The impact of the global economic crisis on Azerbaijan’s banking system

Azerbaijan has not been as seriously affected by the world economic crisis as have many other countries, but it has not been entirely immune both because of declines in the price of oil, Azerbaijan’s major export earner, and of problems with liquidity in the country’s banking system.  The impact of falling oil prices has received a great deal of attention, but the effect of the crisis on the liquidity of the banks has not, even though the banks make up 70 percent of the non-oil GDP of the country. Because of the size of this sector, any problems with Azerbaijan’s banks can have a major impact.  One reason or concern is that during 2007, the country’s commercial banks trebled their foreign debts to 2.5 billion US dollars, with most of these in short-term loans (CESD 2009).  Because of that arrangement, approximately half of these debts had to be repaid just as the financial crisis hit in 2008, thus putting particular stress on the country’s banks. As Najafov (2009) has pointed out, the high ratio of short term to long term indebtedness points to possible Ponzi financing schemes by local banks, thus making them even more at risk of failure.  And even if that is not the case, returns on assets (ROA) fell by nearly half a percentage point to 2.2 percent, with profits growing faster than assets, according to the CBA (2009).  Return on equity also fell.  And both of these developments reflect higher interest and non-interest costs as a result of the crisis. 

           

There are other sings that point to liquidity problems as well.  On the one hand, there has been a decline in loans extended to consumers.  And on the other, banks have reduced their involvement in the securities and treasury bill sector.  The debt market in Azerbaijan is dominated by CBA notes – some 91 percent of the total – and treasury bills.  The placement of notes fell by more than two-thirds during the first quarter of 2009, and the secondary market fell almost as much relative to a year earlier.  These declines, analysts have concluded, reflect the more conservative strategies the banks have adopted to address their liquidity problems.

In response, the Central Bank reduced the refinancing rate from 15 percent to three percent in five steps and lifted the five percent reserve requirement on the foreign liabilities of banks.  In addition, it cut reserve requirements on domestic liabilities in half from 12 percent to six percent.  These changes generated an additional 438 million US dollars for the system.  But all these changes have not led to a significant reduction in interest rates on bank loans, an indication that the impact of centralized loans has not been great because of the relatively small volume and because the banks are more concerned about their own liquidity than about stimulating the business sector. 

The Central Bank urged the country’s banks to reassess risks in order to help the market recover.  At the same time, it tightened the requirements on the quality and securitization of banking assets in order to improve the financial foundation of the banks.  And the Central Bank took some additional actions in order to ensure that foreign borrowing could continue at safe and manageable levels.  These steps reduced the risk of Ponzi financing, but it is already clear that reduced financing from abroad requires the introduction of more local resources, especially since Central Bank loans cannot serve as an alternative. 

Meanwhile, the Azerbaijani government waived the tax on the profits of banks for 2009 through 2012.  That will boost the profitability of the banks in the medium term but not address many of the short-term effects of the financial crisis.  And the situation is serious.  According to the Fitch ratings (2009), two major banks in Azerbaijan, AGBank and Texnikabank have fallen from stable to negative, given “the already significant levels of non-performing loans” at the former and “the high share of restructured loans” at the latter.  In addition, Fitch has downgraded Unibank’s rating from D/E to E given its liquidity problems.  

Because of these problems, Azerbaijani financial experts have called on the Central Bank to consider allocating part of the republic reserve funds in Azerbaijani banks to their assets so that they will be in a position to help the business sector, taking steps to ensure that the public does not lose confidence in the banks by increasing the guarantees of depositors’ accounts, and reviving the mortgage sector via the State Mortgage Fund which should receive additional budgetary money as well.

Other resources, such as Islamic finance, could make a valuable contribution, the experts say.  Islamic banks currently appear more resilient to the global crisis than do conventional banks since they are not engaged in interest-based operations and tend to avoid speculative instruments such as derivatives (Timewell 2009).  At the time when the world is experiencing an unprecedented financial crisis, Islamic banks are being hailed as “bastions of stability” (Quinn 2008, p. 1).  And to draw on their strength, Azerbaijan needs to consider changing the country’s legal codes to all for broader operation of international Islamic financial institutions in Azerbaijan.

Bibliography

CBA (2009) Statement on the Main Directions of Monetary Policy for 2009, Central Bank of Azerbaijan, available at http://www.nba.az (accessed May 25, 2009).

CESD (2009) Anti-Crisis Concept of Republic of Azerbaijan (in Azerbaijani), Center for Economic and Social Development, April, available at http://www.cesd.az/crisis.pdf (accessed May 23, 2009).

Fitch Ratings (2009) “Fitch подтвердило РДЭ пяти азербайджанских банков, изменило прогноз по рейтингам AGBank и Техника Банка на ‘Негативный’”, April 21, available at http://www.fitchratings.ru/financial/banks/news/newsrelease/news.wbp?article-id=7B40D931-1FB3-45F1-9DC2-DCABE990760F (accessed May 25, 2009).

Najafov, Salman (forthcoming) Liabilities over assets: Asian (1998) and the global financial crises and Azerbaijan (in Azerbaijani). 

Quinn, Ben (2008) “London warms to Islamic finance”, Christian Science Monitor, 101(3), November 28, p. 6.