The banking sector in Azerbaijan has continued along the path of consolidation and expansion. In the first quarter of 2006, banking assets grew by 8.6%. Although Azerbaijan's banks are still minnows by international standards, the level of capital is rising. Banks are required to have capital of Am6 million by July 1 2006, Am8.2 million by January 1 2007 and Am10 million by July 1 2007. Foreign investors, particularly international financial institutions but also private equity funds, have taken, or are seeking, equity positions in several Azerbaijani banks. Add to that the revamped Social Protection Fund, which has introduced personal pension accounts expected to be looking for investment opportunities by 2010, and it is clear that the banking and financial services sector is on the path to growth.

The buoyancy of the banking sector has been helped by the flow of oil money (in May 2006, the first oil was lifted from the terminal at Ceyhan in Turkey at the western end of the new Baku-Tbilisi-Ceyhan pipeline). The sector was also given a boost by the introduction of a new currency on January 1 2006 (the new Azerbaijani manat replacing the old one at a conversion rate of 5,000 to 1). With the new currency exchange rate steadily appreciating against the dollar, more people are converting their holdings of US dollars to Azerbaijani manats and are more willing to deposit funds in banks. Consequently, the interest rates offered on manat deposits have declined and are now on parity with those offered on US dollars. Once the long-mooted national deposit insurance scheme for banks has been introduced, another boost in deposits can be expected.

The introduction of the new currency has had one negative effect in that it has added about 1% to 2% to the rate of inflation. But it has also encouraged a greater flow of funds to the banks, much of it going to lending for the purchase of real property. Arising from this has been a little-noticed development of importance – a sale and purchase agreement requiring notarization now also requires settlement to be made through the bank account of the notary retained to notarize the agreement.

The increased liquidity has precipitated a number of legal developments. One is in the area of finance leasing. Finance leasing banking subsidiaries seem to have multiplied as the tax rules have been clarified – in particular, it is now clear that withholding tax of 10% will apply to the interest element only of a finance lease payment.

Another consequence of increased liquidity has been the expansion in lending for the purchase of real property. This has been accompanied by the introduction of a new mortgage instrument – the hypothecation certificate.

Mortgages

As a basic rule, all agreements encumbering immovable property and other property subject to registration in state registers (for example, vehicles, ships, aircrafts, shares in joint stock companies and participating interests in limited liability companies) (hypothecation agreements) should contain certain basic details:

• the names and addresses of the parties;
• the subject of the hypothecation agreement;
• details of the obligation secured by the hypothecation agreement, including details of any underlying agreement and the period for performance; and
• the schedule of repayment.

A hypothecation agreement relating to immovable property should be notarized. Furthermore, where the debtor is a married person, they should obtain the notarized consent of their spouse for the hypothecation of the property. Similarly, if several persons own the property, the notarized consent of each co-owner must be obtained.

All hypothecation agreements should be registered with the relevant state authority, being:

• for immovable property, the State Immovable Property Register Service (the Registry) or, where relevant, the Ministry for Economic Development;
• for vehicles, the Ministry of Internal Affairs;
• for shares in joint stock companies, the State Securities Committee;
• for participating interests in limited liability companies, the Ministry of Justice;
• for aircraft, Azerbaijan Airlines State Concern; and
• for vessels, the State Marine Administration or, for small craft, the Ministry for Emergency Situations.

The Ministry for Emergency Situations and the State Marine Administration have only recently been established and it might take a little time before they are operating responsively.

Enforcement

Security may be enforced through court or out-of-court proceedings. An out-of-court procedure for the enforcement of security is available if explicitly permitted by the loan agreement or where subsequently the owner of the property and the mortgagee enter into a notarized agreement to that effect. In the case of immovable property, the mortgagee should submit a notice of enforcement to the owner and should register the notice in the Registry within seven days from the date of the notice (a failure to register the notice will bar enforcement).

Hypothecation certificates

The Civil Code allows for the creation of hypothecation certificates, and the law On Hypothecation elaborates on the provisions that apply to these instruments.

A hypothecation certificate is a security evidencing the rights of the mortgagee. It is issued for the term of the underlying hypothecation agreement and can be transferred to any other person by endorsement, with subsequent registration of the transfer in the register of the State Securities Committee. Property encumbered under a hypothecation certificate cannot be re-hypothecated. Security created through the hypothecation certificate will always be enforced through an out-of-court procedure.

Mortgagor's disposal of hypothecated property

Upon hypothecation, the owner of the property can only dispose of, lease or grant use of the encumbered property with the consent of the mortgagee, unless the hypothecation agreement specifies otherwise.

Banking sector ventures forth

As the banking sector develops, it is almost certain that consolidation in the sector will continue, liquidity will rise, bank mergers will proliferate and banking legislation will be brought more into line with international practice. With foreign investment flowing into this sector more readily than any outside the oil industry and with the banking sector more quickly adjusting to international practice than others, it is likely that financial sector companies will also be the first to venture overseas to raise capital.

Author biographies

Alum Bati Salans Alum Bati is the managing partner of Salans' Baku office. He specializes in corporate, commercial, employment and taxation law, with particular emphasis on foreign investment in Azerbaijan and the Caspian region. Bati graduated from London University, SOAS (BA 1977); University of Westminster (Diploma in Law, 1978); and Inns of Court School of Law (1979). Bati was admitted to the Bar in England and Wales in 1979. Bati has acted as the Azerbaijan correspondent for International Bureau of Fiscal Documentation since 1994, and is the only non-Azerbaijan citizen to have been appointed to a parliamentary commission (Audit Chamber Commission) and to have addressed the Law Commission in Azerbaijan. Bati has been adjunct professor of law at Western University, where he taught tax law, and oil and gas law to graduate and post-graduate students, and a guest lecturer in international relations at Baku's Khazar University. He has also taught business law at Baku State University. Bati frequently speaks at conferences on doing business in Azerbaijan, on taxation and employment law. In 2005 and 2006 he was invited by the OECD to address the International Experts Meeting on Corporate Governance held in Istanbul and Stockholm respectively. Bati serves on the boards of directors of the American Chamber of Commerce in Azerbaijan and the British Business Group, and is honorary legal adviser to the British Ambassador. Kamal Mamedzade Salans Kamal Mamedzade is a senior associate in the Salans' Baku office. Mamedzade has extensive experience in Azerbaijan in corporate, privatization, banking, and securities law. His work has involved advising on company management and corporate governance, structuring of transactions, foreign investment, and other matters in Azerbaijan. Mamedzade attended George Mason University, Virginia, US (1996 to 1997) and graduated from Khazar University Faculty of Law and Social Sciences (BSc, 1996) (JD, 1999) and Manchester University (LLM with merit, 2001). Mamedzade is the author of "Privatization in Azerbaijan: recent developments and future perspectives" in the USACC guide Doing Business in Azerbaijan (2000). Mamedzade speaks Russian, Azeri, and English.