OREANDA-NEWS. Fitch Ratings has affirmed International Bank of Azerbaijan's (IBA) Long-term Issuer Default Ratings (IDRs) at 'BB', and Kapital Bank (KB) and Pasha Bank (PB) at 'B+'. All three banks have Stable Outlooks. Fitch has also upgraded KB's Viability Rating (VR) to 'b' from 'b-'.

The rating actions reflect the stability of the broader economy and the sovereign credit profile to date; Azerbaijan is rated BBB-/Stable. In Fitch's view, the strong sovereign balance sheet and sizable State Oil Fund provide a significant cushion against the decline in oil prices. Despite lower oil revenues, the goverment's policy response is expected to be relatively modest, so that growth will continue to benefit from fiscal support in the form of high public capital expenditure. However, a prolonged period of low oil prices could ultimately result in significant reductions in budget spending, which has been the major growth driver for the non-oil economy and supported bank lending and asset quality to date. Liquidity in the sector is adequate, underpinned by banks' reasonable deposit collection capacity and limited market wholesale funding (with the notable exception of IBA).

The relatively high risk operating environment constrains the VRs of local banks at quite low levels. Fitch assesses the environment as high risk in light of Azerbaijan's weak institutional development, reflected in a challenging business climate and limited financial transparency of the corporate sector, and potentially high cyclicality of the economy as a result of its commodity dependence. Banks' risks are further heightened by their often long-term and concentrated loan exposures, sometimes with significant grace periods and bullet repayments, including for project and acquisition finance purposes. In Fitch's view, these weaknesses are likely to translate into high and volatile levels of credit losses at most of the country's banks. The higher VRs of PB (b+) and KB (b) relative to IBA reflect their greater resilience to potential swings in asset quality and performance as a result of their larger capital buffers.

KB's support-driven IDRs could be downgraded if the sovereign is downgraded, or if its systemic importance markedly decreases or the banks fail to receive timely support, when needed. However, these scenarios are currently regarded as unlikely by Fitch. Upside potential for KB's support-driven ratings may emerge as a result of notable improvement of its systemic importance. The latter could also result in PB's SR and SRF being revised upwards.

KB's VR could be upgraded if (i) the bank is able to maintain sound asset quality in its retail portfolio, enabling it to continue to perform well; and (ii) a moderation of growth rates allows it to maintain sound capital ratios.

Upside potential for PB's VR is limited at present; however, the rating could be upgraded if (i) loss absorption capacity at the parent bank level remains strong after the planned foreign expansion; and (ii) the bank improves significantly its asset quality track record and profitability.

Downside risks for the banks' VRs could stem from any marked deterioration in the operating environment, for example as a result of prolonged period of low oil prices, if this results in a marked weakening of banks' asset quality and capitalisation.