Financial intermediation of transition economies, including Estonia, is characterised by the replacement of the central distribution of financial resources by financial intermediaries typical of a market economy. Financial system reform together with the rise of capital markets, forms favourable conditions for stable economic development in the long term. The practice of transition economies so-far has shown that without an efficiently operating banking sector, the success of other financial intermediation institutions is not achievable, because:

  • in a market economy, banks are one of the main sources of short-term capital. In addition, the necessary experience for credit risk assessment is formed in banks. The growth of efficiency of financial intermediation also promotes the rise of manufacturing companies efficiency;
  • due to the structure of financial markets, banks are in the middle of financial intermediation because the payment system is based on them. Apart from carrying out payments, banks are the first creditors for other financial intermediaries.

Another important role of financial intermediaries, apart from the distribution of resources, is to create conditions which take into consideration the interests of entrepreneurs and creditors.

The priority of the banking system development does not lessen the importance of other financial intermediaries. The latter, including investment funds, have an important role in privatisation and in the phase immediately after that, because the distribution of resources formed as a result of privatisation may not be optimum from the point of view of corporate governance. In Estonia, investment funds have not played such an important role as in Central Europe (in Poland, the Czech Republic, the Slovak Republic) being limited to the intermediation of minority shares. As a result of privatisation policy applied in Estonia, privatised businesses are often controlled by the so-called strategic (core) investor who, in most cases, owns at least 51% of the shares.

The securities market before 1995 was inactive, the only significant securities being municipal debt securities, obtained mostly by long-term investors. In contrast to several other transition economies, in Estonia minimum use has been made of Government debt securities to finance state expenditures. In 1995, various new securities appeared on the market and the secondary market became operational but has remained largely inactive.

Eesti Väärtpaberite Keskdepositoorium (the Central Depository for Securities Ltd) commenced its activities and the privatisation process along with the use of privatisation vouchers expanded. The latter also attracted private persons among investors, although 92% of the securities of privatised businesses were obtained by companies. As of 1 January 1996, the market value of the securities registered in the Central Depository was 3.19 billion kroons of which the market value of publicly traded securities formed 2.05 billion kroons and of publicly non-traded securities 1.14 billion kroons.

No great changes took place in the insurance market in 1995. Further progress depends on the state policy regarding pension insurance and the development of insurance companies. The latter is connected with the privatisation of Eesti Kindlustus (Estonian Insurance Company) and with the planned increase of the minimum capital requirement for insurance companies. The future of pension insurance - state and/or private insurance - is significant both from the socio-economic aspect and from the point of view of the formation of long-term investment resources.

At the end of 1995, the ratio of the consolidated balance sheet of commercial banks, the securities market and the insurance market, as to their volume and share from the point of view of different financial intermediaries, was 83:14:3. The ratio of the volume of the consolidated balance sheet of commercial banks to GDP was 36%, the ratio of the securities market to GDP 6% and of the insurance market 1%. Thus, the present financial market is mainly determined by the intermediation carried out through banks.

ESTONIAN BANKING IN 1995

General Trends

The economic growth of 1995 was also reflected in the further importance of the banks' mediational role. This, in turn, was supported by their increased credibility and progress in customer service (see also Statistical Appendix, Table 1).

By the end of 1995 there were 18 commercial banks (see Table 26. Credit institutions operating in Estonia on 31 December 1995) and 2 authorized lending and saving cooperatives, Leie and Loo, in Estonia. Eesti Hoiupank (Estonian Savings Bank), which had to have an additional reserve with the central bank to cover the private customers' deposits up to 1 December 1995, is now operating on an equal basis with other commercial banks.

Table 26. Credit institutions operating in Estonia on 31 December 1995

1.

Ameerika-Balti Pank

2.

Eesti Forekspank (Raepank merged with Eesti Forekspank)

3.

Eesti Hoiupank

4.

Eesti Innovatsioonipank

5.

Eesti Investeerimispank

6.

Eesti Krediidipank

7.

Eesti Maapank

8.

Eesti Tööstuse ja Ehituse Kommertspank

9.

Eesti Ühispank

10.

ERA Pank

11.

EVEA Pank

12.

Hansapank

13.

INKO Balti Pank

14.

Põhja-Eesti Pank

15.

Tallinna Pank

16.

Tallinna Äripanga AS

17.

Virumaa Kommertspank (Keila Pank and Rahvapank merged with
Virumaa Kommertspank)

18.

Merita Bank (branch of Finnish Merita Bank)

The year 1995 was a year for accumulating capital for the banks. By 1 April the share capital of a bank had to be at least 15 mn kroons and by 1 January 1996 the requirement for the own funds was 50 mn. The enforcement of the latter requirement signified the implementation of the Eesti Pank Board's decision of 2 September 1994 On the Own Funds of Credit Institutions. All the 22 banks operating at that time, met the first requirement by re-structuring their capital. However, the total amount of own funds actually decreased over the period. Own funds started to increase rapidly in May, culminating in October-November. Raepank merged with Eesti Forekspank and Keila Pank, Rahvapank and Eesti Maapank (the latter on 2 January 1996) with Virumaa Komrnertspank. A licence was revoked from only one bank - Ameerika-Balti Pank (the American Bank of the Baltics) - on 10 January 1996). A larger amount of own funds should allow the banks to widen their activities. Mergers have also increased their competitiveness.

From the point of view of customers, it was important that Eesti Pank, to defend the interests of creditors, intervened radically in the activities of Eesti Sotsiaalpank and NoWe Pank. The licences of these banks were revoked in May, 1995. Eesti Sotsiaalpank whose market share formed 15% at the beginning of 1994, had practically ceased to operate by that time. The reasons for revoking the NoWe Pank licence were its violation of the established norms, presenting incorrect reports and the fact that its activities were not in accordance with banking principles.

By the end of 1995 the paid-up share capital of Estonian credit institutions was made up as follows: state -18.5%, local authorities -1.1%, foreign investors - 29.2%, private sector - 45.6% and customers of foreign banks - 5.7%. The tendency of state participation to decrease and foreign participation to increase can be observed: at the end of 1994 their shares were 32.6% and 11.7%, respectively.

Structure of the Consolidated Balance Sheet

In 1995 the share of assets invested abroad decreased by 4.7 percentage points and amounted to 24.1% on 31 December (see Table 27. Sample figures of the commercial banks' consolidated balance sheet). The share of non-income earning assets (demand deposits with Eesti Pank, cash in vaults and fixed assets) has decreased constantly, forming 30.9% by the end of 1993, 22% by the end of 1994 and 20.3% by the end of 1995.

Table 27. Sample figures of the commercial banks' consolidated balance sheet

 

1995

1994

Increase
1995/1994
(%)

Balance
sheet
volume
(EEK mn)

Share in the
consolidated
balance
sheet (%)

Balance
sheet
volume
(EEK mn)

Share in the
consolidated
balance
sheet (%)

Consolidated balance sheet volume

14,872.2

 

10,082.4

 

47.5

Non-residental claims

3,587.4

24.1

2,907.7

28.8

23.4

Non-residental liabilities

1,688.5

11.4

850.6

8.4

98.5

Customers' deposits

9,662.3

65.0

6,943.7

68.9

39.2

Loans to customers

6,733.1

45.3

4,375.8

43.4

53.9

Own funds

1,436.0

9.7

663.4

6.6

116.5

The balance of loans granted to customers increased by 2.3 million kroons (1.54 times) in 1995. The credit demand was encouraged by lowering interest rates. However, the share of loans in the consolidated balance sheet of Estonian commercial banks is relatively small (see Table 28. Structure of assets of the consolidated balance sheet). With the aim of decreasing risks and improving profitability, the banks have placed more assets than before in fixed income securities. The share of this assets item increased by 3.3 percentage points in 1995.

Table 28. Structure of assets of the consolidated balance sheet (%)

 

31.12.95

31.12.94

31.12.93

Claims on central bank

10.0

13.5

24.6

Claims on credit institutions

24.8

25.7

19.4

Loans to customers

44.2

41.9

42.9

Financial investments

10.3

8.5

6.3

Fixed assets

6.5

6.3

4.1

Other assets

4.3

4.2

2.6

In the second half of 1995 the development of the liabilities' structure was influenced by the minimum own funds requirement established by Eesti Pank. As a result, the share of customers' deposits in the liabilities decreased by 3.9 percentage points although the volume of deposits increased by 2.7 billion kroons (see Table 29. Structure of liabilities of the commercial banks' consolidated balance sheet).

Table 29. Structure of liabilities of the commercial banks' consolidated balance sheet (%)

 

31.12.95

31.12.94

31.12.93

Amounts owed to Eesti Pank and
credit institutions

11.1

8.0

7.3

Deposits of customers

65.0

68.9

74.6

Government lending and counterpart funds

5.2

5.2

3.4

Other liabilities

8.6

11.0

4.1

Own funds

10.0

7.0

10.6

Off-balance Sheet Liabilities

As of the end of 1995 the volume of off-balance sheet items was 6.9 billion kroons, i.e., comparable to approximately half the total balance sheet volume.

Seventy per cent of all off-balance sheet obligations result from derivatives connected with interest rates and foreign exchange rates. This is a market that has rapidly developed over the last two years. Eesti Pank will monitor these transactions more closely starting from 1996, together with establishing new prudential ratios. So far, the sale and purchase volumes for foreign exchange forward transactions have been observed. Over 1995 these have tripled and doubled, respectively. The volume of concluded purchases was comparable to 25% of the volume of the commercial banks' consolidated balance sheet at the end of December 1995 (see Figure 20).

Figure 20. Volume of foreign exchange forward transactions between February 1994 and December 1995 (end of month, EEK billion)

Profit

The gross profit of the banking sector in 1995 exceeded that of 1994 by nearly three times. The reason for the more rapid growth of profitability was due to economising on expenditures: over the year balance sheet volume increased by 47.5%, income increased by 41.5%, but expenditures increased by only 24.2% (see Table 30. Sample figures of commercial banks' profitability).

Table 30. Sample figures of commercial banks' profitability (EEK mn)

 

1995

1994

Increase
1995/1994
(EEK mn)

Increase
1995/1994
(%)

Total income

1,850.1

1,307.7

542.4

41.5

   o/w interest income

1,177.3

878.6

298.7

34.0

Total expenditures

1,520.5

1,224.1

296.4

24.2

   o/w interest expenditures

413.9

291.9

122.0

41.8

   administrative expenditures

781.2

551.1

230.1

41.8

Gross profit

329.6

83.6*

246.0

 

Profitability of assets (total income / volume of balance sheet, %)

13.0

12.4

 

-0.5

Net profit of assets (profit / volume of balance sheet, %)

0.8

2.2

 

1.4

Net profit (profit / total income, %)

6.4

17.8

 

11.4

* without losses of Eesti Sotsiaalpank, the banking sector profit in 1994 would have been EEK 111.4 mn

Prudential Ratios

Capital Adequacy

The capital adequacy of banks characterises the adequacy of their own funds to cover credit and foreign exchange risks.

In 1995 the average weighted capital adequacy of commercial banks was 11.3%, i.e., it decreased over the year by 2.3 percentage points. At the beginning of the year the average capital adequacy was strongly influenced by the difficulties of Eesti Sotsiaalpank. Later in the year the average capital adequacy of the sector increased moderately (see Figure 21).

Figure 21. Weighted average capital adequacy of commercial banks between January 1994 and December 1995 (%)

Liquidity

The liquidity ratio characterises the relationship between the bank's liquid assets and current liabilities. The minimum liquidity ratio is 30%. In 1995 the weighted average liquidity was 41.2%, i.e. higher than that of 1994 by one percentage point (see Figure 22).

Figure 22. Weighted average liquidity of commercial banks between January 1994 and December 1995 (%)

Open Net Foreign Exchange Position

As to foreign exchange risks the situation improved considerably in 1995. Continuing instability on the international foreign exchange markets has made the banks careful. The banks try to keep assets covering foreign currency resources in the respective currency, in order to avoid losses in case of sudden exchange rate changes. Open net currency position is the difference of the assets and liabilities added to the balance of forwards and futures in the respective currency. Foreign exchange risks can be evaluated by the ratio of open net foreign currency position to bank's own funds. The total net open foreign exchange position of all foreign currencies cannot exceed 30% of bank's own funds (except for the German mark the position of which is unlimited as the Estonian kroon is pegged to it; see Figure 23).

Figure 23. Banks' open net foreign exchange position as of end of month between February 1994 and December 1995 (%)

Customers' Deposits and Loans

The increasing share of long-term loans was the main trend in 1995. At the same time, the maturity structure of deposits has not changed much and the majority of deposits are still demand deposits. At the end of 1995 demand deposits formed 81.1% of total deposits and 81.5% of time deposits where those which had a maturity date of up to one year. From loans granted to customers 67.4% were long-term loans, i.e. with the maturity exceeding one year. In December 1994 the share of long-term loans was 50.9% (see Table 31. Structure of balances of deposits and loans by their maturity as of end of 1995 and 1994).

Table 31. Structure of balances of deposits and loans by their maturity as of end of 1995 and 1994 (%)

 

31.12.95

31.12.94

DEPOSITS

 

 

Demand deposits

81.1

81.7

Time deposits

 

 

   up to 3 months

6.6

4.9

   3- 12 months

8.8

10.6

   over 12 months

3.5

2.8

LOANS

 

 

Short-term loans

 

 

   up to 1 month

2.0

2.9

   1-3 months

3.6

5.5

   3-6 months

5.1

8.9

   6-12 months

21.8

31.8

Long-term loans

 

 

   1-3 years

33.6

30.9

   3-5 years

20.2

11.5

   over 5 years

13.5

8.5

The disproportion of maturity between deposits and loans is cushioned, on the one hand, by the fact that in Estonia the ratio of loans to deposits is rather low (69.7% at the end of 1995). This means that part of the resources are used for financial investments. Because of the prevalence of demand deposits, it is extremely important for Estonian commercial banks to find short-term investment possibilities. On the other hand, the above disproportion is also cushioned by the fact that approximately one fifth of the long-term loans are financed by government lending funds and counterpart funds.

As to the profile of customers, nonfinancial public enterprises have decreased their involvement both as borrowers and depositors (see Tables 32. Structure of deposits by customers as of end of 1995 and 1994; and 33. Structure of loans by customers as of end of 1995 and 1994). A stable increase in the share of private enterprises' and individuals' deposits can also be noted. As to loans, financial institutions have become a new object for loan grant. This concerns mainly banks' subsidiaries, e.g., leasing companies. Such subsidiaries help the banks to compete in the market and to widen the range of banking services.

Table 32. Structure of deposits by customers as of end of 1995 and 1994 (%)
  31.12.95 31.12.94
Government 24.5 24.7
Financial institutions 1.6 0.9
Non-financial public enterprises 6.9 11.2
Private enterprises 39.0 40.3
Individuals 28.0 23.0

Table 33. Structure of loans by customers as of end of 1995 and 1994 (%)

 

31.12.95

31.12.94

Government

1.8

1.0

Financial institutions

8.9

0.1

Non-financial public enterprises

4.6

8.3

Private enterprises

73.8

79.5

Individuals

10.9

11.1

Interest Rates

If a certain stabilisation of interest rates could be noted in the middle of 1995 after a constant decrease in these rates over two years, then the end of 1995 brought along a further decrease. The weighted average annual interest rate of time deposits decreased by 2.9 percentage points over 1995: it was 10.13% in 1994 and 7.21% in 1995. The weighted average annual interest rate of demand deposits has been stable for two years now, decreasing from 2.74% in 1994 to 2.61% in 1995 (see Figure 24).

Figure 24. Weighted average annual interest rates of kroon deposits between January 1994 and December 1995 (%)

The interest rates on loans, especially on short-term loans, have constantly decreased over 1995 (see Figure 25). The weighted average annual interest rate of long-term loans has been significantly influenced by the lower than average interest rate levels on the loans mediated via government lending funds and counterpart funds.

Figure 25. Weighted average annual interest rates of kroon loans between January 1994 and December 1995 (%)

Comparing the interest rates on deposits and loans, the interest rate marginal (i.e. balance of resource costs and price of issued loans) can be determined. In Estonia where time deposits mainly mature within one year, one could regard the interest rates on time deposits and those on short-term loans as comparable interest rates. Over 1995 the respective interest rate marginal has dropped from 13.0 to 8.8 percentage points. The reason for that is the more rapid decrease of the interest rates for short-term loans which in turn should cause the investment conditions to be more favourable. Nevertheless, the Estonian interest rate marginal is still rather high compared to those of developed countries.

Other Financial Intermediaries

The development of the securities market which started in 1995 together with the stabilisation of the banking system was also connected with the institutional development of the financial sector, including the foundation of the Estonian Central Depository for Securities Ltd.

The Estonian Central Depository for Securities Ltd was founded in February 1994, on the initiative of commercial banks operating in the securities market, by Eesti Pank and the Ministry of Finance, with the aim of creating trustworthy and secure surroundings for dealing with securities in Estonia. The established structure conforms to world standards, with a central register where the deals are struck through Eesti Pank and the transfer of securities takes place simultaneously with the cross debt set-off on the following banking day. By the end of 1995, the number of securities accounts opened at the Central Depository exceeded 53 thousand. These accounts are serviced by the intermediation of 208 subsidiaries of 10 commercial banks in 73 locations. As of 1 January 1996, there were 93 different securities registered at the Central Depository of which 36 were shares, 48 debt securities and 9 fund units. There were 45 publicly traded securities among them. These figures show the need to develop the following elements of the infrastructure, i.e. stock exchange as well as security for investors.

Since the initiation of the Depository, the number of services offered has continued to increase. In addition to dividends and interest payments carried out on behalf of the owners of securities, the Depository has signed a contract with the Estonian Privatization Agency (Eesti Erastamisagentuur) by which the Depository will act as a conductor of public sale.

The task of the Tallinn Stock Exchange (Tallinna Väärtpaberibörsi AS, registered on 8 August 1995) is to establish a regulated securities market. The Tallinn Stock Exchange was founded by Eesti Pank, the Ministry of Finance and 21 financial organisations in April 1995. As planned, only broker firms will become members of the stock exchange and therefore, banks have to establish broker firms if they wish to deal on the Stock Exchange. Unfortunately, at the moment, the market is dominated by banks which themselves deal with securities as a side-activity.

As to the rules of the Central Depository and the Tallinn Stock Exchange, efforts are made to follow international standards and to establish a market which will be accepted by developed countries. It is hoped that by May 1996, the Tallinn Stock Exchange will be initiated as an electronic stock exchange the transactions of which will be carried out via the Central Depository.

The most important events in the securities market in 1995 were the three year bond non-public issue of the first foreign issuer, the Postipankki OY, in February and the two year bond non-public issue of the Nordic Investment Bank in September that was the biggest issue so far in Estonia worth over 200 million kroons. The biggest public issues were those of the vouchers of the Compensation Fund (Hüvitusfond).

The shares of several enterprises subject to privatisation (Tallinna Kaubamaja Ltd (Tallinn Department Store), Saku Õlletehas (Saku Brewery) and several banks (Eesti Hoiupank, Tallinna Pank) appeared on the market for public sale. One could speak about an active secondary market in the event of the shares of six enterprises (Hansapank, Eesti Hoiupank, Eesti Forekspank, Tallinna Kaubamaja, Saku Õlletehas and Tartu Maja). Their shares are also included in the index of the Central Depository. Considering the fact that the market is at an early stage of development, the price floatations have been high and the market index rather unstable.