Financial stability could be threatened by rising prices and increasing transaction activity in the real estate market



  • Most of the risks to financial stability in Estonia are low in the near future
  • The ability of companies to service their loans is supported by a recovery in economic growth and slower growth in wages
  • Transaction activity increased in the real estate market and prices started to rise faster, though this has so far been in line with rising incomes
  • Rapid growth continues in bank loans to companies and households
  • The debt of the non-financial sector fell as a ratio to GDP as borrowing from abroad was modest, and Eesti Pank is holding the countercyclical buffer rate at 0%
  • A tax on the financial sector may have a negative side effect on financial stability and the financing of the economy


Estonian economic growth in 2016 was slow, but it picked up in the second half of the year. Value added increased in most parts of the economy, including oil shale and energy, where it had earlier fallen. Signs of faster GDP growth were also apparent in the first quarter of 2017. Growth picked up a little in the sales revenue of companies in the fourth quarter of 2016 and the rise in labour costs slowed. The profitability of the corporate sector remains nonetheless low and wage pressures remain high. A further fall in profits could threaten the ability of companies to service their loans.

The recovery in economic growth is endangered by investment remaining at a low level. Investment by companies has declined constantly for four years. Investment activity depends on confidence about the future, which in turn is based on credibility in economic policy, including tax policy. Frequent changes in the tax system with short notice increase uncertainty. When the labour market is rather overheated and there have been no major obstacles to growth for companies focusing on the domestic market, additional spending funded by a government budget deficit would do more harm than good. The government should support economic growth by making the business environment as stable as possible.

The planned taxation of financial services could have negative side effects for financial stability in Estonia and could impede the financing of the economy. For this reason the possible impact of such a tax needs to be analysed carefully before it is introduced. If the tax is introduced it would be sensible to apply it not only to commercial banks but to a wider group of financial institutions in order to reduce market distortions having negative effects on financial stability. Given the free movement of services and capital around the European Union and the integration of the Estonian financial sector, an asset-based tax could also lead to a reduction of the liquidity and capital buffers in Estonia that are important for maintaining financial stability.

Prices in the Estonian real estate market started to rise faster in the last quarter of 2016, but the growth rate is still in line with the growth of income. More transactions were made in the real estate market than a year earlier and the average price of transactions rose rapidly in the fourth quarter of 2016 and at the start of 2017. Real estate developers brought more new residential property to the market than before though, so a larger share of transactions were for new and more expensive residential space, which affected the average price of transactions. If the structure of the transactions had been the same as a year earlier in terms of the location and quality of the apartments, the average transaction price would have increased by an estimated 5-6% in the second half of 2016.

The rapid growth in the loan portfolio of the banks operating in Estonia continued in the first months of 2017. Corporate loans increased in most sectors. Although the growth was fastest in the stock of loans to the retail sector, the biggest contribution to the growth in the corporate loan portfolio came from the real estate and construction sector. Loans have mainly been made to the real estate and construction sector for development of commercial real estate, meaning that the credit risk faced by the banks is related more and more to the development of the commercial real estate market. However, the profitability of the banks remained at a similar level to that of the previous year and the capitalisation remained high.

Lending standards and conditions are currently appropriate, and Eesti Pank does not consider it necessary to change the requirements for issuing housing loans. At a time of rapid growth in wages and real estate prices and low interest rates, there is a danger that both lenders and borrowers may overestimate the ability of borrowers to pay their loans in the future, and may let their debt burden rise to unreasonable levels. Although there is no urgent need to change the housing loan requirements for the banks in the current credit environment, Eesti Pank monitors changes in leverage and the ability to repay loans in the housing market, and is ready to make the requirements stricter if necessary.

Eesti Pank will keep the countercyclical buffer rate at 0%. The debt burden of the non-financial sector as shown by the credit-to-GDP ratio has not changed in recent years and is predicted by the Eesti Pank December forecast to remain at around the same level in the years ahead. However, low interest rates and fast wage rises contain the risk that trading activity and prices could increase further in the real estate market, leading to growth in debt levels. The corporate debt burden could also start to grow again if investment and confidence increase. For this reason Eesti Pank monitors the indicators that could show a possible build-up of risks and can, if necessary, raise the countercyclical buffer rate above 0%.

There was no major reduction in the risks related to the parent groups of the banks operating in Estonia that arise from the high levels of household indebtedness and rising real estate prices in Sweden. Real estate prices in Sweden rose a little more slowly in the first half of 2016 than before, but the rate started to pick up again at the end of the year. Population growth, the movement to towns and low interest rates are keeping demand for housing loans strong. The financial position of the parents of the banks operating in Estonia remains vulnerable with growth in housing loans rapid, as a major part of the funding of the parent banks comes from financial markets. Almost half of this is in the form of covered bonds, which are used to fund housing loans.

The biggest risks to financial stability in the European Union are of a possible fall in international bond markets. Market interest rates are at historically low levels and could rise if the outlook for economic growth improves. A rise in market interest rates and a fall in the value of bond markets would have a negative effect in Estonia primarily through the financial results of pension funds and insurance companies.