The International Monetary Fund (IMF) has concluded that Azerbaijan’s financial system has made considerable progress in strengthening resilience since the 2015 oil price shock and 2020 COVID-19 downturn, but warned that vulnerabilities related to liquidity risks, credit concentration, and financial dollarisation continue to threaten stability under adverse scenarios.

According to the IMF’s Financial System Stability Assessment, part of its 2025 Financial Sector Assessment Program (FSAP), Azerbaijan’s financial sector has substantially improved over the past decade. The central bank’s re-assumption of financial sector regulation in 2019 was described as a critical turning point that revitalised regulatory reforms, corporate governance standards, and risk management practices. The report, based on missions conducted between May and October 2024, noted that foreign exchange reserves doubled since the previous FSAP, banks’ profitability exceeded pre-pandemic levels, and the aggregate non-performing loan (NPL) ratio fell to 2.7% as of July 2024, from 21% at end-2016.

The IMF said the banking system remains adequately capitalised even under a severe hypothetical adverse scenario involving a 50% oil and gas price plunge, domestic recession, and a 30% manat devaluation. Under this stress, the sector’s total regulatory capital ratio would decline by 4.5 percentage points to 13.7%, yet stay above minimum requirements. However, eight banks—including two systemically important lenders—would breach regulatory thresholds, covering 35% of total banking sector assets. Their combined capital shortfall was estimated at AZN657mn (0.5% of GDP).

Liquidity risk, particularly tied to short-term wholesale deposits from oil-related corporates, was highlighted as a key concern. Stress tests indicated that although the overall sector could survive severe shocks, certain banks, especially those dependent on large business deposits, were vulnerable. Withdrawal of the five largest depositors at some banks would cause liquidity shortfalls amounting to AZN2.1bn (1.7% of GDP). The banking system could, however, withstand cumulative 48% manat deposit outflows and 64% foreign currency deposit outflows over a 12-month horizon, assuming full release of required reserves.

The IMF warned that Azerbaijan’s banks remain structurally exposed to external shocks due to their high financial dollarisation. As of July 2024, foreign currency deposits made up 39% of total deposits, and business loans in foreign currency stood at 31%, with a notable share granted to unhedged borrowers. A sharp devaluation of the manat would therefore directly impair asset quality and liquidity.

Credit concentration remains another systemic issue. Banks' five largest exposures represented 63% of their aggregate Tier 1 capital, with some individual banks holding exposures exceeding twice their capital base. In a shock scenario, assuming simultaneous default of each bank’s five largest borrowers, ten banks would breach solvency thresholds, the IMF noted.

Meanwhile, rapid growth in unsecured consumer lending was identified as a cyclical risk. Although consumer NPLs had declined from 28% in 2017 to 3.1% in mid-2024, unsecured loans have expanded at an average rate of 21% annually between 2018 and 2023. A significant share of this lending went to public sector employees and pensioners, but approximately 30% involved vulnerable borrowers with debt-to-income ratios exceeding 60%.

The Fund praised Azerbaijan’s regulatory progress, noting successful implementation of key Basel III components, enhancement of macroprudential policy frameworks, the launch of a risk-based supervision model in 2025, and strengthening of the lender of last resort (LoLR) mechanisms. Establishing sectoral risk buffers and borrower-based measures, such as caps on loan-to-value (LTV) and debt-to-income (DTI) ratios, were welcomed as steps toward improved systemic risk containment.

However, the IMF highlighted that fundamental weaknesses remain. These include the lack of a consolidated supervision framework, an interagency crisis management body, and full operational independence for the central bank. A critical gap was identified as the absence of comprehensive bank resolution powers, including the ability to impose moratoriums or restructure failing institutions without court approval.

The IMF recommended that Azerbaijan urgently address these deficiencies. In particular, it called for reinforcing the central bank’s independence and governance structures, improving disclosure of bank ownership and related-party transactions, developing a formal macroprudential policy strategy, and completing implementation of sectoral capital buffers. It also advised strengthening the deposit insurance framework by removing presidential approval requirements and ensuring that the Azerbaijan Deposit Insurance Fund (ADIF) has direct access to emergency funding sources.

The assessment noted that rehabilitation of the state-owned International Bank of Azerbaijan (IBA) following the 2015-2016 crisis was largely successful. Through asset transfers totalling 37% of GDP and foreign currency liability restructuring, IBA’s financial health improved significantly, although it remains dominant, holding 26% of sector assets compared to 38% in 2015.

Despite robust progress, the IMF stressed that downside risks remain significant. Any intensification of regional conflicts, sharp declines in hydrocarbon revenues, or extreme climate events could seriously impair Azerbaijan’s financial system. Moreover, the concentrated structure of deposits and continued exposure to foreign exchange volatility exacerbate the sector’s fragility in extreme stress scenarios.

The IMF’s conclusions serve as a warning that although Azerbaijan’s financial sector is stronger today than a decade ago, complacency would be dangerous. Further reforms are urgently needed to cement financial stability and enhance resilience against external and domestic shocks.