Microfinance in Azerbaijan: Growth, challenges, and prospects Caliber.Az review

The past few years have been quite successful for the development of Azerbaijan's microfinance sector, with a noticeable increase in the profitability of domestic non-bank credit organisations (NBCOs). This positive trend is largely attributed to the efforts of the Central Bank of Azerbaijan (CBA) and the Ministry of Economy's structures to expand micro-lending and improve access to loans for entrepreneurs operating in the regions of the country. In this regard, it is worth noting the relatively high pace of micro-lending by the end of the first quarter of this year: as of the end of March, this dynamic had exceeded last year's figures by almost 15%.

Global practice shows that microfinance institutions are widespread in Asia, Africa, South America, and the post-Soviet region, where banking services are often expensive or organizationally complicated for individual entrepreneurs. Similar to NBCOs, credit consumer cooperatives, agricultural consumer cooperatives, housing savings cooperatives, pawnshops, and others operate in these regions. In general, microfinance represents a flexible form of classic bank credit, allowing small businesses to start without initial capital, a credit history, or registered collateral. This is a crucial point, as the preliminary conditions set by commercial banks are often too burdensome for entrepreneurs, especially concerning collateral requirements. 

Additionally, small financial operations are not always attractive to banks themselves. For individual entrepreneurs, it is extremely important to quickly obtain small loans to replenish working capital for short periods, without lengthy accounting procedures and credit history checks. Typically, NBCOs provide such loans more easily than commercial banks. However, interest rates on such microfinance loans are generally significantly higher than those offered by banks.

Much of what has been mentioned is also relevant to Azerbaijan, where the microfinance market has experienced several periods of growth and decline. Due to significant risks, according to domestic banks, associated with lending to small and medium-sized businesses (SMBs) operating in the regions of the country, particularly those involved in the agricultural sector (lack of reliable collateral), the banking sector has been quite cautious in its approach to this segment of the lending market in recent years. 

According to the data from the Small and Medium Business Development Agency (KOBIA) under the Ministry of Economy, lending to medium-sized businesses decreased by 27% in 2023 and the first eight months of 2024, while lending to small businesses fell by 12%. At the same time, the volume of microloans issued to entrepreneurs in Azerbaijan increased by 33% during the reporting period. 

According to recently published data from the Central Bank of Azerbaijan (CBA), by the end of March this year, the total volume of loans issued to micro-entrepreneurs in Azerbaijan amounted to 3.072 billion manat ($1.8 billion), which is 394 million manat ($231 million), or 14.7%, higher than at the end of March 2024. Due to the excess liquidity in the banking sector, there has been a recent increase in activity in this area, with the volume of unsecured loans for micro-entrepreneurship now exceeding 40% of their portfolio.

Nonetheless, non-bank credit organisations (NBCOs) continue to be the main drivers of microfinance, especially in rural areas, and over the past three years, against the backdrop of favourable market conditions, Azerbaijan's microfinance sector has rapidly made up for the losses incurred during the pandemic downturn. In particular, in 2023, 54 active NBCOs in the country achieved a threefold increase in profitability through higher interest income from the growing loan portfolio, as well as improvements in the operational efficiency of small credit organisations. These positive trends continued last year. 

"By the end of 2024, the assets of NBCOs reached 1 billion manat [$588 million], more than three times higher than in 2020 and 24% higher than in 2023," said Jalal Aliyev, Chairman of the Supervisory Board of the Azerbaijan Microfinance Association (AMFA). 

According to him, the sector's net profit last year amounted to 231 million manat ($136 million), and the total volume of loans issued exceeded 800 million manat ($470 million). Meanwhile, the authorised capital of non-bank credit organisations increased from 141.4 million manat ($83 million) in 2020 to 456.4 million manat ($268 million) by the end of 2024.

"It is projected that by the end of 2025, the assets of domestic non-bank credit organisations will significantly exceed 1 billion manat [$588 million]. This is facilitated by the expanding branch network of NBCOs, which has grown to 302 structures, while the number of employees has reached 3,500, and the client base exceeds 700,000 borrowers," said Khayyam Ismailov, head of the Department of Credit Organization Supervision at the Central Bank of Azerbaijan (CBA), speaking at the conference "Innovative Solutions for Sustainable Microfinance" held in October last year.

In the recent period, according to the new "Financial Sector Development Strategy for 2024-2026," the Central Bank, with the support of the Azerbaijan Microfinance Association (AMFA) and the Small and Medium Business Development Agency (KOBIA), aims to significantly expand the micro-lending sector, ensuring broader access for small businesses and individual entrepreneurs to loan capital. The country plans to create a new model of microfinance, implement advanced international experience, develop effective legal and regulatory mechanisms, diversify funding sources, offer additional products and services, and simplify entrepreneurs' access to loan capital, thus increasing the competitiveness of the entire industry.

In particular, the Central Bank of Azerbaijan (CBA) has developed new rules for managing credit risks, with one of the key priorities being the strengthening of the institutional capacity of microfinance organisations. In this regard, the rules for prudential regulation have been updated, requirements for corporate governance and external auditing have been strengthened, and norms for outsourcing in NBCOs have been improved. 

Among other things, new initiatives are planned to protect the rights of financial services consumers in order to support inclusiveness and improve risk management in microfinance organisations. For instance, there will be the possibility of making money transfers and currency exchanges without opening an account in an NBCO. Additionally, conditions and mechanisms for regulating online lending in the micro-lending sector have been developed, and the use of alternative monetary and credit instruments will be expanded, including through the implementation of an OpenBanking platform and the application of fintech solutions.

Another important task is to reduce the excessively high interest rates among domestic microfinance organisations, providing businesses with loans on more favourable terms. To achieve this, it is necessary to meet the liquidity needs of NBCOs with low-interest financing, primarily in the national currency. Before the devaluation of the manat in 2015, the lion's share of financing for microfinance organisations came from abroad. 

However, in the last decade, the CBA's policy has focused on the de-dollarisation of the financial market, and as a result, the volume of external donor support has decreased. Unfortunately, in the past, Azerbaijan's financial market was poorly developed in terms of instruments such as mutual investment funds (MIFs), pension funds, mortgage savings funds, and the securities market was not able to provide the accumulation of low-interest and "long-term" funds for the needs of NBCOs.

Nevertheless, according to the document "Strategic Framework for the Microfinance Model" developed by the CBA, it is planned to establish NBCOs with access to a wide range of activities, incorporating stricter regulatory and management requirements. All of this will elevate the status of microfinance institutions as organisations with a lower risk level for investors, thereby reducing their financing costs through enhanced stability. This will optionally expand financing methods in the capital market, including, in the future, opening up opportunities for funding through the issuance of bonds.