banks, whose authorized capital is too small, will be closed.

Azerbaijan had 44 commercial banks, a large number given that the country's population is just over 9 million. The CBA closed two of them in July. Many experts point out that the number of banks in Azerbaijan does not correspond to the size of the economy, naming the optimum number to be 20-25 banks.

“As of early 2015, 44 banks operated in the country. Two of them have been closed recently, as they failed to meet the CBA regulation,” he told local media. “As for me, optimally Azerbaijan should have no more than 17 banks, the rest can either merge or close.”

Banks however, even if they accept the risk of closure, usually do not consolidate despite the fact that international financial institutions such as EBRD, ADB, and IFC are willing to participate in the process.

“There are a couple of banks, whose registered capital ratio exceeded 50 million manats. I believe that the authorized capital level should be increased to 200 million ($190,429). Then the financial institution can be considered of full value.”

The closure of a large number of banks is not a bad thing, as from now on the money will be in a safe place, according to Hagverdiyev.

“There will be stable banks and normal banking system, " he said. “ Everything in the country depends on the oil. Naturally, any changes in this area will be reflected in the budgetary, financial and banking spheres of the country.”

The CBA cancelled the operating licenses of Azerbaijan Credit Bank JSC and EuroBank JSC in July. Thus the number of banks operating in the country fell to 42.

Perhaps these banks could have avoided closure by a merger, a process that the CBA had been promoting for some time.

EBRD Baku office head Neil McKain earlier told AzerNews that the consolidation of existing banks will have a positive impact on their transfer into stronger institutions and ability to finance microloans to corporate lending.

Samir Aliyev, expert at the public association "Assistance to Economic Initiatives," shared this view, saying that Banks that have appeared during the oil boom are doomed to close.

Azerbaijan has had a successful practice of consolidating banks. The present UniBank was formed by the merger of two commercial banks, MBank and Promtexbank, in 2002. The EBRD acquired a 15 percent share, and an 8.3333 percent stake was purchase by the German Investment Corporation DEG. Following this, in 2005, Unibank merged with Bank of Baku and IlkBank.

The economist believes that the banking sector in the future will face hard tests, "never recovered from the effects of the devaluation, the banking sector feels the strengthening of administrative pressure”.

At the stage of formation of a new model of economic development in Azerbaijan, the need for strong financial intermediaries has increased, suggesting the need for further consolidation of banks and greater capitalization.

As a result, local banks will not only be able to sustain the real sector of the economy of Azerbaijan, but could also be involved in financing major regional energy and transport projects, initiated by the country.

Another boost for the banking sector would be the rehabilitation of the largest bank in the South Caucasus, the International Bank of Azerbaijan, which was plagued by an increased credit debt that emerged after the devaluation of the national currency.

The debt hit several billion manats. Its financial situation remained fragile for an extended period of time, despite receiving state support.

Given that the IBA is a backbone bank and holds about 35 percent of total assets of the banking system, its dominance of the sector was set as a priority for achieving a more strong banking system.

Thus, President Ilham Aliyev ordered rehabilitation measures for the IBA in a decree on July 15 that should be completed within the next six months. The president’s order also mentioned that the bank's privatization plan should be submitted to his office for review.

"The shortcomings in the management, investment, and loan policy of the International Bank of Azerbaijan in recent years, as well as financing of less efficient, risky investment projects, worsened the bank's financial state, causing an increase in the share of distressed assets and reduced its liquidity," according to the presidential decree.

The order requires that the bank transfer its distressed assets to the state-owned non-bank credit organization CJSC "Aqrarkredit".

Meanwhile, the World Bank recommended the government not to rush into this issue and offered rehabilitation after its transformation into a development bank, even though there are many other models that can be applied to make the Bank more financially sustainable.

"Today it is difficult to talk about the privatization of the IBA because market conditions in the long run are not conducive to attracting large foreign investors [to participate in the process of denationalization]. The market is in a phase where a few countries, especially after the introduction of the requirements of Basel III, show desire in expanding presence in emerging markets,” Angela Prigozhina, the World Bank coordinator for private and financial sector in the Southern Caucasus, told Trend.

Overall, the rehabilitation measures for the IBA are expected to have a positive impact on the banking sector of the country. The results will be a greater level of competition among the private banks and a decrease in operating expenses of banks and thus a decline in interest rates for end users.

URL: http://www.today.az/news/business/142538.html

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