Page 34 - Caucasus Outlook 2024

3.3.2 Banks
Despite economic uncertainties, overall deposits (both manat and foreign currency) increased steadily throughout 2023 in the Azerbaijani banking sector. The IMF acknowledges the continued advancement of the Azerbaijani banking sector, noting its robust capital buffers with a capital adequacy ratio of 18.5% as of September 2023. The expansion of credit, especially to households, is evident, albeit moderated by tighter regulatory measures. Non-performing loans (NPLs) have reached a historic low of 3.5%, and profitability indicators are strong with a 2.4% return on assets and a 20.8% return on equities. The sector is experiencing a trend of de-dollarisation in deposits and loans, complemented by decreasing net open foreign exchange positions.
However, vulnerabilities persist, particularly in the high proportion of restructured loans, standing at 4.7% by September 2023, after an 18% decline from the previous year. The IMF urges vigilance regarding risks associated with these loans and points out discrepancies in loan-loss provisioning between official figures and International Financial Reporting Standards (IFRS) 9 due to differing qualitative criteria. Comprehensive credit quality assessments, including stress tests and thematic inspections, are recommended, alongside accelerated NPL resolution.
Fitch Ratings presents a favourable outlook for Azerbaijan's banking sector, citing moderation of legacy risks, improved asset structure, and beneficial operating conditions buoyed by high oil prices. The outlook for the 'b+' operating environment score of Azeri banks has been revised to positive, reflecting anticipated boosts in revenue generation and business volumes, especially for the largest bank, the International Bank of Azerbaijan.
Credit penetration in Azerbaijan remains one of the lowest in the CIS+ region, with a loan-to-GDP ratio of about 15%. Nevertheless, prospects for increased business volumes and revenue generation are strong, backed by improved capital and liquidity. Fitch anticipates robust loan growth, driven by retail lending.
Asset quality, historically a significant weakness, has shown marked improvement. The decline in Stage 3 and 2 loans and limited unrecognised or unreported problem loans, primarily confined to smaller banks, underpin this trend. The sector's robust asset structure and shift towards granular local-currency retail lending relative to corporate loans have mitigated credit risks.
Decisive resolution of legacy risks, regulatory clean-ups, and a tougher stance on loan recognition and provisioning contribute to the sector's resilience. Emphasis on retail lending and currency stability has reduced loan dollarisation, enhancing profitability. The sector's pre-impairment profits and Tier 1 capital ratio indicate reasonable loss absorption capacity.
Post the currency devaluation in 2015-2016, which exposed governance and problem loan recognition weaknesses, significant improvements in financial metrics have been observed, suggesting a material reduction in
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