Azerbaijan's financial sector thrives as regulatory changes drive growth Optimization efforts yield results

Azerbaijan is steadily navigating the aftermath of last year's global recession and inflationary pressures. Despite a continued decline in foreign trade activity, the country's GDP has surged by 4.3% in the first two-thirds of the year, while the average annual inflation rate remains impressively low at 1.3%, as reported by the Cabinet of Ministers. In this positive context, the Central Bank of Azerbaijan (CBA) has proactively adopted a more accommodative monetary policy, effectively managing inflationary and monetary risks.

The favourable market conditions, bolstered by the CBA's initiatives to lower the discount rate, have led to notable growth in profits and assets within the banking and insurance sectors. The recently released Financial Stability Report highlights that the resilience of Azerbaijan's financial sector has significantly improved in the first half of 2024.

With declining global inflation expectations, Azerbaijan has prioritized measures to enhance GDP dynamics and alleviate the tax burden on businesses. Since the start of the year, these trends have gained momentum, evidenced by the financial regulator's multiple reductions in the discount rate, which has dropped from 9% to 7.25% by mid-year. Notably, on September 18, the Central Bank opted to maintain the current discount rate, signalling confidence in keeping this year's inflation rate within the target range of 4±2%.

Crucially, the stability of the credit market hinges on the equilibrium of key macroeconomic indicators, particularly monetary factors. Unlike many of its trading partners, Azerbaijan has successfully maintained a stable manat-dollar exchange rate for the eighth consecutive year. These collective efforts contribute to the robustness of the domestic banking sector, providing a buffer against both external and internal shocks.

“The global macroeconomic environment is influenced by various factors, such as ongoing geopolitical tensions, anticipated interest rate cuts in Europe and the U.S., and a slowdown in global growth impacting commodity and raw material prices. In light of these external challenges, Azerbaijan's domestic macroeconomic situation exhibits positive trends,” stated Shahin Mahmudzadeh, General Director of the Central Bank, during the presentation of the Financial Stability Report for the first half of 2024.

He emphasized that the country's economy continues to grow, driven primarily by the non-oil sector, while the real effective exchange rate of the national currency remains stable. Additionally, the foreign trade surplus and the increase in strategic foreign exchange reserves provide an additional safety margin, contributing to enhanced financial stability, higher employment rates, and rising incomes.

It is worth noting that the Central Bank's currency reserves have increased by 1.6% since the beginning of the year, now totalling nearly $11.796 million. This growth significantly enhances the regulator's operational capabilities in managing money supply sterilization and regulating the national currency exchange rate.

According to the Director General, the positive trends in Azerbaijan's financial sector are most prominently seen in the banking sector, which maintains its dominant role, accounting for 94.6% of the total financial sector.

"The primary share of business loans in the first half of this year came from bank loans allocated to the trade, industry, and information and communication sectors. During this period, the business loan portfolio increased by approximately $740 million, or 10%," remarked CBA Director General Shahin Mahmudzadeh during the presentation.

Specifically, the Central Bank's report indicates that the volume of business loans in the trade sector rose by 11%, while loans in the industrial sector increased by 17%, and those in the information and communication sector saw a remarkable growth of 62%.

Overall, data from the regulator shows that from January to August of this year, Azerbaijan's banking sector achieved a net profit of approximately $454 million, reflecting a 6.6% increase compared to the same period last year. The operating income of banks grew even more robustly, exceeding $2.199 billion with a rise of 19.2%. Additionally, total assets in the credit sector surpassed $29.123 billion as of September 1, marking a 9.3% increase. Importantly, statistics on bank deposit growth underscore the continued trust of the population in the country’s financial sector, with the total deposit portfolio (including both individuals and legal entities) expanding by 9.4% to nearly $20.586 billion.

It is crucial to highlight that by mid-year, Azerbaijan's banking sector maintained a foreign exchange position within prudential norms. According to the CBA report, banks' open long foreign exchange position amounted to approximately $118 million, with a ratio of 3.5%, adhering to regulatory requirements. De-dollarization processes in the banking sector are stabilizing; specifically, the dollarization of the loan portfolio decreased by 0.8 percentage points to 18%, marking a historical low. Additionally, indicators from the second most significant segment of Azerbaijan's financial sector, the insurance market, are also showing positive trends. Notably, in the first half of this year, the assets of the insurance sector increased by 5%, or about $54 million, reaching approximately $1.129 billion.

According to the CBA Director General, the regulator continued its policy of enhancing the regulatory framework in the banking sector this year.

"The rules governing transactions with bank-related entities have been updated to ensure safer and more transparent operational conditions, reduce risks, and enhance the stability of the banking system. Amendments were also made to the procedures for managing credit risks, including the expansion of life insurance terms for consumer loans, along with a stronger emphasis on controlling risks associated with loan issuance," he stated.

The next significant step was the establishment of information security requirements for both banking and non-banking credit institutions, aimed at enhancing data protection and mitigating cybersecurity threats. Additionally, a document outlining the implementation of sustainable finance principles was approved, focusing on the integration of sustainable development strategies into banks' corporate governance. This includes enhancing transparency in accounting and reporting, as well as effective risk management.

Specifically, the Recommendations on Corporate Governance Standards in Banks, approved by the CBA Board, reflect a strategic vision for regulating corporate governance in the banking sector. This document emphasizes the importance of independent members within the Supervisory Board (SB), stipulating that they should constitute at least one-third of the total SB membership. Moreover, the corporate governance standards are designed to bolster audit and compliance functions while optimizing the distribution of risk management responsibilities.

These decisions align with the new strategy for financial sector development, initiated last year by the Central Bank and the Ministry of Economy in collaboration with the banking sector. The primary goal of this strategy is to enhance the role of banks in providing loans to the real sector of the country's economy. Among other objectives, the strategy aims to eliminate existing barriers affecting supply and demand, as well as to improve and simplify access to credit for economic agents.

To facilitate these aims, the Central Bank of Azerbaijan (CBA) has recently implemented regulatory changes designed to optimize lending to the real economy. Under these modifications, bank loans for large project financing will be classified as fully secured loans, with interest payment schedules aligned with the timelines of the respective projects. Consequently, the reserve requirements for project finance loans have been adjusted, and these loans will be exempt from concentration limits on unsecured loans.

Moreover, the regulatory criteria concerning the borrower’s debt burden for financing clean vehicles have been simplified, and the requirements for using production, commercial, and other specialized equipment as collateral for business loans have been relaxed.