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Central & eastern EuropeSeptember 3 2006

Balance sheets look better

The banking sector is growing hand-in-hand with the economy, accompanied by consolidation and privatisation, and opportunities for new products.
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Banks in Azerbaijan are bellwethers of the massive growth in the economy. The banking market is growing by a quarter each year, somewhat lower than gross domestic product (GDP) growth of 36%, but enough to stimulate a surge of change, modernisation and expansion in the sector.

Salim Kriman, CEO of Bank Standard, the largest private bank in Azerbaijan, says: “We have experienced tremendous growth in assets and equity capital.” The bank’s balance sheet is expected to double this year, reaching $200m by year end. This is on an equity base of just $25m.

The capitalisation of Azerbaijani banks is low compared with international norms, says Jahangir Hajiyev, chairman of the board of Azerbaycan Beynelxalq Banki (International Bank of Azerbaijan – IBA), the country’s largest bank, which is 51% controlled by the government. “The banking sector is undercapitalised. We need to increase the capitalisation of the banking sector. The ratio between GDP and the banking sector is very low, 14% to 15% of GDP. In developed countries, it is more than 100%. There is a lot to do in the banking sector in Azerbaijan. The banking sector needs to increase its capitalisation, it needs to attract deposits and assets.”

Encouraging competition

This strategy is strongly supported by the country’s central bank, Azerbaycan Respublikasi Milli Banki (National Bank of Azerbaijan – NBA). “Our objective is to ensure free competition and a competitive environment in the banking sector,” says Rufat Aslanli, an executive director and member of the board at the NBA. “Among commercial banks, it will be desirable to ensure very comparable market shares of the commercial banks. We do not believe this can be done by breaking up the large banks so they become smaller banks. On the contrary, we favour an approach that leads to consolidation of smaller banks so they become larger banks because that will make the market much more competitive.

“Capitalisation, consolidation and structuring of the private bank sector will enable the banks to increase their financial viability and be more competitive in the financial sector. Another important aspect is to implement corporate governance standards and strengthen banks’ management ability. This will enable banks to increase their credibility and reliability,” he says.

All major local banks are engaged in a programme to raise funds in the international markets. They will follow in the government’s footsteps. The IBA, like the government itself, has applied to Moody’s for a rating to complement its earlier rating from Fitch. It expects Moody’s to announce the rating in the autumn of 2006, after which it expects to launch a Eurobond of between $150m and $200m. The bank is currently in discussions with international banks that might arrange the bond issue. Citigroup is thought to be the favourite.

Mr Hajiyev says he does not expect the bank to issue its bond before the government has made its debut in the Euromarkets. “It is better if the government goes ahead. We will have a benchmark and then proceed with the bond. Next year, 2007, will be the year of the Eurobonds for the country and the IBA.”

The sale of a 20% equity stake in the IBA continues under review. Discussions with the European Bank for Reconstruction and Development (EBRD) appear to have been halted, and a global investment bank now looks a more likely purchaser. “This process was very long and there was no clear vision of what the EBRD intended. The management of the bank did not believe the EBRD could bring a value-added policy. There was no strategic plan of development,” says Mr Hajiyev.

The matter is being examined by a commission comprising representatives from the NBA, the ministries of finance and economic development and from the IBA itself.

More transparency

Meanwhile, the IBA has sought to make itself more transparent to investors by providing them with twice-yearly financial accounts. “Potential buyers of our Eurobonds will see the progress of our activity,” says Mr Hajiyev.

The NBA says it perceives a growing interest by foreign investors in Azerbaijan’s banks, and generally encourages it. However, it has concerns about governance and accounting systems. “Foreign capital has participated in the equity of five banks since 2003. As a regulatory authority, such an increased interest may be a bit worrisome,” says Mr Aslanli. “Therefore, we attach a great deal of importance to improving both the risk management and the regulation and supervision of the banking system.”

Rationalisation of the banking sector is also likely to lead to a contraction from the current 44 banks. This would be a continuation of the consolidation process that started in the mid-1990s, when Azerbaijan had 200 banks. Mr Hajiyev expects the number to be reduced to 15 or 20 in the medium term. “The NBA is doing a good job in consolidating the banking sector. There should be many fewer. They should be strong in their market share.”

Rauf Rzayev, the chairman of Kapital Bank, also expects consolidation. “There are too many banks in Azerbaijan. Between 75% and 80% of the market is controlled by the three largest banks. So what does that leave for the other banks? Many of those banks are really small,” he says.

The IBA is the country’s dominant bank, with market shares that range over various sectors between 50% and 75%. “Our market share is over 75%. In foreign exchange, it is 90% and in household deposits, it is 60%. We have 40% of deposits,” says Mr Hajiyev.

New products

The drive to increase products is proceeding hard throughout the banking community. “We are very active in implementing new products. The banking sector is not underdeveloped; it is developing. We are creating new products in terms of assets and in terms of liabilities. We have a very diversified policy towards attracting household products and a good variety of products,” says Mr Hajiyev.

Bank Standard’s Mr Kriman reiterates the theme. “You have to be enthusiastic and very creative to offer the market new services, but the banking sector is quite tiny and the services are rudimentary.”

No bank has grasped the nettle of modernisation and technical advancement more firmly in Azerbaijan than Kapital Bank, which is Azerbaijan’s second largest bank, with more branches (89) and sub-branches (93) than any other in the country. Two years ago, state-owned Kapital Bank was languishing with old technology and equipment. Then a change in management in August 2004 raised the pace of modernisation.

Mr Rzayev says: “All the old equipment was replaced, and we bought and established a new quality of service.” The bank updated its software, which was funded by the World Bank. Corporate governance and management procedures have likewise been revised, to delegate decision-making authority further down the organisation. “These reforms are coming to an end,” says Mr Rzayev. “But the most difficult period was 2004 and 2005.”

The changes have fed through into the bank’s financial performance, he says. Kapital Bank showed a $1m profit at the end of 2004, and $4m at the end of 2005. Its equity has trebled in the past two years. The bank’s advances were noted by Fitch, which gave it a B+1 rating.

Privatisation plans

The appointment of PricewaterhouseCoopers in 2005 indicated the government’s intention to privatise at least part of Kapital Bank. PwC subsequently valued the bank at $60m. The government plans to reduce its stake to 51% by issuing a tranche of new shares. This will put the bank’s structure on a par with that of the IBA. The share issue is due to be completed by the end of this year, and the shares will be traded on the Baku Stock Exchange. A second stage of the privatisation process will involve the sale of a stake to a strategic buyer, although no specific plans have been announced.

Kapital Bank has been in the vanguard of Azerbaijan’s credit card business. Mr Hajiyev says that the IBA has served as guarantor for about 20 local banks that have applied to issue their own credit cards. Many of these institutions have subsequently been accepted without the IBA guarantee.

The government is encouraging the use of plastic because the economy is still substantially cash-based. Finance minister Samir Sharifov says: “The levels of salary do not allow people to use credit cards. Even paying banking charges is something that deters people from using their credit cards. This is the reality and it will take time to overcome it.

“We have switched [the payment processes of] all government agencies so that that staff don’t get cash. All employees have bank accounts and all salaries and pensions are paid into their bank accounts. They have all been distributed credit cards. Do they use them in the shops? Yes. But do they use them to the level that pleases us? No. It is still a step forward. They know how to use credit cards. They know how to approach ATMs. It is a process and I hope it significantly reduces the amount of cash in circulation.”

Cash limitations

The extent of the cash economy acts as a deterrent to banks to issue products like mortgages, says Mr Kriman. “To do mortgage loans, we need proof of earnings. Salaries are primarily paid in cash, and it is a problem developing this business here. The first mortgage loans were given by our bank.”

Bank Standard, which is locally owned, has made a particular pitch for some of the wealthier members of the local community. It is launching a private bank in October that will offer wealth management to individuals who have $1m of liquidity to invest. The bank says that 15 to 20 of its clients fall into this category. Investment classes will include treasury bonds and other very secure fixed income products.

The bank is also planning a joint venture with DTZ, a UK-based global real estate company, to create a $50m fund investing in office property in Azerbaijan. The bank is being assisted by international legal firm Baker & McKenzie. Mr Kriman says that economic growth will trigger demand for office property in Baku, of which there is a dearth.

“As our economy grows, the people are becoming richer and this kind of service will grow in interest. It will be invested in international global funds and in local assets. We are trying to give a bit more than deposit rates to this kind of client. Service quality will also be enhanced in the private banking sector. This will be the first private bank in Baku,” says Mr Kriman.

Investment funds from the US and Russia are also thought to be prospecting Azerbaijan for potential opportunities. Red Star Investment Fund, Renaissance Capital and Firebird Investment Funds have run a slide-rule over the country and are known to be interested in participating with local institutions.

The Azerbaijani banks are at the forefront of stimulating investment in the country’s real economy, another key government directive. Kapital Bank, for example, has a $10m credit line for local companies seeking to fund development. It has a further $4m general purpose credit facility with the Black Sea Development Bank.

“We have brought a lot of US and European companies to Azerbaijan,” says Mr Hajiyev. “We have financed their business with local partners. Whole sectors of the economy have doubled. These include the cotton-processing sector, textiles, tobacco, silk harvesting and others. We created new customers and new businesses.”

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Read more about:  Central & Eastern Europe , Azerbaijan