The state-controlled bank announced on Thursday it was suspending payments on some liabilities and seeking creditors' support for restructuring. The news sent IBA's dollar-denominated bond tumbling to its lowest level in over a year.

The bank's problems show how Azerbaijan is still wrestling with the fallout of a prolonged slump on the global oil market, even though prices recovered some lost ground in early to mid-2016.

An economic slowdown caused by the oil prices - which remain around half 2014 levels - left many of the bank's creditors unable to repay their loans. That built up non-performing debts that a previous government rescue package failed to fix.

The bank published on Friday what it said was its proposed restructuring plan. According to this, the total level of debt subject to restructuring stood at $3.34 billion (£2.6 billion) as of April 18.

This included debt owed to entities including commodities trader Cargill, Italian lender Intesa Sanpaolo (>> Intesa Sanpaolo SpA), Germany's Commerzbank (>> Commerzbank AG) and Bayerische Landesbank, and France's Societe Generale. (>> Société Générale)

The debt the bank wants to restructure include the $500 million Eurobond due on June 11, 2019.

FACTBOX - IBA's debts under restructuring plan

The plan did not set out the size of the "haircut" that creditors will be asked to take under the restructuring. Typically, creditors are asked to agree to accept a sum less than they are owed by the debtor.

In the preliminary restructuring plan, the bank said it plans to exchange at least some of the bank's liabilities for Azeri sovereign debt.

Azerbaijan's Finance Minister, Samir Sharifov, has said he will meet the bank's creditors in London on May 23 to seek their approval for the plan.

Commerzbank, Bayerische Landesbank and SocGen declined to comment about how they viewed the bank's proposal. Lazard Frères and White & Case, hired by IBA to handle the restructuring, also declined comment.

People familiar with the views of several creditor institutions, who did not want to be identified, said the institutions will participate in the restructuring talks and try to minimise any losses.

Pavel Mamai, a portfolio manager at UK hedge fund Promeritum Investment Management, said IBA's creditors would be hard-pressed to resist whatever terms Azerbaijan offers because $1 billion of the debt earmarked for restructuring is held by state sovereign wealth fund SOFAZ.

With SOFAZ already on board, IBA will be able to get the approval of the required two-thirds of creditors, especially with the help of trade finance firms, Mamai predicted.

"Creditors will be told either accept the deal or we declare bankruptcy," he added. "I don't think creditors will have a lot of choice."

However the blow will be softened if creditors receive sovereign bonds in the exchange, leaving them with a better-quality asset, said Richard Segal, emerging debt strategist at Manulife Asset Management.

"But they will have to take a haircut, that's just burden sharing," he said.

FINANCIAL CUSHION

The bank's $500 million bond fell by more than 17 cents to 82.6 cents as trade opened on Friday. But prices later recovered to 89 cents while Azerbaijan's manat currency was largely unmoved.

Investors said Azerbaijan had enough of a financial cushion to prevent contagion into the wider economy.

"The government still has plenty of money available in its sovereign wealth fund, it still has a lot of assets it can access in order to underpin its banks, and I imagine that is what they will do," said Alan Shipman, economist and consultant for Oxford Economics.

The bank said it expected 2016 financial results to show a net loss of around 1.9 billion manats (£879.7 million). It attributed this to extra provisions against its loan portfolio, and the fall in the manat's value.

Its Tier 1 capital ratio - a safety cushion against shocks and bad loans - is expected to be approximately -4.7 percent as of the end of last year. For euro zone banks, by contrast, the minimum Tier 1 capital ratio is set at plus 6 percent.

Inside Azerbaijan, a mainly Muslim country that borders Russia and Iran, news of the restructuring broke on mainstream media on Thursday night. Television stations did not report in detail what was happening.

A Reuters reporter who visited several IBA branches in the capital, Baku, on Friday said there was no rush by depositors to withdraw money. An employee at one branch said the bank was paying out money as normal, with no special restrictions on withdrawals.

Several bank customers said they had not heard about the restructuring. None who spoke to Reuters said they planned to close their accounts. "I think it's a state bank and nothing is going to happen with our accounts," said Valida Husseinova, a teacher.

There were, however, rumblings of anger on social media. One Facebook user, Samir Aliyev, asked what had happened to the money that the state had already spent on rescuing the bank.

(Additional reporting by Karin Strohecker and Sujata Rao in LONDON, Arno Schuetze in FRANKFURT and Maya Nikolayeva in PARIS; Writing by Katya Golubkova and Christian Lowe; Editing by Tom Heneghan)

By Nailia Bagirova and Margarita Antidze