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Standard&Poor’s: Azerbaijan’s banking system increasingly affected by global crisis

09 June 2009 12:09 (UTC +04:00)

Baku. Elmin Ibrahimov â€“ APA-Economics. Standard & Poor’s Ratings Services published a first full report on Azerbaijan banking system titled "Bank Industry Risk Analysis: Azerbaijan’s Young, Fragmented Banking System Increasingly Affected By Global Crisis,". In the report Standard & Poor’s Ratings Services said that the Azeri banking sector is vulnerable to potential credit quality and liquidity deterioration after several years of very rapid growth, due to the high industry and economic risks facing the country’s young and fragmented banking system.

High dollarization, the dependence of the economy on oil production, banks’ single-name and industry concentrations, and weak risk-management practices characterize the banking system in the (BB+/Stable/B).

However, the system enjoys decent medium-term prospects for macroeconomic growth. Banks’ dependence on international borrowings and speculative operations is limited. They are adequately capitalized and have performed well financially.

For these reasons, Azerbaijan’s banking system has been spared some of the global economic turbulence that has slammed many other countries in the Commonwealth of Independent States. However it remains vulnerable to possible negative changes in the macroeconomic environment and represents high risk in the global context. This is reflected by its Bank Industry Country Risk Assessment score of ’9’ (out of ’10’, ’1’ is the strongest).

State-owned International Bank of Azerbaijan (not rated) dominates the market, with a 43% share in terms of assets, followed by about 45 private sector banks that hold a market share of 7% or less each.

Until very recently, Azerbaijan was the leading destination for foreign direct investment in the region. However, it was spread unevenly between economic sectors, with oil production dominating (oil contributed 60% of Azerbaijan’s GDP in 2008). The investment environment is consequently sensitive to investors’ dependence on political stability, the government’s commitment to reforms, and continued GDP growth. We expect Azerbaijan’s economic growth to decelerate to 4.0% in 2009 against 8.5% in 2008, following a sharp decrease in oil prices.

At year-end 2008, 49% of total system loans were denominated in foreign currencies, highlighting local banks’ asset-quality vulnerability to an unlikely, but possible, devaluation of the local currency.

We believe deteriorating credit conditions and the slowdown in growth will lead to a significant rise in banks’ credit costs and problem loans. We estimate gross problematic assets for Azerbaijan’s financial system to be in the 35%-50% range.

We consider Azerbaijan to be "supportive" of its banking system (see "Criteria | Financial Institutions | Banks: External Support Key In Rating Private Sector Banks Worldwide," published on Feb. 27, 2007, on RatingsDirect). Under this approach, we give no ratings uplift to private-sector banks for potential government support. During times of financial stress, the authorities are likely to increase supervision and regulation of troubled entities, but, in our opinion, would provide only limited extraordinary financial support to privately owned banks.