The task on Banking Supervision is to protect the interests of creditors by increasing the stability and reliability of the banking sector. The main focus is on the most risk-prone spheres of activity of the banks and on separate institutions that can affect the stability of the whole system the most. However, Banking Supervision does not aim at taking on the duties of bank management, that is, running the banks. Neither can supervision guarantee avoiding problems deriving from the mistakes of the management at any cost and in the interests of the general stability of the banking system it may become necessary to close some banks.

Legally, the work of Banking Supervision is regulated by the Central Bank Act, the Credit Institutions Act, other laws of the Republic of Estonia and the related legal acts, the statutes of the Banking Supervision, decisions of the Board of Eesti Pank, decrees, regulations and instructions of the President of Eesti Pank, international agreements, banking directives of the European Union and methodological recommendations of the Basle Banking Supervisory Committee.

Under the Credit Institutions Act, supervisory activities cover all credit institutions licensed by Eesti Pank, their subdivisions outside Estonia and subdivisions of foreign credit institutions in Estonia. Since 1998, consolidated supervision is carried out over the institutions belonging to consolidation groups of credit institutions.

The deepening integration of the Estonian financial sector and the resulting rapid growth of non-banking financial intermediation have raised the question of pooling the resources of the existing supervisory institutions. In order to seek the best solution to the matter, a joint working group on merging supervisory institutions was set up by the Ministry of Finance and Eesti Pank which handed over its final report at the beginning of 1999. Proceeding from the report, the Board of Eesti Pank supported the idea of creating a unified supervisory body for the entire financial sector, combining banking, insurance and securities supervision. Taking into account international practice and the peculiarities of Estonia, the Board of Eesti Pank considers the most suitable institutional form for the new body a politically and financially independent public legal entity. Until such a body is created, Eesti Pank should maintain the supervisory role over the credit institutions at least or the new supervisory body should be institutionally affiliated to Eesti Pank.


1998 was more fruitful from the point of banking legislation development than several earlier years.

In April, Riigikogu passed the Deposit Insurance Fund Act, which lay the foundations for the Estonian deposit insurance system. The law, which took effect in October 1998, defines the basic principles of the activity of the Fund as well as the principles of compensating for lost deposits.

At the end of November, Riigikogu passed the Prevention of Money Laundering Act, which revoked the respective provisions of the Credit Institutions Act. Under the Prevention of Money Laundering Act the task of preventing money laundering is, besides credit institutions, expanded to financial institutions, including insurance companies, investment funds and professional members of the stock market. The legal act specifies the procedure of checking personal identity, steps to be taken in suspected money laundering instances and provides for the creation of a separate structural unit within the Police Department for collecting data on money laundering and defines its rights and duties.

In 1998, elaboration of the new version of the Credit Institutions Act and the Savings and Loan Association Act continued. Both were sent to Riigikogu in autumn. Riigikogu passed them in early 1999.

The revised Credit Institutions Act proceeds from the EU directives that regulate the activity and supervision of credit institutions and expands the rights and authority of Banking Supervision in accordance with internationally accepted requirements. It specifies the tasks and scope of activities of Banking Supervision, principles of co-operation with the respective supervisory institutions abroad and the arrangement of supervision. The rights of Banking Supervision in accessing information and conducting on-site inspection have been increased, including on-site inspection of various businesses belonging into a consolidation group with the aim of evaluating the correctness of information provided by them. Banking Supervision has the right to demand extraordinary inspection or expertise if the reports submitted by a credit institution prove to be misleading, incorrect or if transactions have been made that harm the credit institution. Banking Supervision is entitled to demand convening of meetings of the credit institutions' management and determining the agenda of these meetings as well as proposing rationalising programmes in case of problems. The outside auditors of the banks are also imposed with the obligation to inform Banking Supervision of the aspects endangering the bank discovered in the course of auditing. The enactment of the new Credit Institutions Act from 1 July 1999 will considerably improve the work of Banking Supervision.

Still missing are the new legal acts on the securities market and insurance, which are in the stage of being drafted by the Ministry of Finance.


The 1998 key words in banking were mergers, inflow of foreign capital, liquidity problems and insolvency of some banks. Not much activity was seen in setting up subdivisions or units of foreign credit institutions neither in Estonia nor by Estonian credit institutions abroad. The only such event was the opening of a representative office of Latvijas Unibanka in Tallinn in May.

The 1998 mergers concerned mostly Estonia's major banks. In mid-July Eesti Pank authorised the merger of Hansapank and Eesti Hoiupank (Estonian Savings Bank) as well as the merger of Eesti Ühispank (Union Bank of Estonia) and Tallinna Pank. The merged Hansapank and Hoiupank continued under the name of Hansapank, Ühispank and Tallinna Pank continued as Eesti Ühispank.

In the inflow of foreign capital Scandinavian countries played the leading role. The Swedish Föreningssparbanken (Swedbank) applied for the right to acquire over 50% of Hansapank shares, which it did in October, and in November Skandinaviska Enskilda Banken took a 34% stake in Eesti Ühispank.

There were four problem banks in 1998.

At the beginning of July the City Court of Tallinn launched bankruptcy proceedings of Eesti Maapank (Land Bank of Estonia), initiated by the Board of Eesti Pank. Maapank was declared bankrupt at the end of August.

In early October Eesti Pank asked the City Court of Tallinn to launch bankruptcy proceedings against EVEA Pank, which was declared bankrupt in early 1999.

Soon after the launch of bankruptcy proceedings against EVEA Pank, an indefinite moratorium was declared on ERA Pank, which had to be resolved in April 1999 the latest.

Due to the failure of meeting capital adequacy requirements, Eesti Forekspank (Estonian Forexbank) merged with Eesti Investeerimispank (Estonian Investment Bank) in the autumn of 1998, assisted by Eesti Pank. The merged bank continues under the name of Optiva Pank.

Also several earlier liquidation processes were completed in 1998. In the autumn, the City Court of Tallinn initiated bankruptcy proceedings against NoWe Pank and Inko Balti Pank, with the latter declared bankrupt in early 1999. In the middle of November, small shareholders of Eesti Innovatsioonipank (Estonian Innovation Bank) decided to end the activities of the bank through a compulsory liquidation. The City Court of Tallinn issued the respective ruling in early 1999.

Due to consolidation and closure of small banks, Estonia had five credit institutions at the beginning of 1999 - Eesti Krediidipank (Estonian Credit Bank), Eesti Ühispank, Hansapank, Optiva Pank and Tallinna Äripank (Tallinn Business Bank), plus the Tallinn branch of Merita Bank Plc. The high concentration of the banking sector (Hansapank and Ühispank together control over 80% of the market) sets new requirements for supervision as well. In the next few years the issue of maintaining fair competition will become ever more topical.


The prudential ratios set on the Estonian credit institutions correspond roughly to EU requirements and, in view of Estonia's rapidly developing and changing economic environment, are even stricter. Thus, for example, the capital adequacy ratio is set at 10% (8% in EU) and the weight of different risks, considered in calculating capital adequacy, is sometimes higher than required in the EU directives.

Among major changes, which took place in 1998, we could mention the addition of market risk to the rules of calculating capital adequacy, the introduction of the tier 3 capital and application of prudential ratios to consolidation groups.

The calculation of the foreign currency risk was improved by limiting the German mark and Estonian kroon joint position to 15% of net own funds, the same as for all Zone A currencies. The position of the currencies of Zone B countries is limited to 5% of net own funds, with the exception of Latvian and Lithuanian currencies which can account for 10% of net own funds. Due to the introduction of the European common currency, the euro and Estonian kroon are treated as a joint position from 1 January 1999 (15% of net own funds).

Reporting of off-balance sheet transactions was improved which allows better overview and analysis of the banks' off-balance sheet activities.


The halt of the exceptionally rapid growth of bank assets and the collapse of the stock market at the end of 1997 caused serious problems for the banks and resulted in large operating losses by the end of 1998. As we can see from analysis, much of what happened was caused by shortcomings in the general management of banks and their internal control units, which in turn derived from either incompetence or negligence. The above conclusions can also be found in the report on Eesti Maapank, commissioned from the former head of the Danish financial supervision Eigil Mølgaard, ordered by Eesti Pank and the Ministry of Finance and published in January 1999. Mr Mølgaard makes various suggestions on the supervisory legislation as well as institutional build-up, both from the legal and managerial aspect of supervision. The majority of his suggestions has already been included in the new Credit Institutions Act and was used in solving the problems of EVEA Pank and ERA Pank in October 1998.

The need to improve the quality of general management has been pointed out in analyses of the causes of banking problems not just in Estonia but also in many other countries. The practice of international financial supervision puts more and more emphasis on the timely availability of governance information and increasing the efficiency of the internal control system. In May 1998, a joint committee was formed of the representatives of Eesti Pank, the European Bank for Reconstruction and Development (EBRD) and several Estonian credit institutions to prepare a new framework of requirements for the management of banks. The new Credit Institutions Act, too, specifies in detail the requirements for the general management of credit institutions.


The 1998 work plan of the supervision of information systems featured supervision of the banks' information systems' readiness for the year 2000. In order to co-ordinate the respective projects of separate banks, a plan of action was prepared for achieving the year 2000 readiness. The work is divided into phases: designing of a strategic approach; creating organisational awareness; inventory of IT systems, evaluation of impacts and creating detailed plans; renovation of systems, applications and equipment, evaluation and repairs through testing; application of tested and compatible systems and planning of uninterrupted functioning. According to the plan of action, compatibility has to be achieved by the middle of 1999.

Banking Supervision set up a team of project managers involved in preparing banks for the year 2000, with the aim of exchanging information and planning joint action. During its regular inspections, the Banking Supervision also studied the banks' projects for readiness for the year 2000. By the end of 1998, the renovation phase was completed by 75%, over one third of the testing phase and less than one third of the application phase was completed.


Co-operation with the supervisory institutions of other countries is an inseparable part of improving banking supervision. This covers relations with the banking supervision bodies as well as the supervision institutions of the stock market and insurance.

Estonian Banking Supervision maintains the closest practical co-operation with the supervision bodies of Finland, Latvia and Lithuania. In 1998, the list was complemented by the Swedish supervision, due to the strategic interest of Swedish banks. A co-operation agreement has been signed with the Finnish supervision, which allows the Estonian and Finnish supervision officials to carry out joint inspections and monitoring of the banking sector. The signing of a co-operation agreement was also initiated with the Russian banking supervision. Agreements specifying the forms and procedures of co-operation are in various stages of completion with a number of countries.

The consolidation of the Estonian banking sector has considerably increased the interest of foreign strategic investors in long-term investments into Estonian banks. In order to secure the credibility of the Estonian banking system it is important to check the background of potential future owners, their previous record and reputation. For this purpose, information is frequently exchanged with the relevant foreign institutions of supervision.

Another important outlet of international co-operation is the involvement of foreign experts in harmonising Estonian legislation with the respective EU norms. The assistance of experts from the International Monetary Fund and the European Union has been used in drafting new regulations.

To keep in touch with the development trends of the global financial system and to harmonise the methodological basis and practical work of supervision, the Group of Banking Supervisors from Central and Eastern European Countries has been set up. The Group co-ordinates relations with the Basle Banking Supervisory Committee and passes on the views of the member countries in banking supervision issues. Estonia has taken active part in the work of the Group since it was established.