Azerbaijan: Systemic Risk Response Framework

Azerbaijan: Systemic Risk Response Framework

The Financial Sector Assessment for Azerbaijan (FSAP), completed in 2004, identified many areas for improvement, one of which was the implementation of a comprehensive and well-sequenced program to ensure soundness of financial institutions. One of the FSAP findings was the weak financial conditions of some banks in the country, which increase the overall vulnerability of the banking sector.

That is why the Central Bank of Azerbaijan (CBA) expressed an interest in developing a tool to test the health of the country’s banking system, which also would help to identify weaknesses in the CBA's supervisory framework. And in April 2010 the CBA applied for FIRST Technical Assistance (TA) to develop a tool to test the health of the country’s banking system. The project was designed to assist the CBA in designing a tailor-made computer model - called “a multi-factor scenario analysis” - to diagnose weaknesses, generated by exceptional but plausible shocks, to individual institutions, but also to the banking system as a whole.

After eight months of implementation the grant objective was achieved: a quantitative model was developed and integrated into key macro prudential processes. In order to ensure continuous use of the model, the model was designed comparable to the CBA’s own new prudential reporting system and now is used as a usual business practice.

As a result of the project, the CBA’s capacity to assess the health of their banking system has improved. The applicability of the model was tested many times and CBA is confident to use the model during their supervisory process. For this, the CBA requested FIRST to fund a Phase II of this project (a follow-up TA) - to adopt Systemic Risk Response Framework into its supervisory process.

Phase II project is currently under way, with the objective to assists CBA to use the quantitative model regularly by (i) fully operationalizing it, and (ii) by adopting it to the CAB’s supervisory process. After completion of the project the CBA is expected to be able to simulate a variety of different scenarios and take policy decisions regarding the banking system based on the results of these different simulations. In addition, CBA is planning to use the model in the areas of risk management and capital planning, which will lead to increased capacity of the CBA and stronger financial system as a whole.