Behavioral models based prudential regulation framework for lending adopted

07-01-2025

7 January 2025, Baku: Stable and secure functioning, regulation, and supervision of the banking sector, as well as its alignment to modern trends are one of the Central Bank's key priority areas. In this context, the Central Bank takes initiatives to improve the prudential regulation framework of the banking sector, aligning it with trends emerging in the financial system amidst the rapid development of new technologies. These initiatives include the adoption of changes to several regulations of the Central Bank to establish a regulatory framework for lending based on behavioral models derived from borrowers' financial activities.

Nowadays the automation of processes in banks, customer-centric approaches, and the application of artificial intelligence solutions have significantly enhanced the accuracy of predictive data and expanded opportunities for offering traditional banking services through alternative channels at lower costs and greater speed. The newly adopted prudential regulation framework for behavioral models leverages these capabilities to enable banks to provide loans to private entrepreneurs and individuals based on their forecasted incomes. The changes define requirements for the development of behavioral models, enhancement of banks' related capacity, validation and reporting of models, as well as stricter classification and increased capital requirements aimed at mitigating risks associated with loans issued based on behavioral models. Consequently, banks will be allowed to issue loans based on behavioral models, provided the total amount does not exceed 10% of their lending portfolio. However, if the volume of loans issued under this model with delinquency exceeding 90 days reaches 10% of the respective lending portfolio, such lending will be suspended.

Overall, the use of behavioral models in lending will improve customer access to bank loans, which, in its turn, will contribute to the expansion of financial and employment opportunities for small and medium-sized enterprises and foster a more productive allocation of resources. Also, leveraging more accurate and novel data through models will optimize banks' business processes, reduce operational costs, accelerate, and enhance the accuracy of credit underwriting and scoring processes, and ultimately help mitigate credit risks.