Things are heating up for Azerbaijan’s finance sector

Azerbaijan’s financial sector has a modest yet strong presence

Azerbaijan's economy is slowly but surely moving forward - the financial sector is key to its ongoing growth
Azerbaijan's economy is slowly but surely moving forward - the financial sector is key to its ongoing growth 

It has been a long time since, upon hearing I am from Azerbaijan, I’ve heard confusion from my foreign counterparts. In the past seven years there have been successful international conferences, sporting events, a Eurovision song contest and gatherings, which have made the sound of the country’s name come as less of a surprise.

More than 20 years ago Azerbaijan gained its independence after the collapse of the former Soviet Union. Located on the historical Great Silk Route, the country is an ancient nation with a long history of commerce and transit trade. Neighbouring Russia, Georgia, Turkey and Iran – which have mostly large markets – ensure the potential for business in the region is high.

The democratic state of Azerbaijan – the first in the Middle East – was established in 1918, but alas, was short-lived. In 1920 the country lost its independence after the Soviet’s Red Army the took it over. After more than 70 years Azerbaijan irrevocably regained its freedom back in 1991. The economy has been left in a shambles after almost 70 years of a Soviet experiment called the “planned economy”.

The economy has been left in a shambles after almost 70 years of a Soviet experiment called the “planned economy”

The first signs of change
For most of the 20th century, one central bank (GosBank) and only one currency (the Soviet Ruble) ruled the economy of Azerbaijan – then one of the 15 states of the Union of Soviet Socialist Republics. It is difficult to imagine now, that banking activity in the country was limited to a collection of savings through the savings bank.

There were of course services rendered to the state-owned entities through three colossi: industry, construction and the savings bank. Foreign currency exchange was a criminal offence, and was prosecuted a law that was revoked in 1991. Private sector activities through cooperatives started in the late 1980s, with non-state trading allowed at the time. New realities and an absence of clear laws governing commercial and private activities brought about a unique type of wild capitalism.

As the centralised Soviet planning-based economy collapsed – along with trade ties – Azerbaijan was left to struggle with galloping inflation and currency devaluation. With scarce liquidity, banks could start with nominal capital from as little as $500, and flourish in a very short time as financial pyramids – the most profitable business at that time. This had completely ruined the population’s trust in the banking industry.

With a new economy five years later in 1996, Azerbaijan – a relatively small country with less than seven million inhabitants – boasted almost 250 bank licences. The ethics and behaviour of banks served only one goal: to make profit, whatever it takes. Attitude to risk was simple; the most popular income was selling cash for non-cash funds into a bank account (the fee could be as high as 50 percent of the transaction volume). Needless to say, cash remained the preferred method when dealing between the businesses.

Rapid market deployment
Between 1995 and 2007, the national banking systems emerged. Two-tier banking systems were created and the Central Bank introduced stricter rules on liquidity and capital. Significant investments by oil majors contributed to the economic revival and created market infrastructure.

With consumer markets vastly developing, the banks started competing for savings to fund their rising consumer and business loan portfolios. The role of banks in the economy has started to increase significantly.

The last 13 years have seen robust growth in the banking sector, albeit with fewer banks (only 59, of which three are state-owned and 16 are with foreign capital). A new generation of businessmen emerged, with longer-term goals and increasing exposure to international business. IFIs, including EBRD and the World Bank, have been setting new standards for the development of Azerbaijan’s private sector in general, and banks in particular.

By 2007 the banking sector had regained the public’s trust, which resulted in steady growth in savings and loan portfolios. Bank regulators and IFIs investing in shares of banks enforced better management, corporate governance, stronger capital requirement and transparency. Banks, corporate entities and their shareholders wanted more transparency.

By 2007 the banking sector had regained the public’s trust, which resulted in steady growth in savings and loan portfolios

The non-banking sectors have been growing faster, while banks still lag institutional capacity to service their needs. The tendency towards a longer-term view of the economy by the private sector is more observed, and banks lend longer, albeit while not adequately funded. Several years of financial crisis have put banks off the corporate issues in general, forcing many to leave the sector while risk concentration is higher. The environment does, however, remain challenging.

Growth opportunities increase risk profile. The players of the market as well as regulators still have a lot to learn, as the frameworks for bank supervision are risk-oriented. Regulators are focusing on capital adequacy and individual risk profiles, as well as operational transparency.

Regulators want to bring financial stability to a much higher lever. The Central Bank of Azerbaijan – in an attempt to address fragmentation of the banking sector, increased the requirement of the nominal capital to AZN50m. With the legacy described, the market has still not established the tradition of governing standards. The alignment of business strategies that are challenging to risk-based methods create a strong competitive advantage. Traditionally, the banks have been on the universal side of the business, adopting ‘all-for-all’ concepts (often nicely interpreted as ‘flexibility’).

Over the course of the bank’s existence, the role of risk management and compliance has been gradually increasing: in the environment where integrity is still an issue, these departments are fulfilling the essential role of guiding the bank’s strategy to this regard. All-in-all, as we are travelling a rough and uncharted – yet at the same time unique and exciting – path, we are witnessing the formation of a strong banking sector in our country.