After several years of rapid economic growth, things are slowing down but certainly not grinding to a halt in Azerbaijan. Real gross domestic product (GDP) growth was 11.6% last year, according to the International Monetary Fund, but it is expected to drop to just 2.5% this year, mainly as a result of falling oil prices - the country's economy is heavily dependent on oil and gas, which accounts for about 60% of GDP.
While any economic growth is impressive in a global recessionary context, Azerbaijan's banks are suffering as a result of the sharp slowdown. The banking sector, which credit rating agency Standard & Poor's (S&P's) describes as "young and fragmented", has become vulnerable to declining credit quality in the commercial and personal sectors and due to liquidity shortages. "High dollarisation, the dependence of the economy on oil production, banks' single-name and industry concentrations, and weak risk management practices characterise the banking system in Azerbaijan," says credit analyst Victor Nikolskiy, author of S&P's first-ever bank industry risk analysis on the country, which was published in June.
Other risk factors include a high level of corruption, recent expansion into new segments such as retail banking, and the weak judicial system which makes it harder to deal with problem loans and the repossession of assets. The agency therefore gives Azerbaijan a banking industry country risk assessment (BICRA) score of nine - where one is the strongest and 10 the weakest.
On the positive side, medium-term growth prospects for the banking sector are good. Banks have little dependence on international borrowings and speculative operations. They are adequately capitalised and have performed well financially. For these reasons, Azerbaijan's banking system has been spared some of the global economic turbulence that has hit many other countries in the Commonwealth of Independent States.
IBA still dominates
State-owned International Bank of Azerbaijan (IBA) dominates Azerbaijan's financial market, with a 43% share in terms of assets, compared with about 45 private sector banks that hold a market share of 7% or less each. IBA has 37 branches and 598 ATMs.
Faig Mammadov, advisor to the chairman of IBA, is upbeat about the country's banking sector. "The downturn in the global financial markets has had an impact everywhere, although in Azerbaijan both the economy and the financial sector were better protected against external vulnerabilities," he says. "We can see that on a macroeconomic level there were no significant influences on the national economy, except maybe for the drop in oil price and related impacts. In the financial sector, we have not seen any defaults in any Azerbaijani banks, except for minor, short-term cash shortages in one." IBA is 50.2% owned by the government, "but the plan is to one day fully privatise it", says Mr Mammadov.
Although Muslims make up 93% of Azerbaijan's 8.2 million population and the country is a member of the Saudi Arabia-based Islamic Development Bank, Islamic banking has made virtually no inroads in the country. There are no stand-alone Islamic banks in Azerbaijan because current legislation does not allow them to exist.
"There are a number of products based on Islamic financial concepts which are being offered by some banks in the country, but as a system of financial management it is still in its infancy," says Mr Mammadov. He says that the government is reviewing banking and other laws to see how sharia-compliant banking could be introduced and regulated. IBA offers some Islamic products which do not conflict with banking regulations, and is considering issuing a sukuk (sharia-compliant credit notes) later this year, which would be the first in the country.
Dynamic new players
AccessBank, which specialises in loans to small and medium-sized enterprises (SMEs) and also lends to individuals, is one of the most dynamic banks in the country. But so it should be - its six foreign shareholders are the European Bank of Reconstruction and Development (EBRD), the International Finance Corporation, the Black Sea Trade and Development Bank, the international arm of German state development bank KfW, AccessHolding (an investor in microfinance) and LFS Financial Systems. The latter is a German consulting company which provides the bank's management.
Andrew Pospielovsky, AccessBank's general manager, says that the bank has about 70,000 borrowing clients and 40,000 depositors, a sizeable proportion of them business clients. "In a global context, we are small," he says. "Our assets stand at $285m and our loan portfolio is $235m. Our Tier 1 capital ratio is 18% and total capital ratio is 24%, so we are very strong on capital adequacy. Three years ago our total assets were $20m, so we have grown more than 10-fold and are still growing fast, which is a characteristic of Azerbaijan."
The bank started life as Micro Finance Bank of Azerbaijan in 2002, but changed its name last year. Although 95% of its loans are for less than $5000, it does lend up to $1m. "The key characteristic of the Azeri banking sector is that it lags behind that of its neighbouring countries," says Mr Pospielovsky, who has 10 years' banking experience working in eastern European and former Soviet Union states, and is an LFS employee.
Cushioned blow
Mr Pospielovsky describes the underdeveloped nature of the sector as "a blessing", because it meant that it was not hit too hard by the global financial crisis. For that reason, he is puzzled by S&P's BICRA score for Azerbaijan of nine - only one up from the lowest scoring level. "I find S&P's rationale difficult to understand because it puts us behind countries that have had major bank crashes and bail-outs," he says. "Here, the banking sector remains quite healthy. There has been some contraction in assets but no bank has had to be bailed out by the central bank.
"Banking here is fairly conservative. Much of the rest of the world now has a 'back-to-basics' mantra - but banks here never got away from the basics. The banking sector was not over-leveraged, capital adequacy was quite strong, the level of bank lending was not over-leveraging clients. Our clients' equity-to-debt is two to one, whereas it is the other way round in the West."
The country's slowing economy has affected loan books, and AccessBank is no exception. "We had virtually zero arrears on our loan book, but we have seen the arrears rate go up a bit, especially on larger loans," says Mr Pospielovsky. "We were anticipating that and so have built it into our business plan, allowing for greater reserves and provisioning, but our PAR [portfolio at risk] over 30 days is less than 1%," he adds.
The bank's funding is done internationally, mostly from dedicated microfinance funds. It also taps into commercial markets and issued a $25m bond two years ago in Luxembourg, for example. "We have very good relationships with our financing partners, so despite the financial crisis we continue to be successful in raising funds," says Mr Pospielovsky. "We raised $80m last year, which was 30% more than the previous year. For example, we did a syndicated loan in November 2008 sponsored by the EBRD."
Attractive proposition
AccessBank's ability to attract deposits is high. Across Azerbaijan's banking sector as a whole, deposits fell 20% in the first quarter of 2009, yet AccessBank's rose 34%, reflecting a flight to quality at a time when depositors had become wary of where they put their money. Inflation last year was more than 20%, which was a major disincentive to save, but now that it has fallen to about 0% and AccessBank is offering 14.5% on one-year deposits in dollars or Azeri manats, many people are finding it an offer that is difficult to refuse.
AccessBank's strategy for the next five years is simple - more of the same. "It is plain vanilla," says Mr Pospielovsky. "There is huge potential for growth by just continuing with our existing products, though we might tweak them a bit."
Multilateral support
Azerigazbank (AGBank) received $10m of a $15m subordinated loan from the International Finance Corporation (IFC) in May to help it lend to up to 70,000 new SMEs. The remaining $5m will be advanced next year.
The eight-year loan supports AGBank's growth plans as well as the IFC's objective of broadening financing opportunities and improving access to cheaper funding for micro-enterprises and SMEs in Azerbaijan, particularly during the global economic downturn. The IFC will also advise the bank on how to improve its risk management.
"We welcome the IFC's support and expression of confidence in AGBank," says Chingiz Asadullayev, AGBank's chairman. He owns 27.5% of the bank's shares, which makes him the main shareholder. The IFC has a 17.5% shareholding. "Thanks to the IFC funding and tailored advisory services, we will strengthen our institutional capacity, which is a priority for the bank's shareholders, and provide affordable funding to SMEs," says Mr Asadullayev.
The IFC loan is the second to be signed by AGBank with foreign investors this year. In April the bank borrowed $9.5m from the Organization of the Petroleum Exporting Countries Fund for International Development. AGBank's assets reached $256m by April 2009 and it has 16 branches and 54 ATMs across the country.
The IFC has been investing in AGBank for three years, and for the past two of those it has been helping the bank raise its corporate governance standards to international levels, part of a country-wide project with numerous banks and other companies. As a result, AGBank has significantly improved the composition and performance of its supervisory board. It is also making progress with internal audit and risk management functions and is establishing dividend and disclosure polices. "For us, good corporate governance is not only a theory, it is an essential part of our growth," says Mr Asadullayev.
AGBank is rated B- by credit rating agency Fitch, but in April the agency revised its outlook from "stable" to "negative". The negative outlook reflects continued and probable future asset quality deterioration, caused by the sharp slowdown in economic growth and the rapid 'seasoning' of loan books after recent fast growth, says the agency. However, the bank's refinancing and liquidity risks remain manageable according to the agency.
