Azerbaijan's banking sector: Growth dynamics and consumer lending risks Review by Caliber.Az

The favourable conjuncture of the global energy market, as well as the high dynamics of the development of the non-oil sector in the first third of 2022 increased the need for borrowed capital and expanded the deposit base, which had a very beneficial effect on the profitability of the domestic banking sector. In general, local banks overcame the period of the pandemic economic downturn without bankruptcies and other losses, on the contrary, according to the data published on May 24 by the Central Bank of Azerbaijan (CBA), the loan portfolio increased in January-April 2022, the dollarization of deposits decreased and the volume of overdue loans decreased. At the same time, the banking sector has not yet got rid of a number of long-standing problems associated with serious imbalances in the loan portfolio.

Despite the negative global factors - pandemics, hyperinflation, imbalance of logistics chains - for Azerbaijan, the second half of last year and the first third of this year were remembered by an unprecedented rise in business activity. Last year, an unprecedented growth of non-oil exports was recorded, the total volume of which reached $2.7 billion, an increase of 47.2 per cent. Expensive oil and gas and record growth of external supplies of industrial products have played a key role in improving the foreign trade dynamics of our country this year. Thus, in the first quarter of this year, Azerbaijan's foreign trade turnover increased by more than 60 per cent, and exports almost doubled. In turn, during the reported period, Azerbaijan's GDP increased by 6.8 per cent, a 10-per cent rise was achieved in the non-oil economy, while the growth rate in the non-oil industry exceeded 18 per cent. These positive processes were supported by large-scale construction and infrastructure works in the Karabakh region, which played the role of a driver that provided state orders to factories for the production of building materials and other non-oil enterprises, involving numerous construction companies, service, design, consulting, transport firms in contract work.

It is obvious that the expansion of foreign trade and, in particular, the export of industrial and agricultural products, significantly increased the need for intermediary and trading firms in working capital, and the growth in the pace of development of the non-oil sector added demand for loans for the modernization of factories, the purchase of construction equipment, equipment, etc. Thus, the favourable external trade environment, domestic demand for industrial and agricultural products and the positive tendencies in the construction and mortgage sector, as well as the growth of consumer lending played the role of a driver, pulling the dynamics of the banking sector.

Unlike the 2014-2017 energy crisis, which resulted in the devaluation of the manat and the bankruptcy of a dozen and a half credit institutions, none of the 26 Azerbaijani banks operating on the market today faced critical problems during the pandemic and energy crisis of 2020. The consistent policy of the Central Bank on de-dollarization of deposits of the banking sector played a role here. Due to a more favourable interest rate, the share of manat deposits increased, on the contrary, investments in foreign currency were consistently reduced due to their extremely low profitability. These processes were observed last year, when the investments of the population in dollars and other foreign currency, having decreased by more than seven per cent, amounted to 41 per cent of the total deposit base. This trend continued in January-April of this year - foreign currency deposits decreased to 39.6 per cent of all investments. On the contrary, the volume of deposits of the population in the national currency increased by 16.4 per cent during the reported period - to more than 6,347 billion manats [$3,735 billion], or 60.4 per cent of all deposits. Well, in general, the total bank deposits of the population, including funds of individuals engaged in individual entrepreneurial activity, increased by 13.8 per cent in January-April, exceeding 10,515 billion manats. All this is a clear evidence of the monetary stability of the manat and stability in the country's monetary market, which also increases public confidence in the banking system as a whole.

On the other hand, the strengthening of banks' positions and a noticeable reduction in credit risks were achieved thanks to the regulator's comprehensive measures aimed at improving the banking sector, boosting prudential regulation, including requirements for managing credit risks in accordance with modern international standards.

In turn, it is necessary to mention the Economy Ministry's operational steps to provide fiscal preferences, sharply reduce the credit burden on entrepreneurs and support labour resources in the most affected sectors of the economy - tourism, trade, catering, air transportation, construction, real estate market, etc. In total, during the pandemic, about 4 billion manats of budget funds were spent for these purposes, and these measures, in general, allowed both businesses and employees to stay afloat, eliminating large-scale ruin and unemployment.

It is also important that this timely state assistance has made it possible to maintain the solvency of bank customers at an acceptable level. As a result, last year, the share of overdue bank loans decreased to 4.2 per cent of the total loan portfolio. This positive trend was also observed in January-April 2002: the volume of overdue loans amounted to 674.8 million manats, or only 3.7 per cent of the total loan portfolio, which is very significant. For comparison, in the crisis year 2020, the share of problem loans in the portfolio of local banks reached 7.28 per cent.

In turn, the increase in export revenues observed since the second half of last year, supported by the growth of the non-oil sector, played an important role in reviving demand for credit resources and improving other banking indicators. In particular, in January-April 2022, the total assets of the country's banking system exceeded 40,149 billion manats, an increase of 22.4 per cent compared to the first third of last year, and the total net profit of banks for the reported period amounted to 248.1 million manats (an increase of 27.4 per cent). This is a very good dynamics, especially when compared with the crisis year 2020, when the assets of banks not only did not grow, but also decreased by 2 per cent.

And most importantly, in January-April of this year, Azerbaijan recorded a 7-per cent growth (year-on-year) in the loan portfolio of banks and non-bank credit organizations (NBKOS), which reached 18,320 billion manats by early May. This is a fairly positive trend, especially against the background of excessive liquidity in the banking sector, significantly exceeding the norm.

But, on the other hand, despite the high demand of industry, the agricultural sector and other sectors for affordable lending, the banking sector of the republic still does not express readiness to ensure the capitalization of the real sector of the economy. The fact that the loan potential available to banks is not being fully realised is evidenced by the data provided by the CBA on the structure of the loan portfolio. Thus, in the four months of this year, industry and the manufacturing sector accounted for only 5.6 per cent of loans issued, construction and real estate - 5.8 per cent, agriculture and fisheries – 3.2 per cent, etc. On the contrary, the main volume of credit resources was directed to consumer lending (over 9,460 billion manats) with an increase of almost 10 per cent, and the share of household financing in the total portfolio exceeded 51 per cent. Loans for trade and services have significantly increased - more than 3,137 billion manats, or 17.1 per cent of the share in the portfolio.

Banks continue to maintain high borrowing rates, which is due to significant risks of financing the development of the real sector of the economy. In turn, loans provided on average for no more than 3-4 years, suitable for consumer and commercial lending, are not in demand for financing industry, where the terms of project implementation and profit take much longer. The situation with agricultural lending is even worse: high risks in crop production, the lack of liquid collateral and weak coverage of agricultural insurance of small farms do not allow banks to expand their participation in the financing of agriculture. However, the banks themselves are limited in access to preferential long-term financing - the market of pension or mutual funds is not developed in Azerbaijan, and the narrowness of the insurance market complicates the process of refinancing credit institutions.

However, the enthusiasm of Azerbaijani banks for lending to households carries even worse risks: at one time, a high share of consumer loans in the loan portfolio has already played a cruel joke with the financial sector, turning into a crisis of non-payments and bankruptcies after two devaluations in 2015. And, taking into account the statistics for the beginning of 2022, the regulator needs to pay close attention to this negative dynamics.