IMF reveals problems of Azerbaijan’s banking sector and ways to solve them

The banking sector in Azerbaijan is robust, but it faces challenges such as low loan-to-deposit ratios, high operating costs and increasing levels of concentration, reads a Staff Report for the 2023 Article IV Consultation of the International Monetary Fund (IMF), held by the head of the fund’s mission for Azerbaijan, Anna Bordon, in November 2023 in Baku, Report informs.

“Capital ratios are relatively strong, and the deposit-to-loan ratio is close to 170 percent, implying that a substantial portion of deposits remains untapped for lending purposes. This underutilization of deposits indicates that the banking sector has not fully maximized its role as an intermediary between savers and borrowers. Therefore, there is significant room for expanding loan supply to meet demand,” the IMF noted.

“Efficiency metrics indicate that noninterest costs in Azerbaijan are the highest in the region, accounting for 58 percent of financial income, while personnel costs represent over 60 percent of the noninterest expenses. However, profitability ratios in Azerbaijan lag most regional peers except Uzbekistan. These factors suggest that optimizing cost structures and improving operational efficiency are critical for reducing the bank spread and even enhancing overall profitability.”

“Further improvements in liquidity management operations are also needed, including further work on developing standards for interbank transactions, use of standard master repo agreements, and continued effort to improve liquidity forecasting techniques,” reads the report.

“Further comprehensive analysis of the cost structure and efficiency is needed to identify areas of inefficiency, including reviewing pricing models for loans, deposits, and other financial products to improve competitiveness. The authorities should also encourage banks to: improve lending in compliance with responsible and sound lending regulations; implement robust risk management practices to minimize credit and operational losses, including strengthening credit risk assessment, monitoring procedures to reduce NPLs, ensuring effective liquidity and interest rate risk management practices; diversify funding sources to mitigate the impact of high funding costs; and leverage data analytics to identify opportunities for optimization and risk mitigation.”

Despite substantial reduction, dollarization remains relatively high, and efforts to reduce it should continue, including through macroprudential and regulatory measures, the IMF added.

“Banking sector financial soundness indicators are strong, but do not fully capture risks. NPL figures are low, but do not fully reflect the level of restructured loans. Despite an 18 percent decrease by September 2023, restructured loans remain elevated at 1.1 billion manats [$647.058 million] or 4.7 percent of the loan portfolio. There is also a difference in loan-loss provisions between the official (prudential-based) figures and that under IFRS 9 (International Financial Reporting Standards), with some banks showing lower provisions under official regulations. Staff recommends continuing to conduct comprehensive assessments of credit quality, including by conducting stress tests and thematic inspections, and faster progress in NPL resolution.”