The increase in the macroeconomic stability in 1996 also had a favourable effect on the development of Estonia's financial sector and financial intermediation. The rapid growth of the non-banking financial intermediation continued as well as the internationalisation of the Estonian financial system.

Similarly to earlier years, there occurred consolidation within the financial system, expressed both through the bank mergers as well as the integration of the banking and other parts of the financial sector. Although the bank mergers of 1996 were, on the one hand, caused by the toughening competition, we should not underestimate the role of the regulative pressure in the final stage of the restructuring of the banking sector. At the same time the mergers marked the end of the institutional stage of the transfer from the planned economy to the market economy. The risks caused by the transition process were at the same time also an important part of the total risks of the Estonian banking system.

The expansion of the corporate activity of the banks to the insurance market and increasing activities on the securities and leasing markets testify to the continuation of the shaping of financial conglomerates. At the same time, such development of the financial system indicates that the Estonian financial sector by its structure is approaching the internationally developed institutional build-up.

From the institutional aspect, the development of the non-banking financial intermediation was greatly facilitated by the successful launch of the Tallinn Stock Exchange in June. The development of the securities market widened the investment opportunities of economic agents considerably. On the other hand, the securities market is becoming an important alternative source of financing besides the banking system. However, despite the rapid increase in the non-bank financial intermediation the banking system preserved its strong lead in the financial market (see Figure 5).

Figure 5. Structure of the Estonian financial intermediaries by financial assets as of 31 December 1996

The integration of the Estonian financial system into the international financial system deepened in 1996. The growing reliability of the Estonian financial environment in the eyes of foreign financial institutions was proven both by access to long-term credit lines and strategic investments into the capital of Estonian banks. For the first time foreign financing became a significant source of satisfying the growing domestic demand for loans.

On the other hand, the internationalisation of Estonian banks could be seen in their expansion to Latvia through the acquisition of a daughter bank and making strategic investments into shares. A similar pattern of development could be seen among the leasing firms owned by banks. The interest of Estonian financial institutions in the Baltic and Russian capital markets was also remarkable.

BANKING SYSTEM

General Trends

The development of the Estonian banking in 1996 was, besides the quick nominal growth, also characterised by the expansion of the banks' activities into the other segments of the financial sector as well as beyond the state borders. Last year also the supply of new kinds of services increased, driven mainly by the growing competition.

A new aspect was the expansion of banks outside Estonia. The growing interest of Estonian banks towards the Baltic region and Russia was testified by the purchase of a daughter bank in Riga by Hansapank and the opening of representative offices in Moscow by Eesti Forekspank (Estonian Forexbank) and EVEA Pank. Other Estonian banks too have stakes in foreign banks. In search for potential new markets more attention has recently been given to the Ukraine.

Several new depositing and loan instruments were introduced to the market and the launch of the Tallinn Stock Exchange increased the role of brokerage services in the total range of banking services. In addition to the product-oriented development work more attention was paid to the customer-oriented approach.

The volume of the consolidated balance sheet of the Estonian commercial banks increased by 48% over the past year, amounting to 21,927.5 million kroons on 31 December 1996. Major structural changes concerned the increase of the share of non-residents from 11% to 18% and the share of foreign currency from 23% to 31% on the liabilities side. Under the assets side, the share of non-residents decreased from 24% to 19% over the past year, while the share of foreign currency increased from 29% to 33%.

At the end of 1996 Estonia had 15 commercial banks and two loan and savings cooperatives. As compared to the end of 1995, the number of banks had decreased by three, a development that testifies to the continuing consolidation of the Estonian banking system (at the end of 1992 the number of banks had been 41, at the end of 1993 and 1994 it was 22). Two banks, Ameerika-Balti Pank (American Bank of the Baltics) and then Eesti Maapank (Land Bank of Estonia) failed to meet the new requirement for the minimum size of own funds (50 million kroons) that took effect from 1 January 1996. The former had its licence revoked and the latter merged with Virumaa Kommertspank (Virumaa Commercial Bank). In September Eesti Tööstuse ja Ehituse Kommertspank (Estonian Commercial Bank of Industry and Construction) and Eesti Hoiupank (Estonian Savings Bank) signed a merger agreement. The negotiations over the merger of Põhja-Eesti Pank (North Estonian Bank Ltd.) with Eesti Ühispank (Union Bank of Estonia) which began in late 1996 ended with a merger decision on 5 January 1997, and the legal process of the merger will come to an end in the first half of the year.

Bank Assets

The dominating tendency in 1996 was the increase in the share of more profitable assets, while the share of funds deposited in other banks decreased, leading to proportionate increase in the loan portfolio and financial investments.

The share of loans in the balance sheet increased from 45% to 53% over the past year (see Table 23. Structure of assets of the Estonian commercial banks' consolidated balance sheet). At the end of the year, the sum of loans given to customers amounted to 11.5 billion kroons, which denotes an annual increase of 71%. The rise in the lending activity has become possible thanks to the inflow of relatively cheap and long-term finances from international capital markets, as well as due to the increase in the deposits of private persons. With the terms of the loans getting longer and interests lower, the size of periodical payments related to the servicing of the loans has become smaller. This means that despite a relatively small change in income, the market expectations about the customers' loan servicing abilities have improved in the context of the general stabilisation of the economy. The volume of housing loans granted to private persons increased rapidly in 1996. Among the new loan products we could mention the young family loan, the young teacher loan, loans for financing travel and medical expenses, consumption loan, consumer factoring, etc.

Table 23. Structure of assets of the Estonian commercial banks' consolidated balance sheet

 

as of 31 December 1993

as of 31 December 1994

as of 31 December 1995

as of 31 December 1996

EEK mn

%

EEK mn

%

EEK mn

%

EEK mn

%

Total assets

6,394.7

100.0

10,082.4

100.0

14,867.4

100.0

21,927.5

100.0

Cash

546.4

8.5

649.2

6.4

769.7

5.2

953.4

4.3

Claims on central bank

1,088.1

17.0

771.7

7.7

759.1

5.1

1,201.0

5.5

Claims on and loans to credit institutions

1,243.7

19.4

2,587.2

25.7

3,684.7

24.8

2,974.8

13.6

Loans to customers

2,740.3

42.9

4,375.8

43.4

6,734.9

45.3

11,537.7

52.6

Doubtful claims and loans

-

-

-154.8

-1.5

-165.4

-1.1

-239.1

-1.1

Financial investments

346.0

5.4

792.7

7.9

1,488.5

10.0

3,242.4

14.8

Other assets

430.2

6.7

1,060.7

10.5

1,595.8

10.7

2,257.3

10.3

 

The year 1996 was characterised by a significant increase in the foreign currency loans - the proportion of such loans in the banks’ loan portfolio increased from 12% to 32 over the year. This can be attributed to the above-mentioned borrowing from international financial markets and the subsequent increase in the share of foreign currency resources. By lending in the same currency they received the resource, the banks transferred the potential risk of the exchange rate fluctuations to the end borrower. This practice, however, can increase the credit risk, particularly if the end borrowers take no precautions to cover their exchange rate risk. Since over 70% of the foreign currency loans have been issued in German marks, the exchange rate risk of such loans can be considered minimum on the condition that the current monetary policy, based on the fixed exchange rate, continues.

The big flow of capital and toughening competition on the market had its impact on the interest rates as well. The interest rates of time deposits in Estonian kroons dropped 1.91 percentage points over the year and stood at 5.30% at the end of the year (see Figure 6). The weighted average annual interest rate of kroon loans dropped 2.16 percentage points last year and stood at 13.76% on 31 December. Calculating the interest marginal for short-term loans and time deposits (presuming that the maturity of time deposits is mostly up to one year) we can see that it fell by an average of nearly 2 percentage points in 1996. The share of foreign currency loans with the floating interest rate has increased considerably. However, the floating interest rate is not very often used for kroon loans - mainly to finance large companies. The introduction of the floating interest rate has made the market more flexible for both the borrowers and the lenders - the bank secures itself a certain interest margin while the interest payments of the customer are linked with the trends on the international money markets.

Figure 6. Weighted average annual interest rates of kroon deposits and loans, between 1994 and 1996 (%)

Although the share of overdue loans and doubtful claims in the 1996 loan portfolio decreased as compared to 1995, it is difficult to connect this with the overall improvement of the quality of loan portfolios in the context of the rapid increase in the loan volumes (see Table 24. The quality of commercial banks' loan portfolio, between 1993 and 1996). Moreover, it is the balance of long-term loans that has increased the most and thus the possibilities of customers’ repayment problems have been distributed over a longer period than before (up to ten years). This in its turn complicates the evaluation of the quality of the loan portfolio.

Table 24. The quality of commercial banks' loan portfolio, between 1993 and 1996 (EEK mn, as of end of year)

 

 

1993

1994

1995

1996

1.  

Loans total

2,740.3

4,375.8

6,734.9

11,537.7

2.

Doubtful claims and loans

-

154.8

165.4

239.1

3.

Overdue loans

194.7

158.8

208.7

282.5

 

Share of overdue loans in the loan portfolio ( 3/1 )

7.1%

3.6%

3.1%

2.4%

 

Share of doubtful overdue loans in the loan portfolio ( 2/1 )

-

3.5%

2.5%

2.1%

In 1996 the financial investments of banks more than doubled. The share of stocks has increased in the banks’ securities portfolio. The volume of shares increased 3.6 times last year, i.e. by 836 million kroons. The increase in share prices, boosted by the launch of the stock exchange, created possibilities for owners of shares quoted on the stock exchange to earn much higher income from the changing prices than from dividends. The volume of fixed-income securities has increased but their share in the banks' securities portfolio decreased from 78% to 64% in favour of shares in 1996. Among investments into securities of non-residents the share of investments into the bonds issued by the governments of the so-called B-zone countries has increased considerably due to high yields from such bonds. In 1996, besides the Lithuanian litas, the Latvian lats and Russian ruble, the foreign currency assets of the banks increased also in the Ukrainian hryvnia.

External and Own Funds of the Banks

The most important changes in the banks' loan resources in 1996 were the longer terms of the loans resources mostly on the account of foreign financing, and the increase in the deposits of private persons. At the same time, the launch of the Tallinn Stock Exchange offered an alternative for investing one's savings for both private persons and commercial undertakings.

In the loan resources, the volume of customers' deposits increased by 44.6% over 1996, amounting to 14 billion kroons at the end of the year (see Table 25. Structure of liabilities of the Estonian commercial banks' consolidated balance sheet). The increase in deposits was smaller than that of loans - the deposits increased by 4.3 billion kroons last year while the loan portfolio grew by 4.8 billion kroons. The higher increase in the demand for loans was financed by direct or syndicated loans from foreign banks and from the money earned from issuing bonds. Direct loans from international financial markets were cheaper as compared to the domestic loan resources. In previous years the credit lines mediated by the Estonian government had served as an important source of financing, while in 1996 the role of such financing decreased.

Table 25. Structure of liabilities of the Estonian commercial banks' consolidated balance sheet

 

as of 31 December 1993

as of 31 December 1994

as of 31 December 1995

as of 31 December 1996

EEK mn

%

EEK mn

%

EEK mn

%

EEK mn

%

Total liabilities

6,394.7

100.0

10,082.4

100.0

14,867.4

100.0

21,927.5

100.0

Amounts owed to central bank

329.7

5.2

344.1

3.4

73.3

0.5

36.0

0.2

Amounts owed to credit institutions

136.6

2.1

461.2

4.6

1,579.1

10.6

2,654.2

12.1

   o/w foreign credit institutions

44.7

0.7

217.6

2.2

610.6

4.1

1,694.4

7.7

Amounts owed to customers

4,768.2

74.6

6,943.7

68.9

9,663.6

65.0

13,974.3

63.7

Government lending and counterpart funds

219.2

3.4

519.2

5.2

779.7

5.2

873.3

4.0

Debts evidenced by certificates

0.7

0.0

220.0

2.2

14.0

0.1

295.5

1.3

Other liabilities

261.7

4.1

930.9

9.2

1,339.2

9.0

1,983.5

9.0

Own funds

678.7

10.6

663.4

6.6

1,418.6

9.5

2,110.7

9.6

The terms of external resources have become longer. At the end of 1996 time deposits accounted for 25% of external funds and their share increased by 6 percentage points over the year. Still, the majority of deposits have the maturity of up to one year and thus constitute a short-term resource. At the same time the share of long-term loans has increased from 67% to 75%. These are mainly financed through loans from foreign banks, 70% of which have the maturity date over one year. The balances of bonds issued by banks increased in the balance sheet by 281.5 million kroons, and this too is a long-term resource.

In the customers’ structure of deposits the share of private persons increased in 1996. In addition to demand deposits related to wages, the biggest increase occurred in time deposits of private persons with the maturity from three months to one year. This is an indication of the population's increasing saving habits which presuppose an increase in incomes, changes in the consumption patterns and the banks paying more attention to private persons.

The share of own funds did not change much in the banks' balance sheets in 1996 - in terms of volume the increase was only 0.7 billion kroons (see Table 25). Among the components of own funds the biggest increase was recorded in profits and share capital, which accounted for 17.3% and 66.1%, respectively.

As of 31 December 1996, the total volume of the banks' share capital (including Eesti Investeerimispank (Estonian Investment Bank)) was 1,256.8 million kroons. In 1996 the volume of the share capital increased by 157.2 million kroons. On 30 September 1996[1] , the share capital of the banking system was 1,214.0 million kroons, of which 22.5% belonged to Estonian businesses; 37.2% to foreign shareholders (of which 10.3% belonged to foreign banks); 11.2% to the state; 7.5% to private persons; and 0.8% to municipalities. Small shareholders owned 20.7% of the system's total share capital, with each having less than 1%. The state participation in commercial banks decreased over 1996. As of 30 September, the state held shares in five banks, owning a total of 135.8 million kroons worth of shares (see Table 26. State participation in the Estonian commercial banks). The share of foreign partners in the banks’ capital increased only by 2.3% in the first nine months of 1996.

Table 26. State participation in the Estonian commercial banks (EEK mn)

Bank

as of 30 September 1995

as of 30 September 1996

Ministry
of Finance

Eesti
Pank

Total

%

Ministry
of Finance

Eesti
Pank

Total

%

Eesti Investeerimispank

 

44.4

44.4

33.3

 

44.1

44.1

33.3

Põhja-Eesti Pank

30.0

20.0

50.0

90.0

30.0

20.0

50.0

83.3

Eesti Hoiupank

 

32.0

32.0

31.1

 

22.5

22.5

16.9

Eesti Maapank

2.0

 

2.0

9.3

2.6

 

2.6

4.3

Eesti Ühispank

16.6

 

16.6

11.1

16.6

 

16.6

7.1

former Rahvapank

1.2

 

1.2

7.2

 

 

 

 

Total

49.5

96.1

145.3

13.1

49.2

86.6

135.8

11.2

Profitability and Profits

The productivity of the banks' own funds did not change in 1996 because in annual average terms own funds increased at the same rate as profits (see Table 27. Sample profitability figures of commercial banks, between 1994 and 1996). But since the role of the share capital in own funds decreased from 80% to 70% over the year, the productivity of the share capital increased. The banks have even managed to slightly increase productivity despite the decrease in interest rates on both domestic and foreign money markets. This has been achieved mainly by increasing the share of more profitable assets, which testifies to increasing competition.

Table 27. Sample profitability figures of commercial banks, between 1994 and 1996 (%, as of end of year)

 

1994

1995

1996

Interest bearing debts/balance sheet volume

84.58

81.84

82.47

Profit earning assets/balance sheet volume

76.06

79.25

79.61

Administrative costs/earnings

42.15

42.23

36.34

Assets yield = annual profit/balance sheet volume

0.99

2.76

3.24

Profit margin = annual profit/earnings

6.39

17.81

20.08

Annual profit/share capital

16.37

44.38

52.53

Yield on equity capital = annual profit/equity capital

11.20

34.02

33.60

Net interest margin = net interest income/profit earning assets

7.59

8.21

7.12

Net non-interest margin = net non-interest income/balance sheet volume

-5.94

-3.64

-2.57

Assets profitability = earnings/balance sheet volume

15.45

15.52

16.15

The pre-tax profits of the banks in 1996 amounted to 567.5 million kroons, which is by 72.2% more than in 1995 (see Table 28. Formation of commercial banks' profit, between 1994 and 1996).

Table 28. Formation of commercial banks' profit, between 1994 and 1996 (EEK mn)

 

1994

1995

1996

Income from interests

878.6

1,177.3

1,717.0

Interest expenses

291.9

413.9

699.9

Non-interest rate income

429.1

672.8

1,109.5

Non-interest rate expenses

923.6

1,106.7

1,559.2

o/w administration costs

551.1

781.2

1,027.1

Pre-tax profit

83.6

329.6

567.5

Income tax

14.9

41.1

50.0

Annual profit

68.7

288.5

517.4

The bulk of the profits was earned in the form of income from interests which at the end of 1996 accounted for 60.7% of total income. From year to year the share of interest income earned from the loan portfolio has decreased. On the other hand, the diversification of the banking activities has increased the share of interest income earned from securities and futures.

The development of the sphere of activities has also led to the increase in the non-interest income which in 1996 accounted for 39.3% (an increase of 2 percentage points over the year). A significant increase was recorded in the non-interest income from financial transactions and securities.

Interest expenses have increased more rapidly than interest income, particularly interest expenses of time deposits (due to the increasing share of time deposits), futures and resources received from other credit institutions. This has resulted in a slow decline in the interest margin.

Among expenditures, the biggest category is the banks' administration costs. In 1995 42.2% of the income was spent on managing the banks, while in 1996 the increase in the administration costs was considerably lower than the increase in income and the respective ratio was 36.3%. Due to this, the profit margin increased by 2 percentage points. The share of administration costs is smaller in large banks which gives them certain advantages in curbing the costs.

OTHER FINANCIAL INTERMEDIARIES

The year 1996 was characterised by the rapid increase in non-bank financial intermediation. The development of the securities market was the most remarkable - the volume of financial resources mediated through the capital market reached a considerable level (see Figure 7). The key events of the year were the launch of the Tallinn Stock Exchange, the rapid increase in the volume of the stock market and municipal bonds as well as the development of the open investment funds. Requirements for the minimum capital of the insurance companies were introduced and the leader of the insurance market in both life and non-life insurance, Eesti Kindlustus, was privatised. There occurred no fundamental changes in the pension insurance and the most important decisions are still to be made. The inner integration of the financial sector deepened, and was first of all expressed in the increasing role of the banks in the non-bank financial intermediation, including on the stock market, the insurance market and the leasing market.

Figure 7. Capitalization of the Estonian securities market and financial assets of commercial banks as of 31 December 1996

Institutional Development of Financial Intermediaries

On the securities market the highlight of 1996 was the launch of the Tallinn Stock Exchange that led to the rapid increase in the liquidity of the market in the second half of the year. The Tallinn Stock Exchange is an electronic market where a combination of the electronic dealer market and the order-book market is used. The rules of the stock exchange regulate several spheres that have not been covered by legislative acts so far and which will probably be regulated by the law on the stock exchange in 1997.

The development of the legal framework of the stock market in 1996 included the draft law on the investment funds and the government's regulation on the new procedure of the public share issues. These legal acts brought the requirements on public share issues and investment funds into line with the respective directives of the European Union. The final goal of the legislation improvements is to guarantee the transparency of the market and protect the investors.

The draft law on the investment funds introduces the requirement of minimum capital for the asset managements, specifies the types of investment funds (open contract-based funds and closed share holding-type investment funds are allowed in Estonia, but no open corporate funds and closed contract-based funds), sets the limits on investments by the investment funds, etc. Differently from the current practice, the shares of the open funds will be freely traded in the future.

The year 1996 was also characterised by the deepening integration of the Estonian securities market with the European capital markets and the quotation first Estonian shares on the European stock markets (Frankfurt, Helsinki). At the beginning of the year, within the legislation a notion was introduced that allows nominee status which gives foreign investors easier access to the Estonian securities market. The agreement signed between the Estonian and Latvian central depositories for securities at the end of the year was important from the point of the institutional development of the market in the future since it creates prerequisites for the emergence of a common Baltic securities market. There has been some discussion on signing a similar agreement with the Lithuanian central depository for securities.

At the end of 1996, a total of 41 broker firms were active on the Estonian stock market, including all the banks (with the exception of the Finnish Merita Bank's Tallinn branch), Hüvitusfond (the Compensation Fund), 13 asset managements and various investment and brokerage firms. Although the number of intermediaries and funds did not increase considerably as compared to 1995, the scope of their activities increased considerably. The distribution of the market shares of the asset managements testifies to the integration of the financial sector (see Figure 8), with asset managements related to banks dominating (93% of the market). The distribution of the market between investment funds including Hüvitusfond is described in Figure 9.

Figure 8. The distribution of the market between the asset managements as of 31 December 1996

Figure 9. The distribution of the market between the investment funds (incl. Compensation Fund) as of 31 December 1996

A new trend in 1996 was the development of the money market and interest funds which allows the investors to put their resources also into funds focussing on the short-term interest products, not just funds aimed at the long-term capital increase. This investment opportunity is first of all meant for developing the companies liquidity management. Another new trend in 1996 was the creation of investment funds oriented on Central and Eastern Europe. In the framework of the domestic and regional integration of financial intermediation, this means a partial transfer of the market segment, that used to be the domain of the banks, into the hands of investment companies.

Capital Market

Development of the Market

On the whole, the year 1996 is characterised by the increase in the market turnover and prices which led to the rapid growth in the share of the capital market in financial intermediation. The volume of the market increased approximately four times, amounting to 13.2 billion kroons[2] at the end of the year which is estimated to form 28% of the GDP. This indicator puts Estonia ahead of all Central and Eastern European countries, with the exception of the Czech Republic. The thin market typical of transition countries deepened considerably over the year as can be seen from the increase in the turnover and capitalisation ratio up to 12.5%. This was facilitated by the launch of the Tallinn Stock Exchange that led to the considerable increase in market liquidity in the second half of the year. Turnover and price developments on the stock exchange are described in Figure 10. The share index of the Estonian Central Depository for Securities[3] has increased nearly five times over the past 18 months, reflecting first of all the fact that the initial underpricing period was over - the initially low price/earnings ratio (4-5) rose to 10-15 during the year. At the end of the year, the Central Depository's share index included the shares of 17 enterprises.

Figure 10. Turnover of the securities market and the share index of the Estonian Central Depository for Securities (ECDS) without non-market transactions, between July 1995 and December 1996

The main difference of the Estonian capital market from that of other transition countries is that it lacks short-term bonds of the central government. Bonds of local governments are quite common and through international investment firms these have also reached European capital markets (the three-year Eurobond of the Tallinn municipality). However, more than 90% of the secondary market is taken up by stocks.Municipal bonds can be rather treated as loans issued in the form of securities which are not active in the secondary market. In 1996 the new instruments on the market include the commercial papers of large-scale companies the interest rate of which followed the inter-bank interest rates (three-month TALIBOR). The average interest rates of the municipal and corporate bonds vary from the three-month TALIBOR and 10-12% (in case of longer-term (4-5 years) bonds). Interest towards financial asset securization has increased sharply although no solution was reached in 1996. The structure of the securities market by instruments can be seen from Figure 11. Another peculiarity of the market is the leading role of banks (including their daughter companies) in the securities intermediation and the domination of the shares of banks in the secondary market (64% of the turnover). This reflects the quicker and more dynamic development of the banking sector as compared to other branches of the economy and at the same time also characterises the increasing role of banks in financial intermediation and in the economy as a whole.

Figure 11. The structure of the securities market by instruments as of 31 December 1996

The volume of investment funds increased up to 0.5 billion kroons in 1996, amounting to 4% of the total market. The bulk of the increase came from funds while the role of closed, privatisation voucher-oriented funds remained modest (15% of the increase in the volume of investment funds) which corresponds to the strategic investor-based privatisation scheme used in Estonia. In Figure 9 Hüvitusfond (the Compensation Fund) has also been included under investment funds although by its nature it is a mixture of an investment bank and a development bank. Together with Hüvitusfond the market share of investment funds amounts to 5.4%. Hüvitusfond has been included under the investment funds[4] because in addition to investing the privatisation vouchers the Compensation Fund obligations are also freely traded on the market. The trend of the investment funds at the end of 1996 was to expand outside the state borders (Hoiupanga Venemaa IF (the Russian Investment Fund of the Savings Bank), Tallinna Panga Kesk- ja Ida-Euroopa IF (the Central and Eastern European Investment Fund of Tallinna Pank)) because at the moment the yield of the securities of several Central and Eastern European countries is higher than the yield of the Estonian securities and it is possible that this will continue to be the case also in the medium run.

A survey of the issuers and investors in the Estonian securities market in 1995-1996 is provided in Table 29 (The structure of the securities market by issuers and investors (%) and major indicators of the securities market in 1995 and 1996). The increase in the liquidity and price of shares resulted in a growing interest of foreign investors in the Estonian securities market, facilitated also by the lack of capital controls. The share of foreign investors in the market increased by 6 percentage points in 1996, from 29% to 35%. Geographically, investors from such countries as the Great Britain, Finland and Sweden dominate (see Figure 12). Of other foreign investors the majority are from off-shore regions who at the end of 1996 accounted for approximately 4% of all investors in the securities market.

Table 29. The structure of the securities market by issuers and investors (%) and major indicators of the securities market in 1995 and 1996

 

1995

1996

Issuers

Investors

Issuers

Investors

Private persons

 

8.0

 

8.8

Institutional investors

94.0 (1)

63.0

96.0

56.1

   o/w enterprises

74.6 (1)

63.0 (1)

86.7

55.4

        open sector

19.4 (1)

 

9.3

 

Non-residents

6.0 (1)

29.0

4.0

35.1

Market capitalization (EEK mn)

 

3.2

 

13.2

Capitalization/GDP

 

7.7

 

26.4

Turnover/capitalization

 

2.9 (1)

 

12.5

(1) estimated data

Figure 12. Distribution of foreign investors in the Estonian securities market as of 31 December 1996

Among other structural changes in the securities market the most important ones concerned the decrease in the share of the state-issued securities and the increase in the number of private investors which indicates that the capital market is becoming an alternative for investing their savings. This is particularly remarkable in the context of the rapid increase in the volume of the securities market.

A more detailed survey of the structure of the securities by issuers and investors is given in Tables 30 (Distribution of securities by issuers as of 31 December 1996) and 31 (Distribution of securities by investors as of 31 December 1996).

Table 30. Distribution of securities by issuers as of 31 December 1996

 

EEK mn

%

 Enterprises

 

 

11,449

86.7

 

Common shares

quoted on the stock exchange

8,541

64.6

 

 

not quoted on the stock exchange

1,981

15.0

 

 

Total

10,522

79.6

 

Debt securities

not quoted on the stock exchange

587

4.4

 

 

Total

587

4.4

 

Open fund shares

quoted on the stock exchange

234

1.8

 

 

not quoted on the stock exchange

29

0.2

 

 

Total

264

2.0

 

Closed fund shares

quoted on the stock exchange

23

0.2

 

 

not quoted on the stock exchange

54

0.4

 

 

Total

76

0.6

 Government

 

 

1,241

9.4

 

Bonds

quoted on the stock exchange

181

1.4

 

 

not quoted on the stock exchange

1,060

8.0

 

 

Total

1,241

9.4

 Non-residents

 

 

523

4.0

 

Debt securities

not quoted on the stock exchange

523

4.0

 

 

Total

523

4.0

 Total

 

 

13,212

1.0

Source: Estonian Central Depository for Securities

 

Table 31. Distribution of securities by investors as of 31 December 1996

 

EEK mn

%

 Enterprises

 

 

7,369

55.8

Common shares

quoted on the stock exchange

4,178

31.6

 

not quoted on the stock exchange

1,160

8.8

 

Total

5,338

40.4

Debt securities

quoted on the stock exchange

105

0.8

 

not quoted on the stock exchange

1,710

12.9

 

Total

1,815

13.7

Open fund shares

quoted on the stock exchange

10

0.1

 

not quoted on the stock exchange

20

0.2

 

Total

31

0.2

Closed fund shares

quoted on the stock exchange

159

1.2

 

not quoted on the stock exchange

26

0.2

 

Total

185

1.4

 Private persons

 

 

1,176

8.9

Common shares

quoted on the stock exchange

917

6.9

 

not quoted on the stock exchange

91

0.7

 

Total

1,008

7.6

Debt securities

quoted on the stock exchange

69

0.5

 

not quoted on the stock exchange

12

0.1

 

Total

81

0.6

Open fund shares

quoted on the stock exchange

11

0.1

 

not quoted on the stock exchange

26

0.2

 

Total

37

0.3

Closed fund shares

quoted on the stock exchange

49

0.4

 

not quoted on the stock exchange

2

0.0

 

Total

51

0.4

 Non-residents

 

 

4,667

35.3

Common shares

quoted on the stock exchange

3,446

26.1

 

not quoted on the stock exchange

730

5.5

 

Total

4,176

31.6

Debt securities

quoted on the stock exchange

7

0.1

 

not quoted on the stock exchange

447

3.4

 

Total

454

3.4

Open fund shares

quoted on the stock exchange

2

0.0

 

not quoted on the stock exchange

8

0.1

 

Total

9

0.1

Closed fund shares

quoted on the stock exchange

27

0.2

 

not quoted on the stock exchange

1

0.0

 

Total

28

0.2

 Total

 

 

13,212

100.0

Source: Estonian Central Depository for Securities

Financial Deepening and the Capital Market

The financial deepening is besides the increase in the share of higher money aggregates (see the Monetary Policy part of the report) also characterised by the increase in the volume of the capital market and the increase in liquidity. Despite the financial sector being bank-dominated in the institutional sense, an important role in intermediating financial resources between different economic sectors also belongs to the securities market in Estonia. In 1996 the securities market became an important channel for rising capital, first of all for those branches of the economy which have a more dynamic structure of capital (banking, and to a lesser extent, industry). At the same time the capital market has played an important role in obtaining financial resources for those sectors of the economy that have a relatively low creditworthiness or higher risk level (local governments, processing of agricultural products, companies depending on the Eastern markets). The securities market is also an important channel of capital inflow.

The role of the capital market in financial intermediation is described by the differences of the positions of the economic sectors against banking and the entire consolidated financial sector (see Figure 13 and figure 14). Adding the capital market to financial intermediation changes considerably the financial position of local governments, making them into net borrowers in relation to the consolidated financial sector[5] (see Figure 14 and Development of the Real Economy in the report). Unlike banking, the position of the total financial sector is positive against the external sector. This is due to the capital inflow through banking and the securities market and the increase in the price of shares in the stock market.

Figure 13. The positions of the Estonian economic sectors in relation to banking, between 31 December 1995 and 31 December 1996 (EEK billion)

Figure 14. The positions of the Estonian economic sectors in relation to the consolidated financial sector, between 31 December 1995 and 31 December 1996 (EEK billion)

Besides the external sector, the increase in share prices in the Estonian stock market is also reflected in the changes of the positions of private persons and enterprises, which have increased in proportion to the share price increase. The price increase shows the increase in the value of Estonian companies against the rest of the world and is also reflected in the short-term international investment position (see the external sector under Development of the Real Economy). The change in the value of Estonian companies in 1996 due to the rise in the price of their shares, exceeds the investments made into Estonian securities by non-residents. The price increase in shares in the stock market was mainly caused by the initial undervaluation of the shares and to a lesser extent by the capital inflow as well as the increasing demand by local small-time investors.

In conclusion we can say that in 1996 the external assets of banking exceeded external liabilities (see the Banking System part of the report) and the investments of non-residents into the Estonian capital market exceeded the investments of Estonian residents into foreign securities. In net value of the loans and investments of non-residents made into the Estonian financial sector exceed the capital investments made by residents into the foreign financial markets (according to the short-term international investment position; without the reserves of the central bank). This is an important change if we recall that in 1992-1995 capital inflow mainly took the form of direct investment. At the same time it points to the increasing efficiency of financial intermediation and Estonia's greater integration with the European financial markets.

[1] Banking Supervision fixes the structure of share capital at the end of the 1st and 3rd quarter.
[2] Preliminary data of the Estonian Central Depository for Securities.
[3] Hereinafter the share index of the Estonian Central Depository for Securities has been used instead of the stock exchange index TALSE which included 8 enterprises at the end of the year. The reason for that is that the share index has a longer times series. At the same time, the values of the share index and the stock exchange index TALSE are congruent to a great extent; different is only their starting-point.
[4] Hüvitusfond (the Compensation Fund) was founded with the aim to enable the investors to place privatization vouchers in a fund which capital is formed of income, received from the privatization. Hüvitusfond issues obligations, i.e. trades with debt instruments and is, thus, closer to a bank than a fund. From the assets side Hüvitusfond is a hybrid of an investment bank (financial investments) and a development bank (loans). For the investors Hüvitusfond is an alternative of the other financial intermediaries and in this sense, resembles rather an investment fund.
[5] The positions of economic sectors in relation to the banking and the consolidated financial sector are different, because in case of the latter, incorporated are also the securities issues (without banks' capital), which are intermediated through the capital market and which, in addition to loans, also include financial investments. Therefore, the term "net borrower" in case of consolidated financial sector is not usually used. In case of the public sector it can be used, because the public sector does not issue equity securities.