FINANCIAL STABILITY REVIEW. The current risks to the financial sector come mainly from geopolitics

Postitatud:

14.05.2025

The latest financial stability review from Eesti Pank finds that the capacity of companies and households to repay their loans was harmed by the series of crises but still remains generally good. The largest risks looking forwards are geopolitical, as Russia’s war in Ukraine and the increasing stresses in international trade threaten growth in the Estonian economy and may make it harder for the banks to access foreign funding, and so limit their ability to lend.

The geopolitical risk that has the biggest impact on Estonia remains Russia’s war against Ukraine, but the deepening global trade tensions have become increasingly important. Increased international trade tensions make it more likely that the Estonian economy will fall into recession again, which would make Estonian companies and households less able to pay their loans. The level of bad loans at the banks remains at a historically low level though, despite rising a little, as companies and households maintained their ability to pay even during the years of recession. They were helped in this by the buffers built up during the good years, unemployment remaining moderate, and interest rates falling. Any possible customs tariffs or interruptions to supply chains would affect the ability to pay of the exporting manufacturing sector first of all. At the same time, the general economic and political uncertainty may also reduce the confidence to invest and consume, and so may affect other sectors.

Geopolitical tensions may also make it harder for banks to borrow from international financial markets. The banks in Estonia mainly fund themselves from local deposits, but the share of funding beyond that has increased from 22% in 2022 to 33% in 2024. Increased geopolitical tensions may limit the access of banks to foreign funding and so limit the supply of lending in Estonia. The issues of bonds by Estonian banks have so far been successful despite the periods of volatility that there have been in financial markets. The cuts in interest rates by the European Central Bank have reduced the interest income of the banks in Estonia, but they still remain profitable. Their strong profitability has allowed them to build up capital buffers and continue lending to companies and people in Estonia.

The interest rate cuts from the central bank have also brought Euribor down and so reduced loan repayments, and that has combined with the recovery in economic activity to increase demand for loans in Estonia. The growth in borrowing by businesses has been driven by real estate companies, and the share of the loan portfolios of the Estonian banks that has gone to those companies is quite large in international comparison. There has been a lot of development work in commercial real estate despite the difficult economic climate, and the addition of new space has meant there is more office space available. The ability of real estate companies to cover their loans is considered to be good, but slower growth in the economy could mean the amount of space standing vacant grows even larger, and that could leave the real estate companies in a worse financial position and increase the loan losses of the banks.

Eesti Pank is maintaining the countercyclical capital buffer for the banks at the level of 1.5%. The two reasons for this are that the rate of growth in borrowing by Estonian companies and households started to increase last year and exceeded the long-term growth in the economy, meaning that cyclical risks increased. In addition, there is a danger that a further increase in geopolitical risks could push the economy back into recession and cause the amount of non-performing loans to jump up from the current level.

The capital buffer requirements that are designed to help manage systemic risks are a little higher than the average in the European Union. Eesti Pank finds that this is justified because the small size and the openness of the Estonian economy means it is more sensitive to a deterioration in the economic climate than others elsewhere in Europe. The central bank considers in summary that the requirements set for the banks in Estonia to preserve financial stability remain appropriate.

Additional information:
Viljar Rääsk
Head of Communications
6680 745, 5275 055
Email: [email protected]
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