In 1997, the development of the banking supervision continued under the concept evolved in earlier years. As before, the emphasis was put on applying internationally acknowledged principles of supervision.

Proceeding from the principle that in the conditions of the market economy the credit institutions themselves hold responsibility for the results of their business activity, the task of the banking supervision cannot be direct intervention in the work of the bank management because this would reduce the disciplining role of the market. Interference in the everyday activities of credit institutions is allowed only in case of a breach of law or other legal acts regulating the activities of banks, or when unjustifiably high risks are taken that can endanger the interests of creditors.

In 1997, the formation of a complex and autonomous institution of banking supervision continued. However, we must differentiate between the functional integrity of the banking supervision and the integrity of the financial market supervision.

The functional integrity of the banking supervision means that all its functions are centred into one organization, starting from the formation of the database and ending with applying sanctions, designing regulations for credit institutions and arranging international co-operation. In this area, the Banking Supervision increased its efforts on working out instructions regulating the reporting procedures of the banks.

The integrity of the financial market supervision means consolidating under universal supervision all the different fields of activity pursued by the institutions subjected to supervision. Here, preparations for the transition to the consolidated supervision of the banking groups in 1998 were finished and co-operation between the different supervisory bodies of the financial market was strengthened. The aim of this trend of development is to switch over to unified financial supervision. The concept of this transition is scheduled to be worked out in the next couple of years.

Particular attention was focussed on capital adequacy, changes in the circle of owners and the resulting concentration of the share capital and decision-making, the quality of assets, intra-bank procedures, as well as the existence and adequacy of the information and risk management systems. Additional instructions were drawn up for market risk evaluation and management.

In accordance with the annual schedule, all Estonian banks were inspected at least once a year and follow-up examination was also carried out. The role of monitoring was enhanced and its share in preparations for on-site inspection increased correspondingly.


Despite the rapid development of the Estonian banking market, this dynamic process will continue also in the future. In 1997, three banks stopped their activities. This serves to indicate that not all credit institutions, particularly the smaller banks, have been able to secure their market position and that certain structural shifts will also take place in the future.

In the conditions of ever tightening competition, banks are forced to widen the selection of their services and improve their quality in order to maintain and expand their market share. In order to secure their market share, banks continued to focus on definite groups of customers.

The share of operations with securities continued to increase in the activities of credit institutions. This is a global trend which in Estonia accelerated in 1997 in particular. Favourable opportunities for this were provided by the Tallinn Stock Exchange that was launched in 1996. Besides trading in securities, banks expand their activities also in other sectors of the financial market, in insurance and financial investments. This changes the criteria of evaluating the market share of the banks, although credibility will still be based on the banks' equity capital which grows through additional investments. In 1997, Estonian banks also expanded their activities into other Baltic countries, Russia and the Ukraine, where subsidiaries were established or qualifying holdings were acquired in credit institutions, insurance companies and leasing firms.

As a result of the above, the share of the consolidated groups of credit and financial institutions increased on the financial market. As the activities of the banks become more complex, the risks increase as well. This, in its turn, sets higher demands on supervision and at the same time also determines the priorities of development. These include:

the development of the market risk evaluation and management systems the necessity of which derives from the banks' operations with securities;

introduction of the requirement of consolidated reporting by banks and transition to consolidated supervision;

implementation of the internationally acknowledged principles of banking supervision; further strengthening of co-operation with other supervisory bodies of the financial market;

drafting of the concept for the transition to unified supervision of the financial market.


Although there are still quite a few gaps in the banking-related legislation, progress in this area was slower than expected. The new version of the Credit Institutions Act, the Deposit Insurance Fund Act as well as the Anti-money Laundering Act and the Securities Market Act are still waiting to be passed and implemented by Riigikogu (the Parliament). The first three draft laws are currently ready to be discussed by Riigikogu, the drafting of the law on the securities market is still underway.


The evaluation of the effect and efficiency of the risk management systems is becoming one of the main concerns of supervision. The downward movement on the stock exchange and liquidity problems in the autumn of 1997 proved that credit institutions with efficient risk management systems are able to operate without significant losses also in the periods of crisis.

The reports submitted by the banks to Eesti Pank do not enable an exact evaluation of the efficiency of the risk management systems used in credit institutions. From the point of view of banking supervision, the identification, measuring, monitoring and management of possible risks and the creation of the necessary information systems is the responsibility of the management and council of each individual bank and a matter of the intra-bank work arrangement, supervised by the bank's internal audit unit. The bank's external auditor also has to evaluate these systems in the course of the examination of the bank's annual and interim reports.

Banking Supervision examines the correspondence of the risk management and information systems to the requirements in the course of on-site inspection, proceeding from the specific activity and market position of the concrete credit institution.

In 1997, particularly after the extensive freezing of accounts of the Baltic credit institutions in the banks of St Petersburg, Estonian banks began to pay more attention to evaluating the country risk.


The prudential ratios set on Estonian credit institutions correspond roughly to the requirements of the European Union (EU), although, in view of the possible dangers of our rapidly developing banking system, they are sometimes even stricter. Among the changes made in 1997, the most important was the increase of the minimum capital adequacy ratio. In addition to this, the risk weights were increased for the Estonian local governments and claims guaranteed by them. In order to increase the liquidity of credit institutions, an additional liquidity requirement was introduced (see Monetary Policy, Measures to Strengthen the Liquidity System). All the above changes were closely linked with the rapid developments in the Estonian macroeconomy in the spring and summer of 1997.

The improvement of the prudential ratios continued in accordance with the recommendations of the EU and the Basel Banking Supervisory Committee, relying on the experience of banking supervision of the EU countries. So far, capital adequacy has been calculated on the basis of the credit risk; among the market risk factors only the foreign currency risk is considered and the risks of trading with the foreign exchange options have been disregarded. The market risk will be included in full in 1998, after the introduction of the new, revised rules for calculating capital adequacy. With the transition to consolidated supervision the prudential ratios imposed on credit institutions will be applied to the consolidated groups as well.

Other important changes provide for the introduction of the tier 3 capital, specification of the procedures for classifying and provisioning of loans and closer observance of the banks' off-balance sheet activities.


As banks expand their activities in other areas of the financial sector as well as other business spheres, financial and mixed activities conglomerates have emerged, in which the banks have a leading role. This requires management rearrangements within each individual organization as well as within the entire group.

The decentralization of banking services continued. The bank headquarters first of all comprise such general service areas as information technology, banking technology and accounting. This enables to economize on costs and standardize the activities of branch offices. More and more banks apply the principle of financial inspection under which branches make decisions without the interference of the head office and the latter judges the work of the branches by their financial results.

The changes also set new requirements on the management information systems. The success of management and achieving the goals has become more and more dependent on timely, relevant and adequate information. The lack of authentic information complicates the competent decision-making and managing the risks involved in the work of credit institutions. Therefore, supervision focuses more and more on the situation of the bank management and the required information systems.

A well-functioning and independent internal audit unit is essential for improving the management of credit institutions and the required information systems. The years 1995 and 1996 can be regarded as the formation of internal audit, while in 1997 already the managements of the banks expressed their clear support to the work of internal audit units, particularly in larger credit institutions. In 1998, the rest of the banks should also devote more attention to creating the environment necessary for the successful functioning of internal audit and recruiting experienced and qualified staff.


The security and reliability of information systems is an important guarantee for the safety of every credit institution. The rapid development of the technology of information systems sets high requirements also on the management of this sphere. Thus, inspecting the management of information systems is the highest priority of supervision in this area.

Proceeding from the results of the 1996 questionnaire on the security of information systems, definite requirements were introduced on the information systems of credit institutions in 1997 and these are required for all credit institutions. Another new requirement is that, in addition to the annual external auditing of the information systems, the Banking Supervision carries out its own audit. Favourable conditions for this are provided by the close co-operation between Supervision and banks in information security.


Alongside the rapid development of credit institutions, the differentiation of their development level continued in 1997. The banks that can offer their customers the widest choice of services and products strengthen their positions on the market, at the same time maintaining the necessary standards of risk management. On the other hand, there are also banks that find it hard to keep their position on the market.

The INKO Balti Pank (INKO Baltic Bank) developed first difficulties in August. The extraordinary meeting of the bank's shareholders therefore decided in favour of the voluntary liquidation of the bank.

Eesti Innovatsioonipank (Estonian Innovation Bank) got into difficulties in the first days of 1997. While the Banking Supervision tried to get more information on the circle of owners and origin of the bank's share capital, a number of violations were discovered. As the Innovation Bank failed to follow the instructions of Eesti Pank, on 10 September the Board of Eesti Pank decided to revoke the license.

At the beginning of the year the merger of Põhja-Eesti Pank (North Estonian Bank) with Eesti Ühispank (Union Bank of Estonia) was completed. The merger agreement, which provided for the transfer of all assets and liabilities of the North Estonian Bank to the Union Bank, was signed at the beginning of January and took effect in the middle of April after being approved by the shareholders' meetings of the two banks.


Due to the rapid development of the Estonian banking sector and the relative smallness of the domestic market, Estonian credit institutions expand their activities to the international market, which also sets new requirements to the Banking Supervision. In order to meet these requirements, co-operation was strengthened with the financial supervision institutions of other countries in the field of practical supervision as well as in the development and unification of the theoretical principles.

Practical co-operation is mainly focussed on arranging supervision over the consolidated banking groups active on the international level. Here the principle of home country supervision is applied under which credit institutions licensed in Estonia and their subsidiaries abroad are subject to the Estonian Banking Supervision. In order to strengthen the principle of home country supervision the Estonian Banking Supervision signed an agreement with the Finnish Financial Supervision in 1995. In the near future a similar agreement will be signed with the Russian Banking Supervision and an agreement has also been proposed to the banking supervision authorities of Latvia, Lithuania and the Ukraine. Co-operation is based on the mutual exchange of confidential information necessary for supervision, as well as assistance for carrying out on-site inspection. In relations with countries where the home country on-site inspection is made difficult due to local legislation, more attention is devoted to the efficiency of the bank's internal auditing measures on the activities of its subsidiaries abroad.

Another sphere of international co-operation is examining the reliability and financial status of non-resident investors and owners. This involves the exchange of information on the background of potential investors and owners in accordance with bilateral agreements concluded with the supervisory bodies of other countries.

Due to the expansion of Estonian banks abroad and preparations for joining the EU, more attention is paid to the issue of harmonizing Estonian banking requirements and supervision methods with international standards. The point of departure here is the banking directives of the EU and the methodological papers issued by the Basel Banking Supervisory Committee.

The Estonian Banking Supervision have taken an active part in the work of the Group of Banking Supervisors from Central and Eastern European Countries. The Group was formed in 1996 and is aimed at co-ordinating the methodological and practical supervision activities of its member countries as well as relations between the member countries and the Basel Banking Supervisory Committee.

In the field of drafting legislation and banking regulations, Banking Supervision have received regular technical assistance from the International Monetary Fund and the World Bank, both in the form of consultations as well as periodical technical assistance missions.

In the context of the globalization of financial markets and Estonia's future membership in the European Union, international co-operation in banking supervision requires even more attention and closer contacts.