• The risks to financial stability in Estonia are small. Risks are being kept down above all by the improved financial position of companies and households, and by the high capitalisation of the banks
• The biggest danger to Estonian financial stability comes from the risks in the Nordic real estate market
• Tensions in the labour market and the high capacity utilisation level indicate possible overheating in the economy
• If the strong growth in housing loans and consumption loans to households continues, the central bank will consider tightening its requirements for housing loans
• Eesti Pank added the recently established Luminor to the list of systemically important banks and requires the bank to hold an additional 2% capital buffer
• The buffer requirement for LHV as a systemically important institution was raised because of its increased market share from 0.5% to 1%
• There are now four systemically important banks in Estonia, and these are Swedbank, SEB Pank, Luminor Bank and LHV Pank

In the assessment of Eesti Pank, the risks to the financial sector in spring 2018 are low. The risks relating to the real estate market and construction industry have increased however. Risks are mitigated by the improved financial position of companies and households, and by the high capitalisation of the banking sector.

The most serious risk to financial stability in Estonia comes from the households and banks in the Nordic countries, as real estate prices there are high and household indebtedness continues to grow. Although prices fell in the Swedish real estate market in the second half of 2017, they remain high and household indebtedness is still growing. Were the risks stemming from the Swedish real estate market to be realised, the parent banks may reduce the funding of subsidiaries or branches operating in Estonia, which would then reduce the loan supply and the financing of the Estonian economy as a whole. Reduced economic activity in the Nordic countries would lower the income of Estonian exporters and their ability to service loans.

The Estonian economy grew fast and some signs of overheating have also appeared. Strong growth in the economies of Estonia’s main trading partners helped the Estonian economy to grow by 4.9% in 2017. The growth in demand has helped increase the sales revenues and profits of companies. The rate of growth is above its long-term sustainable level though. Companies are finding it ever harder to find employees, unemployment is low and the level of capacity utilisation is high. If investment by companies does not increase substantially and demand weakens, continuing rapid growth in wages could reduce the competitiveness of companies and their ability to service their loans.

The main risk to financial stability in Estonia from the business sector stems from the rapid growth in construction and real estate. Strong demand in the real estate market may cause labour and investment to become concentrated in that sector. Demand is being boosted even further by orders from the government. If the business cycle were to turn or orders to decline, the ability of construction and real estate companies to service their loans would deteriorate, as would the loan quality of the banks.

Rapid growth in wages and high levels of confidence may lead households to borrow excessively. The residential property market picked up in the second half of 2017 and prices rose faster, especially in the secondary market for apartments in older buildings. The increase in the supply of new housing helped to balance out the impact of increased demand on prices for new apartments. Demand for loans remains strong and the growth in bank loans and leases to households was some 8% over the year. Although indebtedness has not increased, as incomes have risen rapidly, the current rapid rate of growth in wages may not be sustainable.

It may become necessary to tighten lending conditions in future to restrict the strong growth in housing loans and consumer loans to households. The main means of restricting loan demand from households is the housing loan requirements introduced by Eesti Pank, and making these stricter would reduce the maximum amount that borrowers can take.

The financial position of the banking sector and its resilience to risks remain strong. The quality of the loan portfolio is very good, and lending is mainly financed by the deposits of resident clients. A similar amount of profit was earned as in the previous year, and most banks continued to have high levels of own funds. Changes to income tax law encourage the banks to pay out more in dividends, and so the capitalisation of the banks will start to fall as their assets increase.

Eesti Pank decided to keep the buffer rate for the systemic risk buffer at 1% and to raise the buffer rates for two banks to reflect their systemic importance. The reason for setting the systemic risk buffer is the vulnerability that comes from the small size of the Estonian economy and the large share in it of exports. Additional buffer requirements are set for systemically important banks as their smooth functioning is important for the financial system and the economy overall. Until now, a 2% additional buffer requirement has applied to Swedbank and SEB. Luminor Bank has been added to the list of systemically important banks and an additional buffer requirement of 2% will apply for it. On top of this, the substantial increase in the market share of LHV Pank over the year meant the additional buffer rate for it has been raised from 0.5% to 1%. The countercyclical capital buffer rate, which is set to reduce the risks that come from excessive credit growth, is currently 0% and Eesti Pank does not consider it necessary  to raise it at the moment. The growth in the debt of Estonian companies and households as a whole has in recent years been slower than the growth in GDP and the indebtedness of the non-financial sector has decreased. If credit growth increases further and the indebtedness of non-financial companies and households rise, Eesti Pank can raise the rate of the countercyclical capital buffer above 0%. Capital buffers help to ensure the resilience of the banks.

Additional information:
Eva Vahur
Public Relations Office
Eesti Pank
Tel: 668 0965, mobile 533 00619
Email: [email protected]