At the conference dedicated to the results of the first year of implementation of the State Program on Socio-Economic Development of the Regions of the Republic of Azerbaijan for 2019–2023, President Ilham Aliyev outlined key priorities for the development of the country’s financial and banking sector. Vusal Qasimli, Executive Director of the Center for Analysis of Economic Reforms and Communication (CAERC), addressed questions on this topic.

What have been the main trends in the financial-banking sector over the past year?

Under the successful policy framework led by President Ilham Aliyev, the last three years have seen institutional reforms, the resolution of toxic assets and problematic loans, full insurance of deposits, support for cashless transactions and digitalization, and the maintenance of overall macroeconomic stability, giving new momentum to the financial-banking sector. As a result, last year the banking sector’s credit portfolio expanded, profitability, assets, deposits, and capital increased, while foreign debt declined. Notably, net profits of the banking sector doubled, dollarization of loans decreased from 38% to 35%, and individual deposits fell from 63% to 54%.

In 2019, both the broad money supply (M3) and other monetary aggregates (M0, M1, M2) increased. However, the money multiplier—the ratio of the M2 aggregate to the manat monetary base—declined, as did the ratio of M3 to the monetary base. This indicates that Azerbaijani banks face challenges in creating money through deposits and loans. Indeed, because deposits and loans grew 4–5% slower than the money supply, the money multiplier decreased. Yet, increasing deposits and loans requires sufficient demand as well.

The velocity of the manat decreased by 6% in 2019. When the money supply increases, a reduction in velocity helps maintain monetary balance. Economists Samuelson and Friedman argued that over the long term, velocity tends to fall relative to real income growth, serving a stabilizing function. In Azerbaijan, this principle has been preserved, preventing inflation from accelerating even as the money supply expanded. Excess money in circulation is regulated through Central Bank deposits and notes, mandatory reserve requirements, and government securities issued by the Ministry of Finance, thereby stabilizing the manat. Last year alone, the Central Bank and the Ministry of Finance sterilized more than $700 million.

In terms of sectoral allocation of real-economy loans last year, households, trade, and public catering dominated, accounting for 60% of the total credit portfolio. Notably, loans to households approached half of the portfolio for the first time. Considering that nominal incomes increased by 7.4% in 2019, demand has risen rapidly. To prevent acceleration of imports or excessive financing of foreign producers, the non-oil economy must grow in step. Credit portfolio analysis shows that the most common loans in Baku are long-term, manat-denominated, and targeted at households, trade, catering, transport, and communications. Long-term loans in local currency are a positive trend, though more work is needed to extend credit to regions and the broader real economy.

How effective is the scale and structure of the credit portfolio?

Credit to GDP in Azerbaijan is about 20%, while the global average is 130%, 91% for Europe and Central Asia, and 123% for upper-middle-income countries including Azerbaijan. Considering that investments also flow from foreign securities markets, there is substantial room for credit portfolio growth and financial deepening, as highlighted by the President.

According to World Bank data, the spread between lending and deposit rates was 7.17% in 2018 and is now 4.65%, still high relative to regional peers (e.g., Belarus 2.78%, Georgia 2.29%, Russia 3.5%, Moldova 4.36%).

To reduce interest rates and build a healthier credit ecosystem, Azerbaijan has implemented three internationally recognized mechanisms: a registry of encumbered movable assets enabling entrepreneurs without real estate to secure credit, credit guarantee mechanisms to reduce risk, and credit bureaus to improve data exchange, reporting transparency, and digital banking services. Enhancing the functionality of these mechanisms remains essential. Legal and judicial reforms, including enforcement of court decisions, also reduce banks’ risk aversion and lower the effective cost of credit.

Banks rely heavily on deposits: over 70% of every 100 manat of resources comes from deposits, up from 57% in 2016. This shows high dependence on a single source. Furthermore, 55% of total deposits are demand deposits, while 83% of manat-denominated and 76% of foreign-currency loans are long-term, creating a maturity mismatch. As economic growth and confidence increase, the share of term deposits is expected to rise, narrowing this gap.

Therefore, expanding alternative funding sources—including foreign markets and Central Bank refinancing resources—is desirable. For context, with a 7.25% Central Bank discount rate, banks attract deposits at an average of 9.3%. Currently, Central Bank refinancing accounts for less than 5% of the total credit portfolio. Banks facing liquidity constraints could access foreign funds at low rates under guarantees (e.g., LIBOR 1.8%, TIBOR 0.1%, Euribor -0.4%).

Operational costs, including staff, branch maintenance, and loan processing, also contribute to the cost of credit. Implementing fintech solutions and institutional reforms can reduce these costs. Internationally recognized credit bureaus could also be utilized, considering national information security interests.

In short, liquidity is uneven and costly. Banking regulation should emphasize market mechanisms, competition, and deeper integration with international financial markets. If commercial banks can invest Central Bank resources at 6%, they could extend cheaper loans to the real sector, provided businesses present credible and well-founded business plans.

Regulatory framework development and international best practices

Significant progress has been made under the President’s leadership: foreign exchange operations, electronic mortgages, credit guarantees, bridge banks, bank resolution, asset classification, open FX position limits, and credit risk regulation. The Strategic Roadmap for the Development of Financial Services emphasizes sound risk management and corporate governance in banks. Legal acts passed in June 2019 enhance efficiency and corporate standards in the banking sector. Banks must continue improvements in strategic planning, organizational structure, management, oversight, and internal committees, while timely, accurate, and systematic disclosure increases trust among investors and businesses.

Global financial markets and fintech developments demand agile responses. The Central Bank will continue institutional reforms using risk-based prudential regulation, systemic risk analysis, and early risk forecasting, applying consolidated supervision as needed. Strengthening capital requirements for systemically important institutions is also necessary, following Basel III counter-cyclical norms.

Debt discipline and monitoring of non-performing loans should not rely solely on arrears; banks must assess borrowers’ capacity to absorb shocks, as in Georgia’s regulations. Measures such as DSTI and LTV ratios could mitigate consumer credit risk. Additional capital requirements are applied in Israel, Luxembourg, Georgia, and the Netherlands, and similar tailored solutions are needed for Azerbaijan.

Securities market development and innovative finance

Last year, the Baku Stock Exchange’s annual trading volume totaled 14 billion AZN (17% of GDP). Azerbaijan’s securities market is underdeveloped compared with the so-called Buffett indicator, signaling substantial growth potential. Currently, over 80% of the market consists of government securities. Azerbaijan has a high domestic savings rate—33% of GDP in 2018—providing ample resources to channel into the real economy through investment companies, funds, banks, insurers, pension funds, dealers, and international financial institutions.

Innovative finance supports SDGs by directing investment to energy, climate, transport, biodiversity, education, and healthcare. Mechanisms include financial products (bonds, bank notes, loans, microfinance, SME financing, venture and private capital), risk mitigation tools (guarantees, insurance, subsidies, options), results-based financing, and technology solutions (blockchain, digital tools, crowdfunding).

Prospects for asset-based finance

Asset-based finance differs from traditional interest-based systems, relying solely on tangible assets and real production, prohibiting speculative operations. Asset-based instruments reduce leverage in financial institutions and strengthen capitalization. Azerbaijan can draw on Turkey’s experience to develop this sector. Successful implementation encourages transparency, accountability, and financial inclusion for SMEs, fostering economic development. Globally, asset-based banking in Muslim countries has grown faster than traditional banks, while non-Muslim countries like the UK, Luxembourg, and Hong Kong are adopting similar frameworks.

This approach also attracts foreign investment, particularly from Gulf countries, provided an effective regulatory framework exists. The global asset-based finance market exceeds $1.67 trillion annually, with 15–18% growth, supported by institutions such as HSBC, Citi, Lloyds, Deutsche Bank, UBS, and Royal Bank of Scotland, which operate Islamic windows. Special zones in Kazakhstan (Astana) and Russia (Kazan) also support asset-based finance. Regulatory bodies like IMQMAT, IMXI, BIRA, and LIM ensure comprehensive oversight.

SME financing

SMEs constitute 90% of businesses and 50% of jobs globally. Developing countries’ economies are 40% SME-driven. By 2030, 600 million jobs are expected to arise mainly through SMEs. President Aliyev has prioritized SME development in line with global trends. According to an OECD survey, 58% of Azerbaijani SMEs cite limited access to finance as a growth constraint. Alternative financing tools include asset-based finance (leasing, factoring), equity financing (crowdfunding, venture capital), and alternative debt instruments (corporate bonds, guaranteed loans).

The Small and Medium Business Development Agency (SMBDA), along with Development Funds, Agrarian Credit and Development Agency, Innovation Agency, and EnterpriseAzerbaijan.com, supports SME access to finance. Measures are underway to broaden SME financing in line with Presidential directives.

Summary of Presidential priorities

Under President Aliyev, a resilient, risk-aware, and infrastructure-supported financial system is being developed, capable of withstanding domestic and external shocks and supporting sustainable economic growth.