The banks have sufficient buffers to cope with an increase in problem loans
The latest financial stability review from Eesti Pank finds that the capacity of companies and households to repay their loans may deteriorate a little in the near term. This is particularly a risk in economic sectors that are affected more by Russia’s invasion of Ukraine and the consequent sanctions. The war is also driving inflation further upwards from its already high levels, hurting the financial positions of companies and people. However, the banks in Estonia have sufficient buffers to cope with an increase in problem loans, to allow payment holidays if needed, and to continue lending to businesses and individuals.
Russia’s war in Ukraine reduces some of the export options for Estonian companies and their ability to import some of the supplies they need. Inflation having been pushed up by the war will make the financial position of companies and people more difficult, and the risk of losing jobs will particularly threaten people working in sectors that are affected more by the war. If growth in the economy slows at the rate that was predicted by the central bank in its March forecast, the war could cause the level of problem loans at the banks to rise from its current 0.2% to 1.5%. This would still be well below the level in the crisis of 2008-2010, when problem loans were more than 7% of the total volume of loans. The central bank considers that the banks in Estonia will be able to cope with the loan losses and to continue funding the economy with credit, as their profitability is high and their capital buffers are strong.
Growth in housing loans will remain fast moving forward, as incomes are continuing to rise and demand remains for housing. The issuing of housing loans slowed when the war started, but demand for loans is now recovering. Real estate prices are expected to continue to rise, as the addition of new residential property to the market remains limited because of supply difficulties for construction materials and rapidly rising prices for them. Growth in real estate prices and housing loans could increase household indebtedness, raising the risk of people facing difficulties in making their loan payments if the economy were to turn down or if higher interest rates were to make loan payments larger. The minimum requirements set by Eesti Pank for issuing housing loans help to alleviate the risks from rapid growth in lending. Eesti Pank stands ready to tighten the requirements for issuing housing loans further if lending continues to grow fast. The central bank currently does not see a need for this. Neither does the central bank currently see any need to raise the capital buffer requirements that apply to the banks.
The direct impact on the Estonian financial sector of Russia’s invasion of Ukraine is small, as the connections are quite limited. Investments related to Russia will only affect substantially a few individual investment funds and investment firms, which make up a very small part of the Estonian financial sector. The war has increased uncertainty in international securities markets and this has made it more expensive for banks to obtain funding by issuing bonds. The largest, and increasing, source of financing is local deposits though, and this reduces the financing risks for the banks. Like in Estonia, the capacity of companies and households in Latvia and Lithuania to pay their loans is affected by the war, and this then has an impact on the financial positions of Estonian banks operating in those markets.