If Azerbaijan’s gross domestic product (GDP) growth is among the highest in the world, the growth in both loans and deposits has been even more spectacular in recent years. “For more than 30 years as an academic and working with the government, I have studied this country’s economy and I never imagined our banks would have such a growth rate,” says Ziyad Samadzade, chairman of the parliamentary standing commission on economic policy.
Only a few years ago, Azerbaijan was burdened with too many banks and too little banking, after pyramid schemes and economic chaos in the immediate post-Soviet era provoked public mistrust of the whole system. Today, the second problem at least is fading away. Eldar Ismailov, chairman of the Azerbaijan Banks’ Association, says: “There has been a kind of revolution.” He adds: “Bank machines are used in trade very widely, most consumer goods are bought on credit. Before, we had to try to persuade people to keep their money in a bank, now they bring it to us themselves.”
Making a leap
The country appears to be in the process of making a leap directly from an underbanked cash economy to a cashless economy, skipping several stages of development that took decades in other European countries. It is a revolution in which the government itself played a vital part. Via the state-owned International Bank of Azerbaijan (IBA), which has a 25% share of household deposits, the state pension fund issued bank cards to all pensioners, replacing the previous system of pension payments by mail.
This innovation kick-started plastic banking in the country. Jahangir Hajiyev, executive chairman of IBA, says: “We were the first country in the Commonwealth of Independent States to pay pensioners through bank cards, and many workers are now using cards as well. Our intention is to fill these cards with all kinds of banking products – paying-in and withdrawals, salary payments, electricity and utility payments, metro tickets, etc.”
The explosive growth of ATM machines (to more than 1300 nationwide by February 2008) as well as non-branch merchant outlets is also likely to intensify competition in the sector. IBA has a network of almost 100 branches countrywide, dwarfing even its largest private sector retail banking competitors. Unibank is aiming to double its network to 32 branches in 2008, and Bank Respublika has increased its reach to 14 branches and opened its first 24-hour branch in Baku. But the uptake of internet, mobile and automated banking offers the possibility for these banks to reach new customers without the cost of physical infrastructure.
As bank penetration rises and competition intensifies, all of the banks are also focusing on quality of service to attract new customers and increase earnings from existing customers. Many banks are working closely with insurance arms to cross-sell retail products. Insurance market growth has averaged 47% a year during the past decade, according to Jamil Sultanov, the president of IBA-owned International Insurance Company.
The market is maturing and Mr Sultanov believes that total premiums for the country will grow by little more than 10% in 2008, to $200m. However, he explains that he is working on “six or seven new projects for individual insurance products”, because he expects close co-operation with retail banking customers to enable retail insurance, and especially the life segment, to pick up the baton from corporate activity.
All of the major banks are also turning their attention to Mastercard and Visa services. Mehti Mustafayev, director of international relations at Bank Respublika, says: “As Azerbaijan citizens are restricted from taking more than $10,000 out of the country in cash, people are beginning to understand that credit cards are very useful for foreign business travel.” Faig Huseynov, Unibank’s executive chairman, also finds the credit card market “particularly interesting”, but he adds the warning that it is still largely “unexplored”. “It is not only the banks that must be prepared to offer credit cards, the market must also be prepared to accept credit cards; there are still a lot of cash transactions,” he adds.
Systemic weaknesses
The operating environment still places major constraints on the banks. The informal economy is thought to account for 50% of GDP and 30% of employment. This cramps retail banking development and corporate banking in the small and medium-sized enterprise sector.
Even the largest banks are dependent on a few major corporate clients, which sometimes have cross-ownership with the banks themselves, but there is an improving trend. IBA’s Mr Hajiyev says: “A few years ago, almost all of our funding came from one client, the state oil company SOCAR, but now the percentage of oil money is no more than 30% to 35% of our deposits, we are not so dependent on a single customer or a single situation.”
The scale of informal employment and the low level of declared salaries have also hampered the development of a mortgage market, which is now approaching AZN42m ($50.6m). The minimum salary to qualify was about $700 to $1000 a month (GDP per capita is forecast at only $4500 a year for 2008), with interest rates as high as 20%, but this would exclude most public sector and military employees. To offset this, the government introduced a subsidised component to the national mortgage fund two years ago, with an interest rate of just 6%.
Bank Respublika’s Mr Mustafayev says: “Of course, demand for this grew very quickly, but after one year it was understood that this was not sustainable, and it was suspended.” However, Mr Ismailov of the Banks’ Association believes that the suspension is only temporary and the scheme could be restarted with some modifications. In any case, the experiment served to educate. “A few years ago, even bankers themselves were unfamiliar with the concept of a mortgage but now almost every citizen knows what it is and how to obtain it,” he says.
Because deposit rates of 10% to 15% are below official inflation, and loan rates of 20% to 25% are possibly less than the price rises seen by many Azerbaijanis, there is plenty of appetite to “borrow, buy, enjoy”, as Mr Huseynov of Unibank puts it, with loan values inflated away. However, the negative real deposit rates mean that funding is the main constraint for loan growth. He adds: “There is not enough local deposit growth; people prefer to buy real estate, gold or commodities.” Real estate prices in Baku have soared during the past two years, fast closing on the levels in some EU countries even though salaries are nowhere near keeping pace.
Given the still small base of local institutional investors, the domestic capital markets are not a deep source of funding either – total turnover for the Baku bond market in 2007 was less than $3bn and most of this activity was on government rather than corporate paper. Mr Sultanov says much of the insurance asset portfolio is still held simply in bank deposits.
Considering the options
Consequently, overseas funding is an attractive option and foreign creditors are, no doubt, excited by the high growth potential on offer. Mr Hajiyev says: “We have no problem attracting capital at any stage.” IBA obtained a $100m 10-year subordinated loan and a $140m syndicated loan in 2007, and many of the other leading banks have smaller credit lines or loss guarantees on parts of their portfolio.
The International Finance Corporation (IFC) and European Bank for Reconstruction and Development have also stepped up participation in many Azerbaijani banks. In addition, investors are awaiting Azerbaijan’s debut sovereign Eurobond, for which Citi and Deutsche Bank were mandated as lead managers in 2007. IBA and Unibank are both at an advanced stage of preparation to follow the sovereign benchmark.
IBA mandated JPMorgan and Citi to lead its planned Eurobond issue and Unibank has hired ING and BNP Paribas. IBA’s Mr Hajiyev says: “We have not officially registered the issue yet, but it may happen by the end of 2008 or early 2009, and we are considering an initial roadshow perhaps in Singapore to test Asian appetite.” Mr Huseynov of Unibank says the Eurobond is also a “logical next step” for his bank, and a prospectus has already been prepared. “But our lead managers have strongly advised us to await better market conditions,” he adds.
High loan growth, a surge in real estate prices, a shortage of deposits and the potential to ramp up foreign borrowing are ingredients that could cause nervous flutters for those familiar with the recent experiences of banking in eastern Europe. But Azerbaijan’s bankers are keen to learn from the more painful experiences.
Mr Hajiyev of IBA says: “We do not have the international market exposure that Kazakh banks have, and we are very conservative in where we place our investments.” Mr Mustafayev says that Bank Respublika is modelling its development strategy on the experience of Bulgarian banking during the period of EU convergence. Unibank is not content simply to “sit and move with the river” of rapid economic growth in Azerbaijan, says Mr Huseynov. “We prefer to row the boat, and certainly, we have no intention to jump over the waterfall that is at the end of every river.”
Measuring progress
The National Bank of Azerbaijan (NBA) is leading efforts to ensure that local banks measure their progress, not just by loan growth but also by the improvement of internal management systems. Foreign bankers in the country say that (like the commercial banks themselves) the NBA has learnt from other countries in the region and is relatively sophisticated. NBA governor Elman Rustamov says: “We have a quality legal framework that is now up to international standards and this is modernising the governance systems of commercial banks, including corporate governance principles, technology, human resources, financial infrastructure, and, of course, quality supervision by the central bank.”
Slowly but surely, the message is getting through to the banking sector, carried partly by a new generation of young bankers, many of whom have experience in finance outside Azerbaijan – most often in Russia. Unibank adopted the Experian credit-scoring system in 2007, and Azerigazbank has received technical assistance from the IFC to build capacity in asset-liability management and core information management systems.
Azer Movsumov, executive chairman of Azerigazbank, says: “Since June 2007, we decided to artificially restrain our loan growth in order to introduce more adequate risk management.” Orkhan Mamedov, director of risk management at Bank Respublika, says that his bank has preferred to build its own system in house rather than adopting a generic foreign-designed alternative, given the particular nature of risks in Azerbaijan. “We want to embed the control process across the whole bank, every department controls their own risks, and I control the overall procedures,” says Mr Mamedov. IBA has hired Ernst & Young as a consultant for a major restructure, including the separation of wholesale and retail activities.
In its drive to raise standards, the NBA also appears to be adopting an increasingly supportive line on the entry of foreign banks. Mr Rustamov points out that Azerbaijan has “the most liberal regime in the CIS for foreign capital participation – there are no limits” on the stake that foreign investors may hold in an individual bank or the domestic banking system. To date, 30% of assets in the system are held by banks that have foreign participation, and Mr Rustamov also expects global banks to enter the market directly, especially for investment banking activities. There is no intention to impose any licensing limits.
Early stages
Citi and Commerzbank have representative offices but the banking system may be at too early a stage of development to support larger foreign activities. Marco Graff, Commerzbank’s representative in Baku, emphasises that the main focus will be on German corporate clients with business in Azerbaijan. Similar services are offered by the National Bank of Pakistan and Turkey’s Yapi Kredi Bank for businesses from their home markets operating in Azerbaijan; and Russia’s Nikoil is the only foreign bank to enter the local retail market successfully so far.
Both HSBC and Dresdner attempted to offer wider services in the domestic market, but without success. Dresdner failed to generate enough business, and HSBC appeared to fall victim to a concerted lobbying campaign by local banks when it started offering loans at interest rates about 5% lower than the domestic players. “They broke the rules,” says one local banker, speaking in a philosophical sense rather than on any legal basis.
Cutting the headcount
It appears that attitudes are becoming more accepting. Mr Hajiyev says: “I welcome foreign banks in our market. The presence of first-class banks in Azerbaijan is a matter of prestige, it brings in new banking technologies, and competition is very good.” The competition is welcome partly because it may also help to complete the process of rationalisation in a banking sector that still has a residual tail of small banks.
The sector is already consolidated in as much as assets and deposits are concentrated in the top 10 banks, and the total number of banks has fallen from more than 500 in the 1990s to only 46 registered with the NBA. However, even some of these are “little more than money-changing shops”, according to Mr Ismailov, who expects the number to halve in the coming years.
The question is how the reduction will be achieved. Executives at Unibank and Bank Respublika indicate little enthusiasm for buying banks with poor management that would add few new customers. Consolidation among the smallest players is hampered by the fact that many have a localised focus. Consequently, many may simply shut down or apply for non-bank status. The Deposit Insurance Fund (DIF) launched in August 2007, will help to speed up the process and strengthen public confidence in the leading banks.
Banks must pay a membership fee of AZN10,000, and a quarterly 0.125% of the daily balance of deposits they hold, from the third quarter of 2008. They will be excluded from taking retail deposits if they do not join, says DIF chairman Chingiz Asadullayev. To date, 37 banks have joined and this includes several of the foreign subsidiaries.
