Heiner Klemm in Baku -
Azerbaijan's banking sector is on fire. Banks across emerging Europe have recorded phenomenal growth in recent years, but none are growing stronger than in Azerbaijan. The growth is starting to attract international attention and the first foreign banks have moved into Baku with rep offices, while others are on the prowl for takeover targets.
Banking sector assets and liabilities have increased by some three and a half times over the last three years, according to Rufat Aslanly, member of the management board of Azerbaijan's Central Bank, the National Bank of Azerbaijan. In terms of capitalization, the banking sector recently surpassed the AZN1bn mark ($831m), having grown 5-times from AZN200m three years ago.
Aslanly points out that, despite booming credit portfolios, banking prudential indicators are on par with the best in the world: over-due loans decreased from 3.5% to 3.1% over the last three years, and non-performing loans at under 5%. Return on equity stands at above 35%, while return on assets is above 3.7%.
Three main factors account for the strong growth says Aslanly: economic growth running over 30% a year; Azerbaijan's banks started to borrow from the foreign markets in 2006; and, probably most importantly, restructuring of the banking sector.
Over the last four years the Central Bank has been working to standardize the legal basis for banking activity, implement corporate governance standards, restructure the private banking sector and develop financial infrastructures including payment systems and implementation of IFRS.
"As result, in 2004, we adopted a new central banking law which is in full compliance with Basel Core Principles on effective banking supervision," says Aslanly, "We drafted this law with assistance from international financial institutions and followed up with a special financial sector assessment project from the World Bank and the IMF. Consequently, all banking activities in Azerbaijan now have a solid legislative basis."
Squeezing the sector into shape
The Central Bank has successfully slashed the number of banks in Azerbaijan from some 250 about eight years ago, to the current number of 46. But an attempt to cut the number further by hiking the minimum capital requirements and thus pressure smaller banks to merge or be bought failed. Banks are growing so fast that no one was ready to sell and to the annoyance of the central bank all the banks in the sector managed to meet the new requirements. With total banking sector assets still only equal to about 20% of GDP, compared with values of over 100% in the West, the banks expect plenty more growth.
Jahangir Hajiyev, chairman of the state-owned International Bank of Azerbaijan (IBA), by far the largest bank in the country, believes that even the IBA, with AZN100m in shareholder equity as of the end of 2007, is under capitalized, but ultimately the country needs no more than 15 banks. The IBA, however, is not likely to fall foul of capital adequacy requirements.
"We are achieving record earnings - profits were at AZN70,404,000 in 2007, up 92% on the previous year - so we are sticking these back in and have no problems growing the bank," says Hajiyev.
The smaller private banks are frequently seeing their profits boom by several hundred percent, year on year, and Aslanly concludes that, for now, upping the minimum capital requirement above AZN10m would be unproductive. "Capital adequacy is at 12% and the top 15 banks have healthy capital adequacy ratios of around 14% to 16%," comments Aslanly.
The Central Bank is having more success in cutting down on the number of banks by way of regulatory reforms. At the start of 2008, after several years of discussion, a deposit insurance scheme was introduced. Currently, nine banks have not joined the scheme and Aslanly says: "these nine banks have limited banking licenses - they cannot collect deposits from the general public. Ultimately they have two options: merge or transfer to become non-bank financial institutions."
Public trust in the banking sector has been growing in leaps and bounds and even ahead of the insurance scheme, deposits were rocketing, up by 67% in 2006 compared with the previous year, and increasing by a further 102% in 2007. Aslanly believes that public trust is mainly based on the improving quality of banking services and trust in the government's regulatory authority.
"In 2004, we revoked the license of one bank. The Central Bank led the liquidation process and within three months had repaid all the deposits. This gave a crucial boost in confidence to the public," says Aslanly.
Local depositors are not the only ones that are gradually being won over. Vladimir Myashin, an analyst at GlobalRating, in February wrote: "Active banking reforms in Azerbaijan have started showing results."
Catching up with the giant
Until recently the IBA entirely dominated the banking sector, but over the last few years it has lost virtually half its share of the market to private banks.
"Five years ago, IBA's market share was around 75% and it collected over 80% of deposits, while by the end of 2007, IBA's market share had dropped to under 38% and the top 15 private banks alone accounted for more than 65% of deposits," comments Aslanly.
Faig Huseynov, chairman of the privately-owned UniBank, Azerbaijan's third largest bank, comments: "a few years ago IBA dominated the market, but now the picture is changing as the other banks move ahead rapidly. IBA is still the giant of Azerbaijani banks, but I wouldn't say that it monopolizes the sector or that we suffer because of any advantages that they might have. In the same way, the small banks should not, and do not, suffer from us being bigger. Everyone focuses on slightly different businesses and success is dependent on each bank's personal strategy."
UniBank, which was set up in October 2002, as a result of the merger of the two small private banks MBank and PromTekhBank, appears to have its strategy fine-tuned to perfection. The bank focuses on financing private companies in the non-oil and gas sector, including SMEs and financing of nascent businesses via micro-lending. In a little over five years, the bank has grown its assets by a staggering 45-times, from some $10m to $450m.
The EBRD and Germany's DEG joined the success story, respectively acquired stakes of 20% and 8.33% in 2003 and 2005. Having two well-known institutional shareholders has also helped UniBank to attract international funding by way of bilateral and syndicated loans to local companies and Huseynov comments that the bank is doing significant business with a host of foreign banks including Deutsche bank, Citi Group, JP Morgan, Morgan Stanley, Standard Bank and VTB.
UniBank recently started to sharply expand its retail business and now retail deposits account for nearly half of its $300m portfolio. Huseynov explains that: "Overall public wealth is growing, which raises retail banking to a new level of importance."
The bank is seeing increasing demand for car loans, credit cards, and mortgages. Last year the government set up a state mortgage fund, which gives the public access, via selected banks, to funding at extremely favourable rates. UniBank, as is the case with many other private banks, has launched its own mortgages and is currently signing agreements with foreign financial institutions to attract between $15m and $30m for 10 to 15 years, specifically for mortgage purposes. The establishment of mortgage financing is described by Myashin as one of the main recent accomplishments of Azerbaijan's financial sector.
As with most of the banking sector, UniBank's presence is still nearly exclusively limited to Baku with only two of its 13 branches located outside the capital. This year UniBank plans to expand strongly into the regions, adding as many as 10 branches outside Baku and increasing its overall number of branches to 30. Huseynov confirms that the government's efforts to develop infrastructure throughout the country are paying off: "The regions are developing very fast. More small to medium plants and workshops, and private companies are opening up. There is business in the regions and it has become strategically important to expand beyond Baku."
From off the map to off the scale
For leading international banks, Azerbaijan has suddenly gone from being a blank zone on the map to the place to be. While local banks are filling in their coverage of the regions, foreign banks are queuing up to establish their first presence in the capital.
Germany's Commerzbank, which was operating in Russia long before the Wall came down and in the 1990s was quick to launch rep offices everywhere from Ukraine to Kazakhstan, and Belarus to Uzbekistan, left it until the end of 2007, to arrive in Baku.
"There was only one blank area where we had no presence at all and that was the Caucasus. In the 1990s, we developed some relationships with the main banks in the region but dealt with business from Frankfurt because things were not moving ahead. The countries of the Caucasus were very underdeveloped and didn't keep pace with their neighbours such as Kazakhstan," comments Dr Marco Graff, head of Commerzbank's rep office in Baku.
"All that changed with the completion of TBC. The Azerbaijani businessman, loaded with oil dollars, started looking around for where to spend the money and the market started to develop so quickly that we felt we had to be here to keep our figure on the pulse and develop more complex banking solutions," says Dr Graff.
Commerzbank joined France's Societe Generale and Latvia's Parex Group, which have had rep offices in Baku since 1998 and 2005, respectively, and will soon be joined by the Turkish division of US banking giant Citibank, which was granted permission to open a rep office by the Central Bank in February. According to Aslanly, Citibank plans to switch from a rep office to opening a subsidiary bank within a year or two.
Commerzbank is in no such hurry. Dr Graff plans to watch developments closely and before making any plans to switch to full banking activities.
"Trade is picking up quickly between Azerbaijan and Germany. Siemens and Lufthansa have been here for ages. The utility RWE just opened a rep office and the road construction company Wirtgen Group is looking to set up operations in Azerbaijan. So there is plenty of business for us but the banking sector still has some catching-up to do. The content of the financial instruments being used are often much more developed than the know-how of the market," comments Dr Graff.
Hajiyev welcomes the arrival of the foreigners, commenting: "Foreign banks bring know-how, new technologies and new services. Its good for developing the banking sector and it also helps to create a more competitive environment."
The number of banks with foreign capital has recently increased to 21, and while six of these are already majority owned by foreigners, the media and local bankers alike are talking about the imminent purchase of a local bank by Russia's second largest bank VTB as the first major acquisition by a foreigner.
VTB is rumoured to be purchasing AF-Bank, reportedly the 35th largest bank in the country, and while sources say that the deal has already been closed, Aslanly says that the Central Bank is still considering the issue.
Several US and European banks, including ABN Amro, have reportedly approached the Central Bank regarding buying a local bank. Kazakhstan's Halyk Bank has also been named in the media, while the Bank of Georgia and IsBank, respectively, the leading banks in Georgia and Turkey, are also reportedly taking a closer look at the country.
"We won't know for sure until we see a huge VTB sign on top of one of banks in Baku," comments Huseynov. As for how it will change the local landscape, Huseynov says:
"Hopefully we'll see something fresh. But again it really depends on the bank's strategy. If they just come to serve existing clients then it wouldn't change much, but if a major foreign bank moves in with big plans to provide the full spectrum of banking services to local, foreign, new and old clients then we'll see competition really heat up."
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