CC BY
319
As a result of the measures carried out, electricity generation in Georgia increased between 1997 and 2007 by 13.9% and consumption by 4.1%, while the use of natural gas doubled. In 2007, the country had a non-deficit energy balance for the first time during the years of state independence. During the period under review, the growth rate in consumer prices for regulated energy products was lower and more even than market prices for unregulated products. Nevertheless, several problems (improvement of the existing regulatory legal base, improvement of tariff methodology, ensuring monitoring of the reliability of energy supply, and so on) related to rationalization of the industry’s regulation have still not been resolved.
Fakhri MURSHUDLI
Graduate student,
Research Institute of Economic Reforms, Ministry of Economic Development of the Azerbaijan Republic
(Baku, Azerbaijan).
AZERBAIJAN BANKING SYSTEM: CHALLENGES AND PROSPECTS OF GLOBALIZATION
Abstract
This article explores the development problems of the Azerbaijan Republic’s banking system in the context of financial globalization. The author analyzes its current state, focusing on its successes, objective difficulties and unresolved problems. He describes the main manifestations of globalization processes in the world banking services market and pays much attention to problems that may be encountered in these conditions by the domestic banking sector,
particularly after Azerbaijan’s accession to the WTO. The author examines the consequences of foreign bank entry in the national market and proposes concrete measures for its protection. Based on a case study of the International Bank of Azerbaijan (IBA), the country’s leading bank, he identifies the specific features of the transnationalization of banking activities (cross-border banking) and outlines the ways to implement this strategy on a national scale.
I n t r o d u c t i o n
In the 21st century, faced with the growing challenges of globalization, Azerbaijan has entered a stage of active reform in all spheres of social life marked by strengthening political stability, progressive development of the national economy, advances in living standards, and the country’s con-
THE CAUCASUS & GLOBALIZATION
sistent integration into the world economy. An effective factor of sustainable economic growth is the existence of a proper, competitive, sound and stable banking system, whose formation is among the strategic tasks of the Azerbaijan state. The socioeconomic and legal environment and the investment and business climate currently emerging in Azerbaijan create good opportunities for ensuring qualitative growth in the banking sector based on positive macroeconomic indicators and experience gained by domestic banks operating in market conditions, and for accelerating its integration into the world banking system in accordance with current globalization requirements.
Current State of the National Banking System
The national banking system today is one of the most essential parts of Azerbaijan’s market economy. At present, the republic has a two-tier market-based banking system, which is represented, in the first place, by the National Bank of Azerbaijan and a set of credit institutions. They ensure virtually uninterrupted settlements between all parts of the economy, redistribute temporarily surplus funds and perform other banking functions in close and constant interaction in the market with each other and with the external environment. These components constitute a single system designed to service monetary circulation and united by common functions and purposes. This is also confirmed by the existence of a common legal and regulatory framework: banking legislation, which determines the legal status of the key elements of the banking system and the rules of their interaction and regulates the most stable types of relationships between them.
The National Bank of Azerbaijan (NBA) has the necessary independence for performing the functions of a central bank. Its main task is to ensure price stability within the scope of its authority. Another major task is to ensure the stability and development of the banking and payment systems. In addition, the NBA licenses, regulates and controls the activities of commercial banks, and also has the discretion to determine and implement the state’s monetary and exchange rate policy.
Among Azerbaijan’s credit institutions, the leading role is played by commercial banks. At the end of 2007, the country had 46 commercial banks: 2 state-owned and 44 private, including 21 with foreign capital.1 The prevailing model is a universal bank which offers a full range of banking services, including e-services. Some domestic banks are specialized institutions (like the Azerbaijan Microfinance Bank) and captive finance companies.
In the transition period, the republic’s banking sector underwent a structural and organizational transformation, whose main trends coincided with the general development patterns in the transition countries.2 Banking rules were updated, bank efficiency improved, costs were rationalized, bank earnings and net profit steadily increased, and modern products and technologies were introduced. These actions have resulted in the creation of a modern banking system in Azerbaijan capable of operating in market conditions and properly responding to customer needs and to the changes underway in the country.
It should be noted that the upturn caused by the general economic recovery in Azerbaijan and by rising household income in recent years has strengthened the positive trends in the banking sector. Statistical data show that by now this sector has made undeniable progress in the main quantitative and qualitative parameters. The capital base of credit institutions has been strengthened, and the supply of innovative banking products and services has increased. Growth of total bank assets has been coupled with an improvement in their structure and quality. Thus, at the beginning of 2008 bank eq-
1 See: Statistical Bulletin of the National Bank of the Republic of Azerbaijan, Baku, No. 12, 2007, p. 40.
2 This is pointed out, in particular, in: I.K. Kovzanadze, Tendentsii i perspektivy razvitia ekonomiki i bankovskogo sektora transformatsionnykh stran, Finansy i statistika, Moscow, 2005, p. 147.
uity capital reached $1,297.9 million, increasing by 87.6% compared to the same period of the previous year. With an increase in capitalization and liabilities, total bank assets rose in that period by 83.5% to $7,949.1 million. They made up 26.7% of GDP compared to 14.9% in 2003; the respective figures for loans were 18.1% and 8.3%, and for attracted funds, 22.3% and 8.5%.3
The total amount of deposits has increased, with a shift toward longer-term deposits. Loan volumes have increased significantly, loan portfolio quality has improved (both in sectoral and currency terms and in terms of maturities), lending rates have fallen and loans have become more affordable. The bank branch network has expanded markedly, from 305 branches in 2003 to 485 in 2007, and they have strengthened their support for the development of the regions and small and medium businesses. Commercial bank loans to the real sector totaled $5,382.0 million, which is 8.9 times more than in 2003, and their ratio to total banking sector assets reached 67.7% (compared to 57.0% at the beginning of 2004).4
These processes have been accompanied by an improvement in the banking sector’s legislative and institutional framework. New laws have been adopted in the past four years: on banks, the National Bank, mortgage and bank deposit insurance. The Law on Currency Regulation was further liberalized; in particular, restrictions on the export of currency have been eased. Domestic banks have started implementing international standards of corporate governance and reporting forms. The infrastructure of the banking system has strengthened rapidly: a Central Credit Register, National Card Processing Center, National Payment System, Mortgage Fund and Deposit Insurance Fund have been created in Azerbaijan; currency and stock exchanges and a National Depository Center are in operation in the country; and consistent efforts are being made to develop the securities market. More attention is being paid to progressive technologies and the latest management information systems.
But despite an improvement in the situation and the successes achieved in Azerbaijan’s banking sector, its current state should not be overestimated. There are still many problems in this sector. A SWOT analysis5 of the strengths and weaknesses of commercial banks with an assessment of the opportunities for their further development and the threats posed by potential risks has produced the following results.
SWOT Analysis of Azerbaijan’s Banking Sector
STRENGTHS
■ wide range of banking products and services;
■ developed correspondent network;
■ improving asset quality against the background of favorable credit conditions;
■ opportunities to finance large projects;
■ use of modern information technologies;
WEAKNESSES
■ lack of a clearly formulated development strategy;
■ low level of financial intermediation in the republic's economy;
■ high lending rates;
■ concentration of activity in limited market segments, inadequate loan portfolio diversification;
■ low capitalization and, accordingly, limited opportunities for covering
3 Calculated based on data from: Statistical Bulletin of the National Bank of the Republic of Azerbaijan, Baku, No. 12, 2007, pp. 4, 19, 42.
4 See: Ibid., pp. 19, 40, 42; Bulletin of Banking Statistics, Baku, No. 1, 2004, p. 21.
5 SWOT is an acronym for Strengths, Weaknesses, Opportunities and Threats. The internal environment of the banking sector is mostly reflected in S and W, and its external environment, in O and T.
adoption of financial accounting standards generally consistent with international standards;
functioning deposit insurance system;
low share of problem loans in total loan portfolio;
provision of bank card services, existence of an ATM system;
financial and political capital of major shareholders;
increasing competitiveness of small banks coupled with their greater mobility and gradual capture of some markets, including retail banking markets;
improving qualification of bank staff, especially junior and intermediate staff, clearly manifested competence;
weak dependence on world financial market resources, high degree of protection from international crisis phenomena.
bank risks, lack of a sufficiently effective system for risk assessment and hedging;
inadequate level of household deposits and of the payment system;
deficiencies in corporate governance, internal control and audit systems;
low transparency of the share capital structure;
lack of transparency in hiring personnel, their inadequate professional standards;
underestimation of an aggressive marketing policy;
defects in internal legal regulations;
low investment activity of commercial banks;
insufficiently developed branch network, unequal access to banking services in the center and the regions.
OPPORTUNITIES
THREATS
political and macroeconomic stability, positive changes in the socioeconomic environment helping to raise the credit rating of both the country as a whole and its banking system;
government intentions to accelerate the development of the non-oil sector of the economy;
adoption of new and improvement of effective legislative acts directly or indirectly related to the banking system;
improvement of the investment climate;
expanding access to long-term resources due to the attraction of foreign investment and household savings;
significant increase in the customer base, further extension of the range of offered products and services,
political risk of Armenia's renewal of the war against Azerbaijan;
monopoly trends in the economy and, accordingly, certain difficulties in doing business;
disproportionate development of sectors of the economy and its overall dependence on the oil sector;
inflationary expectations, high degree of dollarization;
instability in the world hydrocarbon market;
high fragmentation among commercial banks, significant sector and obligor concentrations;
dependence of a significant part of the population, especially in the regions, on remittances from abroad;
difficulties in recovering delinquent loans;
sharp increase in demand for some of them;
rising household income, slowing inflation and easing tax burden on economic agents;
development of retail lending, including consumer and mortgage lending;
increase in bank equity capital;
improvement in loan portfolio quality;
spread of e-payments, Internet and mobile banking, further computerization of banking operations;
improving professional standards of personnel.
■ lack of real alternatives to loans;
■ limited long-term resource base;
■ shortage of quality borrowers, concealment of information by borrowers on their actual financial position;
■ changing customer preferences;
■ market entry by new foreign banks, their takeover of domestic banks;
■ introduction of restrictive measures;
■ increase in competition in the banking sector in view of Azerbaijan's accession to the WTO.
The presented assessment of the state of the domestic banking sector shows that today, alongside a whole range of positive factors conducive to its further development, there is a mass of factors which either already exert a negative influence on the stability of financial institutions or can have such an influence in the long term. This includes, in the first place, high credit and foreign exchange risks, unsatisfactory level of creditor protection and management quality, relatively low bank liquidity and capitalization, inadequate public confidence in banks, a shortage of long-term resources, high costs of banking, its low investment attractiveness and weak interaction with the production sector, limited number of funding sources, slow implementation of corporate governance mechanisms, insufficient transparency of credit institutions, their inadequate equity participation in modernizing and retooling enterprises, and also in the securities market. Some obstacles to the development of the banking system are associated with imperfections in the legislative and regulatory systems. But on the whole, the current strengths of the republic’s banking sector largely offset the threats that may await it in the future, while the available opportunities, coupled with more stringent banking legislation requirements, can mitigate its weaknesses.
Azerbaijan Banking System in the Context of International Comparisons
In addition to our internal analysis of the domestic banking system, let us also consider various international assessments of this system. For example, the EBRD’s Transition Report 2007 points to positive changes in Azerbaijan’s monetary system, particularly in matters of liberalizing capital flows.6 Nevertheless, the EBRD index of banking reform in the country over a period of seven years (starting from 2001) has remained unchanged at 2.3 (compared to 2.0 in 1995-2000),7 while the max-
6 See: Transition Report 2007: People in Transition, EBRD, November 2007.
7 See: Transition Report 2003: Integration and Regional Cooperation, EBRD, November 2003.
imum score is 4+.8 According to the EBRD Report, the underdevelopment of this sector of the domestic economy significantly limits the effectiveness of monetary policy in reducing inflation. It also points to the need to strengthen banking supervision.9
According to an assessment by the international rating agency Fitch IBCA,10 Azerbaijan’s banking system was once again placed in one of the highest risk categories: MPI 3,11 which means that domestic banks exhibit the highest level of macro-prudential vulnerability. It should be noted that
Table 1
Fitch Ratings:
Issuer Default Ratings of Azerbaijan Commercial Banks12
Issuer Long-Term Local Currency IDR* k o lo tl u O Support Rating Floor Short-Term Foreign Currency IDR* Individual Rating g in ti a R t or p p u S Date of Assignment/ Last Revision
International Bank of Azerbaijan BB+ Stable BB+ B D/E 3 06/09/ 2007
Kapital Bank BB- RW** Nega- tive BB-/ RW** Negative B D/E 3/RW** Nega- tive 08/11/ 2007
Azerdemiryolbank B- Stable No floor B D/E 5 17/10/ 2007
Technikabank B- Stable No floor B D/E 5 06/02/ 2008
UniBank B- Stable No floor B D/E 5 11/10/ 2007
* Issuer Default Rating. ** Rating Watch. Ratings are placed on Rating Watch to notify investors that there is a reasonable probability of a rating change and to indicate the likely direction of such change. RW Negative means that the rating may be downgraded.
8 According to the EBRD rating scale, 4+ represents the standards and performance typical of advanced industrial economies, full convergence of banking laws and regulations with the standards of the Bank for International Settlements (BIS) and a full set of competitive banking services (see: Ibidem).
9 See: Transition Report 2007: People in Transition, pp. 13, 20.
10 See: Banking Systemic Risk Report: February 2006; Banking Systemic Risk Report: September 2007, available at [http://www.fitchratings.com].
11 The Macro-Prudential Indicator (MPI) with scores ranging from 1 (low) to 3 (high) points to the level of vulnerability of banking systems to corrections in asset prices and exchange rates and to the impact of the economic downturn that may follow such corrections. An MPI score of 3 is assigned in case of a high level of vulnerability to potential systemic distress (see: Banking Systemic Risk Report: February 2006, p. 3).
12 Compiled based on data from Fitch Ratings, available at [http://www.fitchratings.ru/financial/banks/ratings/list/
index.wbp].
THE CAUCASUS & GLOBALIZATION
in 2005-2006 the MPI score for Azerbaijan was raised from 113 to 3, which was due, according to Fitch analysts, to a combination of rapid credit growth and an appreciating real exchange rate of the national currency. In Fitch’s Systemic Risk Matrix, which brings together two systemic risk indicators, BSI and MPI, and so emphasizes their complementarity, Azerbaijan was placed in the weakest cell (E3) of the matrix (BSI E category).14 On the whole, the republic’s banking system is assessed as very weak with high macro-prudential vulnerability and low tolerance to potential macro-prudential stress,15 an assessment reaffirmed in Azerbaijan’s sovereign ratings review carried out by Fitch Ratings in early March 2008.16 In the agency’s opinion, high MPI scores in countries where the banking system is already weak (as indicated by a high BSI score) cause particular concern, because this system has the highest risk indicator. In addition, according to Fitch, the exchange rate of the national currency is maintained at its level due to high oil revenues.
Apart from rating Azerbaijan’s banking system as a whole, Fitch Ratings has made a similar assessment of some of its commercial banks17 (see Table 1). As the table shows, the highest ratings were assigned to the International Bank of Azerbaijan. Moreover, an analysis of issuer default ratings for the other republics of the Central Caucasus (Armenia and Georgia) makes it clear that in these parameters IBA is the best performer not only in the country, but also in the whole Central Caucasian region.
Another international rating agency, Moody’s Investors Service, has also assigned ratings to a number of commercial banks in the republic for bank deposits in local and foreign currency (see Table 2).
As in the previous case, the highest ratings were assigned to the International Bank of Azerbaijan. IBA’s long-term local and foreign currency ratings were set, respectively, at Baa2 and Ba2, and its short-term ratings, at Prime-2 (P-2) and Not Prime (NP). Its Financial Strength Rating (FSR) was set at the level of E+ with a stable outlook. It should be emphasized that IBA’s foreign currency ratings could have been higher, but they are limited by Azerbaijan’s sovereign rating (Ba2/NP), whereas local currency ratings are not subject to such limitations. IBA’s ratings reflect the risk of global defaults and expectation of losses, as well as Moody’s confidence that Azerbaijan’s financial authorities will support this bank in case of need. The bank’s FSR is maintained at the E+ level by strong internal privileges with good potential for further growth, but is limited by its very high concentrations of assets and liabilities and its undercapitalization with virtually absent free capital that can be used to cover unexpected losses. Besides, IBA’s corporate governance is still developing, which also has a negative effect on its FSR.
The above credit ratings show that the leading place in the domestic banking system belongs to the International Bank of Azerbaijan. Year after year, its image has been enhanced by nominations from internationally esteemed analytical publications of the world banking industry (Euromoney, The Banker, Global Finance)1 In the past three years, IBA, which accounts for over 47% of the coun-
13 See: Assessing Bank Systemic Risk: July 2005, available at [http://www.fitchratings.com].
14 The Banking System Indicator (BSI) is derived from a weighted average of individual ratings for banks covering at least two-thirds of banking system assets in a particular country. It is a summary measure of banking system quality ranging from “very high” (BSI A) through “high” (BSI B), “adequate” (BSI C) and “low” (BSI D) to “very low” (BSI E). It should be noted that this measure takes no account of potential support from shareholders or governments, because the objective of the methodology is to highlight potential systemic stress which might trigger the need for such support (see: Banking Systemic Risk Report: February 2006, p. 2).
15 See: Banking Systemic Risk Report: February 2006; Banking Systemic Risk Report: September 2007.
16 For more detail, see: Fitch Affirms Azerbaijan at “BB+''\ Outlook Stable / Press Release (28.02.08), Credit Analysis on Azerbaijan Republic / Full Rating Report (05.03.08); The Azerbaijani Banking System and Prudential Regulations, FitchRatings, London, Moscow, 24 April, 2008. 19 pp., available at [http://www.fitchratings.com].
17 In terms of the number of banks rated by Fitch Ratings by March 2008, Azerbaijan and Georgia are ahead of Armenia, with five banks each against two.
18 A detailed characterization of IBA’s activities in the 2000s is given, in particular, in research papers and other publications by IBA Board Chairman Jahangir Hajiyev: Denezhno-kreditnaia sistema i Mezhdunarodnyi bank Azerbaid-
Moody’s: Bank Deposit Ratings in Azerbaijan19 Table 2
Issuer Long-Term Rating Short-Term Rating Out!ook
International Bank of Azerbaijan Ba2 Not Prime STA
Kapital Bank Ba2 Not Prime RUR
Bank Standard B1 Not Prime STA
Bank Respublika B2 Not Prime POS (m)
Technikabank B2 Not Prime STA
UniBank B2 Not Prime POS (m)
1. STA—Stable;
2. RUR—Rating(s) Under Review;
3. POS (m)—Positive (an “m” modifier means that an issuer has multiple ratings with outlooks of differing directions).20
try’s total banking assets and loans to the economy, has not only had its Fitch IBCA rating upgraded (from “BB-“ to “BB+”) but, as noted above, has also been rated by Moody’s Investors Service. In the traditional rankings of a thousand major CIS banks based on the results of the first six months of 2007 (Interfax-1000: CIS Banks), IBA was 51st in terms of assets and 61st in terms of equity capital, well ahead of the leading banks of Georgia and Armenia.21
As for other banks, Bank Standard became the only Azerbaijan bank to get the highest rating in the country’s private banking sector (B1) for short-term and long-term deposits in local and foreign currency. It was also assigned an E+ financial strength rating, with a stable outlook for all its ratings. According to Moody’s, these ratings were underpinned by the bank’s strengthening position, substantial market shares, good profitability and strong growth potential. Moody’s has a positive view of the bank’s strengthening position in the retail segment, which will enable it to diversify risks, stabilize profit and reduce vulnerability to potential political processes. The agency has confirmed the possibility of a further upgrade in Bank Standard’s rating as it diversifies by attracting new clients unrelated to the business of its shareholders, improves corporate governance, enhances transparency, and develops risk management tools.
Moody’s also takes a positive view of the plans of Bank Respublika (assigned B2 long-term local and foreign currency deposit ratings) in expanding its branch network in the country’s regions,
zhana, Finansy i statistika, Moscow, 2008, 240 pp.; “MBA—generator reform,” Analiticheski bankovski zhurnal, No. 6, 2008, pp. 20-23; “MBA—iadro bankovskoi sistemy Azerbaidzhana,” Zerkalo (Baku), No. 216, 12 November, 2005; “Bankovski sektor i Mezhdunarodnyi bank Azerbaidzhana,” Biznes i banki (Moscow), No. 5, February 2005, pp. 1-4; “Tendentsii razvitia Mezhdunarodnogo Banka Azerbaidzhana,” in: Strategia i prioritety ekonomicheskoi politiki sovre-mennoi Rossii, Institute of Economics, Russian Academy of Sciences, Moscow, 2003, pp. 291-317; “MBA—Bank obshchenatsionalnogo razvitia,” Ekonomika i audit (Baku), No. 7, 2003, pp. 2-16, and others.
19 Compiled based on data from Moody’s Investors Service, available at [http://www.moodys.com].
20 Moody's Rating Symbols & Definitions, Moody’s Investor Service, New York, March 2007, p. 50.
21 See: “1000 bankov stran SNG. Itogi pervogo polugodia 2007,” Supplement Bank to the newspaper Kommersant, No. 225, 6 December, 2007.
THE CAUCASUS & GLOBALIZATION
and also of the bank’s focus on the small and medium business sector and consumer lending, because this provides good opportunities for steady growth. The presence of major German financial institutions among the bank’s shareholders, their participation in its strategic management and the technical support provided by them have also had a positive influence on its rating.
The assignment of credit ratings by two major rating agencies is further tangible evidence of the correctness of the course chosen by Azerbaijan and its economic development level. As regards the assessments themselves, they can be characterized as positive and promising, especially considering that these are initial ratings, and the main thing now is to ensure positive development.22
According to a cross-country study called Index of Economic Freedom (IEF), conducted annually by the Heritage Foundation and The Wall Street Journal,23 Azerbaijan is among 15 countries in the world (ranks 130-144) with a level of financial freedom24 of 30%25 (see Table 3.A26). In terms of this indicator, in mid-2007 Azerbaijan was on the same level, in particular, with such BRIC27 countries as China and India and was ahead of Uzbekistan (20%), Belarus and Turkmeni-
22 At the same time, in order to specify the targets for the long-term development of Azerbaijan’s banking system, let us spell out some of the rating symbols used, for example, by Moody’s:
Ba — Banks rated Ba for deposits offer questionable credit quality. Often the ability of these banks to meet punctually deposit obligations may be uncertain and therefore not well safeguarded in the future;
B — Banks rated B for deposits offer generally poor credit quality. Assurance of punctual payment of deposit obligations
over any long period of time is small.
Note: Moody's appends the numerical modifiers 1, 2 and 3 to each generic rating category from Aa to Caa. The modifier 1 indicates that the bank is in the higher end of its letter-rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the bank is in the lower end of its letter-rating category.
NP— Banks rated Not Prime for deposits offer questionable to poor credit quality and an uncertain capacity for timely payment of short-term deposit obligations;
E — Banks rated E display very modest intrinsic financial strength, with a higher likelihood of periodic outside support
or an eventual need for outside assistance. Such institutions may be limited by one or more of the following fac-
tors: a weak and limited business franchise; financial fundamentals that are materially deficient in one or more respects; or a highly unpredictable or unstable operating environment.
Note: In this case, a “+” modifier shows that the bank falls into an intermediate category.
23 In 2008, this study covered 162 countries ranked in both the overall Index of Economic Freedom and each of its
10 components, including the level of financial freedom. In the overall economic freedom rankings, Azerbaijan is 107th (with a score of 55.3%) and is included in the category of “mostly unfree” countries (see: 2008 Index of Economic Freedom, available at [http://www.heritage.org/index].
24 Financial freedom is a measure of banking sector liberalization (banking security) and independence from government control.
25 According to the methodology for measuring economic freedoms, a 30% level of financial freedom means extensive government influence; credit allocation is extensively influenced by the government; the government owns or controls a majority of financial institutions or is in a dominant position; financial institutions, especially foreign ones, are heavily restricted, and bank formation faces significant barriers (see: 2008 Index of Economic Freedom, Chapter 4: W.W. Beach, T. Kane, Methodology: Measuring the 10 Economic Freedoms, available at [http://www.heritage.org/re-search/features/index/chapters/pdf/index2008_Chap4.pdf]).
26 See: 2008 Index of Economic Freedom. Azerbaijan, available at [http://www.heritage.org/index/
country.cfm?id=Azerbaijan].
27 BRIC is an acronym for Brazil, Russia, India and China. This acronym was coined in 2001 by Jim O’Neill, chief economist of the Goldman Sachs Group (see: J. O’Neill, “Building Better Global Economic BRICs,” Goldman Sachs Global Economics, Paper No. 66. November 2001). These four countries are referred to as the most promising “emerging markets;” by the middle of the century they will rise to top positions in the world economy and become its engines of growth in the medium-term perspective (for more detail, see: J. Hawksworth, G. Cookson, The World in 2050: Beyond the BRICs — a Broader Look at Emerging Market Growth Prospects, PricewaterhouseCoopers LLP, March 2008, 32 pp.; “BRICs and Beyond,” Goldman Sachs Global Economics, November 2007, 272 pp.; “The World and the BRICs Dream,” Goldman Sachs Global Economics, February 2006; J. O’Neill, D. Wilson, R. Purushothaman, A. Stupnytska, “How Solid are the BRICs,” Goldman Sachs Global Economics, Paper No. 134, 2005; B. Grozovskiy,
stan (10% each), lagging significantly behind its Central Caucasus neighbors: Armenia (70%) and Georgia (60%). In 1996-2008, Azerbaijan’s financial freedom score has remained invariably low.28 Despite the reforms carried out in the republic in the past 12 years, their scale and depth have proved to be insufficient to improve its ranking in the degree of liberalization of the financial and banking sector of the economy.29
Table 3
A. 2008 B. Global Competitiveness
Index of Index
Economic Freedom 2007-2008
Financial Freedom — 30%
Azerbaijan's financial system is underdeveloped but growing. The banking sector is weak and burdened by non-performing loans, but its capital is increasing rapidly. The central bank, independent since 1995, has overseen a process of closures, consolidation, and privatization under which the number of commercial banks has fallen from 210 in 1994 to 43 in 2007. The banking sector is dominated by two major state-owned banks, which together account for about 60% of assets; provide financing for most government departments and many of the state-owned enterprises, often at below-market rates; and stunt the growth of private commercial banks. The central bank has raised minimum capital requirements, but many commercial banks are undercapitalized. Foreign banks have a minimal presence. The stock exchange, founded in 2000, is very small.
Financial market sophistication:
Rank
(out of 131
countries/economies);
Score (out of 7).
— 91
— 3.88
The most problematic factors for doing business:
Access to financing
Foreign currency regulations
— 15.20;
— 2.60.
Out of 131 countries/economies:
Notable competitive advantages:
Legal rights index (hard data) — 17.
Notable competitive disadvantages:
Regulation of securities
exchanges — 114
Soundness of banks — 113
Restriction on capital flows — 107
“Velikolepnaia chetviorka,” Vedomosti, 16 December, 2005; D. Wilson, R. Purushothaman, :Dreaming with BRICs: The Path to 2050,” Goldman Sachs Global Economics, Paper No. 99, October 2003, 24 pp.).
28 Financial freedom is determined based on a set of five factors which, in the opinion of the IEF authors, provide a sufficiently exhaustive description of the financial climate in a particular country: the share of state ownership in the financial sector; restrictions on foreign banks in opening branches and offices in the country; government influence on the allocation of credit; regulations hindering financial operations; and opportunities to provide all forms of financial and securities services.
29 For more detail, see: N. Muzaffarli (Imanov), Reiting Azerbaidzhana v mezhdunarodnykh sravnitelnykh issle-dovaniakh, Kavkaz, Baku, 2006, pp. 364-370; N. Muzaffarli (Imanov), “Comparative Economic Competitiveness of the Central Caucasian States,” The Caucasus & Globalization, Vol 1 (4), 2007, pp. 75-76.
Financing through local
equity market — 106;
Ease of access to loans — 91;
Strength of investor protection
(hard data) — 87;
Market sector improvement — 81;
Venture capital availability — 65.
Equally authoritative and large-scale international comparative studies are conducted by the World Economic Forum (WEF), which has annually published a Global Competitiveness Report since 1979. Starting in 2005, the WEF began to compile an overall Global Competitiveness Index,30 which is based on 12 “pillars.” Among these pillars, financial market sophistication is of particular importance in the context of the problem being examined. In this pillar, Azerbaijan ranks 91st. The only notable competitive advantage of the republic’s financial market identified in the Report is the legal rights index, whereas the list of its shortcomings and weaknesses (competitive disadvantages) includes 8 items: soundness of banks (rank 113), restriction on capital flows (107), financing through local equity market (106), ease of access to loans (91), and others. Among the most problematic factors for doing business in Azerbaijan the Report lists access to financing and foreign currency regulations (see Table 3.B).
Azerbaijan’s rankings in financial freedom and in financial market sophistication and some of its parameters are given in tables 4 and 5.
Table 4
2008 Index of Economic Freedom:
Azerbaijan’s Rankings in Financial Freedom
Indicator FF1 TE2 CIS CEA3 CC4
Financial freedom 130-144 22 9 6 3
1 FF—Financial freedom.
2 TE—transition economies: Central and Eastern Europe (Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Hungary, Macedonia, Poland, Rumania, Slovakia, and Slovenia,), Baltic states (Estonia, Latvia, and Lithuania) and CIS (Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan). Two CEE countries, Serbia and Montenegro, are not included in the GCI rankings.
3 CEA—Central Eurasia: Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan.
4 CC—Central Caucasus: Armenia, Azerbaijan, and Georgia.
30 The WEF Global Competitiveness Index (GCI) was developed in 2004 by Professor Xavier Sala-i-Martin of Columbia University. In 2008, this index was calculated for 131 countries/economies, which were ranked in both the overall GCI and each of its 12 pillars, including financial market sophistication. In terms of overall competitiveness, Azerbaijan
Table 5
Global Competitiveness Index 2007-2008: Azerbaijan’s Rankings in Financial Market Sophistication and Its Components
Indicators GCI1 TE2 CIS CEA3 CC
Financial market sophistication 91 18 4 3 2
| Including: |
Market sector improvement 81 13 3 3 1
Financing through local equity market 106 20 5 3 1
Ease of access to loans 91 18 4 2 1
Venture capital availability 65 14 3 2 1
Restriction on capital flows 107 21 7 6 3
Strength of investor protection 87 18-21 6-7 4-5 2
Soundness of banks 113 21 6 4 3
Regulation of securities exchanges 114 20 5 4 2
Legal rights index 17 5-6 3-4 1 1
1 GCI—Global Competitiveness Index. 2 TE—CEE (including Serbia and Montenegro), Turkmenistan). 3 CEA—excluding Turkmenistan. Baltic states and CIS (excluding Belarus and
Among the “trouble spots” of Azerbaijan’s banking system, the authors of the Index of Economic Freedom have included its weakness, inefficiency, burden of non-performing loans, inadequate amount of loans to private businesses and non-oil sectors in the absence of a credit shortage, excessive credit risks, low level of bank capitalization, strong state presence in the banking sector, and weak presence of foreign bank branches and offices in the country.31 The limited scale of development of the domestic banking sector is evident from the low figures for banking assets and loans to the real economy as a percentage of GDP; in terms of these indicators, Azerbaijan is significantly behind other transition countries in the CIS, the Baltic states, and Central and Eastern Europe (CEE), to say nothing of states with a more mature economy.
At the same time, in all fairness it should be pointed out that this set of problems is rather of a system-wide nature, because to a certain extent it is typical of many sectors of the Azerbaijan economy and stems from the fact that the transition to market relations in the country has not been completed.
The complexity of the tasks facing the republic’s banking sector in the period of economic transformation is also due to a number of other circumstances, the most important of which, in our opinion, are the undeveloped market elements of the socioeconomic environment in which the sector
ranks 66th with a GCI score of 4.07 (see: Global Competitiveness Report 2007-2008, available at [http://www. weforum.org/en/initiatives/gcp/Global%20Competitiveness%20Report/index.htm]).
31 See: 2006 Index of Economic Freedom.
THE CAUCASUS & GLOBALIZATION
operates, the low potential of national banks, and their real differences in the key parameters of their activity (including the amount of capital and assets and the competitive environment).
Problems in the development of the republic’s banking system have also been generated by shortcomings and deficiencies in the work of the banks themselves. The most significant factors here are as follows: relatively low quality of governance geared toward current tasks to the detriment of the bank’s long-term development; ineffective internal control, lack of systemic work to prevent problem situations in bank development; nontransparent ownership structure; and low level of banking technologies. A comparison of the domestic banking sector with emerging markets shows that it is less developed than the real sector of the economy. The amount of capital at the disposal of the country’s commercial banks does not allow them to meet the demand for loans from domestic companies. Attracted funds, in view of their structure and formation trends, cannot as yet be regarded as sources of long or medium-term investment.
However, in the near future Azerbaijan’s banking system will have not only to overcome the existing difficulties, but also to address the new requirements and challenges associated with the globalization of the world economy, which is rightly seen as the most appropriate characteristic of the present stage of world development.
Globalization Processes in Banking
Economic globalization as a current process affects every aspect of the world community’s economic life and determines the direction and intensity of international economic relations. Its challenges sharply increase the vulnerability of the national economy to external shocks and call for appropriate mechanisms helping the financial system to adapt to the ongoing changes.
The core and the most dynamic subsystem of economic globalization is financial globaliza-tion,32 which is a qualitatively new stage in the internationalization of the world financial market based on innovative technologies. The essence of this phenomenon consists in strengthening ties and integration between the financial sectors of national economies, world financial centers and international financial institutions resulting in the emergence of a new configuration of the global economy, in the formation of its financial architecture. A visible result of these processes is the growing interdependence and integration of the financial systems of individual states, which gave birth to the current global financial system.
Globalization of the international financial system has been a major trend in the development of the world economy in recent decades. Today’s model of financial globalization, whose outlines first appeared in the 1960s and 1970s, alters the conditions that determine the prosperity of regions and nations in both the near and distant future. It has brought about significant changes in the world financial and monetary order towards its liberalization, has markedly accelerated international capital flows, boosted capital mobility, expanded the scope of foreign direct investment, and radically transformed the mechanism and scenarios of decision making and competition in foreign markets. At the same time, financial globalization has had important institutional and structural consequences for the developed states and has opened previously unavailable opportunities, especially for transition countries.
A major prerequisite for financial globalization was the lifting of restrictions on current and cross-border capital transactions at the national level.33 Foreign exchange and financial liberalization
32 For a comprehensive analysis of financial globalization and its consequences see: Reaping the Benefits of Financial Globalization, International Monetary Fund, Washington, 2007, 50 pp.
33 For more detail, see, for example: M. Golovnin, “Finansovaia globalizatsia i ogranichenia natsional’noi denezh-no-kreditnoi politiki,” Voprosy ekonomiki, No. 7, 2007, pp. 20-21; Mirovaia ekonomika: prognoz do 2020 goda, ed. by
THE CAUCASUS & GLOBALIZATION
processes first got underway in the developed market economies (1960s-1980s). Later on, these processes spread to the developing countries (1980s-1990s) and the former socialist republics of Central and Eastern Europe (CEE) and the Commonwealth of Independent States (CIS), and also to China. An equally important prerequisite for the development of globalization processes in banking was the implementation of technological achievements, which made it possible to perform operations in real time and regardless of distance, to ensure interconnections between national banking systems and the market of diverse financial instruments.
The scale of financial globalization processes can be illustrated with data reflecting the dynamics of various segments of the world capital market. For example, by the beginning of the 21st century the total size of the capital market increased to $37.6 trillion, almost reaching the amount of the gross world product (83.6% of GWP); commercial bank assets reached $55.7 trillion (125.9%), and the value of bonds and other debt instruments issued throughout the world, $58.9 trillion (132.6% of GWP).34 Average daily foreign exchange turnover in 2007 (April) exceeded $3.2 trillion, increasing more than 3.9 times from 1992.35 The average annual growth rate of the global foreign exchange market in 1989-2007 was 9.85%, whereas world trade in goods and services increased in that period at an annual rate of 6.7%,36 which shows that the global forex market is geared to handle transactions related to the movement of capital.
Consolidation of financial institutions, which got underway in the 1980s, should be included among the most significant features of the financial globalization process. As foreign experience shows, transactions involving bank consolidation occur in waves. Waves of mergers and acquisitions (M&A) rolled across both the developed countries and emerging markets. The main reason for this is that the globalization of the world economy has led to a standardization of banking activities, removal of barriers to capital flows, lifting of administrative bans, deregulation of markets, rapid development of computer technologies and electronic data processing systems, etc. According to Thomson Financial, about 13.5 thousand transactions resulting in the acquisition of one financial firm by another (totaling $2.5 trillion)37 were recorded from 1990 to 2002. These activities peaked in 1998, which brought such mega-mergers38 as those of Citicorp and Travelers Group, BankAmerica and NationsBank, Banc One-First Chicago and Norwest-Wells Fargo.
Most M&A deals in the financial sector have been recorded in the developed countries (the leader here is the United States, which is due to the lifting of restrictions on combining lending and deposit activities with investment activities) and, structurally speaking, in the banking system (60% of all financial mergers and 70% of their volume). In these countries, where even individual banks have large assets incomparable with those of entire banking systems in CIS countries, the M&A process in the banking sector has become very active in the past two decades.39 Large-scale consolidation
Academician A.A. Dynkin, Magistr, Institute of World Economy and International Relations, Russian Academy of Sciences, Moscow, 2007, pp. 36-39, 45, 49.
34 See: Global Financial Stability Report, International Monetary Fund, Washington, April 2006, p. 95.
35 “Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity in 2007,” Bank for International Settlements, December 2007, p. 4.
36 See: Ibidem; “Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity in 2004,” Bank for International Settlements, March 2005, p. 5; World Economic Outlook: Globalization and Inequality, International Monetary Fund, Washington, October 2007, p. 230.
37 In 45% of such transactions, data on transaction amounts were not available.
38 Mega-merger is a merger between two companies with assets of over $100 billion.
39 M&A trends in the banking sector of the developed countries are described in detail in the following research papers: Y. Altunbas, D. Marques, “Mergers and Acquisitions and Bank Performance in Europe: The Role of Strategic Similarities,” Journal of Economics and Business, 2007, 19 pp.; A.V. Baranov, “Sliania i pogloshchenia v bankovskoi sisteme SShA,” SShAVKanada: ekonomika, politika, kultura, No. 2, 2005, pp. 47-60; E.M. Serdinov, “Sliania i pogloshchenia v bankovskoi industrii SShA,” Bankovskoye delo, No. 9, 2004, pp. 21-28; I. Walter, Mergers and Acquisitions in Banking and Finance: What Works, What Fails, and Why, Oxford University Press
THE CAUCASUS & GLOBALIZATION
in the developed countries has been promoted by technological innovations that have reduced management costs, deregulation of financial services, and changes in corporate governance practice (linking of executive compensation to the market value of shares, shift of emphasis from traditional interest-bearing bank transactions to the provision of settlement and investment services to customers, etc.). The main spur to mergers and acquisitions was the belief (currently questioned by many) that economies of scale and synergistic effects from combining the strengths of different organizations “under the same roof” can serve to reduce costs and lead to faster growth of business volume and capitalization by creating additional economic value for customers.
This process has also started in the CEE and CIS countries, including Russia, Ukraine and Kazakhstan,40 where mergers and acquisitions in the banking sector are driven by internal consolidation, and also by foreign bank expansion. Since 2001, M&A trends in this region have differed from the situation in the developed countries: there is an increase not only in the number of such deals, but also in their size, and smaller banks are increasingly involved in this process. According to Dresdner Kleinwort, in the past two years foreign banks have invested about $13 billion in acquiring bank assets in CIS countries, mainly in Russia and Ukraine.41 Investors set the highest value on Ukrainian banks, in deals with which the average price-to-book (P/B) ratio is 4.6; the ratio for Russian banks is 3.5, and for the only deal in Kazakhstan, 4.4.42
In CEE countries, just as in West European countries, deals made by national banks prevail, although they are incomparable in size (value) with the combinations of major transnational banks (TNBs). The objectives and forms of such combinations are very diverse: acquisition of all the assets and liabilities of the target bank; purchase of shares in order to acquire a controlling stake in the target bank and turn it into a subsidiary bank; acquisition of the target bank’s tangible assets; indirect acquisition of banks by luring away their major customers, etc.
The recent intensification of the bank merger and acquisition process is due in large part to foreign bank expansion. The problem of foreign investor participation in the national banking systems of developing43 and transition countries,44 considering its current relevance, has been adequately ad-
Inc., London, 2004, 330 pp.; C.M. Buch, G.L. Delong, “Cross-Border Bank Mergers: What Lures the Rare Animal?” Journal of Banking and Finance, No. 28, 2004, pp. 2077-2102; R. Vander Vennet, “Cross-Border Mergers in European Banking and Bank Efficiency,” Working Paper 02/152, Ghent University, September 2002, 48 pp.; Mergers and Acquisitions Involving the EU Banking Industry — Facts and Implications, European Central Bank, Frankfurt am Main, December 2000, 46 pp.
40 For the peculiarities of M&A in CEE and CIS countries see, for example: Foreign Acquisitions of CIS Banks, Dresdner Kleinwort Research, 23 July, 2007, 6 pp.; Mergers & Acquisitions in the Financial Sector in Russia, A Joint Report by PricewaterhouseCoopers and Mergermarket, October 2007, 48 pp.; Sliania i pogloshchenia v SNG. Obzor ryn-ka, Ernst & Young, March 2006, 24 pp.; Rossiiski rynok M&A: Samyie optimistichnye prognozy podtverzhdaiutsia, ReDeal Group, 2007, 11 pp.; CEE M&A Survey 2006: Maturity, Momentum and Mega-Deals, PricewaterhouseCoopers, 2007, 19 pp.
41 Foreign Acquisitions of CIS Banks, p. 1.
42 Despite the difference in P/B ratios, Russian banks remain the most attractive ones from the standpoint of growth potential and earning power compared to the price paid for them.
43 See: A. Kodjo, “Foreign Investment in Chinese Joint Stock Banks: 1996-2006. March 2007,” MPRA Paper, No. 2894, posted 7 November, 2007, 9 pp.; A. Tschoegl, “Foreign Ownership in Mexican Banking: A Self-Correcting Phenomenon. 23 October, 2006,” MPRA Paper, No. 586, posted 7 November, 2007, 9 pp.; A.F. Aysan, S.P. Ceyhan, “Why Do Foreign Banks Invest in Turkey?” MPRA Paper, No. 5491, posted 7 November, 2007, 24 pp.; idem, “Globalization of Turkey’s Banking Sector: The Determinants of Foreign Bank Penetration in Turkey,” MPRA Paper, No. 5489, posted 7 November, 2007, 31 pp.; R. Lensink, N. Hermes, “The Short-Term Effects of Foreign Bank Entry on Domestic Bank Behaviour: Does Economic Development Matter?” The Journal of Banking Finance, Vol. 27, 2003, pp. 1-30; Inos-trannye banki v Latinskoi Amerike v kontekste strukturnykh reform i finansovoi globalizatsii, ed. by I.K. Sheremetyev, Nauka Publishers, Moscow, 2002, 239 pp.
44 See: R. Haselmann, “Strategies of Foreign Banks in Transition Economies. July 2006,” Emerging Markets Review, No. 7 (6), 2006, pp. 283-299; O. Havrylchyk, E. Jurzyk, “Profitability of Foreign Banks in Central and Eastern Europe: Does the Entry Mode Matter?” BOFIT Discussion Papers, 5/2006, Bank of Finland, Institute for
THE CAUCASUS & GLOBALIZATION
dressed in the economic literature. Entry by foreign-controlled banks into the banking systems of CEE and CIS countries is of particular interest. The main factors leading to an extension of this process include, first and foremost, growing foreign trade volume, tightness of the national banking services market characteristic of the developed countries, differences in profitability and risk levels, increase in foreign direct investment in the economy of the given country, and government policy in transition countries. Among the main reasons for the attraction of foreign capital into the banking system of transition countries one should include the weakness of their financial system and their striving for the maximum possible integration into global institutions (for example, the WTO) or a desire, as expressed by a number of CEE countries, to become EU members.
Cross-country comparisons of the role of non-residents in the banking sector of various countries indicate that in the countries, whose banking services market has long been divided while their national banks are powerful and stable (Western Europe), including due to tight state control (China), the banking sector is dominated by national capital; developing countries with a sufficiently strong economy and a protectionist government policy (such as Latin American countries) are characterized by comparable participation of national and foreign capital in banking systems; and countries with a weak financial system or the state’s high propensity to attract foreign capital (CEE countries) have implemented a model where foreign capital predominates.45 Analysts identify two theoretical models of bank entry: acquisition and integration. The first model is more effective for countries with fairly weak local business (like Hungary, Poland or the Czech Republic, where the share of foreign capital in the banking system is significantly over 50%);46 and the second, for actively developing economies (implemented in major Latin American countries, including Argentina and Brazil).47
A study of foreign bank practices in the national banking systems of the said countries and their adaptation to local conditions are of considerable importance for adjusting the development of the banking system of the Central Eurasian republics (including Azerbaijan) and for upgrading the competitive strategies of their commercial banks.
One of the main manifestations of financial globalization in current conditions is the transnationalization of banking (cross-border banking). It is seen as an expansion of the international business of banks as they go beyond the national boundaries of individual countries, promoting the maximum adaptation of the banking sector to modern trends in the world economy and to the current state of the world financial system. Cross-border banking is the main component and, at the same time, an important economic mechanism of general globalization processes; it serves as a key regulator coordinating the operation of the world economy within a global framework.
Among the main driving forces behind the transnationalization of banking capital one should include its concentration and consolidation, increasing competition in national markets associated
Economies in Transition, Helsinki, 2006, 40 pp.; A. Vernikov, Inostrannye banki v perekhodnoi ekonomike: sravnitelnyi analiz, Institute for International Economic and Political Studies (IIEPS), Russian Academy of Sciences, Moscow, 2005, 304 pp.; N. Bayraktar, Y. Wang, Foreign Bank Entry and Domestic Banks’ Performance: Evidence Using Bank-Level Data, 12 October, 2005, 29 pp.; M. Giannetti, S. Ongena, “Financial Integration and Entrepreneurial Activity Evidence from Foreign Bank Entry in Emerging Markets,” ECB Working Paper, June 2005, No. 498, European Central Bank, Frankfurt am Main, 2005, 51 pp.; M. Balling, F. Lierman, A. Mullineux, Financial Markets in Central and Eastern Europe: Stability and Efficiency, Routledge, Taylor&Francis Group, London, 2004, pp. 189-223 (352 pp.); C. J. Green, V. Murinde, I. Nikolov, “The Efficiency of Foreign and Domestic Banks in Central and Eastern Europe: Evidence on Economies of Scale and Scope,” Journal of Emerging Market Finance, Vol. 3, No. 2, 2004, pp. 175-205, and others.
45 See, for example: D. Lepetikov, “Perspektivy uchastia inostrannogo kapitala v rossiiskoi bankovskoi sisteme,” in: Finansovaia sistema Rossii i ekonomicheski rost, Independent Economic Analysis Series, MONF, Moscow, 2006.
46 See: CEE Banking Sector Report, Raiffeisen Centrobank Group, October 2007; Banking in CEE and the Role of International Players, UniCredit Group, July 2007.
47 See: Inostrannye banki v Latinskoi Amerike v kontekste strukturnykh reform i finansovoi globalizatsii, pp. 56-72.
THE CAUCASUS & GLOBALIZATION
with these processes, the need to provide transnational companies with financial resources, the appearance of a eurocurrency market and other global financial markets, and the creation of global information and financial networks significantly facilitating the flow of capital. Transnationalization of banking, economically driven by the possibility and necessity of capital flow from countries with a relative surplus of capital to regions with a shortage of investment but a surplus of other factors of production which cannot be used effectively for lack of capital, facilitates reproduction processes and helps to equalize economic conditions in different countries.
TNBs mainly represent the interests of the Group of Seven (G-7), which includes the United States, Japan, Germany, France, Britain, Italy and Canada, and also those of countries with the fastest growing economies in the world: China, Brazil, India and Singapore. In 2008, according to the FT-500 ranking,48 29 of the 71 banks (over 40%) were from the G-7,49 and another 15 (over 21%), from the dynamically developing countries of East Asia.50 The world’s largest bank in 2008 was the Industrial and Commercial Bank of China ($277.2 billion), followed by HSBC (Britain, $195.8 billion) and China Construction Bank (China, $176.5 billion). In another bank ranking, 2008 The Banker Top-1000, the EU is in the lead in terms of the number of banks (266 banks against 279 in 2007), followed by Asian countries (184 against 152) and the U.S. (169 against 185). European banks account for 41% of the total profit of all banks included in this ranking. A point to note is that this indicator for American banks is down from 24% in 2007 to 14% in 2008, while the figure for Asian countries has markedly increased: from 12% to 19%. The new leader, according to The Banker, is the British HSBC, whose capital has increased, despite the crisis, by 19.5% (to $105 billion); Citigroup is in second place with $89.2 billion (down 1.8%), and Royal Bank of Scotland has moved into third place with $88.9 billion (a jump of 47.7%).51 The economic might of TNBs included in the FT and The Banker ranking lists of the world’s largest companies is comparable, for example, to the national income of some states (such as Greece, Finland, Portugal, Ireland, and many states in Asia, Africa and South America).
Challenges and Prospects of Globalization for the Domestic Banking Sector
Financial globalization poses new challenges for the national banking system, which is due to the growing influence of the external environment on processes at work in the Azerbaijan economy. The domestic banking sector’s involvement in financial globalization is evident from the increase in foreign borrowing, wide use of modern information and banking technologies, transition to international accounting and auditing standards, and Azerbaijan’s active participation in international financial organizations. In this situation, the republic’s commercial banks are faced with the need to address a whole range of new problems, among which I would like to name the most significant ones.
First of all, it is the need to enhance the competitiveness of domestic banks through mergers and an increase in bank capital. The undercapitalization of Azerbaijan’s banking sector should be regard-
48 See: Financial Times, 24 June, 2008.
49 The FT-500 ranking includes 7 U.S., 3 Japanese, 2 German, 4 French, 6 British, 2 Italian and 5 Canadian banks (see: Ibidem).
50 The FT-500 ranking includes 8 Chinese banks (the largest number in this list), 2 banks each from India, Hong Kong and Singapore, and 1 South Korean bank (see: Ibidem).
51 See: The Banker, 1 July, 2008. Among the top 13 banks there are 3 Chinese banks, although only five years ago there were none at all. Twelve Russian banks were included in this list for the first time, so that their total number reached 35.
THE CAUCASUS & GLOBALIZATION
ed as the most important systemic factor behind its low competitiveness and, at the same time, as the main reserve of competitiveness. The task of increasing bank capitalization as the banking services market is liberalized leads to a search for ways to increase capital, the most promising of which are bank M&A and attraction of foreign direct investment into the banking sector.
The republic is only in the initial stages of bank consolidation. Today there are many small and weak banks operating in its banking market, and this, given the increase in minimum capital requirements for banks,52 is conducive to their consolidation and helps to attract international financial institutions as their promoters. But despite the National Bank’s efforts to accelerate consolidation in the banking sector, such cases are regrettably rare.
Thus, in October 2002 a merger between two of the republic’s leading commercial banks— MBank and Promtekhbank—resulted in the creation of UniBank, a large universal credit and financial institution capable of providing the widest possible range of quality services to its customers. In early 2005, two other commercial banks—Bank of Baku, which specialized in retail banking services, and Ilkbank, oriented towards corporate clients—merged into a new bank, which began operating under the name of Bank of Baku. The successful mergers of these banks largely prompted the decision by international institutions to become their shareholders: the EBRD has acquired a 15.2% equity stake in UniBank and a 25% stake in Bank of Baku, and the German investment company DEG has taken an 8.3% equity stake in Bank of Baku.53 The presence of foreign investors in the ownership structure of Azerbaijan banks should be regarded as a key factor which has the strongest influence on their competitiveness and capitalization opportunities in the conditions of a liberalized banking services market.
Yet another and more modern method for increasing the capitalization of Azerbaijan banks is IPO (Initial Public Offering).54 Plans to launch IPOs have already been announced by IBA (which intends to issue $200 million worth of eurobonds), Kapital Bank ($12 million) and Bank Standard ($50-100 million).55 Thus, IBA has already held a tender among the biggest players in this market and has selected a lead manager (JP Morgan and Citigroup). The funds obtained will be used to finance priprity projects in various sectors of the economy: oil, non-oil, mortgage, etc. Eurobonds related to the most interesting projects may be distributed through the Luxembourg or London exchange (their correct choice implies a thorough study of the advantages and disadvantages of a particular international trading floor). At the same time, not a single bank IPO has yet been held in practice: all the above-mentioned Azerbaijan banks, which planned IPOs for late 2007 and early 2008, have postponed them in view of various organizational and legal problems, and also considering the crisis phenomena in the world financial market. In other words, this alternative mechanism for increasing capitalization has not yet been activated and should be regarded as a potential one.
Continued high rates of capital increase in this sector will help, in our opinion, to strengthen the trend towards bank mergers and the creation of large financial conglomerates: banking and financial groups and holding companies. And this, for its part, will accelerate the formation of a banking system meeting the requirements of a new type of economic growth and the process of its integration into the world financial community.
The urge of national capital in Azerbaijan to take advantage of the favorable conditions in the world market and form powerful structures brings the problem of transnational banking in the re-
52 As of 1 July, 2007, minimum capital requirements for banks were established at 10 million manats, doubling from 1 January, 2006. At the beginning of January 2008, the capital of 39 banks exceeded this amount, and their share in total banking capital was 95.1%. Five other banks with a share of 4.4% had a capital of 5-10 million manats (for reference: 1 manat = 1.18 U.S. dollars).
53 See: [http://www.unibank.az/?tid=52&id=74]; [http://www.bankofbaku.com/rus/acquaintance02.php].
54 IPO is a company’s first offering of shares to the public. In the classic sense of the term, IPO is when a company’s shares are accepted for trading (listed) on a stock exchange.
55 [http://www.day.az].
THE CAUCASUS & GLOBALIZATION
public into sharper focus. One of the country’s most effective financial institutions meeting transnationalization requirements is the International Bank of Azerbaijan, which occupies, as noted above, a dominant position in the domestic financial market. Using this financial holding company as an example, let us consider some of the signs of transnationalization in banking at the regional level. Apart from a ramified service network throughout the republic (36 branches, 128 offices), the bank has 5 representative offices abroad (in London, Frankfurt am Main, New York, Luxembourg and Dubai), subsidiary banks in Moscow (with two branches in St. Petersburg and Yekaterinburg) and Tbilisi, and a number of other subsidiaries, including the International Insurance Company, the Joint Leasing Company and the processing company Azericard. The bank and all its divisions are staffed with highly skilled and experienced personnel, who provide over 150 banking products and services to their clients.
As a generator of reforms and innovative solutions in the credit and financial segment of the economy, IBA has a leading position in the drive to implement new banking products and services meeting international standards and advanced service and information technologies, The bank’s high credit rating has enabled it to establish stable long-term relations with major international financial institutions and to enter into correspondent relations with authoritative banks in the CIS, Europe, Asia, U.S., Canada and Australia. The bank services all regional international projects, such as the construction of the Baku-Tbilisi-Ceyhan oil export pipeline and the South Caucasus (Baku-Tbilisi-Erzurum) gas pipeline, the TRACECA and Great Silk Road transportation arteries, and the Baku-Tbilisi-Kars railway. In addition, IBA provides assistance to many Azerbaijan banks in solving problems associated with access to foreign financial systems.
With due regard for domestic peculiarities, the key measures designed to implement the strategy for transnationalizing banking activities should be as follows:
■ Promotion of concentration of banking capital in financial institutions chosen as the basis for building TNBs, their recapitalization using the resources of the State Oil Fund of Azerbaijan.
■ Participation of the state in domestic TNBs as their controlling shareholder in order to guarantee their stability and influence their financial policy.
■ External expansion by domestic banks designed, among other things, to acquire existing foreign banks and their branches and to establish their own branches, subsidiaries and representative offices in countries that are world financial centers, and also in regions that have potential for economic cooperation with Azerbaijan.
Although the implementation of a strategy to transnationalize Azerbaijan’s banking system us highly advisable, this process can be completed effectively only with the active participation of the state. The implementation of this strategy is an objectively necessary step aimed at maximum adjustment to the challenges of financial globalization, a step without which it is impossible to create a developed and competitive banking system in the country or ensure its effective integration into the world economy.
The globalization of the world economy, while causing significant growth of capital flows, markedly increases the volume of traditional international trade, and this, for its part, makes it necessary to expand and improve banking services in support of foreign economic activity (FEA) and induces commercial banks to expand their foreign operations. The main motives for their external expansion are: “follow the customer,” “strategic behaviors” and “risk diversification.” International settlement and credit relations are becoming an essential element of foreign economic relations.56
56 The most comprehensive in-depth analysis of the key problems in Azerbaijan’s foreign economic strategy in the conditions of globalizing world economic relations is made in a research monograph and other publications by Sh.G. Haji-
yev: Azerbaidzhan na puti k mirovomu soobshchestvu: strategia vneshneekonomicheskogo razvitia, Ekspres-ob’yava, Kiev, 2004, 504 pp. (monograph); “Azerbaidzhan: integratsia v mirovoie khoziaistvo,” Bakinski rabochi, 10 January,
THE CAUCASUS & GLOBALIZATION
Their appearance and further changes are associated with the development and internationalization of commodity production and circulation. Terms of settlement are included in any foreign economic contract, and these terms determine timely performance, cash inflow and turnover, and the general financial well-being of the FEA participant.
Rapid development of foreign economic activity in Azerbaijan dictates the need to develop the following forms of banking services for the maximum protection of the interests of buyers and sellers:
— Letters of credit as a form of international settlements, which have obvious advantages for all parties, for the banking sector and the whole domestic economy, are the most popular and widespread instrument because they are reliable and serve to balance the interests of all parties in the best possible way.
— Bank guarantees, which play a growing role because they can be used to ensure the performance of any transactions and faster compensation of damage caused by improper performance of contractual obligations.
— International leasing, which is of particular importance to developing and transition countries, ensures an additional flow of funds into the production sector and helps to boost domestic production, increase sales of fixed assets and develop financial mechanisms accessible to domestic enterprises.
— International factoring and forfaiting, which are important instruments of modern management, especially with regard to commercial financing of foreign economic activity and related risk management.
— Project financing and syndicated loans, which are necessary to mobilize international investment resources for implementing large-scale investment projects with the participation of foreign partners and foreign private capital, significantly increasing the economy’s investment potential.
An important set of these problems is related to the future of the banking sector in the context of Azerbaijan’s accesstion to the WTO. Clearly, WTO membership is not an end in itself, but only one of the instruments in promoting the interests of the natioinal banking system. One of the issues being addressed in this case is a liberalization of legislation on access to the national market for the capital of foreign banks or their branches.57 From 1 January, 2004, restrictions on the participation of foreign capital in the Azerbaijan banking market were lifted by decision of the NBA, and today its share is 15.3%.58 There is no question that foreign bank entry in the republic is a fundamental long-term factor.
At the same time, their presence has both positive and negative sides. The former include a reduction in lending rates, increasing competition in the banking system, expansion of the range and volume of banking products, growth of capital and improvement in its quality, implementation of modern technologies, improvement in the quality of services provided to bank clients, and lower borrowing costs, all of which together will serve to accelerate economic growth. In addition, foreign
2002; “Analysis of the Current State of Geo-economic Problems of the Azerbaijan Republic,” Report on Publicly Funded Research Work in 2007, AGEU, Baku, 2008, pp. 7-14 (in Azerbaijani), and others.
57 The problem of foreign bank expansion in the national banking market has not been adequately addressed in the works of Azerbaijani economists. The only exceptions are the research monographs and articles by Z.F. Mamedov: Den-ezhno-kreditnaia sistema stran SNG i Baltii: tendentsii i perspektivy, Azerneshr, Baku, 2008, pp. 43-45, 198-229; Banko-vski krizis i reformirovanie bankovskogo sektora v kontekste globalizatsii, Azerneshr, Baku, 2007, pp. 197-239; “Russian Bank Expansion in CIS Countries and CIS Bank Participation in the Russian Market,” The Caucasus & Globalization, Volume 2, Issue 1, 2008, and others.
58 NBA data.
THE CAUCASUS & GLOBALIZATION
bank entry, especially in transforming or emerging markets, has a positive influence on potential investors, enhancing their confidence in the business climate of the host country.
On the other hand, in our opinion, more complicated supervision of foreign bank branches may present a new problem. This is because their financial statements will be consolidated outside Azerbaijan and they will be supervized by the central banks of the home countries of the respective banks (countries of registration of their head offices). Besides, the presence of foreign capital can put pressure on Azerbaijan’s banking system through the supply of cheaper credit, whereas the relatively expensive credit of domestic banks may prove to be uncompetitive in the domestic market. There is also the risk that banks with a dubious reputation will enter the country in order to make profit from speculative operations or to launder “dirty” money. Another possibility is partial loss of independence by the national banking system (as in a number of CEE states), which always has an adverse effect on the host country’s economic security.
For a solution of these problems it would make sense, first, to establish stringent capitalization requirements for foreign bank branches and their parent bank. Second, permits to open branches in Azerbaijan should be granted only to foreign banks with an international rating not lower than AA+ and with assets of at least $500 million. Third, in order to prevent possible complications in the area of banking supervision after the establishment of each new foreign bank branch, it is necessary to anticipate this by concluding agreements with the home countries of the respective parent banks specifying the obligations of the supervisory authorities of these countries regarding supervision of their branches in Azerbaijan. And fourth, in order to maintain the balance of costs and benefits from the presence of foreign banks, it is advisable to establish clear criteria for the entry of foreign capital into the republic’s banking system, to create the most favorable conditions for foreign equity investment in major Azerbaijan banks and, depending on the latter, to provide for the possibility of quota restrictions.
C o n c l u s i o n
On the whole, it should be emphasized that although the situation in Azerbaijan is far from simple and in some cases contradictory, the financial globalization and liberalization process has had a certain stimulating effect on the development of the national banking system. A generalized reflection of the progressive changes is the steadily growing confidence in banking institutions among both corporate clients and the general public. A positive point is that the country’s banking sector, as represented primarily by major credit institutions, is rising to a new and higher level and is steadily drawing closer to international standards, which will ultimately help to turn Baku into the financial and investment center of the Caucasus. The efficient operation of this segment of the economy also depends in large part on an optimal combination between the policy of promoting financial globalization processes, on the one hand, and measures designed to regulate these processes, on the other. Consequently, it is a matter of creating conditions in which Azerbaijan’s banking system would operate as an effective factor that enhances the activity of local business and helps to improve the investment climate by upgrading the quantitative and qualitative performance of the country’s monetary and financial systems.
