Project Number: 39930 Loan Numbers: 2233-003 November 2011

Loan Private Banks and Leasing Companies in Azerbaijan (Azerbaijan)

In accordance with ADB‘s public communications policy (PCP, 2005), this abbreviated version of the XARR excludes confidential information and ADB‘s assessment of project or transaction risk as well as other information referred to in paragraph 126 of the PCP.

Extended Annual Review Report

CURRENCY EQUIVALENTS

Currency Unit – Azerbaijan manat/s (AZN)

At Appraisal At Project Completion 20 February 2006 28 February 2011

AZN1.00 – $1.0914 $1.2572 US$1.00 – AZN0.9138 AZN0.7954

ABBREVIATIONS

ADB – Asian Development Bank ALCO – Asset Liability Committee CAGR – compounded annual growth rate CBA – Central Bank of the Republic of Azerbaijan EBRD – European Bank for Reconstruction and Development EMS – environmental management system EROIC – economic return on invested capital GDP – gross domestic product IFC – International Finance Corporation IFI – international financial institution IFRS – International Financial Reporting Standard IT – information technology PAU – project administration unit ROIC – return on invested capital SMEs – small and medium-sized enterprises

NOTES

(i) In this report, ―$‖ refers to US dollars. (ii) Calendar year denotes the year in which the fiscal year ends, e.g., FY2010 ends

on 31 December 2010.

Vice-President L. Venkatachalam, Private Sector and Cofinancing Operations Director General P. Erquiaga, Private Sector Operations Department (PSOD) Director R. van Zwieten, Capital Markets and Financial Sectors Division, PSOD Team leader S. Hruschka, Head, Project Administration Unit, PSOD Team member I. Chua, Investment Officer, PSOD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page BASIC DATA EXECUTIVE SUMMARY i

I. THE PROJECT 1

A. Project Background 1 B. Key Project Features 1 C. Progress Highlights 1

II. EVALUATION 2

A. Project Rationale and Objectives 2 B. Development Impact and Outcome 3 C. ADB Investment Profitability 12 D. ADB Work Quality 12 E. ADB‘s Additionality 14 F. Overall Evaluation 14

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 15

APPENDIXES 1. Project-Related Data 16 2. Private Sector Development Indicators and Ratings: Financial Intermediaries 23 3. Sector and Operations Review 31 4. Comparative Financial Statements 34

BASIC DATA

Private Banks and Leasing Companies in Azerbaijan (39930 - Azerbaijan)

Key Project Data

As per ADB Loan Documents ($ million)

Actual ($ million)

Total project cost ADB investment

Loan: Committed Disbursed

4.0

4.0 4.0

4.0

4.0 4.0

ADB = Asian Development Bank.

Key Dates Expected Actual

Concept clearance approval Board approval Loan agreement Loan effectiveness Disbursements

2005 2006 2006 2006 2006

17 Sep 2005 30 Mar 2006 31 Aug 2006 31 Aug 2006

31 Aug 2006 and 16 Oct 2006

Project Administration and Monitoring No. of Missions No. of Person-Days

Fact-finding 1 26 Jul–2 Aug 2005 Appraisal 1 12–25 Oct 2005 Project administration 2 4–7 Aug 2009, 23–25 Nov 2009 XARR mission 1 22–25 Aug 2011

XARR = extended annual review report. Note: Number of person-days for mission is not on record, only mission dates are available.

EXECUTIVE SUMMARY

During 2000–2004, Azerbaijan‘s economy posted record growth, averaging 10.6% per

annum, as a result of income from the oil and gas sector. The growth from this sector spurred growth in other sectors such as finance, transport, trade, and construction. The finance sector was dominated by the state-owned banks, which accounted for 50% of the domestic market; private banks were growing rapidly but remained underdeveloped. In 2005, the Asian Development Bank (ADB) sent a mission to Azerbaijan and thereafter realized the need to initiate private sector operations in Azerbaijan. A subsequent mission was able to identify the requirements and opportunities to support development of the finance sector. As a result, in March 2006, the ADB Board approved assistance, consisting of loans and equity, of up to $15 million to private banks and leasing companies in Azerbaijan. This became the first private sector project in Azerbaijan. Three banks—Azerigazbank, Bank Respublika, and AccessBank (then called the Micro Finance Bank of Azerbaijan)—were eventually selected. On 31 August 2006, ADB and AccessBank signed a facility agreement for a $4 million, 4.5-year senior-term loan. The proceeds were fully disbursed in October 2006 and the loan was fully repaid on 28 February 2011. ADB extended the loan to AccessBank with the expectation of promoting private sector development through improvement of the finance sector, and supporting the Government of Azerbaijan‘s goal in developing the non-oil sector to achieve sustainable economic growth.

AccessBank was established on 29 October 2002 as the Micro Finance Bank of Azerbaijan to provide financing to micro and small enterprises. The bank initially had five shareholders, led by AAA-rated international financial institutions. These shareholders were the European Bank for Reconstruction and Development (EBRD), International Finance Corporation (IFC), KfW, Black Sea Trade and Development Bank, and LFS Financial System. In April 2007, AccessBank issued 4.3 million new primary shares to boost its share capital and, at the same time, a new shareholder—Access Microfinance Holding (AccessHolding)—joined the bank. As the bank grew, in 2008 it underwent a restructuring and rebranding exercise to expand its banking service coverage to further improve services to its existing clientele. As a result of this restructuring, the bank was renamed AccessBank.

ADB‘s loan to AccessBank had the following development objectives: (i) strengthening the private banking sector to gradually reduce the dominant market share of the public sector (state-owned) banks, (ii) expanding the micro and small business portfolio, (iii) improving the ability to raise deposits and issue bonds, (iv) adopting better practices for critical banking functions, and (v) achieving sustainable operations that allow for increased financial intermediation while coping robustly with inevitable business cycles.

The development impact and outcome of ADB‘s loan to AccessBank is rated excellent based on the following criteria: (i) private sector development; (ii) business success; (iii) economic sustainability; and (iv) environmental, social, health, and safety performance. ADB‘s loan to AccessBank contributed to the growth of the private banks‘ share in Azerbaijan‘s domestic market. The share of private banks in the local market increased during 2006–2010 as evidenced by the continuous rise of the share of private banks in the finance sector in terms of assets, loans, and deposits, while the market share of state-owned banks fell. As a result of the increased market share of private banks, their contribution to non-oil gross domestic product also rose. This in turn caused greater growth in the non-oil sector than in the oil sector from 2008 onwards.

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ADB‘s loan to AccessBank also helped in the bank‘s growth in terms of expanding the loan portfolio, increasing deposits, raising bonds, improving banking standards, and achieving sustainable operations. As a result, the bank‘s overall performance improved, as seen in the rise in AccessBank‘s sector ranking and strong reputation it established in the market. Given this, and the growth of the private sector because of the development of private banks, private sector development is rated excellent.

AccessBank‘s expanded loan portfolio, deposit growth, and improved banking standards allowed it to improve both operationally and financially. This was evidenced by the turnaround in the bank's bottom line when it realized a net profit in 2007 from a net loss in 2006. Since then, AccessBank has continued its robust performance, which allowed it to declare dividends in 2010 for the first time. Due to AccessBank‘s strong performance during 2007–2010, the bank‘s time-adjusted real financial return on invested capital yielded a result which, based on the Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations, merits AccessBank a rating of excellent for business success. Also, economic sustainability was rated excellent given AccessBank‘s contribution to creating jobs and employment, and payment of taxes to the government.

ADB‘s environmental, social, health, and safety performance is rated satisfactory. The loan to AccessBank was classified as a financial intermediary based on ADB‘s Environment Policy (2002), which required AccessBank to (i) put in place an environmental management system (EMS) which outlined the procedures for the screening of sub-borrowers and the activities financed by the loan, and ensured that sub-borrowers would comply with applicable environmental laws and regulations; and (ii) adhere to ADB‘s policies on involuntary resettlement and indigenous peoples. AccessBank now has an EMS in place to ensure that the bank only finances environmentally and socially sound projects and businesses. It also has environmental management procedures, which have been in operation since 2004. This was based on EBRD requirements and is aligned with international standards. In September 2010, the bank‘s environmental procedures were strengthened with the implementation of the Environmental and Social Policy and Risk Management Plan, which covers both the activities of the bank and the activities of businesses financed by the bank. To date, the bank has strictly implemented the EMS procedures and has not made any exceptions. Further, there have been no involuntary resettlements or impacts on indigenous peoples as a result of AccessBank‘s activities. ADB‘s investment profitability is rated satisfactory. To gauge ADB‘s profitability, the loan to AccessBank was benchmarked against the loans granted to AccessBank by other financial institutions. ADB was able to charge a margin spread based on prevailing market pricing in 2006. ADB‘s overall work quality is rated satisfactory based on (i) screening, appraisal, and structuring of the project; (ii) monitoring and supervision; and (iii) its role and contribution. ADB‘s loan to AccessBank was part of a $15 million lending project to Azerbaijan aimed at strengthening the Azerbaijani private banking sector, which was dominated by state-owned banks. ADB conducted two missions—fact-finding and due diligence. The current activities of other development partners (i.e., Deutsche Entwicklungsgesellschaft (DEG), EBRD, IFC, and KfW) were taken into consideration, given that it was ADB‘s first entry into the Azerbaijani private sector. Most of the top-tier banks were considered as candidates. After ADB‘s evaluation, it extended loans to three banks. AccessBank was one of these three banks given that it showed strong management and governance, good credit process, low delinquency rate, and adequate capital, which would enable ADB to achieve its objectives. ADB decided to extend a

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loan instead of equity to AccessBank in order to strengthen the bank‘s leverage position as it expanded its loan portfolio and to lower the bank‘s cost of capital. Given these factors, ADB‘s screening, appraisal, and structuring of the project is rated satisfactory. The project administration unit of ADB‘s Capital Markets and Financial Sectors Division regularly monitored AccessBank‘s overall business and financial performance by requiring the bank to submit unaudited quarterly financial statements and audited yearly financial statements, together with the required compliance certificates. Further, the project administration unit regularly prepared semi-annual and annual monitoring reports on AccessBank‘s performance. Based on these, ADB‘s monitoring and supervision is rated satisfactory.

ADB‘s role and contribution is rated satisfactory since the ADB loan (i) came at the start of AccessBank‘s ―take-off phase,‖ which allowed AccessBank to reach its achievements; (ii) enabled AccessBank to diversify, improve its funding mix, and minimize asset–liability mismatches; and (iii) reporting requirements assisted in promoting proper disclosure and transparency, thereby helping improve the corporate governance of AccessBank. ADB‘s additionality is also rated satisfactory, given that ADB became one of AccessBank‘s earliest and biggest creditors which helped prove AccessBank‘s creditworthiness, thereby attracting other international investors to invest in and lend to AccessBank. Further, ADB‘s loan has helped more sub-borrowers to benefit.

Given the above, it can be said that ADB‘s loan to AccessBank has helped contribute to

both the bank and Azerbaijan‘s private sector development. Therefore, the project can be considered highly successful overall.

I. THE PROJECT A. Project Background 1. Azerbaijan joined the Asian Development Bank (ADB) in 1999 and signed the Private Sector Operations Framework Agreement in November 2004. This paved the way for the first private sector operations project in Azerbaijan. 2. The Azerbaijan economy has posted record economic growths, averaging 10.6% annually during 2000–2004, due to its oil and gas endowments. The oil sector boom has also benefitted other sectors, with the finance, transport, trade, and construction sectors showing strong growth. The financial system, which is dominated by commercial banks, has also recorded dramatic improvement. Total bank assets amounted to 19.9% of gross domestic product (GDP) in 2004. Though this was higher than previous levels, the level of bank intermediation was still low by international standards. 3. In 2005, a high-level ADB mission to Azerbaijan concluded that private sector operations should be initiated in Azerbaijan. A subsequent mission identified the needs and intervention opportunities in the finance sector. This led to the formulation of ADB's initial private sector activities in Azerbaijan. The report and recommendation of the President for the Proposed Assistance to Private Banks and Leasing Companies in Azerbaijan was approved by the Board in March 2006.1 This project was ADB‘s first private sector project in Azerbaijan. The approval was for total assistance of up to $15 million, consisting of loans and equity investments to private banks and leasing companies. Ten banks were initially short-listed as candidate institutions for the ADB assistance. Fact finding and due diligence missions resulted in the eventual selection of the three banks—Azerigazbank, Bank Respublika, and AccessBank (then called the Micro Finance Bank of Azerbaijan). 4. On 31 August 2006 ADB signed a facility agreement with AccessBank for a $4 million senior loan, the proceeds of which were fully disbursed in October 2006. B. Key Project Features 5. ADB provided a senior unsecured floating rate loan to AccessBank for $4 million payable in 4.5 years. 6. The loan was fully paid on 28 February 2011. C. Progress Highlights 7. In April 2007, AccessBank issued 4.3 million primary new shares which increased the bank's share capital to AZN11 million. All five of the existing shareholders participated in the capital increase, and a new shareholder, Access Microfinance Holding (AccessHolding) joined the company.2 In December 2007, AccessHolding increased its stake to 16.53% (from 9.95%) by buying out the shares of KfW and LFS Financial System (LFS).

1 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Assistance to

Private Banks and Leasing Companies in Azerbaijan. Manila. 2 AccessBank was established in 2002 by four founding shareholders—European Bank for Reconstruction and

Development (EBRD), International Finance Corporation (IFC), Black Sea Trade and Development Bank, and LFS Financial System (LFS). KfW joined as fifth shareholder in 2004. AccessHolding, the sixth shareholder, was established in 2006 by an international group of private and public investors, including LFS, IFC, KfW, and the European Investment Bank, which together own more than 50% of its equity.

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8. In August 2007, AccessBank had its debut bond issue. The first tranche of the 5-year bonds raised $11.4 million. The bond issuance was a landmark transaction that was a triple "first" as it was the first international capital markets bond issue of AccessBank, international capital markets bond issue for an Azeri issuer, and international capital markets bond issue for a single microfinance lender. The second tranche of the bond was issued on February 2008; this raised another $13.6 million and brought the total amount raised to $25.0 million. 9. In 2008, the bank underwent a business restructuring and rebranding exercise to broaden its banking services coverage to better serve its existing client base. As a result of this, the bank was renamed AccessBank from the Micro Finance Bank of Azerbaijan. The bank pioneered the micro finance bank concept in Azerbaijan but through the years it outgrew its original name as it began to provide services other than funding to the micro business community. To date, AccessBank, despite its growth, has continued to cater to the same market segment (micro and small enterprises) instead of shifting to the bigger group of medium-sized and large corporate enterprises. 10. The name ―AccessBank‖ emphasizes the bank‘s mission of providing micro and small enterprises and the underserved market segments with access to a full-range of banking services. These objectives were aligned with ADB‘s purpose of providing such assistance to Azerbaijan‘s finance sector. 11. Also in 2008, the strength of AccessBank was formally recognized by Fitch Ratings when it was awarded a credit rating of BB+ (matching the country ceiling), the highest rating for a private bank in Azerbaijan. This was affirmed in 2010, when the individual rating was increased to D, the highest individual rating of any bank in the country. In 2010, Standard and Poor‘s recognized AccessBank as the ―most transparent bank‖ in Azerbaijan. 12. Through the years, the bank has continued to show strong growth and profitability performance, and in 2010 paid its first dividend (a total of AZN5 million) to shareholders.

II. EVALUATION A. Project Rationale and Objectives 13. Prior to ADB‘s loan to AccessBank in 2006, the Azerbaijani banking sector was dominated by two state-owned banks which together commanded about 50% of the domestic market. ADB‘s loan to AccessBank was aimed at supporting the emerging private banking sector in Azerbaijan. Private banks in 2006 were experiencing rapid growth but remained underdeveloped. Additional capital was being raised through private placements to comply with increased minimum capital requirements and to match rapid asset growth. 14. ADB extended the loan with the hope of promoting private sector development and supporting the goal of the Government of Azerbaijan to develop the non-oil sector in order to achieve broad-based and sustainable economic growth. Private banks started to focus their lending outside the oil and gas sector and were a key source of small and micro loans to the private sector. The loan aimed to further expand AccessBank's support to micro enterprises and small and medium-sized enterprises (SMEs) and thus create employment and livelihood opportunities.

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B. Development Impact and Outcome 15. The development impact and outcome is rated excellent when evaluated using the following criteria: (i) private sector development; (ii) business success; (iii) economic sustainability; and (iv) environmental, social, health, and safety performance.

1. Private Sector Development

a. Beyond Company Impact 16. Strengthening the private banking sector to gradually reduce the dominant market share of public sector (state-owned) banks. At the time when ADB granted the loan to AccessBank in 2006, the private banking sector was at a rudimentary stage of development and the two state-owned banks—the International Bank of Azerbaijan and Kapital Bank—controlled 53% of total banking sector assets, 51% of loans (excluding loans to financial institutions), and 65% of deposits. 17. Buoyed by strong economic growth during 2006–2010 and with the guidance of the Central Bank of the Republic of Azerbaijan (CBA), private banks grew rapidly and became more competitive. In 2008, Kapital Bank was fully privatized, further boosting private banking sector growth. 18. The private banks managed to expand their branch network to 606 branches in 2010 from 295 branches in 2006, despite only three new entrants in 2006–2010. On the other hand, the state-owned banks‘ branch network shrunk to 38 branches in 2010 from 125 branches in 2006 as Kapital Bank was privatized. As a result, the financial intermediation of the banking sector greatly improved and accessibility to financial services was greatly enhanced, as evidenced by the rise in the number of banks to 10.6 per 100,000 people in 2009 from 7.8 per 100,000 people in 2006. Table 1 reflects the growth of the branch network of private banks and the decline in the branch network of state-owned banks.

Table 1: Branches of State-Owned and Private Banks in Azerbaijan, 2006–2010

Bank Branches 2006 2007 2008 2009 2010

State-owned banks 125 125 37 38 38 Private banks 295 360 530 588 606 Total branches 420 485 567 626 644

Source: Central Bank of the Republic of Azerbaijan.

19. Private banks drove the strong expansion of the banking sector during 2006–2010. The assets of private banks grew at a compounded annual growth rate (CAGR) of 49.7% during that period, outpacing the 21.5% CAGR of the assets of state-owned banks. Similarly, the loan portfolio of private banks grew faster, at a CAGR of 45.8% compared to the 34.5% CAGR of the loans of state-owned banks. 20. Public confidence in private banks significantly increased during 2006–2010, resulting in a CAGR of 26.0% in total bank deposits. Private banks largely contributed to the build-up in public confidence, as evidenced by the 44.7% CAGR of their deposits, overshadowing the 10.8% CAGR of deposits of state-owned banks. Table 2 shows the growth of the assets, loans, and deposits of private banks and state-owned banks during 2006–2010.

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Table 2: Total Assets, Loans, and Deposits of Azerbaijan’s Banks, 2006–2010 (AZN million)

Item 2006 2007 2008 2009 2010 Total Assets 3,778 6,726 10,273 11,665 13,291 State-owned banks 1,998 3,011 3,856 3,771 4,358 Private banks 1,780 3,715 6,417 7,894 8,933 Contribution of private banks to total assets (%)

47.1

55.2

62.5

67.7

67.2

Total Gross Loans 2,363 4,682 7,191 8,408 9,163 State-owned banks 1,210 2,284 3,111 3,494 3,958 Private banks 1,153 2,398 4,080 4,914 5,205 Contribution of private banks to total gross loans (%)

48.8

51.2

56.7

58.4

56.8

Total Customer Deposits 2,162 3,411 4,761 4,655 5,449 State-owned banks 1,400 1,981 2,084 1,794 2,112 Private banks 762 1,430 2,677 2,860 3,337 Contribution of private banks to total customer deposits (%)

35.3

41.9

56.2

61.4

61.2

Sources: Fitch Ratings. 2011. CIS/Georgian Banks: Semi-Annual Review and Outlook. New York; International

Bank of Azerbaijan audited financial statements 2006–2010; Kapital Bank audited financial statements 2006– 2007.

21. Capitalization of private banks increased by a CAGR of 44.6% in 2006–2010 (compared with the 11.1% CAGR of state-owned banks). Private banks strengthened their capital base to support rapid asset growth and comply with regulatory requirements. In 2006, only nine out of the 42 private banks were able to meet the AZN10 million minimum capital requirement set by the CBA.3 However, by the end of 2010, 42 out of the 44 private banks had capital of more than AZN10 million. 22. AccessBank has been at the forefront of private banking growth during 2006–2010. It has exceeded private banking sector growth across most banking metrics, and its ascent in the rankings of banks in Azerbaijan attests to the robust performance and scale of growth it has achieved. In 2006, AccessBank was ranked 14th in terms of assets, 12th in terms of loans, 25th in terms of retail deposits, and 30th in terms of capital. By the end of 2010, AccessBank had become one of the top competitors in the banking sector, ranking seventh in terms of assets, sixth in terms of loans, 11th in terms of retail deposits, and fifth in terms of capital. It may seem difficult for AccessBank to become the leader in the banking sector due to its size and target market, but the fact that it has moved from a double-digit ranking to a single-digit ranking within 5 years can be considered a significant achievement and major contribution to the growth of the private banking sector. 23. Promoting development of the non-oil sector to increase employment and livelihood opportunities. A key economic challenge for Azerbaijan is to reduce its dependence on oil and support its non-oil industries to achieve sustainable growth. 24. Private banks direct their lending mainly to non-oil industries. The ratio of private bank loans to non-oil GDP almost doubled to 26.8% in 2010 from 14.5% in 2006. Table 3 shows the rise in the ratio of private bank loans to non-oil GDP.

3 The CBA raised the the minimum capital requirement for new banks to AZN10 million (approximately $11 million)

effective from 1 January 2006. Existing banks were given until 1 July 2007 to comply with this capital requirement.

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Table 3: Ratio of Private Bank Loans to Non-Oil Gross Domestic Product, 2006–2010 (%)

Item 2006 2007 2008 2009 2010

Private bank loans to Non-oil GDP 14.5 23.6 25.9 31.1 26.8 GDP = gross domestic product.

Source: Central Bank of the Republic of Azerbaijan.

25. Table 4 shows the growth of the oil sector and non-oil sector GDP during 2006–2010, and forecast growth in 2011–2012. The growth of the non-oil sector has become stronger, even outperforming the growth of the oil sector in 2008 and 2010. In 2009, the effects of the global recession resulted in a slowdown in non-oil sector growth, while the rise in oil prices bolstered oil sector growth. However, in 2010, the non-oil sector was able to rebound, registering 7.9% growth versus only 1.8% growth for the oil sector. In 2011–2012, it has been projected that growth will be dominated by non-oil activity.4

Table 4: Growth in Oil and Non-Oil Gross Domestic Product, 2006–2012

(%)

Actual Forecast

Item 2006 2007 2008 2009 2010 2011 2012

Total GDP 34.5 25.1 10.8 9.3 5.0 5.8 5.8 Oil 62.0 37.3 6.9 14.8 1.8 4.0 4.5 Non-Oil 11.8 11.3 15.7 3.2 7.9 8.0 8.5

GDP = gross domestic product. Source: Asian Development Bank. 2011. Asian Development Outlook 2011. Manila.

26. With the non-oil sector‘s growth and increased contribution to GDP, the country‘s average unemployment rate has remained at 0.9%–1.0% during 2006–2010, which implies that employment in the country has been sustained.5 27. AccessBank has contributed largely to development of the non-oil sector. The agriculture subsector, which forms part of the non-oil sector, is one of the fastest-growing subsectors. AccessBank leads in lending to this subsector with a total agriculture portfolio of $50 million and 35,000 clients as of the end of 2010. Table 5 shows the agriculture loan portfolio of AccessBank.

Table 5: AccessBank Agriculture Loan Portfolio, 2007–2010

Item 2007 2008 2009 2010

Total agro loans (AZN'000) 3,391 9,991 27,411 37,124 Number of agro loans 2,173 10,013 22,086 31,710 Average agro loan (AZN) 1,430 1,768 1,762 1,835

Source: AccessBank audited financial statements 2007–2010. 28. The launching of the Agro Loan product in 2007 has led to the success and growth of AccessBank‘s loan portfolio. This product is used to finance agriculture and agriculture-related services and businesses that have some seasonal income flows (e.g., businesses selling fertilizers and seeds during the planting seasons) and makes use of flexible disbursal and repayment structures. AccessBank‘s Agro Loan product combined with the continued expansion of the regional branch network has contributed to the successful development of the non-oil sector in Azerbaijan.

4 ADB. 2011. Asian Development Outlook 2011. Manila.

5 Economist Intelligence Unit. 2011. Country Report: Azerbaijan, September 2011. London.

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29. The government also has taken steps to encourage growth in the agriculture sector by attracting foreign direct investment. As a step towards achieving this objective, in March 2008 the government established the Caspian International Investment Company jointly with the Islamic Corporation for the Development of the Private Sector and the Azerbaijan Investment Company, a state investment fund.6 The government continues to provide support for the growth of the agriculture sector.

b. Direct Company Impact

30. Expanding the portfolio of micro and small businesses. AccessBank‘s mission is to provide financial services to micro and small businesses and to low- and middle-income households. When AccessBank obtained the loan from ADB in 2006, it had about 16,000 loan clients and an outstanding loan portfolio of AZN41.6 million. As of the end of 2010, it had a client base of 120,000 (equivalent to a CAGR of 64.7%) and outstanding loans of AZN273.8 million (equivalent to a CAGR of 60.2%).

31. Despite the bank‘s spectacular growth and considering the impact of the 2008 financial crisis in Azerbaijan, AccessBank continues to cater to micro and small businesses. It did not change its strategy or focus to service the middle-sized and large enterprises, as is usual for banks experiencing rapid growth. In fact, in 2007, it even introduced the Agro Loan product to provide financing to agriculture and agriculture-related services and businesses.

32. By the end of 2010, about 92% of AccessBank‘s loans were business loans, comprising 57% micro loans (with an average loan size of AZN1,449) and trust loans (with an average loan size of AZN8,751); 43% of loans were SME loans, with average loan sizes of AZN22,463 for small enterprises and AZN128,500 for medium-sized enterprises. Table 6 shows the breakdown of AccessBank‘s loan portfolio, including the number of clients for each category.

Table 6: Breakdown of AccessBank’s Loan Portfolio, 2006–2010 (AZN ‗000)

Item 2006 2007 2008 2009 2010 Business Loans Micro and trust loans 16.28 36.66 76.28 125.18 142.72 Number of clients 12,152 28,394 44,988 74,114 88,492 SME loans 22.97 48.92 77.94 98.42 108.48 Number of clients 673 1,135 1,579 1,961 2,144 Subtotal business loans 39.25 85.58 154.22 223.60 251.20 Subtotal number of clients 12,825 29,529 46,567 76,075 90,636 Retail Loans Retail loans 1.66 9.66 9.83 11.65 17.27 Number of clients 3,459 17,071 22,553 21,680 29,582 Total business and retail loans 40.91 95.24 164.05 235.25 268.47 Total clients 16,284 46,600 69,120 97,755 120,218

SME = small and medium-sized enterprise. Sources: AccessBank management reports 2006–2007; AccessBank audited financial statements 2008– 2010.

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The Caspian International Investment Company increases foreign direct investments by making equity investments in new and existing entities in growth sectors of the economy compliant with Shariah principles. The company targets all sectors except for exploration and production of oil and gas.

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33. AccessBank has increased its portfolio without sacrificing portfolio quality. It has exercised responsible lending both in retail and business lending, ensuring that its clients are not burdened by debt which they may not be able to afford. The bank‘s commitment to this principle has been demonstrated by its exceptionally low arrears rates. AccessBank has one of the lowest portfolios at risk (PARs) >90 days at 0.72% compared to the banking sector‘s 13.4%. 34. Improving the ability to raise deposits and issue bonds. When ADB disbursed the loan in 2006, AccessBank had only AZN3.3 million in deposits. With ADB‘s presence coupled with AccessBank‘s strong performance the bank was able to gain a strong reputation in the market which allowed it to increase its deposits to AZN126.7 million as of the end of 2010 (Table 7).

Table 7: AccessBank Deposit Growth, 2006–2010

Item 2006 2007 2008 2009 2010

Total deposits (AZN'000) 3,274 12,134 21,852 64,999 126,671 Number of deposit accounts 5,538 11,864 28,158 114,507 181,635

Sources: AccessBank audited financial statements 2006–2010; AccessBank management reports 2006–2010.

35. With the rise in AccessBank‘s deposits, the bank was able to diversify its funding sources and in turn improve its funding mix. During 2006–2010 the loan–deposit ratio decreased (Table 8).

Table 8: AccessBank Loan–Deposit Ratio, 2006–2010

Item 2006 2007 2008 2009 2010

Total deposits (AZN'000) 3,274 12,134 21,852 64,999 126,671 Total loans (AZN'000) 41,587 95,964 167,785 240,275 273,820 Loan to deposit ratio (%) 1,270 791 767 369 216

Source: AccessBank audited financial statements 2006–2010.

36. AccessBank also accessed the international markets for additional funding. In 2007, it completed the first closing of its debut bond issuance by initially issuing $11.4 million of 5-year bonds through DWM Securitizations, a Luxembourg securitization vehicle. In February 2008, AccessBank completed the second closing of its debut bond issuance by issuing an additional $13.6 million of 4.5-year bonds, using the same securitization vehicle, bringing the total amount raised for both bond issuances to $25.0 million.7 This was the first international capital markets bond issue of AccessBank. It was also the first international capital markets bond issued for an Azeri issuer and the first international capital markets bond issue for a single microfinance lender anywhere.8 These bonds brought in new stakeholders to the bank and started a track record for AccessBank‘s bond issues. The fact that AccessBank was able to successfully issue bonds in 2008 during uncertain market conditions arising from the financial crisis was a demonstration of investor confidence in the bank. 37. Adopting better practices for critical banking functions. AccessBank has been committed to pursuing the highest standards and international best practices in banking. 38. The organizational structure of the bank outlines clearly defined duties and responsibilities. Work processes are clearly delineated and documented in policies,

7 AccessBank issued bonds through DWM Securitizations and in turn a term loan was granted to AccessBank by

DWM Securitizations. 8 AccessBank. 2008. Micro Finance Bank of Azerbaijan Completes $25 Million Bond Issue. Baku.

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procedures, and job descriptions. Revision and improvement of these policies and procedures is a continual and constant process. 39. AccessBank adopted detailed procedures for managing anti-money-laundering and anti-terrorist financing issues, which were centered on a strict know-your-client policy and which served to protect the citizens and laws of Azerbaijan. The procedures were prepared in accordance with the Financial Action Task Force and other international recommendations. 40. In 2007, AccessBank received an Alpha rating from M-CRIL, a microfinance rating agency. In awarding the Alpha rating, M-CRIL highly recommended the bank to international investors based on strong leadership, excellent management systems including a Management Information System (MIS), and good asset quality. 41. In 2009, AccessBank was named one of the three most sustainable banks of Eastern Europe in the 2009 Financial Times Sustainable Banking Awards, with the main criteria being environmental, social, and corporate responsibility and corporate governance. 42. AccessBank‘s leading commitment to corporate governance was confirmed in 2010 by the Standard and Poor‘s ratings agency which ranked AccessBank as the "most transparent bank" in its inaugural transparency and disclosure survey of Azerbaijan‘s banking sector.

43. Achieving sustainable operations that allow for increased financial intermediation while coping robustly with inevitable business cycles. When ADB disbursed the loan in 2006, AccessBank had negative earnings. Due to the growth of its loan portfolio and improved operational efficiencies, the bank became profitable in 2007 and has consistently posted robust performance since. The bank ranked 35th in 2006 in terms of net income before tax; in 2010, it was the second most profitable bank in Azerbaijan. 44. In 2009, the year when the global financial crisis peaked and gripped much of the global banking sector, AccessBank recorded significant growth and expanded its outreach, doubling its regional branch network and increasing its client base. Its assets and loan portfolio grew without needing to access government assistance for its liquidity requirements.9 The growth was achieved without compromising portfolio quality, a testament to the strength of AccessBank‘s risk management and commitment to responsible lending. 45. During the global turmoil in 2008, the strength of AccessBank was formally recognized by Fitch Ratings when it was awarded a credit rating of BB+ (matching the country ceiling), the highest rating for a private bank in Azerbaijan. 46. During the economic cool down in 2009–2010, when liquidity continued to be very tight and business had not yet recovered, AccessBank continued to expand its branches outside of Baku and increase its loan portfolio while successfully managing the increased risk. As a result, the total value of all loans with past due of over 30 days remained at 1% of the total portfolio.

47. The exceptional quality of AccessBank's loan portfolio and its profitability has allowed it to effectively carry out its mission of serving micro and small businesses and contribute to sustainable economic growth.

9 Based on the International Monetary Fund Country Report (May 2010), the CBA provided around $1.1 billion in

liquidity support to Azerbaijani banks in 2009.

9

48. In 2010, Euromoney, in its annual Awards for Excellence, named AccessBank the ―Best Bank in Azerbaijan.‖ The Azeri Business Awards named AccessBank chief executive officer ―Banker of the Year‖ for 2010.

c. Overall Assessment of Private Sector Development 49. In 2006, the private banking sector in Azerbaijan was in the early stage of development and was dominated by state-owned banks. Under the guidance of the CBA and underpinned by the country‘s solid economic growth, private banks grew rapidly and became more competitive. They outpaced state-owned banks and eventually dominated the market. AccessBank not only thrived amidst these changes in the banking sector as a whole but also outperformed the private banking sector in most performance metrics. Supported by a culture of strong corporate governance, the robust growth of the bank translated to greater impact in terms of outreach and penetration of the micro and SME market. The bank serves as a model of best practice and its success has motivated many other banks to copy its practices. In this regard, the contribution of the ADB assistance to private sector development is rated excellent.

2. Business Success 50. Financial performance. AccessBank demonstrated strong overall financial performance during 2006–2010. Financial highlights are shown in Table 9, and the bank‘s ratios are presented in Table 10.

Table 9: AccessBank Financial Highlights, 2006–2010 (AZN ‗000)

Item 2006 2007 2008 2009 2010

Balance Sheet Liquid assets 5,172 12,931 22,243 56,435 64,868 Total assets 48,281 112,636 193,915 300,772 366,023 Total deposits 3,274 12,134 21,852 64,999 126,671 Total liabilities 42,323 98,792 160,616 247,487 291,568 Total equity 5,958 13,844 33,299 53,285 74,455 Income Statement Net interest income 5,358 14,212 32,926 49,465 62,114 Net non-interest income 495 1,766 728 995 1,856 Gross operating income 5,853 15,978 33,654 50,460 63,970 Net income/(loss) (243) 3,599 10,455 19,986 26,170

( ) = negative. Source: AccessBank audited financial statements 2006–2010.

Table 10: AccessBank Selected Financial Ratios, 2006–2010

(%)

Item 2006 2007 2008 2009 2010

Return on equity (4.00) 36.35 44.35 46.17 40.97 Return on assets (0.71) 4.47 6.82 8.08 7.85 Cost to income 96.34 62.93 53.86 55.25 55.74 Liquid assets to total assets 10.71 11.48 11.53 18.76 17.72 Equity to assets 12.34 12.29 17.17 17.72 20.34 Deposits to liabilities 7.74 12.28 13.61 26.26 43.44 Loans to deposits 1,270.22 791.87 767.82 369.66 216.17 PAR >30 days 0.45 0.04 0.56 0.86 1.00 PAR >90 days 0.04 0.03 0.24 0.77 0.72

( ) = negative, PAR = portfolio at risk. Source: AccessBank audited financial statements 2006–2010.

10

51. Profitability. AccessBank reported a AZN0.2 million net loss in 2006. The loss stemmed from the cost of management services that was fully borne by the bank, starting in 2006. In earlier years, a significant portion of the management cost was financed by international donors as part of technical assistance grants, which ended in 2005. However, in 2007, AccessBank rebounded, reporting a bottom line result of AZN3.6 million net income after tax, driven by its aggressive loan growth. AccessBank has since consistently shown strong profitability. 52. The bank‘s profitability has been supported by a high net interest margin. The bank generates wide interest margins to cover expenditures for the continuous operation of branches located in remote areas. Unlike commercial banks, AccessBank is compelled to open and operate remote branches to service the requirements of the micro and small businesses in those locations. Net interest income derived from lending operations was the bank‘s main revenue source (97% of total revenues in 2010) and this grew at a CAGR of 84.5% during 2006–2010. The rest of the bank‘s revenues are non-interest income obtained mostly from fees and commissions and foreign currency trading gains. Net non-interest income grew at a CAGR of 39.2% during 2006–2010.

53. Operating expenses grew at a CAGR of 58.6% during 2006–2010. The bank‘s cost–income ratio steadily fell to 55.7% by the end of 2010 from 96.3% at the end of 2006. A high cost–income ratio is a characteristic of micro lending but the bank brought down the ratio as it achieved economies of scale and efficiency gains from rapid portfolio growth, improved systems, and more experienced staff.

54. As a result of robust earnings and improved cost efficiency, AccessBank‘s return on assets and return on equity are among the highest in the Azerbaijani banking sector. 55. Asset quality. Asset quality remained sound and resilient throughout the financial crisis. The loan portfolio, which accounted for 75% of total assets, grew at a CAGR of 60.2% during 2006–2010. As of the end of 2010, only 1.23% of its total outstanding portfolio was in arrears. The portfolio at risk (PAR) >30 days was 1.00% and PAR >90 days was 0.72%, which are among the industry‘s lowest.

56. A strong focus on asset quality has allowed the bank to have low arrears rates despite the rapid loan growth. Focus on asset quality was underpinned by a strong culture of good governance. The bank also has a good system of tracking overdues. Its MIS generates a list of overdue accounts each day, which were required to be followed up by loan officers immediately through telephone calls and visits to the clients.

57. The salaries of loan officers are also correlated with the quality of loans issued rather than with the volume of loans. Loan officers are personally responsible for the quality of disbursed loans and are motivated to monitor the loan book, as their remuneration depends not only on the achieved growth results relative to the budget but also on the asset quality of their individual outstanding loan portfolio.

58. Liquidity. AccessBank has a high level of liquidity. Liquid assets to total assets have risen from 10.7% in 2006 to 17.7% at the end of 2010.

59. Deposits grew significantly during 2006–2010, registering a CAGR of 149.4%. This brought down the loans–deposits ratio to 216% as of the end of 2010 from 1,270% in 2006. AccessBank‘s strong performance has increased public confidence to bank and maintain deposits with them. In 2009, the year when the financial crisis struck Azerbaijan, the bank‘s campaign promoting its business loans turned out to be its best deposit campaign, conveying

11

the message that it was business as usual in AccessBank, unlike other banks which had restrained lending due to the financial crisis. The effect of the campaign was a migration of depositors from other banks to AccessBank.

60. Capital position. AccessBank is well capitalized. Table 11 shows that the bank‘s tier 1 capital adequacy ratio (CAR) and total CAR have always been above the regulatory requirements of 6% for tier 1 CAR and 12% for total CAR.

Table 11: AccessBank Capital Adequacy Ratios, 2006–2010

(%)

Item 2006 2007 2008 2009 2010

Tier 1 capital adequacy ratio 13.3 13.6 18.8 21.6 24.8 Total capital adequacy ratio 13.4 20.4 24.6 26.2 28.2

Source: AccessBank audited financial statements 2006–2010.

61. Aside from strong shareholder support, the bank‘s capital position has improved because of the company‘s good capital generation, a result of plowing back all of its net income in 2006–2009 and most of its 2010 profits to retained earnings. Since its establishment, AccessBank has not declared any cash dividends other than in 2010. The bank also availed itself of the government‘s incentive that allows tax exemption on income that was capitalized starting from 2009. 62. Return on invested capital. The time-adjusted real financial return on invested capital (ROIC) was used as a proxy to derive the financial internal rate of return. AccessBank‘s ROIC was computed based on the bank‘s paid-in capital, long-term debt, net income after tax, and terminal value then adjusted for inflation. The terminal value was arrived at by deriving the present value of the bank‘s future cash flows.

63. The resulting ROIC adjusted for inflation is significantly greater than the hurdle rate, and therefore the project merits a rating of excellent based on the Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations.10 AccessBank's impressive ROIC was due to its robust financial performance underpinned by strong profitability.

3. Economic Sustainability

64. Economic return on invested capital. To quantitatively assess the contribution to economic development of ADB's loan to AccessBank, the economic return on invested capital (EROIC) was calculated. 65. AccessBank achieved a high real EROIC after adjusting for inflation during 2006–2010 due to improved profitability from 2006 as the bank expanded its loan portfolio. The bank has contributed to the development of the non-oil sector of the economy through diversifying its loan portfolio, particularly through expanded lending to micro businesses and SMEs, which eventually contributed to the creation of jobs and employment. The bank also made a positive contribution to the Azerbaijan economy by way of payment of corporate income taxes. 66. Based on the Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations, ADB‘s loan to AccessBank is rated excellent, as the resulting EROIC was considerably greater than the hurdle rate.

10

ADB. 2007. Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations. Manila.

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67. Environment. ADB‘s loan to AccessBank was classified category FI (financial intermediary) under ADB's Environment Policy (2002). An FI project involves a credit line or an equity investment to a financial intermediary where an environmental management system (EMS) is required unless all subprojects have insignificant environmental impacts. Based on the terms of the loan, AccessBank was required to establish an EMS that set out the procedures for the screening of sub-borrowers and the activities to be financed by the loan. This was to ensure that borrowers complied with applicable environmental laws and regulations. 68. AccessBank‘s EMS is in place to ensure that it finances only environmentally and socially sound projects and businesses. In 2004, the bank established environmental management procedures, which were based on European Bank for Reconstruction and Development (EBRD) requirements and were benchmarked against international standards. The environmental procedures were strengthened with the implementation of the Environmental and Social Policy and Risk Management Plan in September 2010. This document outlines AccessBank‘s plan with regard to the activities of the bank as well as the activities of businesses financed by it.

69. Overall, the responsibility for ensuring that management adheres to the bank‘s EMS lies with the Internal Audit Department, and the head of internal audit was appointed as AccessBank‘s environmental officer. The bank‘s EMS and procedures are adhered to from the time the sub-borrower‘s loan is pre-approved until the time the loan has been fully paid.

70. To date, AccessBank has strictly implemented the EMS procedures and has not made any exceptions. 71. Social safeguards. The ADB loan was classified as a category C project. There were no involuntary resettlement or impacts on indigenous peoples resulting from AccessBank‘s activities. 72. In 2009, AccessBank was named one of the three most sustainable banks of Eastern Europe in the 2009 Financial Times Sustainable Banking Awards, with the main criteria being environmental, social, and corporate responsibility and corporate governance.

73. Given AccessBank‘s compliance efforts with regard to environmental standards, practices, and procedures, the ADB assistance is rated satisfactory.

C. ADB Investment Profitability 74. ADB‘s investment profitability is rated satisfactory. 75. The interest rate margin charged on ADB's senior unsecured loan was based on prevailing market pricing in 2006. Due to inadequate public data, ADB's loan was specifically benchmarked to loans made to AccessBank by other international financial institutions (IFIs) during the same period. 76. AccessBank paid the interest and applicable principal in a timely manner. The repayment of principal started on 31 August 2007 and was fully repaid on 28 February 2011. D. ADB Work Quality 77. ADB's work quality is rated satisfactory based on screening, appraisal, and structuring of the project; monitoring and supervision; and its role and contribution.

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1. Screening, Appraisal, and Structuring of the Project 78. ADB's loan to AccessBank was part of a $15 million lending program to Azerbaijan. The program aimed to strengthen the Azerbaijani private banking sector in a transition economy where the banking system was still dominated by state-owned banks. This was consistent with ADB's country strategy, which identified private sector development as an important thematic priority 11 The program extended loans to three banks, including AccessBank. Prior to selecting the three banks, ADB conducted fact-finding and due diligence missions, wherein most of the top-tier banks in Azerbaijan were considered as candidates. Selection criteria included development impact, additionality, potential to implement strong governance, and commercial considerations (e.g., strength of franchise and preliminary pricing discussions). As it was the first time that ADB was to enter the Azerbaijani private sector, the activities of other development partners in the Azerbaijani banking sector—DEG, EBRD, IFC, and KfW—were taken into consideration. 79. Due diligence was carried out with the assistance of an external consultant with strong expertise in the local banking sector. Findings revealed that AccessBank had strong management and governance, good credit processes, low delinquency rates, and adequate capital over the other top tier banks.

80. AccessBank is majority owned by IFIs. Initially, the bank's shareholders funded it during its start-up phase, but the bank started to diversify its funding base by accessing other development institutions, including ADB. To support the expansion of its lending activities, AccessBank focused on raising debt rather than equity to strengthen its leverage position and lower its cost of capital. ADB‘s involvement in AccessBank has acted as a catalyst in raising leverage and liquidity in a very short period. Working with AccessBank has provided ADB with access to important know-how and experience in Azerbaijan‘s SME lending sector, which has been useful for ADB's activities with other banks. 81. ADB's screening, appraisal, and structuring of its assistance is rated satisfactory.

2. Monitoring and Supervision 82. The project administration unit (PAU) of ADB‘s Capital Markets and Financial Sectors Division regularly monitored AccessBank‘s overall business and financial performance following loan approval and disbursement. The bank submits unaudited quarterly financial statements and audited yearly financial statements, together with the required compliance certificate. AccessBank was compliant with all the financial covenants. The PAU regularly prepared a quarterly private sector investment management report to summarize business performance and evaluate financial results. However, this report was replaced by the private sector semi-annual report, a more comprehensive monitoring tool launched in 2010, which includes monitoring of sovereign, industry, and development effectiveness of the account. The PAU also prepares an annual monitoring report that contains macroeconomic analysis, financial performance review, and risk rating calculation. The report is submitted to the Office of Risk Management. 83. ADB's monitoring and supervision is rated satisfactory.

11

ADB. 2006. ADB Country Strategy and Program for Azerbaijan. Manila.

14

3. ADB's Role and Contribution 84. The management of AccessBank characterized the years 2006–2010 as the ―take-off‖ phase of the bank‘s development. The ADB loan came at the start of the take-off phase and, as such, the assistance became a springboard for the bank‘s achievements in the years that followed. 85. In 2006 AccessBank suffered a net loss from the full assumption of operating costs that were previously financed through technical assistance grants. The ADB assistance provided support through growth of the loan portfolio which helped the bank grow in 2007. 86. AccessBank was still rolling out its deposit products in 2006. Hence, ADB‘s funding was very timely in supporting the expansion of AccessBank‘s loan portfolio. In addition, ADB‘s presence in the bank gave the public additional confidence to bank and maintain deposits with AccessBank.

87. The ADB loan has also allowed AccessBank to diversify, improve its funding mix, and minimize asset–liability mismatches. Further, the financial covenants put in place aided in ensuring that AccessBank‘s financial position remained sound. This enabled the bank to expand its loan portfolio, thereby continuously providing funding to micro and small and medium-sized businesses even during the global economic slowdown. The reporting requirements in the covenants reporting also assisted AccessBank in fostering proper disclosure and transparency, which contributed to improved governance.

88. Given the above-mentioned development impacts, ADB's role and contribution is rated satisfactory. E. ADB’s Additionality 89. AccessBank issued the first tranche of its debut bonds in August 2007. At the time of the bond issuance, the ADB loan was AccessBank's fourth-largest nonshareholder loan. The involvement of ADB as one of AccessBank‘s earliest and biggest creditors has helped prove the creditworthiness of the bank. This has attracted international investors, thereby contributing to the success of the bank‘s bond issuance, which was hailed as a landmark transaction not only for the bank but also for Azerbaijan as a whole. 90. The size and term of ADB‘s loan has benefitted a great number of beneficiaries or sub-borrowers. According to AccessBank management, the ADB loan of $4 million has funded around 1,200 entrepreneurs at one time and the relatively short loan terms of these type of loans (average of less than 1 year) meant that the funds were re-lent four times on average over the period of the loan. As such, the loan on average had an impact on about 4,800 businesses over the 4.5-year loan period.

91. ADB's additionality is rated satisfactory. F. Overall Evaluation 92. Overall, ADB‘s loan to AccessBank is rated highly successful. Table 12 shows a summary of the individual category ratings.

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Table 12: Evaluation of ADB's Loan to AccessBank

Item Unsatisfactory Partly

Satisfactory Satisfactory Excellent

A. Development Impact and Outcome √ 1. Private sector development √ 2. Business success √ 3. Contribution to economic

development √ 4. Environment, social, health, and safety √ B. ADB Investment Profitability √ C. ADB Work Quality √

1. Screening, appraisal, and structuring √

2. Monitoring and supervision √

3. ADB's role and contribution √

D. ADB's Additionality √

Overall Rating Highly Successful ADB = Asian Development Bank. Source: ADB staff.

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

93. Overall, cooperation with AccessBank was pleasant, professional, and mutually beneficial. When asked, however, if AccessBank would enter into future financings of the same kind again, the bank pointed out that the length and complexity of ADB's approval process would make it less attractive to do similar financings with ADB in the future. The length of ADB's approval process is often not conducive to private sector transactions whose participants are accustomed to swifter execution. Particularly in the case of financial institutions with significant know-how from more developed markets (such as AccessBank), the clients' processes may be significantly faster than ADB's. ADB should shorten approval processes so it is better able to attract cooperation with the best financial institutions in each of its developing member countries.

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PROJECT-RELATED DATA A. Overview 1. AccessBank, headquartered in Baku, was established as a closed-type joint-stock bank on 29 October 2002 as the Micro Finance Bank of Azerbaijan. In September 2008 it changed its name to AccessBank. The bank has six shareholders led by AAA-rated international financial institutions that are committed to the development of Azerbaijan and micro finance. At the end of 2010 the nominal value of AccessBank was AZN41.8 million, consisting of 20 million shares with a par value of AZN2.09 per share. Through capitalization of retained earnings, the share capital was increased by a further AZN26.0 million in March 2011 to AZN67.8 million. As a result, the par value per share increased to AZN3.39 per share but the distribution and number of shares remained the same. 2. AccessBank was ranked seventh among the 44 private banks in Azerbaijan in terms of total banking assets at the end of 2010. The bank maintained its market leading position in micro and small business lending. AccessBank has been known for its efficiency and transparency, and recognized for its good practice in terms of client protection. B. Products and Services 3. AccessBank groups its operations into two major categories: business banking and retail banking. Business banking deals with both domestic and foreign corporate clients, while retail banking caters to household and retail clients such as families and employees.

4. Business banking. AccessBank‘s business banking services include the following:

(i) Business loan portfolio. AccessBank‘s business portfolio is broken down by size of loan at disbursement. Loan size is segmented into micro loans, ranging from $100 to $10,000; trust loans, ranging from $10,001 to $20,000; and small and medium-sized enterprise (SME) loans, which are loans over $20,000. The micro segment continued to dominate in terms of number of loans disbursed and total amount disbursed. In 2010, a total of 87,000 micro loans (95% of total business loans disbursed) were disbursed. This was nearly twice the total amount disbursed to SME clients in 2010, demonstrating AccessBank‘s continued focus on the micro product. The trust loan segment posted the most significant growth in 2010, with the outstanding portfolio increasing by 47% (equivalent to 1,700 loans disbursed). The trust loan was introduced in 2008 to further improve efficiency in micro loan lending. The SME portfolio grew by 11% in 2010. A total of 1,781 SME loans were disbursed in 2010.

(ii) Corporate services. AccessBank set up a corporate services department to meet more sophisticated financial services needs of clients, such as specialized products and payroll management solutions. The department is also tasked to seek out and serve the larger domestic and foreign companies which require corporate banking services and/or funding.

5. Retail banking. The bank‘s retail banking products and services include the following:

(i) Deposits and current accounts. The growth of deposits in 2010 remained extremely strong after exceptional growth in 2009, with total deposits increasing by 95% in 2010 after growth of 197% in 2009. This in turn improved the bank‘s loan–deposit ratio from 767% in 2008 to 369% in 2009 and 216% in 2010.

(ii) Money transfer systems. International remittances from family members working abroad are a vital source of revenue for many low-income Azerbaijani

Appendix 1

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families. To serve this market, AccessBank offers clients a range of leading international money transfer systems for account and non-account holders, including Western UnionCoinStar (formerly Travelex), Bistraya Pochta, PrivatMoney, Caspian Money, and Contact, the last four being oriented to the Commonwealth of Independent States where the majority of Azerbaijani migrant workers seek employment. The total number of transactions via these systems grew by 24% to 37,500 in 2010, while the total amount transferred increased by 18%.

(iii) VISA cards. In 2010, AccessBank strengthened its plan to increase the client base for the Bank‘s VISA-branded plastic cards through salary projects, expansion of the automated teller machine network, and wider acceptance. Features of the AccessBank VISA Cards include a multicurrency option, meaning that the cards can be linked to Azerbaijan manat, United States dollar, and euro accounts, allowing the user to make purchases in any of the three currencies, both in Azerbaijan and abroad, without incurring any currency conversion fees or commissions—a first for Azerbaijan. Other features include card-to-card transfers and payment for mobile phone services and utilities through automated teller machines. One of the objectives in introducing the VISA debit cards was to encourage clients to use their current accounts and keep excess cash on deposit in AccessBank. With salary projects, employees receive their salaries via their AccessBank debit cards.

(iv) Retail lending. Retail lending serves three strategic objectives of AccessBank: extending funding access to low- and middle-income households; helping AccessBank develop a retail client base, a market where AccessBank was relatively unknown and which is essential for attracting deposits; and strengthening links with SME and corporate clients by providing financing to their customers and employees. AccessBank‘s range of retail loans includes the following: (a) Partner loans. This was the first retail loan product introduced in 2006 to

help families finance the acquisition of core household goods. Under the Partner Loan product, AccessBank teamed up with some of its SME clients who are retailers of electrical goods, household appliances, and furniture. The retailers direct their customers to AccessBank for funding. There are also cases where the retailers would provide a credit guarantee, if necessary.

(b) Auto loans. These were introduced in 2007 to fund the purchase of vehicles

(c) Cash loans. These were introduced in 2009 for individuals with stable professions.

(d) Deposit loans. In 2009, the bank allowed clients to obtain short-term loans secured by their own deposits. This way, borrowers need not terminate their deposits with the bank.

6. As of the end of 2010, the retail loan portfolio increased by 48% year-on-year (equivalent to 30,000 loans). The retail loan portfolio comprised 6.3% of the total loan portfolio. AccessBank is committed to developing retail lending responsibly to ensure that clients are not overburdened with debt. Management has actively restrained the growth of this business by strictly limiting the number of retail partners with which it works, developing restrictive retail loan products, and observing stringent limits on debt–income ratios of loan applicants.

Appendix 1

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C. Organizational Structure

1. Ownership Structure 7. Table A1.1 shows the ownership structure of AccessBank.

Table A1.1: Ownership of AccessBank as of 30 December 2010

Shareholder Number of

Shares % Ownership

Black Sea Trade and Development Bank 4,000,000 20.00 European Bank for Reconstruction and Development 4,000,000 20.00 International Finance Corporation 4,000,000 20.00 KfW 4,000,000 20.00 Access Microfinance Holding 3,306,000 16.53 LFS Financial Systems 694,000 3.47 Total 20,000,000 100.00

Source: AccessBank 2010 Annual Report.

2. Organization

8. Table A1.2 shows the current supervisory board of directors of AccessBank.

Table A1.2: AccessBank Supervisory Board of Directors

Board Member Title

Michael Jainzik Chair Syed Aftab Ahmed Member Orhan Aytemiz Member Thomas Engelhardt Member Victoria Miles Member

Source: AccessBank 2010 Annual Report.

9. Table A1.3 shows the management board of directors of AccessBank.

Table A1.3: AccessBank Management Board of Directors

Board Member Title

Andrew Pospielovsky General manager and chair Rufat Ismayilov Deputy general manager and infrastructure director Shakir Ragimov Business banking director Anar Gasanov Retail and operations director Elshan Hajiyev Finance director

Source: AccessBank 2010 Annual Report.

10. The highest decision-making body in AccessBank is the general assembly of shareholders, which met five times in 2010. The general assembly appoints the five members of the supervisory board; the members of the management board; and the members of the Audit, Risk, Asset Liability (ALCO), and Information Technology (IT) committees. The general assembly of shareholders also determines the remuneration of the supervisory board and audit committee members. Other responsibilities include selecting the external auditor, creating reserves, approving extraordinary audits, and approving branch openings and closing. The general assembly of shareholders also has the authority to decide on matters pertaining to the

Appendix 1

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shares of the bank, distribution of profit, increases in charter capital, issuance or listing of shares, and selling of shares to any party.

11. The supervisory board determines the business policy of the bank and oversees the work of the management board and the bank‘s committees. None of the supervisory board members own shares in the bank and they are remunerated for their attendance in meetings at a fixed rate. 12. Day-to-day business is directed by the five-member management board, with the chair (also known as the general manager) having the overall responsibility for the management of the bank. The compliance officer and the legal and human resources departments report directly to the chair of the board. The general manager is supported by four directors—for business banking, retail and operations, infrastructure, and finance. Branch managers also report to the management board. The remuneration of the management board is determined by the supervisory board and may include annual bonuses in relation to the performance of the bank. No managers or employees of AccessBank are shareholders of the bank. 13. AccessBank recognized that, as the economy slowed down and while the bank continued to expand, risks were also escalating; hence, strengthening risk management and control remained critical. Four committees were created—the audit, risk, ALCO, and IT committees—to ensure that the risk management process of the bank is continuously and constantly reviewed.

(i) Audit Committee. The Audit Committee is appointed by the general assembly of shareholders and reports directly to the supervisory board and the general assembly of shareholders. The committee oversees the work of the Internal Audit Department and reviews the work of the external auditors. It consists of three members with a broad range of local and international audit and banking experience.

(ii) ALCO Committee. The ALCO Committee is appointed by and reports directly to the supervisory board. On a monthly basis the committee reviews liquidity, maturity, currency, interest rate matching, and compliance with regulatory norms and loan covenants including capital adequacy and large loan exposures. The committee consists mainly of the management board and the head of treasury.

(iii) Risk Committee. The Risk Committee is appointed by and reports directly to the supervisory board. The committee monitors and reviews on a quarterly basis systemic and bank-specific risks including sector, currency, liquidity, refinancing, market, and operational risks. The committee also reviews macroeconomic and social developments in Azerbaijan and how this could impact the business of the bank. The committee makes recommendations to the bank‘s management on adjustments to lending and refinancing policy. The committee consists of the management board and the head of risk.

(iv) IT Committee. The IT Committee is appointed by and reports directly to the supervisory board. The committee monitors and manages IT issues in AccessBank on a quarterly basis, including IT investments, development projects, and communication links between the branches and the head office. The committee consists of the management board and the head of IT.

14. AccessBank‘s professionally trained and highly motivated team is the foundation of its success. The bank takes pride in the transparent and equal-opportunity staff selection and promotion process. The bank recruits primarily university graduates, valuing integrity and motivation over previous banking experience. Professional and banking skills are taught to new staff through extensive training, most of which is conducted through in-house seminars and on

Appendix 1

20

the job. The rapid growth of the bank offers dynamic career opportunities. Management positions that were initially held by foreign managers have been filled by local candidates from within the institution, with only the general manager position still filled by an expatriate. As a result, AccessBank can rely on a team of experienced, tested, confident, and loyal employees who are willing to work and think independently. 15. Figure A1.1 shows the organizational chart of AccessBank as of the end of 2010. D. Risk Management 16. Since the creation of the four committees overseeing the risk management process, the department has grown to eight staff and is responsible for (i) reviewing all exposures over $100,000, (ii) undertaking selective portfolio reviews, and (iii) performing strategic monitoring and analysis in all aspects of risk. The efficacy of the control mechanisms and risk management in AccessBank is subject to constant review by the internal audit function. At the end of 2010 the Audit Department had nine full-time staff who audit each branch and head office department twice a year. The technical development of risk management in the bank is also supported by business risk and audit specialists from LFS Financial Systems (LFS) in Berlin at the AccessHolding level. AccessBank‘s business success is reliant on the bank‘s IT systems for its day-to-day operations and management information. All branches are connected online, and all business is fully integrated through a central database. This provides management with instant up-to-date information on all activities, available at any time on their desk-top computers, contributing to management‘s control capacities and risk management. This will be further strengthened by the introduction of the Temenos T24 system, which has been vetted throughout internationally respected banks over many years. The migration of the bank‘s core banking software to Temenos T-24 MCB will continue throughout 2011–2012.

1. Credit and Operational Risk Management 17. Credit and operational risks are the major risks faced by AccessBank. Credit risk management was strengthened significantly in 2005 with the creation of a head office credit management unit to oversee business lending. This relieved senior loan officers of direct lending duties, allowing them to concentrate fully on managing, controlling, training, and supervising loan officers in branches. At the branch level, credit and operational risks are essentially managed through strict policies and procedures and segregation of functions. Senior loan officers, senior back office specialists, chief cashiers, and heads of SME are dedicated to training, supervising, and controlling their respective teams. They are supported by their branch manager and head office business and departmental heads. The matrix control structure of hierarchical subordination to the branch manager, with technical supervision by head office business managers, has proven to be not only efficient but also effective in ensuring that policies and procedures are adhered to and risk is well managed.

2. Currency and Liquidity Risk Management 18. Currency and liquidity risk is managed on a daily basis by the Treasury Department, finance director, and general manager of the bank. Currency risk is mitigated by minimizing currency mismatches by lending in local and foreign currency in accordance with the bank‘s local and foreign currency resources. Management of currency, liquidity, and interest rate risk is reviewed on a monthly basis by the ALCO Committee and at least on a quarterly basis by the Risk Committee and supervisory board. With the increase in noncredit operations, anti-money-laundering and anti-terrorist financing procedures become even more important. AccessBank has adopted detailed procedures for managing both issues, which are centered on a strict

Appendix 1

21

know-your-customer policy and which serve to protect the citizens and laws of Azerbaijan. The procedures were prepared in accordance with the Financial Action Task Force. E. Liquidity 19. In 2010 AccessBank met most of its refinancing needs through increased deposits and retained earnings. The bank obtained only $25.5 million in borrowings in 2010 and rolled over a further $5.5 million. This amount is significantly less than the $70.0 million obtained in 2009 and $81.0 million in 2008. 20. The $25.5 million in new borrowings were as follows: (i) an Azerbaijan manat-denominated loan of $10 million from the EBRD; (ii) a $3 million loan from DWM Income Funds, also denominated in Azerbaijan manats, (iii) $5 million from the OPEC Fund for International Development, and (iv) $7.5 million from the Microfinance Enhancement Facility. Three expiring loans from Triodos Fair Share Fund and Triodos Doen totaling $5.5 million were rolled over. While the amount of international refinancing required in 2010 was relatively small, the bank faced no shortage of funding from international lenders. This position is reinforced by the continuing annual reconfirmation of AccessBank‘s BB+ long-term issuer default rating by Fitch Ratings, the highest rating given to any private bank in Azerbaijan.

Appendix 1

22

Figure A1.1: AccessBank’s Organizational Chart as of December 2010 ALCO = Asset Liability Committee, IT = Information Technology, SME = small and medium-sized enterprise. 1

The management board consists of the general manager and chair of the board and the directors of business banking, retail and operations, infrastructure, and finance. Source: AccessBank 2010 Annual Report.

Branch Managers

General Manager and Chair of the Management Board

Legal Advice

Human Resources

Compliance Officer

Finance Director

Accounting

Financial Control

Treasury

Retail and Operations

Director

Payment Cards

Cashiers

Retail and Operations

Deputy Director

Banking Services

Retail Lending

Retail and Operations

Methodology and

Development

Call Center

Marketing

Infrastructure Director

Administration

Security

IT

Business Banking Director

SME

Micro Lending

Credit Back Office

Corporate Services

Risk Management

Business Banking Methodology and Development

Risk Committee

ALCO Committee

IT Committee

Corporate Secretary

Audit Committee

Internal Audit Department

General Assembly of Shareholders

Supervisory Board

Management Board1

Appendix 2

23

PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS: FINANCIAL INTERMEDIARIES

Indicator Rating

a Justifications

1. Beyond Intermediary and Sub-Borrower Impacts

1.1. Private sector expansion and institutional impact

1.1.1. Contribution to an increased private sector share and role in the economy and to sustainable jobs or self-employment

Excellent Azerbaijan‘s economy grew by 5.0% in 2010 with private sector share in GDP rising to 82% from 60% in 2006, based on estimates by the EBRD. The higher contribution of the private sector was underpinned by the privatization efforts of the government and reforms implemented to improve the business climate. The banking sector growth has been driven by private banks. In 2006, there were 42 private banks and two state-owned banks. Since 2007 private banks have dominated the market in terms of assets, loans, and capital. By 2008 private banks had also garnered a bigger share of deposits (Table 2, Development Impact and Outcome section of main text). The robust private banking sector has allowed better financial intermediation by banks in the economy, especially the non-oil economy. The ratio of bank assets to non-oil GDP rose from 53.4% in 2006 to 72.1% in 2010. The ratio of loans to customers to non-oil GDP increased from 33.4% in 2006 to 49.7% in 2010. The expansion of private banks‘ branch network, especially into the regions, has helped sustain employment, as implied by the country‘s unemployment rate which remained between 0.9% and 1.0% during 2006–2010. AccessBank had 1,243 employees as of the end of 2010, almost thrice the 451 employees as of the end of 2006. The bank has been able to contribute more to raising employment because of its policy of hiring fresh university graduates and training them rather than hiring staff of other banks. The bank provides employees with long-term career development supported by intensive training, workshops, seminars, and an incentive system. The bank has a dedicated training center and has developed specialized training programs for each position in the bank. On average, AccessBank hires 25 new employees every month. In 2010, the bank was named by the AMFA as the ―Best Microfinance Institution to Work For‖.

Appendix 2

24

Indicator Ratinga Justifications

AccessBank promotes gender equality in employment. With the assistance of the EBRD, the bank developed its Gender Policy and Measurement Plan, which was implemented in 2009. Under the plan, the bank will maintain disaggregated database information based on gender, including breakdown of borrowers by gender and staff breakdown by gender. This aims to empower women through employment and access to finance.

1.1.2. Contribution to expanded SME lending with good portfolio and sub-borrower performance

Excellent AccessBank defines micro and SME loans based on loan size.

Table A2.1. SME Loans Classification

Classification Loan Amount

Micro loan $100–$10,000 or equivalent in Azerbaijan manats

Small loan $20,001–$100,000 or equivalent in Azerbaijan

manats Medium-sized loan

>$100,001 or equivalent in Azerbaijan manats

Source: AccessBank management reports.

As of the end of 2010, the bank's micro loan portfolio accounted for 46.73% of the total loan portfolio. AccessBank‘s micro loan portfolio grew at a CAGR of 53.5% during 2006–2010. The number of micro-sized borrowers rose to 88,492 from 12,152 in 2006. AccessBank‘s SME portfolio was equivalent to 39.5% of the total loan portfolio. The bank‘s SME loans grew at a CAGR of 50.4% during 2006–2010. SME borrowers increased to 2,144 by the end of 2010 from 673 in 2006. Most of the SME borrowers are in the trading business. The bank‘s strong focus on asset quality was reflected in the 0.8% NPL ratio of SME loans.

Appendix 2

25

Indicator Ratinga Justifications

1.1.3. Contribution to institutional change by

(i) improving supply and access to formal credit and banking service for SMEs; and

(ii) influencing an enabling

environment for SMEs via lobby activity, policy dialogue, or otherwise

Satisfactory Expansion of the branch network is one of the bank‘s priorities in terms of ensuring access to banking services and finance for SMEs. The bank has expanded its branch network to cover the whole territory of Azerbaijan as widely as possible, taking into account the growing demand for banking services by SMEs.

Table A2.2. AccessBank’s Branch Network Item 2006 2007 2008 2009 2010

Total number of branches (including head office)

10 14 20 23 28

Branches in Baku 7 10 12 13 16 Branches in regions (urban and rural areas outside Baku)

3 4 8 10 12

Source: AccessBank management reports.

To promote productivity in branches, AccessBank holds a monthly competition among branches, and winning branch staff receive prizes in cash or gifts. Further, all credit employees are compensated based on their productivity as well as low arrears rates. This effectively improves the services provided by staff to the clients.

Table A2.3. Branch Productivity Item 2006 2007 2008 2009 2010

Average number of borrowers per branch staff

36.3 93.1 105.1 126.3 125.7

Average number of borrowers per branch loan officer

71.9 126.8 152.8 237.6 229.2

Source: AccessBank management reports.

1.2. Competition. Contribution to new competition for SME business among local banks (including new product and service offerings and local currency products) and/or to increased competition in key sub-borrower markets

Satisfactory In August 2007, AccessBank introduced the Agro Loan product. This product is used for financing agriculture and agriculture-related services and businesses (e.g., clients selling fertilizers and seeds and who have some seasonal income flows). The Agro Loan allows farmers as well as agriculture services clients to obtain loans as the bank takes into account their nonlinear income flows. Grace periods and recognition of all forms of income allow this product to be extended to various clients that otherwise might not be reached. AccessBank has a total agro portfolio of $50 million and 35,000 clients as of the end of 2010. The Agro Loan product now makes up 15% of the total loan portfolio and contributes more than 15% of the interest income.

Appendix 2

26

Indicator Ratinga Justifications

AccessBank remains the primary agriculture lender in the country, with little competition. However, the success of this product has encouraged other banks to increase lending in agriculture and they have begun to follow the more liberal assessment and collateral policies of AccessBank in lending to agriculture.

1.3. Innovation. Contribution to new ways of offering effective banking services to clients (including new products, services, and technologies) in ways that are replicated by other banks and in the financial system (item 2.2)

Excellent The Agro Loan product of AccessBank is the first of its kind offered in Azerbaijan. In fact, it was named "Best New Product" by the AMFA. The bank offers a low minimum balance requirement and flexible deposit products. Through these products, the bank has been able to gain deposits of lower-income citizens. As these deposits are primarily in the local currency, this has increased the bank‘s ability to extend local currency financing to borrowers. AccessBank was not a pioneer in terms of entering certain geographic areas to provide bank products and services. However, it was the first bank to introduce direct marketing in these areas, with loan officers often travelling to villages and distant bazaars to offer services to clients. This has established the bank as a household name throughout many of the regions.

1.4. Links. Contribution to local saving and deposit mobilization via networks of participating bank(s), and/or relative to size of subportfolios, and contributes to notable upstream or downstream link effects to sub-borrowers‘ businesses in their industries or the economy

Satisfactory In a span of 5 years AccessBank was able to increase its customer deposits by 38.7 times. From AZN3.3 million in 2006 customer deposits ballooned to AZN126.7 million in 2010, equivalent to a CAGR of 149.4%. The bank‘s loans have led to the expansion of businesses, as illustrated by some of the success stories of its clients: In 2003, a trained engineer opened a business that focuses on trading soy beans, raising and selling chickens, and producing starch and the locally popular sugarloaves, known as gand. By 2006, the business had expanded to 70 employees and was profitable but was unable to obtain financing from commercial banks. The engineer/owner approached AccessBank and obtained an SME loan to increase stock and production levels. Since then the business has received six further SME loans from AccessBank, helping it to continue its growth and boost margins. The business now employs 100 staff, whose salaries have also increased significantly, and is exploring opportunities to export sugarloaves.

Appendix 2

27

Indicator Ratinga Justifications

An air traffic controller at the local airport in Lenkoran supplements his income by carving traditional accessories for weddings and souvenirs and takes orders from individuals and shops in Lenkoran and Baku. However, high-quality products with fine detail require high-quality materials and, without spare cash, the air traffic controller often had to purchase materials for each individual order. This meant that he had to shuttle back and forth to buy raw materials. Moreover, he could not take advantage of volume discounts. Aside from the additional transportation cost incurred, the time spent transporting small quantities can delay the process as well. With the help of AccessBank, the air traffic controller took loans of AZN2,000 in 2007 and $3,000 in 2009 to purchase materials in bulk and expand his stock. This has helped him to meet orders quickly and increased his margins. Now he is planning to open his own shop so that he can sell his craftwork to the public.

1.5. Catalytic element. Contribution to mobilization of other local or international financing to SMEs and to positive demonstration to market providers of debt and risk capital to SMEs

Satisfactory ADB‘s loan contributed to expanding SME financing at the time when AccessBank‘s deposits were still growing and unable to fund the loan portfolio growth. ADB‘s loan, together with other IFI loans, in the early years of operation of AccessBank have acted as catalysts in building public confidence in AccessBank. As a result, AccessBank received funding from other IFIs to support SME growth. AccessBank partnered with USAID under the Loan Portfolio Guarantee Agreement supporting a 5-year collaboration dedicated to make available additional financing for micro, small, and medium-sized enterprises in the agriculture sector of Azerbaijan. This helps to continue further diversification of the loan portfolio and provides access to financial services for potential borrowers in the agro sector who are still unable to meet high collateral requirements. This guarantee is used to strengthen the collateral for large agro loans (over $10,000). A positive demonstration effect can be ascribed to the ADB loan during AccessBank‘s debut bond issuance in 2007. The involvement of ADB as one of the largest creditors of AccessBank at the time of the bond issuance contributed to its success, which was considered a landmark transaction for the bank and Azerbaijan as a whole.

1.6. Affected laws, frameworks, and/or regulation. Contribution to improved laws, regulation, and inspection affecting formal

Excellent AccessBank is spearheading a program called ―One Client, One Lender‖ with the AMFA in order to limit potential overindebtedness of clients who have been receiving financing from multiple sources without full disclosure of their liabilities.

Appendix 2

28

Indicator Ratinga Justifications

SME banks and banking services to SMEs in the local financial system

AccessBank is an active participant in the American Chamber of Commerce in Azerbaijan and in the Banking and Finance and Insurance Committee, which takes an active role in developing banking legislation and policy in an effort to increase financial access for clients. AccessBank provides a demonstration effect of banking best practices and has broadly influenced the development of Azerbaijan‘s banking sector.

1.7. Wider demonstration of new standards. Contribution to raised standards in the finance sector or in sub-borrower industries and sectors in corporate governance, transparency, and stakeholder relations

Excellent Since its establishment, AccessBank has been committed to pursuing the highest standards and international best practices in corporate governance and transparency. AccessBank‘s leading commitment to corporate governance was confirmed in 2010 by the Standard and Poor‘s ratings agency which ranked AccessBank as the "most transparent bank" in its inaugural Transparency and Disclosure Survey of Azerbaijan‘s banking sector. In 2009, AccessBank submitted its microfinance loan products pricing data to MFTransparency. MFTransparency is an international nongovernment organization founded in the United States in 2008 for the purpose of facilitating transparent markets through the dissemination of true cost information. AccessBank demonstrated its commitment to transparency in its pricing and client protection by being one of the first Azeri financial institutions to submit their loan pricing for international scrutiny.

2. Participant Banks and Sub-Borrower Impacts

2.1. Skills with wider impact potential. Contribution

(i) to improve SME credit approach at all stages in the participant bank(s) in ways that will be replicated by other providers of SME finance and banking service; and

(iii) via the participating

bank(s) to improved sub-borrower skills in operating their businesses, e.g., via good appraisal, and monitoring by the bank(s)

Satisfactory

AccessBank continuously improves its credit risk management. In 2009, AccessBank joined the International Campaign for Client Protection hosted by the Center for Financial Inclusion, which advocates avoidance of overindebtedness, transparent pricing, appropriate collection practices, ethical staff behavior, mechanisms to redress grievances, and privacy of client data. AccessBank was the first bank in Azerbaijan to join the campaign.

Appendix 2

29

Indicator Ratinga Justifications

2.2. Demonstration and new standards-setting potential. Demonstrates potential through improved and achieved standards in corporate governance, transparency, stakeholder relations, and ESHS spheres

Excellent AccessBank is a model of best practice in the areas of corporate governance, transparency, stakeholder relations, and ESHS. In 2008, AccessBank formalized its commitment by joining the UN Global Compact. The compact specifies adherence to principles within four core areas: human rights, environmental protection, labor rights, and anti-corruption—basic principles pursued by AccessBank since its inception. Once more, AccessBank was the first bank in Azerbaijan to join the Global Compact. AccessBank, sharing the Global Compact‘s commitment to labor protection, is committed to fair and equal opportunity recruitment, treatment, and promotion of staff irrespective of gender, race, nationality, or religion. This is set out within the staff and gender policies and includes a code of conduct providing guidance to staff on professional behavior. AccessBank leads the sector with the provision of staff training and provides additional private health insurance as well as highly competitive remuneration. Further to the goals of the Global Compact, AccessBank has been taking proactive measures to encourage women to pursue careers in what are generally perceived in Azerbaijan as "male positions" within the bank. The transparent, clean, and unbureaucratic financial services provided to AccessBank‘s clients met the anticorruption standards of the Global Compact, which became AccessBank‘s trademark. The bank devotes great care to ensure that the loans provided make a positive contribution to both the client and the community. There are many business activities that AccessBank will not finance, as management considers them to be detrimental to the community. AccessBank strongly adheres to corporate social responsibility principles by supporting, sponsoring, and encouraging staff to become involved in charitable and community projects that both benefit and promote the evolution of inclusive local communities. Examples of such projects include sponsoring the Girls Leading Our World (GLOW) summer camp for schoolgirls from the regions of Azerbaijan, with participation of an AccessBank female manager; distribution of food to needy families for the holidays by bank staff; regular visits by staff to various homes for orphans, the disabled, pensioners, and veterans to distribute goods and provide entertainment and company; sponsorship

Appendix 2

30

Indicator Ratinga Justifications

and judging of the Azerbaijani portion of the Writing Olympics, an international English-language writing competition; sponsorship of the Seeing in Colour art exhibition and workshop for young Azeri artists organized with the British Council in Azerbaijan; financing and printing a handbook for doctors, care givers, and relatives of people with Down‘s syndrome; and numerous other community projects handled personally by the bank‘s staff.

Overall Rating Excellent ADB = Asian Development Bank; AMFA = Azerbaijan Microfinance Association; CAGR = compounded annual growth rate; EBRD = European Bank for Reconstruction and Development; ESHS = environment, social, health, and safety; GDP = gross domestic product; IFI = international financial institution; NPL = nonperforming loan; SME = small and medium-sized enterprise; UN = United Nations; USAID = United States Agency for International Development. a

Ratings scale: excellent, satisfactory, partly satisfactory, and unsatisfactory. The rating is not an arithmetic mean of the individual indicator ratings, which have no fixed weights. Consider already manifest actual impact (positive or negative) and the potential impact and risk to its realization.

Sources: AccessBank annual reports 2006–2010, AccessBank management reports 2006–2010, and EBRD reports.

Appendix 3

31

SECTOR AND OPERATIONS REVIEW 1. The outlook for Azerbaijan‘s banking system continues to be positive, particularly in terms of credit growth, higher profitability, and improving asset quality as favorable economic conditions augur well for the growth of banks over the short term. High oil prices will continue to be the driver of ongoing government spending, boosting the non-oil sector and creating business opportunities for domestic banks.1 The Azerbaijan banking sector was largely shielded from the effects of the global financial crisis, in comparison to its peers in Central and Eastern Europe, due to limited international financial integration and a low level of foreign borrowings. 2. Offsetting the sector‘s positive outlook are (i) high system-wide dollarization and high credit concentrations; (ii) sustained, high problem-loan levels; and (iii) the undercapitalization of the sole state-owned bank, the International Bank of Azerbaijan, which dominates the banking system (footnote 1). 3. The sector is highly concentrated, with the top seven banks accounting for more than 65% of the system‘s total assets and deposits as at the end of 2010. The International Bank of Azerbaijan continues to dominate the system with a 40% share of assets and liabilities, although plans to privatize are under way. The rest of the sector is made up of smaller banks holding individual market shares of 2%–6%. 4. In 2010, total banking system assets in Azerbaijan grew by 13.9% to AZN13.3 billion. The banking sector‘s growth has slowed down compared to high growth levels of over 50% year-on-year during 2006–2008. This slowdown has led to reduced lending as liquidity tightened as a result of refinancing difficulties. However, the Central Bank of the Republic of Azerbaijan (CBA) intervened to boost liquidity by reducing the deposit reserve to 0.5% in March 2009 from 12% at the end of the third quarter of 2008, abolishing the 5% reserve requirement on foreign borrowings, and providing direct loans to many banks. To encourage the strengthening of the banking sector, the president of Azerbaijan also declared a 3-year tax exemption for profit capitalized from 1 January 2009. A. Profitability 5. In 2010, the aggregate net income of banks declined to AZN120.0 million, 52.4% lower than the AZN252.9 million in 2009. The slowdown in business activities coupled with the increases in banks‘ loan-loss charges took its toll on the banks‘ bottom lines. Out of the 45 banks, 32 were profitable in 2010. Net interest income continued to account for 65% of bank revenues. For 2011, overall profitability is expected to improve for most banks as a result of increased business volumes, healthy interest margins, and a gradual decline in credit costs (footnote 1). 6. The significant drop in net income pulled down the sector‘s return on assets to 1.0% in 2010 (from 2.3% in 2009) and its return on equity to 5.8% (from 13.6% in 2009).

B. Asset Quality of the Banking Sector 7. The banking sector loan portfolio grew by 9.0% to AZN9.2 billion in 2010, following several consecutive years of double-digit growth (including 98.2% in 2007). Nonperforming loans in 2010 were 13.4%, higher than the 12.2% in 2009. However, this is expected to decline by the end of 2011 given a favorable economic environment, moderate credit growth, and recovery of problem loans. In addition, losses from loans granted before the global financial

1 Moody‘s Investors Services. 2011. Azerbaijan: Banking System Outlook. August 2011.

Appendix 3

32

crisis have been taken into account, reducing the chance of incurring considerable losses in the short term (footnote 1). C. Capital Position of the Banking Sector 8. Total bank capital was AZN1.90 billion in 2010, 7.9% higher than the AZN1.76 billion in 2009. The increase reflected a favorable banking environment, despite the effects of the global financial crisis. 9. The capital adequacy ratio for the banking sector was in the 16%–20% range during 2006–2010 (Table A3.1). The banking sector‘s capital adequacy ratio was considerably above the 12% regulatory minimum and the 8% internationally accepted minimum requirement.

Table A3.1: Banking Sector’s Capital Adequacy Ratio, 2006–2010 (%)

Ratio 2006 2007 2008 2009 2010

Capital adequacy ratio 18.0 20.0 19.6 17.0 16.0 Source: Fitch Ratings, CIS/Georgian Banks: Semi-Annual Review and Outlook, 28 July 2011.

10. Banks that capitalized profits were exempted from taxation, starting from 2009, in order to fast track the process of capitalization of banks. D. Corporate Governance 11. With the aim of establishing effective management systems, banks continuously introduce corporate governance standards in accordance with international best practices. In 2005, the CBA developed six corporate governance standards and the Strategic Plan Development Program to provide methodological support to applying corporate governance principles in banks. In 2007, measures were taken to complete the process of bringing financial reporting practices into compliance with International Financial Reporting Standards (IFRSs) as one of the most significant elements of ensuring transparency and implementing corporate governance standards in the business of banking. The process of transition to the IFRSs was completed by fully removing the nonconformities of financial statements with the IFRSs. 12. In 2009, banks adapted and implemented the IFRSs. According to the requirements of the Law of Azerbaijan Republic On Banks, 34 banks were audited by international audit firms, which accounted for 97.7% of total bank assets. As banks endeavored to enhance their endurance and worked to improve how they were perceived by foreign financial markets, they developed a greater interest in obtaining an international rating. Thus, nine banks acquired international ratings and managed to maintain these ratings during the global financial crisis. E. New Banking Regulations 13. In 2010, the CBA established new leverage ratio guidelines to control imbalances in asset and capital growth rates, secure the banking sector‘s stability, and prevent asset bubbles. The maximum leverage ratio is 8.0%.2 During 2010, the CBA also implemented the Basel standards to further improve banking regulations and supervision. 14. In 2009, the banking sector retained its time-proven financial sustainability and preserved its stability. Banks maintained the soundness and safety of their operations based on

2 Computed using the ratio of tier 1 capital to balance sheet assets and off-balance sheet liabilities.

Appendix 3

33

the new economic settings springing from the global financial crisis. Thus, the banking sector was well prepared for the new economic challenges and was able to minimize the external effects of the crisis on its financial viability. In addition to maintaining its pace of growth, the banking sector also gained valuable crisis management experience induced by the potential that had been formed prior to the crisis with the support of the CBA. The CBA carried out preventive management and ―financial immunization‖ measures. Since 2007, the CBA has advised banks to follow a better devised and more conservative business strategy. 15. An anticrisis program for the banking sector was designed and developed along the lines of the government‘s anticrisis policy. As the program developed, the risk profiles and main sources of hazard were identified for the entire sector and individual banks. The measures to mitigate the effects of the crisis on the banking sector were also identified. 16. Table A3.2 shows the amendments made to the Law of Azerbaijan Republic on the Central Bank of the Republic of Azerbaijan.

Table A3.2: Amendments to the Law of Azerbaijan Republic on the Central Bank of the Republic of Azerbaijan

Date Modification of Macroprudential Normative Requirements

30 Apr 2008 The provisioning ratio for asset classification rates was made more stringent: (i) watch-listed assets were increased to 10% from 6%; (ii) unsatisfactory assets were increased to 30% from 25%; (iii) doubtful assets were increased to 60% from 50%; and (iv) Loan to value ratio was increased to 150% from 120%.

18 Feb 2008 The maximum amount of subordinated debt was set at 50% of tier 1 capital. The mortgage loan risk rate was increased to 100% from 50%.

18 Nov 2008 Requirements with respect to evaluation of the borrower‘s financial position and creditworthiness as well as regular monitoring of the borrower and overall surveillance of the loan portfolio quality were expanded by the amendments made to the bank lending regulation.

17 Dec 2008 The open currency position calculation methodology was improved, including adjustments to off-balance sheet accounts, and transactions involving bank‘s precious metals were included in reporting as part of position calculation.

Amendments made to the regulation for nonaccrual of interest on lending transactions revised the priority order of payment of debt claims set off by customers‘ payments against nonaccrual loans.

1 Jan 2009 The profits of banks and insurance companies used for capitalization were exempted from profit tax.

8 May 2009 Determination of the yearly interest rate limit for insured deposits was made more efficient, with the maximum amount of insured deposits going up to AZN30,000 from AZN6,000. Deposits with an interest rate of up to 15% were included in the insurance scheme.

17 Jun 2009 Mortgage lending was reinstated from July 2009, at the Central Bank of the Republic of Azerbaijan‘s initiative (CBA).

The rate of risk on mortgage-backed securities issued by the Azerbaijan Mortgage Fund under the CBA was set at 0%.

7 Aug 2009 The president of Azerbaijan issued a decree on the government‘s involvement in the management of banks and nonbank credit institutions with the government‘s equity investments, which aimed to enhance supervision of financial institutions owned by the state.

Source: Central Bank of the Republic of Azerbaijan.

34 Appendix 4

COMPARATIVE FINANCIAL STATEMENTS

Table A4.1: Comparative Balance Sheets, 2006–2010 (AZN ‗000)

Balance Sheet 2006 2007 2008 2009 2010

Assets Cash and cash equivalents 2,668 5,402 16,360 46,567 57,805 Mandatory cash balances with the

Central Bank 296 1,083 995 253 371

Investment securities available for sale

40 5,293 5,863 40 40

Due from other banks 2,464 2,236 20 9,828 7,023 Loans and advances to customers 40,730 93,977 163,669 233,681 266,185 Investment properties 21,708 Property, plant, and equipment 1,537 3,504 5,127 7,123 9,382 Intangible assets 59 72 977 1,994 1,615 Deferred income tax asset 84 31 51 Other financial assets 66 51 163 289 527 Other assets 337 987 616 997 1,316 Total Assets 48,281 112,636 193,915 300,772 366,023

Liabilities Due to other banks 2 3,005 Customer accounts 3,274 12,134 21,852 64,999 126,671 Other borrowed funds 39,020 77,360 128,051 169,120 153,692 Current income tax liability 440 1,754 130 Other financial liabilities 29 248 756 2,107 2,766 Other liabilities 34 129 Subordinated debt 8,610 8,189 8,222 8,180 Total Liabilities 42,323 98,792 160,616 247,487 291,568

Equity Share capital 6,713 11,000 20,000 20,000 41,800 Retained earnings (755) 2,844 13,299 33,285 32,655

Total Equity 5,958 13,844 33,299 53,285 74,455

Total Liabilities and Equity 48,281 112,636 193,915 300,772 366,023

( ) = negative Source: AccessBank audited financial statements 2006–2010.

Appendix 4 35

A

pp

en

dix

6

35

Table A4.2: Comparative Income Statements, 2006–2010 (AZN ‘000)

Income Statement 2006 2007 2008 2009 2010

Interest income 7,715 20,855 45,471 68,198 87,703 Interest expense (2,357) (6,643) (12,545) (18,733) (25,589) Net interest income 5,358 14,212 32,926 49,465 62,114 Provision for loan impairment (422) (1,111) (2,116) (2,599) (2,067)

Net interest income after provision for loan impairment

4,936 13,101 30,810 46,866 60,047

Fee and commission income 634 1,490 523 767 1,129 Fee and commission expense (100) (187) (200) (171) (175) Gains less losses from foreign

currency dealing (109) 54 395 893 749

Foreign exchange (loss)/gain 2 (528) 75 Other operating income 70 409 8 34 78 Impairment loss on property, plant,

and equipment (54) (257)

Administrative and other operating expenses

(5,639) (10,055) (18,071) (27,879) (35,397)

Profit before tax (208) 4,812 13,413 19,982 26,249 Income tax (expense)/credit (35) (1,213) (2,958) 4 (79)

Profit for the year (243) 3,599 10,455 19,986 26,170

Source: AccessBank audited financial statements 2006–2010.