The cooling economy may threaten the ability of companies to service their loans

The latest financial stability review from Eesti Pank indicates that risks to the financial sector are small. The probability has increased though of the cooling economy making it harder for businesses to make their loan payments.

Governor of Eesti Pank Madis Müller said that the risks overall to the financial system were small. “The lion’s share of the Estonian financial sector comprises banks, and they need to be strong because banking is essentially the lifeblood of the economy. The banks operating in Estonia have sufficient capital and they are profitable, which gives hope that they would be able to cope well with in more difficult times”, he explained.

Eesti Pank sees four risks that could threaten how well banking in Estonia can cope and could make it harder for businesses and households to borrow. The risk of companies being less able to repay their loans has increased a little since the spring.

Growth has slowed more sharply than expected in the global economy, which may have consequences for the export revenues of Estonian companies. “Exporters are at risk of being caught between the hammer of falling revenues and the anvil of rising labour costs. Their problems may also spill over rapidly to companies serving the domestic market. Companies are less indebted than they were a decade ago though, and so they would be better placed to service their loans in a recession than they were ten years ago”, added Mr Müller.

The second risk that the central bank foresees comes from an excess of real estate development. “That sector could face problems as the economy cools. The share of loans to the real estate sector that turned bad in the last economic crisis was double that in other sectors. The risk may be amplified because real estate loans are such a large part of the loan portfolio of the banks”, noted Deputy Governor of Eesti Pank Maive Rute.

The third risk is that the Swedish banking groups may reduce their lending in Estonia. This risk arises because people in Sweden are heavily indebted and their debt continues to grow. Any economic difficulties could cause people to limit their consumption, and that could then make the Swedish economy cool down even faster. As the banks in Estonia are closely linked to their parents, concerns about the Swedish economy could mean that loans in Estonia become more expensive and harder to access.

The fourth risk the central bank sees is that people who have become used to rapidly rising wages may take on greater financial liabilities than they can afford. Rapid growth in borrowing gives grounds to fear that some borrowers have not taken sufficient account of the risk of the economy cooling and could encounter difficulties in repaying their loans if they were to lose their job.

Eesti Pank has introduced housing loan requirements for the banks to minimise this risk, and these requirements help protect people and the banks against excessively risky lending. The housing loan requirements set out the maximum loan maturity, the loan-to-value limit and the debt-service-to-income limit.

If borrowing should grow at a faster rate than the economy, Eesti Pank may find it necessary to apply the countercyclical capital buffer, which requires banks to hold additional capital for each loan issued. Although household debt continues to grow fast, corporate borrowing has been moderate so far and so the countercyclical capital buffer is currently at zero.

Financial Stability Review 2/2019

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For further information:
Viljar Rääsk
Eesti Pank
Tel: 668 0745, 527 5055
Email: viljar.raask [at] eestipank.ee
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