Negative outlook for Azerbaijan’s banks amid concerns

The medium-term credit outlook for the Azerbaijan banking system is negative, reflecting recent developments in the Azerbaijani banking sector, Moody's Investors Service said in a new Banking System Outlook. The outlook takes into account Moody's concerns that the deceleration in Azerbaijan's economic growth, the weakening operating environment coupled with funding constraints are likely to adversely affect banks' asset quality, liquidity and ultimately capitalisation.
In recent years, Azerbaijan gained considerable advantage from its status as an oil-based economy, fully benefiting from the high oil prices. This, coupled with the government's efforts to diversify and expand the non-oil segment of the economy, has contributed to the rapid growth of the country's banking sector.
"Indeed, against the background of the oil boom, the Azerbaijani economy has recorded double-digit GDP growth since 2003 (10.8% in 2008). However, slower economic growth is forecast for 2009 due to the impact of the significant decline in oil prices that started in H2 2008," said Lev Dorf, author of the report.
The rapid credit expansion in Azerbaijan has now come to a halt, revealing growing asset quality problems as the banks' loan books start to season. Moody's believes that this trend is likely to continue in the context of more challenging economic conditions. Notably, the global liquidity crisis has significantly reduced banks' access to external funding, thus putting pressure on their liquidity profiles and increasing refinancing risks.
"Over the past several months Azerbaijani banks have increased their reliance on central bank funding to refinance their market borrowings. In Moody's opinion, this indicator should be regarded as a cause for concern, highlighting stand-alone weaknesses of those banks," added Dorf.
Moody's observes that the Azerbaijani banking system, on the one hand, displays high concentration, with the seven-largest entities (out of 46) controlling 70% of the system's total assets, whilst, in contrast, the remaining 39 banks account for 30% of assets — indicating the relatively fragmented nature of the banking system amongst the smaller institutions.
In addition, the banks' economic capital is being pressured by a significant level of single-name concentrations in the loan book, potentially understated levels of related-party lending and increasing levels of non-performing loans in the context of weakening economic conditions.
Moody's also noted that concentration of state ownership in the sector is still high as the banking system is dominated by the state-controlled International Bank of Azerbaijan (IBA), which accounted for about 43% of the banking sector's total assets at year-end 2008. Moreover, Azerbaijan's largely domestically focused activities remain concentrated in urban areas, and the system's geographic diversification is constrained by the relatively small size of the Azerbaijani economy.