Expansion of consumer lending in Azerbaijan Caliber.Az explores the pros and cons

In the last two years, Azerbaijan has strengthened its control over the financial market due to the global crisis and high imported inflation. The Central Bank of Azerbaijan (CBA) has made efforts to tighten monetary policy and strictly regulate credit conditions and compliance with prudential norms in the banking sector. Unlike the energy downturn of 2014-2017, which caused a devaluation of the manat and a default crisis, domestic banks are currently resilient. However, consumer lending has seen renewed growth this year, with its share in the bank portfolio being 30%. The CBA recently announced high demand for consumer loans in the third quarter of this year, and until the end of 2023.

Consumer loans and partly mortgages are among the most in-demand banking services. They occupy a significant share of the portfolio, particularly for smaller banks. This practice is typical for both developed countries and the post-Soviet region.

On one hand, banks' involvement in the retail segment of the market contributes to the overall development of the credit system. The growth of consumer borrowing has a tangible impact on the economy's development. It stimulates trade demand, which in turn helps to increase the production of goods and supply of services.

On the other hand, the dynamic growth of consumer lending and the resulting overheating of the monetary system may lead to an increase in credit risks in case of force majeure, contributing to inflationary dynamics.

It's worth remembering that nine years ago, Azerbaijan faced the energy crisis of 2014-2017, which, like other oil-producing countries, had a significant impact on its banking system. The energy market's dramatic price collapse resulted in a more than twofold devaluation of the national currency, the manat, which led to massive credit defaults.

During the previous period, the domestic market experienced a boom in consumer lending, and local banks very shortsightedly simplified access to unsecured loans to maximise access to a wide range of borrowers. Loans issued in manat were often linked to the US dollar exchange rate, which led to multiple increases in payments for debtors in case of a collapse of the national currency exchange rate.

The high level of dollarisation of bank deposits put a heavy burden on the banking structures, which had to pay high interest on such deposits. All this negativity cost Azerbaijan dearly: the Central Bank lost many billions of assets, and tens of thousands of citizens who were unable to repay consumer loans suffered, not to mention numerous bankruptcies. As a result, the number of Azerbaijani banks was reduced from 45 to 25.

Over the past two years, the ongoing Russian-Ukrainian war and a surge in imported inflation have led to a series of global crises. In response, the Central Bank has pursued comparatively conservative lending policies. In the latter half of last year, the Bank adjusted its monetary policy and gradually increased the discount rate to 9%. This contributed to a slight decrease in the inflation rate by the autumn of this year. Finally, on November 2nd, the CBA reduced the discount rate from 9% to 8.5%, signalling a cautious easing of monetary policy to the financial sector.

Despite the global turmoil, the banking sector in the country has shown high resilience to toxic credit exposures that were a serious problem in the past.

According to the Central Bank of Azerbaijan (CBA), as of August this year, the non-performing loan portfolio to the total loan portfolio ratio is 3.6%, which is significantly lower than the critical level of 21% reached during the crisis year of 2016. The regulator has also been successful in controlling banks' capital adequacy indicator, which is considered normal if it is 8-10% internationally, but in Azerbaijan, it reaches an impressive 18%. Moreover, the instant liquidity indicator should not be lower than 30%, but in the country, it is currently at 60%, indicating that banks operate with high liquidity, which is essential for depositors. It is essential to note that the stability of the credit market is highly dependent on the equilibrium of basic macroeconomic parameters, primarily the monetary factor. Fortunately, unlike many of our trading partners, the manat-dollar exchange rate has remained unchanged for the seventh year in a row. All the above-mentioned factors have contributed to the banking sector's resistance to internal and external stresses.

At the beginning of January this year, the head of state introduced the fourth social package which increased the minimum pensions, salaries, and other social benefits. As a result, about 1.9 million people received additional social payments. This initiative played a significant role in the growth of the nominal monetary incomes of the Azerbaijani population. From January to October 2023, the nominal monetary income increased by 13.2%, surpassing $37 billion. Consequently, the population's spending on consumer goods and residential property is also increasing, leading to the growth of bank lending dynamics.

In a recent survey conducted among banks, they revealed that they expect the demand for loans through credit cards to increase in the fourth quarter of this year. This indicates an increase in the demand for consumer loans. The Central Bank of Azerbaijan (CBA) also highlighted the strong demand for consumer credit in the third quarter.

According to previous reports, the demand for consumer loans in Azerbaijani banks increased by 29% in the second quarter of this year and by 13% in the third quarter. The highest demand between July and September was for card loans, which increased by 17%, and "salary" loans, which increased by 10%.

The high demand for consumer loans is a common situation in the entire post-Soviet region, including Azerbaijan. This is especially true for the younger generation, who are not deterred by the relatively high-interest rates for this type of banking service. For instance, the average interest rate on consumer loans for the purchase of household equipment was kept at 24% between January and September of this year. The rate on loans by credit cards in the national currency remained at 25%, and the average interest rate on car loans even increased by 1 percentage point to 13% per annum.

Reducing interest rates on loans is almost impossible at the moment because it would require a proportional reduction in deposit rates. This would have an extremely negative impact on citizens' desire to keep their savings in banks.

As demonstrated by the experience of neighboring countries, consumer lending has its benefits, but it can also cover large segments of the population, which can lead to a sharp increase in social discontent during times of force majeure. Additionally, many risk factors in this segment are difficult to predict: a default crisis can be triggered by global crises, falling prices for energy raw materials, high inflation or monetary instability, problems can arise from a decline in income, a high debt burden of the borrower, their financial illiteracy, and more.

Regulators around the world are cautious when it comes to a sudden surge in consumer lending and keep a close eye on this sector. Azerbaijan is no exception, given that the share of consumer lending in the country's loan portfolio is significantly larger than the volume of loans issued for other important sectors like industrial, agricultural, and ICT. At a recent meeting of the Milli Majlis Committee, Rashad Orujev, the First Deputy Chairman of the CBA, mentioned that business loans account for 55% of the banks' loan portfolio, while consumer loans account for 30%, and the remaining 15% mortgages.

The Central Bank's main priority today is to increase the involvement of banks in lending to the real sector of the country's economy. In collaboration with the Ministry of Economy and the banking sector, a new strategy is being developed to improve the financial sector. The strategy will include measures to remove existing barriers in the ratio of demand and supply and to simplify access to credit for economic agents.

Recently, the CBA introduced regulatory changes to optimize lending to the real economy. The amendments state that loans for large project financing will be considered fully secured loans, and the frequency of interest payments on these loans will correspond to the terms of the relevant project. Consequently, the reserve load on project finance loans has been adjusted, and these types of loans are excluded from the concentration limit on unsecured loans. Regulatory requirements for the borrower's debt burden on loans to finance environmentally friendly vehicles have also been simplified, and requirements for production, commercial, and other specialized equipment used as collateral for business loans have been eased.