CC BY
164
Sulkhan-Saba Orbeliani was not a physiocrat; he never spoke of industry as a “fruitless” sphere which means that, on the one hand, his ideas were close to those of the physiocrats, while on the other, they were close to the classical economic theory.
C o n c l u s i o n
This analysis of the history of economic science shows us the dynamics of scientific progress and the driving forces behind it.
It is a concise study of one aspect of this inexhaustible subject demonstrating that the Georgian sources contain ideas fully compatible with the main economic trends.
The Georgian written sources analyzed above, especially The Knight in the Tiger Skin, The Code of Laws, Kalmasoba, and The Book of Wisdom and Lies, demonstrate numerous aspects typical of the economic doctrines of mercantilism, classical political economy, and, in particular, the ideas of the physiocrats.
Vasif ABIYEV
Ph.D. (Econ.), Lecturer, the School of Economics and Management at Khazar University (Baku, Azerbaijan).
THE ROLE OF ASYMMETRIC INFORMATION IN THE FINANCIAL SYSTEM: THE CASE OF AZERBAIJAN
Abstract
This study analyzes nature of financial crises, information asymmetry in the Azerbaijan banking sector and Central Bank’s anti-crisis policies in the global financial crisis period. The implemented anti-crisis programs eliminated credit crunch
problem resulting from asymmetric information problem in the economy. However, the banking sector requires improving modern risk management techniques in order to diminish causes of informational asymmetries.
I n t r o d u c t i o n
The global financial crisis has created complex problems over the world. Financial globalization is accelerating the spread of the crisis worldwide. Policymakers, particularly those in the central
bank, are faced with the questions of what they should do to prevent financial crisis. In order to answer this question, one must first understand the nature of financial crises and how they might affect the aggregate economy.
The banking system in Azerbaijan, like other emerging countries, is a primary component of domestic financial market and the only source of external financing for some important sectors of the economy. In financial markets, asymmetric information between lenders and borrowers is very important in understanding financial disturbances. Disturbances in financial markets stemming from informational asymmetries may lead to a reduction in lending to borrowers—the credit crunch—and thus result in contractions in investments and economic activity. In this case banks are unable to fully perform their intermediation role.
After describing how an asymmetric information approach helps to understand the nature of financial crises, this paper focuses on informational asymmetries in the Azerbaijan banking sector and Central Bank’s antirecessionary policies that eliminated credit crunch problem resulting from asymmetric information problem in the economy. As well as considering the nature of asymmetric information, recent sustainability of the banking sector will be analyzed.
The Nature of Asymmetric Information in the Financial System
The asymmetric information literature which looks at the impact of financial structure on economic activity provides a broad definition of the nature of financial crises. The asymmetric information focuses on the differences in information available to different parties in a financial contract. In financial contract borrowers have an informational advantage over lenders because borrowers know more about the investment projects they want to undertake. This informational advantage results in “lemons” problem.1 A lemons problem occurs in the debt market because lenders have trouble determining whether a borrower has a good investment opportunity with low risk or he has poorer investment project with high risk. If the lender cannot distinguish between the borrowers of good quality and bad quality (the lemons), he will face an adverse selection problem and make the loan at a higher interest rate. The result is that high-quality borrowers will be paying a higher interest rate than they should. As a result of this lemons problem, some high-quality borrowers may drop out of the market. The lemons problem analysis indicates that the adverse selection problem will lead to a decline in lending and therefore a decline in investment and aggregate economic activity.
The information asymmetry may result in credit crunch in the economy. This occurs because higher interest rates lead to even greater adverse selection. It is difficult for a bank to identify good borrowers from riskier borrowers and to do so requires the bank to use interest rate as a screening device. As the interest rate rises, riskiness of borrowers increases which in turn lowers bank’s profit. So it may not be profitable to raise the interest rate when a bank has an excess demand for credit. Instead banks decrease supply of loans to borrowers. Even if there is an excess demand for loans, a higher interest rate will not equilibrate the market because additional increases in the interest rate will only decrease the supply of loans and worsen the excess demand for loans even further. Consequently a rise in interest rates result in credit crunch in the economy.2
1 See: G.A. Akerlof, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” The Quarterly Journal of Economics, No. 84 (3) , 1970, pp. 488-500.
2 See: J. Stiglitz, A. Weiss, “Credit Rationing in Markets with Imperfect Information,” The American Economic Review, No. 71, 1981, pp. 393-410.
THE CAUCASUS & GLOBALIZATION
Asymmetric information between borrowers and lenders also results in a “moral hazard” problem which affects the efficiency of financial markets. Moral hazard occurs after the loan agreement takes place because the lender is subjected to the hazard that the borrower has incentives to engage in activities that are undesirable from the lender’s point of view. The rise in interest rates may induce a drop in asset values of firms, thus decreasing the value of collateral and weakening borrowers’ balance sheets. Especially, high loan rates of interest cause moral hazard, in the sense that once loans are made available to borrowers whose asset values decreased, they have incentives to undertake riskier investment projects. Indeed a decline in borrowers’ net worth increases adverse selection and moral hazard problems. Hence, a decline in borrowers’ net worth leads to a decrease in lending, and thus a decline in investment and aggregate economic activity.3
An unanticipated deflation or a disinflation redistributes wealth from debtors to creditors by increasing the real value of debt, and thereby reducing borrowers’ net worth. This decline in net worth induces borrower to cut down on current expenditures and future commitments, sending the economy further down. The resulting increase in adverse selection and moral hazard problems causes a decline in investment and economic activity.
The importance of asymmetric information provides another mechanism by which financial crises reduce economic activity. Disturbances in financial markets that reduce the amount of banks will lead to a reduction in lending to borrowers, resulting in a contraction of economic activity.4 In the case of bank panics, banks are unable to fully perform their intermediation role. In a panic, depositors, fearing the safety of their deposits, withdraw them from the banking system, causing a contraction in loans and a multiple contraction in deposits. Here an asymmetric information problem is at the source of the financial crisis because depositors withdraw deposits from solvent as well as insolvent banks since they cannot distinguish between them. Thus bank panics may create contagion effect in the financial system; the lack of information about the solvency of depositors’ own bank leads to large deposit withdrawals from all banks. Furthermore, banks’ desire to protect themselves from possible deposit outflows leads them to increase their reserves relative to deposits, which also produces a contraction in loans and deposits, and thus results in liquidity crisis.
One way of reducing the adverse selection and moral hazard problems (or more generally agency problems) in debt markets is to have the borrower provide collateral for the loan.5 Thus, if the borrower defaults on the loan, the lender can take title to the collateral and sell it to make up the loss. If the collateral is of good enough quality, then it is no longer as important to learn whether the borrower is of good or bad quality. Therefore, with collateral, the fact that there is asymmetric information between the borrower and lender is no longer as important factor in the market.
The other way of reducing the adverse selection and agency problems in debt markets is to decrease interest rates by expansionary monetary policies of central bank. Low interest rates attract high quality borrowers with profitable investment projects into the market, rising net value of firms. Hence the expansionary monetary policy that leads to low interest rates in debt markets increases investments and economic activity thus decreases adverse selection and agency problems in financial markets.
On the other hand, an unanticipated inflation, which doesn’t affect the real value of assets, decreases the real value of debt liabilities in the firms’ balance sheets, and thus increases borrowers’ net worth. The resulting increase in borrowers’ net worth decreases adverse selection and agency problems causing a rise investment and economic activity.
3 See: B.S. Bernanke, M. Gertler, “Agency Costs, Collateral and Business Fluctuations”, The American Economic Review, No. 79, 1989, pp. 14-31.
4 See: B.S. Bernanke, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression”, The American Economic Review, No. 73 (3), 1983, pp. 257-276.
5 See: F.S. Mishkin, “Asymmetric Information and Financial Crisis: A Historical Perspectives,” in: Financial Markets and Financial Crisis, ed. by R.G. Hubbard, University of Chicago Press, Chicago, IL, 1991, pp. 70-75.
Asymmetric Information in the Banking Sector and the Central Bank’s Monetary Policy during the Global Financial Crisis Period
Azerbaijan’s financial system mainly consists of a total of 148 commercial banks and non-bank credit institutions. Forty-seven of these institutions are commercial banks, 46 of which are private banks and 1 is a public bank. Out of the 47 commercial banks, 23 are banks with foreign capital. There are 7 foreign banks among the total number of banks.6 Remaining 101 credit institutions are non-bank credit institutions, 80% of which are credit unions. Although the banking sector accounts for 32% of credit institutions, currently 98% of total financial assets of credit institutions consist of banking sector assets. Moreover, 98% of long-term loans and 94% of short-term loans are issued by commercial banks.7 Currently in Azerbaijan, the number of total bank branches is 640 and the number of total bank departments is 114.
Banks are vital for Azerbaijan economy. Banks channel funds from savers to investors. That is to say, they gather funds by collecting savers’ money, issuing debt securities, or borrowing in the interbank markets. The funds collected are invested in short-term and long-term risky assets, which consist mainly of loans to various economic entities such as individuals, companies and governments.
Effects of bank bankruptcies on the economy are greater than effects of other financial institutions’ bankruptcies. Bank bankruptcies have a particularly negative effect on lenders, borrowers and deposit owners. Not paying the loans to the lenders or demanding loans from the borrowers shows that the financial market has a liquidity problem that causes depositors to withdraw all their deposits not only from the bankrupt banks but also from trustworthy banks that have no liquidity problems. Thus a liquidity crisis in the banking sector leads to credit crunch in the economy.
The primary goal of the Central Bank of Azerbaijan (hereinafter CBAR) is to ensure the price stability, while the financial stability is seen as important as well, since the CBAR is also responsible for prudential regulation. In response to the current market turbulence, the financial stability objective has become more pre-eminent. Indeed, the dual role of monetary policy in responding to a financial stability shock—the credit crunch—as well as the price stability shock—highly volatile oil and commodity prices—has posed particularly challenging dilemma for the central banks.
The monetary policy stabilizes the financial sector basically through credit channel. The credit channel builds on the realization that for important sectors of the economy, banks are the only source of external financing. Indeed, for some important sectors of the economy, banks in Azerbaijan are the only source of external financing. Therefore, the credit channel plays a crucial role in financing these sectors. The term “credit channel” comprises a number of distinct mechanisms. The two most important are the reserve requirement mechanism and the balance sheet mechanism. The reserve requirement mechanism is based on the banking sector’s balance sheet identities. When as a result of tightening monetary policy or for some other reason banks’ deposits decrease, the banks that need reserve requirements to pay for immediate deposit withdrawals cut back their lending. Thus, tightening monetary policy reduces investment expenditures of firms that have not got any external financing except bank credits. Consequently, tightening monetary policy creates credit crunch problem in the financial sector of the economy via reserve requirement mechanism.8
6 A bank is defined as “foreign” if at least 50 percent of the equity is owned by foreigners.
7 See: The Central Bank-Statistical Bulletin, 12/2009.
8 See: B.S. Bernanke, A.S. Blinder, “Credit, Money and Aggregate Demand,” The American Economic Review, Vol. 78, No. 2, 1988, pp. 435-439; J.H. Boyd, M. Gertler “US Commercial Banking: Trends, Cycles and Policy”, Working Papers, No. 93-19, 1993, pp. 3-5.
THE CAUCASUS & GLOBALIZATION
Balance sheet mechanism does not refer to the banking sector’s balance sheet but to the balance sheets of the borrowers. For many borrowers, collateral is the most important determinant of the availability and terms of bank loans. When as a result of tightening monetary policy or for some other reasons interest rates on credits increase, it may induce a fall in asset values of firms, thus decreasing the value of collateral and weakening borrowers’ balance sheets. Consequently, bank’s loan availability decreases, which in turn gives a further downward push on asset prices. As the cycle continues, a credit crunch problem arises. On the other hand, if the interest rate on credits is allowed to rise to a very high level, it will discourage safe borrowers and encourage riskier borrowers—a phenomenon that is called an “adverse selection.” High real loan rates of interest also cause “moral hazard,” in the sense that once loans are made available to borrowers whose asset values decreased, they have incentives to undertake riskier investment projects. Adverse selection and moral hazard problems arise as a result of asymmetric information problem in the financial market.9
The global crisis mostly had an impact on the country in terms of a price drop on oil and other non-oil export goods, a sharp decrease in loan inflow from foreign institutions into the banking system, reductions in money orders. In short, there was a decrease in all foreign financial resources of aggregate demand. The global crisis gave rise to negative expectations in the currency market and banking sector and especially caused a slump of 8.2% in the construction sector. As a result, the national economy was faced with economic recession and financial instability, such as losing of newly created working places, devaluation of the national currency, worsening of the quality of banks’ payment system, and credit crunch problem in the banking system.
In the global financial crisis period, asymmetric information showed itself in the form of bank panics and resulting credit rationing in the banking sector of Azerbaijan. In a panic, depositors, fearing the safety of their deposits and not knowing the quality of the banks’ loan portfolios, withdraw them from the banking system, and cause banks to fail. In bank panics, both solvent and insolvent banks go out of business. At the end of 2008, Azerbaijani banks had to pay off approximately USD 1 billion of external debts. Furthermore, due to the scarcity of lending resources in the world markets, all of the banks reduced their lending programs and some of them completely stopped loans to households and enterprises.
In the context of global financial instability, the CBAR’s prior objective was to maintain financial stability. In 2009, the CBAR’s monetary policy, which was characterized as antirecessionary, aimed at ensuring financial stability, stabilizing the banking sector and firms’ activities, preventing credit crunch problem and raising economic growth. As a result of preventive measure of the CBAR, negative effects of global financial crisis on the banking sector have been greatly reduced.
The increased efficiency of monetary policy based on important amendments to the Law on Central Bank in 2009 and provision of the economy with greater liquidity played an important role in preserving economic growth and stabilizing the banking system. According to the changes and amendments, the CBAR was able to lend to banks in various currencies for a longer term, including subordinated debts in order to protect interests of creditors and depositors.10 The amount of subordinated debt was determined in the limit of 50% of the Tier I capital. In addition, the CBAR can issue special-purpose loans to banks on the basis of state guaranty in order to provide financial aid to the real sector and suitable socioeconomic projects of the economy. All these amendments and changes played an important role in preserving economic growth and employment.11
To stimulate commercial banks’ activities, from the end of 2008 till June 2009 the CBAR reduced a refinancing interest rate from 15% to 2% and reserve requirement rate from 12 to 0,5% grad-
9 See: F.S. Mishkin, op. cit.
10 Subordinated debt serves as regulatory capital because it does not have to be repaid in the near term and there-
fore acts as a form of protection for depositors.
11 See: The Law of Central Bank 2009, Arts 49 and 49-1, available at [www.cbar.az].
ually. Consequently, approximately 1.8 billion AZN has been pumped into the economy through the Central Bank’s indirect and direct policy tools.
The CBAR activated mortgage loans in order to preserve construction and real estate market sectors. Increased mortgage loans prevented sharp drops in prices in the construction sector and real estate market, and increased activities in the banking, insurance and security markets. At the same time, mortgage loans increased the value of collateral for bank loans by hampering sharp drops in real estate prices. Thus, revived mortgage loans helped to reduce the credit crunch in the economy.
The government took some measures in order to support banking sector capitalization in the crisis period. The banks’ profits directed to capitalization are exempt from income tax. Owing to such measures, in 2009, the total capital of the banking system increased by 17.9%. In parallel to gross capital formation, capital adequacy ratio of the banking sector was 17.9% in 2009, greater than the officially determined minimum rate (12%).12 At the same time, adequacy ratio of Tier I capital has been 13% greater than officially determined ratio (6%).13 Higher capital adequacy ratios cushioned banks’ balance sheets against financial risks.
Despite the global liquidity crisis, financial stability of the banking system has been preserved through the conduct of preventive measures by the CBAR and the government. The banking system has met economy’s demand for financial resources and has demonstrated high level of financial sustainability.
The implemented anti-crisis programs mentioned above reduced financial risks emanating from adverse selection and moral hazard problems, and eliminated credit crunch in the economy. As a result, financial endurance of the banking system became stronger. In 2009, total credits in the economy increased by 17.3%, total assets of the banking sector increased by 13,5%, the ratio of bank loans to total bank assets has increased from 69% to 72%. Moreover, long-term loans increased from 70.6% to 72.8%. The ratio of non-standard credits to total credits was 6%, the ratio of nonperforming credits to total credits was 3.5% and the share of overdue loans in credit portfolio amounted to 3.6%. Moreover, the indicator of capital adequacy of the banking sector was much higher than the accepted norm and amounted to 17.9%.14
Sustainability of the Banking Sector in the Conditions of Informational Asymmetries
Recently, asymmetric information tends to show itself as moral hazard and adverse selection in the credit market. Accelerated loans to the real sector in the conditions of informational asymmetries may raise credit risks and thus deteriorate the quality of credit portfolios. Rising loans may give rise to excessive lending in risky investments, which may lead to increase moral hazard and adverse selection problems in credit market and thus may cause deterioration in banks’ balance sheets by rising risky and nonperforming loans. In particular, moral hazard occurs because a borrower has incentives to invest in projects with high risk in which the borrower does well if the project succeeds but the lender bears most of the loss if the project fails. Indeed, there has been observed a rise in overdue credits in recent months, while loan loss provisions have been at a very low level. Because risk man-
12 Capital adequacy ratio is the sum of Tier I capital, Tier II capital and Tier III capital (short-term subordinated debt) divided by risk-weighted assets.
13 See: Financial Stability Report-2009, pp. 24, available at [www.cbar.az].
14 See: Statistical Bulletin, 12/2009, pp. 18-23; Financial Stability Report-2009, pp. 18-22, available at [www.cbar.az].
agement expertise of banks in issuing loans is very limited, lenders may fail to distinguish between good and bad borrowers, resulting in heavy investment in risky and nonperforming assets. This may lead to deterioration in banks’ balance sheets in future.
In the first half of 2010, the liquidity position of the banking sector has been high enough. About 84% of current liabilities have been provided with liquid assets which exceed minimum requirement of 30%. Capital adequacy of the banking sector made 17.2%, exceeding the required norm of 12%. The aggregate capital of the banking sector rose to AZN 1.8 billion. The authorized capital of the banking sector comprised 73% of the aggregate bank capital. Since the corporate bonds market is virtually immature, issuing securities is still not a viable option for banks to raise their funds. Therefore, they have been borrowing substantially from abroad. While in 2008 the volume of transactions on corporate bonds was AZN 18.10 million, it grew 3.4 fold to AZN 61.76 million in 2009, and in the first half of 2010 transactions constituted AZN 64.8 million.15
In Fig. 1, as a credit risk measure, the overdue credit ratio (hereinafter OCR) decreased from 11% in 2005 to 1.6% in 2008.16 Because of the negative effects of global crisis, the OCR rate has started to rise gradually from 1.6% in 2008 to around 5% by June of 2010. Since global financial crisis created negative expectations in the economy and especially in the financial markets, adverse selection and moral hazard problems began to accelerate in the credit market causing the OCR to begin rising from the middle of 2008 up to the middle of 2010.
Figure 1
Banks' Loan Loss Provisioning and Overdue Credit Ratio
In the global crisis period, as the OCR began to rise, CBAR decided to raise the loan loss provisions (hereinafter LLP) against the accelerated credit risks. Thus, loan loss provisions for credits under supervision were raised from 6% to 10%, for non-satisfactory loans from 25% to 30%, for risky loans from 50% to 60% and for hopeless loans to 100%. As a result, banking sector loan loss provi-
15 See: Financial Stability Review, January-June, 2010, available at [www.cbar.az].
16 OCR is the ratio of overdue credits to total credits and LLPR is the ratio of LLP to total credits.
sions rapidly moved up over the OCR rate. Generally, loan loss provisions created by banks in 2009 are 2 times as high as nonperforming loans and 5 times as high as hopeless loans. However, recently, the ratio of LLP to total credits (LLPR) (1.5%) is not enough level to cover the OCR (5%) and remains much below the OCR. This means that the moral hazard and adverse selection problems become to increase in credit market. Growing numbers of overdue credits and declining loan loss provisioning may lead to deterioration in banks’ balance sheets in the near future. The recent rising in OCR shows that the banking sector requires improving modern risk management techniques, including proper credit evaluation, development of better nonperforming loans’ management and improvement of staff quality through the training of existing personnel.
Table 1
The Banking Sector Depth and Intermediary Development Ratios (%)17
W
® o
in Q
in (0
w 0.
5 Q
6 O
Q
§ 0.
<b Q
o o
2 «
£ ®
2 «
o in
-J c*
in -O
o
& 3
Q m
2006 20.95 11.99 13.10 62.54 109.28 59.10
2007 25.08 12.72 17.46 69.61 137.26 51.12
2008 25.60 11.86 17.85 69.72 150.47 39.47
2009 33.74 13.46 24.31 72.07 180.64 36.81
Jan.-Sep. 2010 42.14 16.09 30.49 72.36 189.53 37.35
Table 1 shows the banking sector depth and intermediary development ratios over time in the economy. Despite the negative influence of global financial crisis all the indicators increased in recent years. In particular, the loans to GDP ratio, loans to total assets ratio and loans to deposits ratio increased significantly between 2006 and 2010. Today loans constitute main part of total bank assets (72%). Other assets constitute 28% of total bank assets. Growth of loan portfolio primarily occurred through increase of deposits, interbank operations, and liquidity support of the CBAR. As is shown in Table 1, loans to the real sector rose rapidly in recent years, from 13.10% of GDP in 2006 to over 30% of GDP in the first nine month of 2010. Rapid growth of loans to the real sector may lead to increase moral hazard and adverse selection problems in credit market, which may cause deterioration in banks’ balance sheets by rising risky and nonperforming loans.
Fig. 2 shows the spread between average lending and deposit interest rates in domestic and foreign currencies. The spread between lending and deposit rates serves as an indicator of credit rationing. A widening of this spread might indicate that banks have restrained lending. As is shown in the figure, in 2009, there was sharp decrease in the average interest rate spread in national currency. In the time of crisis, in order to hamper recession and raise the total demand in the economy, the central bank’s expansionary monetary policy caused interest rates on credits to go down.
17 See: Financial Stability Report-2009, pp. 13-18; Statistical Bulletin, 12/2009, pp. 18-23, available at [www.cbar.az].
Figure 2
The Spread between Lending and Deposit Rates in Domestic and Foreign Currencies
12.00 10.00 8.00 6.00
4.00
2.00 0
555566667777888899990000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 000000000000000000000000 222222222222222222222222
wv
k4i ikiki A1 d_azn d fx
Y \ i.i AV
r
111111111111111111111111111111111111111111111111111111111111111111111
However, the spread between lending and deposit rates in foreign currency has widened since the beginning of 2008. So it can be said that there has been a credit rationing on loans in foreign currencies since 2008. In the late 2008, banks had to pay off approximately USD 1 billion in external debts. Furthermore, due to the scarcity of lending resources in the world markets, all the banks in Azerbaijan reduced their lending in foreign currencies. According to the Statistical Bulletin of Central Bank, the share of loans in foreign currency in total credits dropped from 50% to 42% in 2009 and to 40% in the first half of 2010.
Table 2
Structure of Total Capital of the Banking Sector (million AZN)18
1/1/2008 1/1/2009 1/1/2010 1/7/2010
Tier I Capital 755.3 1,091.8 1,285.5 1,501.7
Percentage change (%) 79.2 44.6 17.7 16.8
Tier II Capital 305.4 449.0 530.9 357.5
Percentage change (%) 116.7 47.0 18.2 -33.0
Total Capital after deductions 1,009.1 1,491.7 1,758.9 1,799.3
Percentage change (%) 66.6 47.8 17.9 2.3
18 See: Financial Stability Review-2010, pp. 13-16.
Table 2 summarizes the structure and development of the banking sector capitalization process during the 2008-2010 period. Volume of the aggregate capital of the banking sector has increased approximately by 78.3% during these years and made AZN 1.8 billion. The growth of the total capital of the banking sector has mainly come from Tier I capital. Tier I capital has increased by 99% during the 2006-2010 period and constituted 83% of total bank capital (AZN 1.5 billion).
Table 3
Bank Sector's Profitability Indicators (%)19
Years Net Interest Margin ROA ROE
2006 4.53 2.52 18.70
2007 4.61 3.54 23.50
2008 5.19 2.91 22.60
2009 4.88 2.80 19.40
Jan.-June 2010 2.1 1.2 8.8
Table 3 shows net interest margin, ROA and ROE ratios as the banking sector’s profitability indicators.20 In the global financial crisis period, there were decreases in net interest margin, ROA and ROE. Because the Central Bank’s expansionary monetary policy caused interest rates on credits to decrease in the banking sector, the net interest margin, ROA and ROE dropped in 2009. In the first half of 2010, ROA and ROE constituted 1.2% and 8.8%, respectively.
C o n c l u s i o n
Azerbaijan’s banking sector, contrary to its peers in other developing markets, has not been dramatically affected by global financial crisis. The banking system of Azerbaijan met global crisis sufficiently prepared with adequate level of capitalization, high financial bewaring and liquidity indicators. This has been mainly due to the macroeconomic policies of the CBAR.
The implemented anti-crisis programs eliminated credit crunch in the economy. As a result, financial endurance of the banking system became stronger. Revived mortgage credits, which were one of the important tools of antirecessionary program of the CBAR, stabilized the construction sector and real estate market. Loans to economy have grown significantly in recent years. The credit growth was accompanied by the effective risk management and prudent lending policies so that overdue credits have remained reasonably low. Especially, loan loss provisions increased significantly against rising credit risks. Besides, loans in foreign exchange were retained at relatively low levels in order to prevent exchange rate risks. High capital adequacy ratio has cushioned banks’
19 See: Financial Stability Report-2009, pp. 18; Financial Stability Review-2010, pp. 13-14, available at [www.cbar.az].
20 The net interest margin equals interest income minus interest expense over total asset; ROA is before tax profits over banking sector’s total assets; ROE is before tax profits over the banking sector’s total equity (for more information, see: A. Demirgu9-Kunt, R. Levine, Financial Structure and Economic Growth: A Cross-Country Comparison of Banks, Markets and Development , MIT Press, Cambridge, MA, 2001).
balance sheets against financial risks. As a result, financial endurance of the banking system became stronger so that assets of the banking sector increased by 13.5%, loans to economy increased by 17%, deposits increased by 23% and the total capital of the banking sector increased by 18% in 2009.
However, despite the high capital adequacy ratio and high level of liquidity ratio of the banking sector, growing numbers of overdue credits and declining loan loss provisioning may lead to deterioration in banks’ balance sheets in the near future. The recent rising in OCR shows that the banking sector requires improving modern risk management techniques, including proper credit evaluation, development of better nonperforming loans’ management and improvement of staff quality through the training of existing personnel.
Today, Azerbaijan’s banking sector still has a significant potential for growth in addition to its higher performance as opposed to its peers. The depth and financial intermediary indicators of the banking sector, such as loans to GDP ratio or deposits to GDP ratio are still very low when compared to developed markets. Some basic financial products that have significant revenue generation potential are still in the development phase in Azerbaijan. Moreover, a large percentage of population is unbanked or potentially bankable in the medium term. All these indicators that illustrate the potential for growth have been accompanied by the CBAR’s strong and prudent management experience, which has retained a distinguished place for the banking sector throughout the crisis period in contrast to its peers.
Bahruz AHMADOV
Ph.D. candidate
at the Institute for Scientific Research on Economic Reforms, Ministry of Economic Development of the Azerbaijan Republic (Baku, Azerbaijan).
OPPORTUNITY COST OF THE CRISIS: CRISIS LOSS RANKING FOR THE CIS COUNTRIES
Abstract
This article takes a look at the opportunity cost index methodology based on deviation from the pre-crisis development trends for measuring and comparing the economic losses of different countries during the crisis. The methodology is
also used for estimating the opportunity cost index, ranking the losses the CIS countries have incurred, and assessing the reasons for the various impacts the crisis has had on different countries and its implications for the Azerbaijan economy.
