Fitch Ratings evaluates prospects for Azerbaijani banking sector for 2026

The gap between Azerbaijan's 'BBB-' sovereign rating and most bank ratings reflect banks' weaker standalone credit profiles (captured by their VRs), which incorporate both the operating environment and bank-specific constraints, Olga Ignatyeva, senior director of Fitch Ratings, and Maksim Maliutin, associate director for financial institutions and banks, told Report in a joint statement.

Fitch's 'bb-' Operating Environment assessment provides an important baseline for the sector, as it captures structural factors that influence banks' ability to generate sustainable business volumes at acceptable risk levels, including macroeconomic volatility, institutional strength and governance standards, financial market depth, and the regulatory/supervisory framework.

Across Azerbaijani banks, the main bank-specific constraints that most often limit upside relative to the operating environment assessment and, in many cases, the sovereign are funding and liquidity: deposit concentration, high funding dollarization, and (for some banks) less diversified funding franchises. These factors can increase sensitivity to confidence shocks and FX liquidity risk relative to higher-rated banking systems.

Risk concentration and growth risks: meaningful single-name and sector concentrations and, where present, rapid growth. These can amplify loss volatility and make capital and earnings more sensitive to idiosyncratic shocks.

Asset quality: more volatile asset quality and a track record of higher problem loans' origination than in higher-rated systems.

Institutional and governance factors: varying strength of risk management, underwriting standards, transparency and performance through stress, and, for some banks, related-party exposures and corporate governance risks, the analysts noted.

The operating environment is therefore a constraint but not a hard cap: a bank with a clearly superior domestic franchise, strong capitalization, a conservative risk appetite, and resilient funding and liquidity could be rated above operating environment assessment, although this is less common.

"The CBA's tighter Basel III-aligned capital rules, that introduce CET1 requirements and add buffers such as capital conservation and SIB buffers (on top of the countercyclical buffer), should strengthen the sector's loss-absorption capacity and improve resilience through the cycle.

From a ratings perspective, this is credit positive and may, over time, support our view of the operating environment and, indirectly, banks' standalone credit profiles. However, higher Viability Ratings (VR) would not be automatic. We would typically look for evidence that reforms are fully implemented and consistently enforced, and that they lead to sustained improvements in sector-wide resilience through stronger bank-level capitalization, more prudent risk taking, a stronger risk management, supporting an improved asset quality and stable funding.

Further progress with Basel III alignment and supervisory practices, such as the introduction and implementation of additional liquidity requirements (e.g., NSFR, if adopted) and more robust Pillar 2 processes (including ICAAP-ILAAP frameworks), would also increase the likelihood that these regulatory upgrades translate into VR upside over the medium term," the analysts said.

"The CBA's macroprudential toolkit is more developed than in the past and should help moderate the build-up of household leverage. Key measures include the ban on FX retail lending, DTI-based requirements (including higher risk weights for high-DTI exposures) and tighter limits on credit cards. We see these as broadly adequate for now, although further targeted tightening remains possible if growth re-accelerates.

We do not expect retail lending trends, in themselves, to be a broad ratings pressure in 2026. Household debt remains manageable (18.5% of disposable income at end-1H25), and retail credit penetration is still low (14% of GDP at end-3Q25), leaving scope for continued expansion. We expect some asset-quality deterioration as recent vintages season, with the sector Stage 3 loan ratio rising to around 4.5% in 2026 (from 3.5% at end-2024) but rated banks' pre-impairment profitability should be sufficient to absorb this without material rating impact," they added.

"We view mortgage lending as relatively low risk for several reasons. First, it is collateralised, which typically supports higher recoveries than unsecured retail lending. Second, in Azerbaijan, it is almost entirely denominated in local currency, limiting borrowers' exposure to exchange-rate fluctuations. Third, a meaningful portion of mortgage lending has been originated under state programmes via the Mortgage and Credit Guarantee Fund. These programmes tend to involve more standardized underwriting and eligibility criteria, and often include features such as subsidies, below-market rates, which support affordability and reduce default risk.

This segment's historical performance has been solid, with NPLs below 1%, and we expect this trend to continue. Mortgages also comprise a moderate share of retail loans (around 16% at end-3Q25), meaning the performance in this segment has a limited impact on overall sector asset quality," they said.