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Standard & Poorâ€™s Banking Industry Country Risk Assessment places Azerbaijan in Group 9

25 February 2009 12:26 (UTC +04:00)

Baku. Vugar Israfilov â€“ APA-Economics. Standard & Poor’s Ratings Services
said it categorized the banking industry of the Republic of Azerbaijan
in Group 9, following its Banking Industry Country Risk Assessment (BICRA).

Our BICRA rankings reflect the strengths and weaknesses of a country’s
banking system, compared with those of other countries, on a scale ranging
from Group 1 (the strongest) to Group 10 (the weakest). Other countries in
Group 9 include Belarus, Nigeria, Costa Rica, Guatemala, Lebanon, and Vietnam.
Azerbaijan ranks ahead of Ukraine (Group 10), but behind Russia and Kazakhstan
(Group 8).

The placement of Azerbaijan in Group 9 reflects the high industry and
economic risks facing the young and fragmented banking system, which is
vulnerable to potential credit quality and liquidity deterioration after
several years of very rapid growth. The system is characterized by high
dollarization, the economy’s oil dependence, banks’ single-name and industry
concentrations, and weak risk-management practices. These vulnerabilities are
partly mitigated by decent medium-term prospects for macroeconomic growth,
banks’ limited dependence on international borrowings, and their adequate
capitalization and financial performance. For these reasons, the Azerbaijani
banking system has so far been less affected by the global economic
turbulence, compared with many other countries in the Commonwealth of
Independent States.

The banking sector is dominated by a state-owned bank, International Bank
of Azerbaijan, which has a market share of 40%, followed by very dynamic
private-sector banks--about 45 of them at year-end 2008--with the market share
of the largest at less then 8%.

Economic growth is expected to decelerate to a still decent 4.0% in 2009
against 8.5% in 2008, following a sharp decrease in oil prices. Azerbaijan’s
economy is highly dependent on oil, which contributed 60% of GDP in 2008.

The rapid lending growth of the past few years is now slowing, owing to
sluggish macroeconomic growth and reduced access to international funding.
Total system loans increased by only 6% in the fourth quarter of 2008 compared
with more than 40% in the first nine months of the year and more than 80% in
2007. As of Dec. 31, 2008, 49% of total system loans were denominated in
foreign currencies, highlighting local banks’ asset-quality vulnerability to
an unlikely, but still not impossible, devaluation of the local currency.

We expect deteriorating credit conditions and a slowdown in growth to
lead to a significant rise in banks’ credit costs and problem loans, at least
over the next two to three years. Although loans overdue by more than 30 days
were at 2.2% of total loans on Dec. 31, 2008, this ratio does not reflect
potential problem loans because portfolios are unseasoned. The expected
deterioration was only partly offset by the sector’s adequate capitalization
(an average capital ratio of 17%) and satisfactory profitability, reflected in
a return on assets of 2.2% at year-end 2008. However, banks’ provisioning,
which covered 6.2% of total loans at year-end 2008, provide an adequate
cushion to absorb potential credit losses.

Our key analytical measure, which reflects the contingent liability of a
banking system relative to sovereign risk, is an estimate of the incidence of
gross problematic assets (GPAs) in a reasonable worst-case scenario of
economic recession, expressed as a percentage of domestic credit to the
private sector and nonfinancial public enterprises. We have estimated the GPAs
for Azerbaijan’s financial system to be in the 35%-50% range (on par with
Belarus, Russia, and Kazakhstan).

Although customer deposits have continued to increase rapidly, rising 37%
in 2008 after 55% in 2007, the banking system’s ratio of loans to deposits
reached a fairly high 162% on Dec. 31, 2008, reflecting the strong growth in
lending in recent years. At the same time, foreign funding represented 23% of
the system’s liabilities, largely comprising more sustainable financing from
multilateral institutions.

Under our criteria, we consider Azerbaijan to be "supportive" of its
banking system (see "Criteria: External Support Key In Rating Private Sector
Banks Worldwide," published on Feb. 27, 2007, on RatingsDirect). In line with
this approach, we give no rating 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.