Annual Report 1993. Development of Banking System in 1993

AFTER-EFFECTS OF THE 1992 BANK CRISIS

The behaviour of banks in 1993 and the future development of the whole banking system was, indisputably, influenced first of all by the bank crisis that arose in November 1992. The fact that three of the biggest (Tartu Kommertspank, Balti Ühispank and Põhja-Eesti Aktsiapank) and eight smaller banks became insolvent considerably weakened the trust of the public towards the Estonian banking community.

A rescue operation was executed with co-operation between Eesti Pank and the Government of Estonia; as a result a new bank, Põhja-Eesti Pank (North Estonian Bank), was founded by merging Balti Ühispank (Union Baltic Bank) and Põhja-Eesti Aktsiapank (North Estonian Bank Ltd). The latter opened its doors in May 1993. Solvency of the new bank was guaranteed by Government long-term debt securities and liquidity by a deposit with Eesti Pank. The frozen accounts of Balti Ühispank and Põhja-Eesti Aktsiapank with the former Vneshekonombank of the Soviet Union, that made up 63% and 64% respectively of the total assets of the above banks, were joined by the decision of the Riigikogu (Parliament) into the so-called VEB Fund. The claims against Balti Ühispank and Põhja-Eesti Aktsiapank by the owners of frozen accounts, as well as the claim by the owners of Balti Ühispank were also joined into the VEB Fund. The claims of the above banks against the Vneshekonombank of the former Soviet Union were compensated for by the VEB Fund certificates in an amount exceeding the sum of the legal claims of the customers. The VEB Fund certificates were later purchased by the Government and Eesti Pank in order to set operations of the new bank in motion. Tartu Kommertspank (Tartu Commercial Bank) was put into compulsory liquidation. The analysis done during the moratorium showed that running the bank turned out to be impossible and no better solution for the protection of its customers could be found. And this due to the fact that in order to restore solvency, there was a need for more than 200 billion kroons which included 176 billion kroons to cover the shortfall of liquidity. Thanks to the resolute behaviour of Eesti Pank and the Government it was possible to avoid a panic which could have led to withdrawal of deposits from other banks as well.

The resolute behaviour of Eesti Pank and the Government gave a very clear signal to other banks as well as other units of the economy: financial strategy must be reorientated to the demands of the market economy. There was a turn in the behaviour of banks from that of speculative to that of careful. More attention was paid to risk analysis and diversification. The change in tactics resulted in the growth of foreign assets and a very careful domestic credit policy, due to the scantiness of projects with low risks and also the inexperience of loan applicants in compiling their business plans.

The bank crisis also provided a lesson for the bank customers, who began to select banks more carefully. This strengthened the competition between banks and increased customer-friendliness, which in turn contributed to the restoration of credibility in the banking community.

Development plan of Eesti Hoiupank (Estonian Savings Bank)

By the decision of the Board of Eesti Pank of 14 April 1992 a shareholders bank, Estonian Savings Bank, was founded as a legal successor for the Estonian branch of the Savings Bank of the USSR. All the shares were to be subscribed for by Eesti Pank.

In order to guarantee the savings of the Estonian population when monetary reform was introduced, Eesti Pank took over from the Estonian Savings Bank a debt claim against the former State Bank of the USSR for the sum of 3.05 billion rubles. At that time 85% of the population's savings were held in the Estonian Savings Bank.

During preparation for founding the Estonian Savings Bank it became clear that the Estonian Savings Bank could not work in its old form, that it must be reorganized and large investments needed for its development. Without changes in its organisation, calculated annual loss of the bank could have reached 40 million kroons. By decision of the Board of Eesti Pank of 11 August 1992 share capital of the Estonian Savings Bank was doubled by releasing new shares. A competition to subscribe for the new shares had to be announced for Estonian banks. The tender was announced by the Resolutions of the President of Eesti Pank of 30 October 1992 and 4 banks were invited to participate. In reality only two of them (Hansapank and Tallinna Pank) presented their projects. By the Resolution of the President of Eesti Pank of 1 March 1993 Hansapank was announced winner of the tender and negotiations were started with the bank to specify conditions for the subscription of new shares.A purchase and sale agreement on the new shares was signed between the parties, i.e. Eesti Pank and Hansapank on 30 April 1993 . After the agreement became valid, on 19 June 1993, the share capital of the Estonian Savings Bank increased up to 21 million kroons, of which 1/3 , i.e. 7 million, belongs to Hansapank. In addition it was agreed that preliminary investment in the development of the Estonian Savings Bank would be 60 million kroons, of which 40 million were to be covered by Eesti Pank and 20 million by Hansapank.

The balance sheet loss of the Estonian Savings Bank as of 1 May 1993 was 10.5 million kroons and the calculated loan loss 13.3 million kroons, making a total loss of 23.9 million kroons.

The Government of Estonia disputed the expansion and partial purchase of the share capital of the Estonian Savings Bank and initiated a law suit in order to declare the agreement void. The Government's motive for initiating a law suit was that purchase of the shares should have been transacted through the Erastamisagentuur (Privatisation Agency) and by way of a large public sale.

RENEWAL OF BANK LICENCES AND PROCLAMATION OF STABILISATION PERIOD

Another factor of importance that influenced the development of the Estonian banking sector in 1993 was the Decree of the Monetary Reform Committee of the Republic of Estonia on 17 June 1992 on obligatory renewal of bank licences as well as the decision of the Board of Eesti Pank in June the same year stating that by 1 January 1993 share capital of banks had to reach at least 6 million kroons. As a result of the minimum capital requirement and the liquidation of insolvent banks the number of banks pursuing their activities decreased almost twice: by the end of the year there were 21 commercial banks, 2 savings and loans co-operatives and the Estonian Investment Bank. The rise of new banks was limited by the above mentioned larger minimum capital requirement, and also by the relatively high starting costs and lead gained by banks already in operation. In April 1993 the Board of Eesti Pank proclaimed a period of stabilisation up to 1 January 1994. Throughout this time no new licences for banks were issued.

Increase of competition and new bank services

During the stabilisation period the formation of the banking system and the increase of competition in different market segments which forced banks to think about offering new services continued. Thus many banks started offering consumption credits to trustworthy customers. Banks also started to participate more actively in leasing activities. This shows an increase in the amount of trust banks had for their clients as well.

Introduction of credit cards began. In addition to offering intermediation services to the owners of international credit cards (Visa, Mastercard/Eurocard, Diners Club, American Express etc.) some banks introduced their own magnetic card. One processor card (ELT Kaart) was put in use and tests for another (Rae Kaart) reached the final phase.

Project of short term money market

The 1992 bank crisis had had a negative influence on trust between banks themselves. Hundreds of millions of non-interest bearing kroons were deposited on commercial banks' correspondent accounts with Eesti Pank and kept there in order to avoid liquidity difficulties. There was practically no inter-bank money market that would have allowed banks to regulate their liquidity in a better way. In January 1993 Eesti Pank initiated a project for a short term money market. A software system based on electronic communication was created which allowed banks who so desired to offer on the market their short-term excess liquidity and obtain assistance from other banks in the form of a short term loan in case of liquidity difficulties.

Despite of its possibilities the system did not initially create much activity. Banks foresaw impediments in the new system, firstly shortcomings in the clearing system of Eesti Pank, where the results of clearings carried out for customers could be seen only at the end of banking day, and secondly, distrust between banks. Therefore, on 1 April 1993, Eesti Pank set in motion a new project for a short term money market. At the Clearing Centre of Eesti Pank the so-called double clearing that enabled banks to see the results of operations effected for their customers at 3 p.m. every banking day was applied. Thus up to 5 p.m., i.e. to the final clearing, there remained 2 hours for interbank transactions. At the same time banks, in the course of operations effected for their customers, could have an overdraft up to 10% of their reserve requirement. Later on the overdraft limit was increased to 20% (since 30 December to 30%) of the reserve requirement.

Short term certificates of deposit (CD) of Eesti Pank

In order to increase trust between banks, Eesti Pank began release discountable 28-day certificates of deposit with the nominal value of 100,000 kroons. Their primary sale takes place in auctions held every other week. The certificates of deposit of Eesti Pank offer banks the opportunity to execute a hundred percent guaranteed secondary market transaction and thus promote the development of an inter-bank money market and trust between banks. The certificates of deposit of Eesti Pank offer a favourable opportunity for practically risk-free short-term loan transactions. A CD which is not yet due to be redeemed can be resold, by the same value day, to the issuer or a third party. Repurchase agreements where the CD is used as a collateral are possible as well: if the borrower is not able to repay the loan in due time, the creditor becomes the owner of the CD and thus has the right to resell it. As Eesti Pank quotes the purchase price of its CDs every day, the creditor does not have to worry about payment difficulties due to an overdue loan.

Starting from the first auction of the CDs of Eesti Pank, where CDs in the value of 5 million kroons were offered, the volume of emission has steadily increased. It has reached 30 million kroons. Also, the number of banks participating in the auctions has increased. If only three banks participated in the first auctions, now there are 10. Together with the increase in demand, the weighted average interests of emissions have fallen from 8.9% in the first auctions within the range of 6.5% and stay at this level relatively steadily.

Interbank overnight market

Starting from the second half of 1993 the interbank overnight market has shown a tendency to grow. The volume of overnight loans has grown from 25.7 million kroons in September to almost 180 million in November and 504 million in December. Because the above market has become more active it is possible to measure the average free balance of a correspondent account with Eesti Pank for many of the commercial banks by tens of thousands of kroons instead of the hitherto tens of millions.

Changes in interbank foreign exchange operations

Within 1993 essential changes in the foreign exchange operations executed by the mediation of Eesti Pank took place. If at the beginning of the year almost half of all the interbank foreign exchange transactions were carried out through Eesti Pank, by the end of the year the share of transactions through Eesti Pank decreased up to one fourth of the total amount of transactions. This development is promoted by two main factors. At the beginning of 1993, apart from Eesti Pank, competitive foreign exchange rates were offered by only a couple of commercial banks. During the year the number of active "foreign exchange banks" has increased considerably: of the 22 licenced banks 21 have obtained a licence for independent foreign transactions. The other factor was the general increase in the amount of foreign exchange transactions executed in Estonia. The development of the foreign exchange market was favourably affected by the joining of 6 banks with the Society for Worldwide Interbank Financial Telecommunications (S.W.I.F.T) on 6 December 1993 (in 1994 the number of S.W.I.F.T. members among the commercial banks of Estonia will probably increase).

The development of banking was generally characterised by the restoring the credibility of banks in the eyes of the public in 1993 and also an increase in trust inside the banking system itself. In order to win new customers, a number of technical innovations were introduced and new banking products were offered. The latter fact gives evidence of the increase in competition in the banking market. The increasing interest of foreign banks in the Estonian banking market and economy as a whole can also be considered positive. A direct confirmation of this is the opening of representative offices in Estonia by three Finnish banks - Suomen Yhdyspankki (SYP), Osuuspankkien Keskuspankki OY (Okobank) and Kansallis-Osake-Pankki (KOP).