Ayaz Museyibov, Head of the Department

Macroeconomic development trends in the banking sector

Last year, Azerbaijan implemented its policy of financial stability in the face of a recession in the world economy, an increase of significant global risks, and instability in world financial and commodity markets that appeared because of the pandemic, as well as of rising political tensions in the region. The macroeconomic policy was aimed at achieving such goals as keeping up optimal inflation while maintaining the stability of the manat, strengthening development and stability in the banking and financial sector.

In line with the main goals and objectives ahead, there have been taken continuous measures to form a financial and banking system that is resistant to internal and external shocks, deeply focused on risk management processes, covered by effective regulation, transparent corporate governance, and strong infrastructure elements. As a result of those measures, over the past 10 years, the country's strategic foreign exchange reserves have almost doubled reaching 49.1 billion US dollars, while the Central Bank's official foreign exchange reserves amounted to 6.4 billion US dollars. The measures taken over the previous period has lead to the restoration of macroeconomic stability, attaining significant achievements in increasing the stability of the financial and banking system, and replacement of stabilization trends, observed in the banking sector against the background of recovery of general economic growth, from the recession moderate economic activity.

The fluctuations observed in the banking sector in the first half of 2020 due to the pandemic have remained stable since the second half of the year. Also, the loan portfolio, total assets of the banking system, net profit, and capital have moved out of the negative stalemate. In April 2021, the assets of the banking sector remained stable at 32.7 billion manats, which demonstrates an increase by 1.3 billion manat or 4.3 percent compared to 2016. Another important indicator is that the net loss of the banking sector in 2016 amounted to 1.6 billion manat, while the net profit in 2020 amounted to 567.8 million manat. According to the results of 2020, the total assets to non-oil GDP ratio, which is considered the financial depth ratio, was 63%. The revival that began in the banking sector in the past period is also reflected in the number of employees. Thus, according to official statistics for April 2021, compared to the end of 2016, the number of employees in the banking sector increased by 11% (18,893-16,947), which indicates a significant recovery in the sector. 

The analysis of the financial indicators of the banking system also shows that the stability indicators in banks have increased over the past period. Return on assets and capital have also been positive during the last year. Analysis of the relevant data of the Azerbaijan Banks Association shows that if in 2016, unprofitable banks accounted for 50% of the sector (16 banks), in the 1st quarter of 2021, this figure was only 8% (2 banks).

In 2020, for rehabilitating and regulating the activities of separate financial institutions in the country, the activities of the 4 banks were terminated within the microprudential policy. The measures taken and the normative-legal documents adopted have not only increased the stability of the financial sector but also strengthened local financial institutions and increased market confidence. Along with that, despite achievements attained in the current period, it is also desirable to implement future development strategies to bring the banking sector in line with the country's economic development strategy.

Credit ecosystem rehabilitation

According to statistics for 4 months of 2021, the specific weight of non-performing loans (NPL ratio), which are considered as one of the main quality indicators of credit portfolios, have reduced to 6.1 percent. It should be mentioned that this is the most positive indicator in Azerbaijan in this area since the oil crisis of 2015. In fact, along with being one of the main signals of recovery of the sector, this indicator is also one of the factors that have a positive impact on the risk burden of the loan portfolio of the banking system and the reduction of overall loan interest rates. In comparison with the “negative boom” of 2017 (NPL ratio – 15.5 percent), this indicator also means a 2.5-fold decrease. In its turn, such a decrease will have a positive impact on the reduction of credit costs of the banking system and result in the formation of lower interest rates and a healthier culture of credit reporting. It should be noted that the constant decline in the non-performing loan portfolio in recent years has made Azerbaijan one of the most successful countries in Eastern Europe and the CIS in this area. Of course, we reach such results due to long-term and sustainable strategic activities implemented under the leadership of President Ilham Aliyev. 

The potential of the banking system formed in Azerbaijan and the experience of the past years give grounds to say that despite the challenges, there are quite wide opportunities for further positive progress in this area in the coming years. At the same time, one of the issues of special importance in terms of the stability of the sector is the increase in long-term loan trends. 

According to the results of the first 4 months of 2021, the share of the long-term loan in the total portfolio reached 82.5%. For comparison, the corresponding figure was 75.6 percent in 2015 and only 36 percent in 2005. Despite the negative effects of the pandemic, there has not been indicated any negative trend in this direction. The increase related to this indicator is in itself the result of increased confidence in the sector and the establishment of more qualitative and substantive customer-banking relations. In the previous period, there have been observed de-dollarization in loan portfolios. If compared to 2019, the share of manat loans in the total portfolio increased by 4.9 percent and reached 70.2 percent in 2020. The results of the first 4 months of 2021 also show positive trends in this direction, and the corresponding figure increased by 2.1 percent from the beginning of the year and reached 72.3 percent.

Development trends of the deposit ecosystem

As it is known, being an iterative continuation of the processes following the 2015 global oil crisis, in 2017, deposits of legal entities decreased to 19 billion manat and deposits of individuals to 6.8 billion manat. In April of this year, the volume of deposits in banks stabilized at around 22.4 billion manat, and the volume of deposits of individuals amounted to 8.3 billion manat. Compared to 2001, deposits of legal entities increased by 58 times, and deposits of individuals - by 71 times. The increase in these two indicators can be considered both an element of economic development and a positive change in confidence in the banking sector. It should also be mentioned that a slight increase in deposits of legal entities and individuals, registered in 2020, was related to the banks having their license liquidated, and this volatility system is not considered a significant risk. 

The de-dollarization of deposits and deposits portfolios, observed in last years, has also continued this year. The specific weight of manat in deposits has reached 46.5%, which is one of the important factors neutralizing the critical level of foreign exchange risks. The corresponding figure is the highest since 2015 – the year when it decreased to 15.3 percent. The de-dollarization of deposits increased by 4.9 percent in 2020 and by 2.9 percent in the first four months of this year.

The share of time deposits was 39.7%. If this figure was higher, of course, it would serve to increase confidence in the banking sector. However, here, the increase in the weight of required deposits can also be explained by the demand for liquidity created by investment activity. At the same time, it is no coincidence that the share of long-term loans is growing. In this case, the only issue to consider is the correct calculation of risks by banks, operation of mitigation tools, and not allowing the difference between loan and deposit terms to become any systematic banking risk.

Reforms implemented for the development of infrastructure 

To ensure sustainable operation of the banking system, there have been launched National Payment System, Government Payment Portal, Central Credit Register, and Interbank Card Center in Azerbaijan. By applying a special blockchain platform for the first time in the country, the Digital Identification System was introduced. The development of this project will play a very important role in the formation of a climate of trust in the sector, as well as in the protection of the integrity, availability, and confidentiality of information in the banking system. 

Among the achievements attained within the frame of reforms implemented previously is lowering of loan rates, the introduction of 3 important mechanisms applied in the best international practice to build a healthy credit ecosystem, and the launch of Credit Bureau, State Registry of Encumbrance of Movable Property, and Mortgage and Credit Guarantee Fund. Over the past period, institutional reforms have also covered the insurance sector. As a result, the Compulsory Insurance Bureau, the Agrarian Insurance Fund, and the Joint Agrarian Insurance Company were created.

One of the recent significant reform measures in the banking system was the launch of the Instant Payment System (IPS). The introduction of the IPS is one of the measures realized within the State Program on Expansion of Digital Payments in the Republic of Azerbaijan for 2018-2020. The Center for Analysis of Economic Reforms and Communication conducted the monitoring and evaluation of the Program. As a result of the application of IPS, application of QR code functionality and introduction of registration, inter-account transfer, and payment functions for the population through internet and mobile banking services were provided. We anticipate that opportunities provided by the use of the IPS will give a new impetus to the expansion of digital payments among economic entities and the formation of a cashless society.

Another important innovation in the banking system is the introduction of new credit scoring based on international methodologies, which will allow the introduction of automated lending decision-making systems. Once the banks use this system appropriately, it will let underwriting processes be automated, and lending processes be carried out "instantly". The most important point is that the application of these mechanisms is such a development project that everyone who uses banking services will feel the increase in the quality of services in the payment and credit ecosystems in their lives. 

Fight against effects of the pandemic 

To reduce the negative impact of the pandemic on the capital stability of banks in 2020, the prudential framework has been relatively relaxed, concessions have been made on regulatory control processes, a support program has been adopted to create conditions for credit expansion and promote digitalization. According to the program, large-scale support measures were taken to prevent deterioration of loan quality during loan restructuring, to shift to a relatively "soft prudential framework". Also, the measures covered significant support to banks in 5 key areas on capital adequacy indicators, as well as support for financial access or credit reporting systems and digitalization. Consequently, the banking system could be built its work by new conditions. 

New development prospects

To increase the positive impact of the financial and banking system on macroeconomic development, it may be expedient to form a strategic framework for corporate governance concerning these services and the real sector. From this point, reviewing the world’s three main models (Anglo-American, German, and Japanese corporate models) can be sufficient. 

At the same time, if local banks become "development banks", they can reduce their dependence on interest income by earning income at all levels of business (development of business plans, finding external partners, access to markets, marketing, etc.). It also can positively affect the development of the real sector. The development of Islamic finance in Azerbaijan can also be an additional impetus for attracting foreign investment (especially from the Gulf countries). Currently, such world’s largest banks as HSBC, Citi Bank, Lloyds TSD (U.K.), Deutsche Bank, UBS, Royal Bank of Scotland have established an “Islamic window” customer service structure. Islamic financial institutions are considered as a good platform for expanding access to financial services in the real sector, as well as for small and medium enterprises to access finance, thereby supporting growth and economic development.

Thus, the statistics of previous years demonstrate that the banking sector in Azerbaijan has passed a significant development path. At the same time, new paradigms that emerged due to the pandemic showed all world countries the importance to design such a banking system that is moving faster towards digital transformation, has a solid base of banking services, and can transfer advanced development technologies to the country.

In conclusion, it should be mentioned that for the Getting Credit indicator of the Doing Business 2020 report, Azerbaijan is ranked first among 190 countries. It means that, as in other areas, our country has wide and sufficient potential to reach the best results in the financial and banking sector.