Fariz Huseynov
Assistant Professor of Finance
North Dakota State University  

The global financial crisis has had a negative impact on the Azerbaijani banking industry, but many analysts argue that the impact has been limited because of the absence in Azerbaijan of a well-functioning stock market.  That interpretation is wrong, given that stock markets provide the most comprehensive information about the economy and thus can provide the most accurate measure of the impact of such a crisis. 

Financial markets are usually viewed either as substitutes for or complements to the banking industry.  Because of better screening and monitoring, banks can lower the agency costs, while stock markets provide both firms and investors with liquidity and sustainable access to funds.  If they are substitutes to each other, then the development of stock markets may increase the hidden costs.  Thus, it is important to measure their impact on economic growth.

Several papers, such as Stiglitz (1985) and Bhide (1993) favor banks for better corporate governance and resource allocation, some others, such as King and Levine (1993) suggest that stock markets lower the transaction and information costs.  Stock markets also induce growth-enhancing activities more than banks as suggested by Allen and Gale (2000).  Several other papers suggest that combined effect of banks and stock markets matter for growth.  For example, Demirgüç-Kunt and Levine (2001) conclude that banking industry grows parallel to financial markets.  Furthermore, Beck and Levine (2004) suggest for both independent and combined effects of banks and stock markets on the growth rate.

From the perspective of a small developing country, the financial crisis exposed an important aspect of stock markets - provide the public with updated information about firms.  A major function of stock markets is to provide information to public through disclosure requirements.  Countries without such normally functioning stock markets, such as Azerbaijan, therefore have suffered from an information vacuum during the crisis.

The effect of financial crisis in Azerbaijan can be divided into two stages.  The first stage is the impact on banking industry as a result of foreign liabilities.  The first signs of crisis appeared in late October when Moody’s downgraded Unibank and several other commercial banks due to the risk associated with the large amount of foreign debt obtained during the last year.  The Central Bank of Azerbaijan (CBA) loaned 50 million AZN to Unibank in order to send positive signals to the market and preserve the confidence in Azerbaijani banking industry.  The CBA also lowered its refinancing rate from 15 percent in October to 2 percent eventually in June.  The overall impact of this stage could be somewhat estimated from publicly available data, such as individual banking statistics published by the CBA and bank-specific data by Fineko/ABC.

The second stage of financial crisis in Azerbaijan hit the real economy.  Many public and private enterprises have in this stage faced low sales and low profitability both because of shrinking demand and the difficulty of getting financing.  This effect has been strongest in non-oil industries, such as construction, metallurgy and chemistry industries.  Because the domestic demand comprised only small fraction of industrial production, manufacturing industries have become vulnerable to external shocks.  Exports by these industries plummeted by 50 to 70 percent, with the country’s chemical industry literally stopped during the first quarter of 2009.  But a researcher with limited data on these industries cannot measure the true impact of financial crisis on individual firms.

The financial crisis exposed the important difference between bank and equity markets financing: the level and impact of information asymmetry.  Equity markets require that firms disclose more information, and consequently, if firms prefer obtaining funds from equity markets, they provide investors with transparent information about their financial performance.  In other words, if Baku Stock Exchange (BSE), the only stock exchange in the country, performed the role of a truly functioning equity market and if more firms were eager to list their stocks through BSE, independent analysts and investors could measure the impact of crisis on these firms and make more accurate judgments that will reflect their views and expectations about economy.

While banks can closely monitor the firms to maintain lending requirements, the public does not have access to this information.  Using only the aggregate data released by Azerbaijan State Statistics Committee, analysts cannot make an accurate judgment about the real situation in economy.  Major companies are able to avoid releasing financial statements to media, and the Ministry of Taxation does not require firms to disclose any financial data.  In such an opaque environment, rumors can have a variety of negative consequences.  But perhaps most seriously, because it is almost impossible to distinguish between good and bad firms, companies with sound financial performance are forced to carry as great a burden as poorly managed firms.

In order to avoid that in the future, it is crucial to improve the role of BSE in providing funds for firms.  Currently, only six companies are shown to be listed at BSE. [1] No data on market capitalization is provided, perhaps, because of the low but growing secondary market liquidity.  Moreover, for many years, regulatory bodies of Azerbaijan have neglected – or intentionally ignored – this fact.  The main market activity has been limited to private or direct placement of stocks issued by privatized state-owned enterprises and not been effective for increasing the market liquidity.  Most privatized state-owned firms remain closed joint stock companies, thus limiting liquidity and the development of secondary markets for their shares.  The crisis has demonstrated that it is crucial that the BSE attracts firms to offer their shares in IPO.

There are several obstacles that prevent firms from IPO issues.  First, the firm managers in Azerbaijan are not ready to accept the exchange of ownership for financing.  They prefer bank loans to equity markets because, otherwise, they will be required to share voting and controlling rights.  Although increasing financing options will enable firms to grow, the managers are not ready to utilize those options in the expense of sharing ownership.  Second, the firm managers are not ready to provide enough transparency and to disclose their financial performance.  Thus, limited transparency also makes bank financing more preferable to equity financing.

The Azerbaijan State Committee for Securities clearly recognizes the importance of equity markets.  It has recently announced six main directions (from developing fully automated trading mechanism to improving investor protection rules) in order to promote the development of stock markets in Azerbaijan.  But in addition, it is essential to provide incentives for public offering, such as investment credits or tax breaks, in order to encourage firm managers to trade ownership for funds. And mandating the one share-one vote principle is essential to attract investors to equity markets.  Harris and Raviv (1989) point out that this principle minimizes the conflicts and optimizes the firm value. 

Moreover, the markets for emerging companies in developed countries, such as AIM in UK, Mothers in Japan and Alternext in Europe, can set up a successful example for developing the BSE.  Alike Alternext and AIM, CIS stock exchanges should require each company to have a nominated advisor (“nomad”) to assist them before and after listing.  “Nomads” in most cases use their reputation to promote company listing and thereby affect the liquidity of company’s shares.  This structure can be successfully merged with market maker/quote driven market mechanism.  Market makers will ensure enough liquidity and nomads will provide investors with transparent and updated information about the company.

References

Allen, F. & Gale, D. (2000) Comparing Financial Systems, (Cambridge, MA: MIT Press).

Bhide, A. (1993) ‘The hidden costs of stock market liquidity’, Journal of Financial Economics, 34, pp. 1–51.

Demirgüç-Kunt, A. & Levine, R. (2001) Financial Structures and Economic Growth. A Cross-Country Comparison of Banks, Markets, and Development, (Cambridge, MA: MIT Press).

Harris, M. & Raviv, M. (1989) ‘The Design of Securities’, Journal of Financial Economics, 24, pp. 255-287.

King, R.G. & Levine, R. (1993) ‘Finance and growth: Schumpeter might be right’, Quarterly Journal of Economics, 108, pp. 717–738.

Stiglitz, J.E. (1985) ‘Credit markets and the control of capital’, Journal of Money, Credit, and Banking, 17, pp. 133–152.

Note

[1] This information is taken from the website of the Federation of Euro-Asian Stock Exchanges at http://www.feas.org.

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