The latest Financial Stability Review from Eesti Pank finds that the financial sector is in a generally good position, but geopolitical tensions and war in the Middle East have increased the risks to financial stability. The war in the Middle East has affected markets for commodities and energy and increased uncertainty in international financial markets, temporarily making it harder for banks to issue new bonds. The risk is also higher of economic activity declining and the problem loans of the banks increasing. The resilience of the banks in Estonia is still backed though by their strong capitalisation and large liquidity buffers.

The war in the Middle East has increased uncertainty in international financial markets and made it harder for banks to issue new bonds. This impacts some of the banks in Estonia, as funding from international bond markets has become more important for them in recent years because they have needed more funds from abroad alongside local deposits to fund their lending activities. Financial markets have reacted more calmly to the conflict than they did to earlier crises, but the war dragging on means markets may also be volatile moving forwards. This means the banks must allow that funding may become more expensive and could prove harder to access to the schedule planned for it.

The Estonian economy has started to grow gradually and the financial position of businesses and households has improved, as has their ability to pay their loans. This improvement is overshadowed however by geopolitical risks, and if these were to worsen then growth in the Estonian economy could slow again and demand for the goods and services of Estonian companies could decline in markets both at home and abroad. Energy prices have risen because of the conflict in the Middle East and concern has grown about inflation, pushing up money market interest rates and raising the cost of servicing loans. This may reduce the ability of people and companies in Estonia to service their loans and increase the amount of problem loans. Eesti Pank finds that the capacity of the banks to cope with potential loan losses remains good because they remain strongly capitalised.

An active lending market increases the risks of loan losses to some extent for the banks. There has been growth of around 10% over the year in loans to real estate and construction companies and in housing loans. At the same time the amount of commercial real estate standing empty has increased, which could make it harder for real estate companies to pay their loans if the economy turns down or the market hits difficulties. Borrowing to buy housing continues apace though, and the share of borrowed money in housing transactions is at its highest level of the past 15 years. This has then increased the debt burden of households. If the growth in housing loans remains rapid for a longer period and household indebtedness increases further, the risk increases that a larger number of borrowers could fall into difficulties in repaying their loans in future.

Rapid growth in lending in Latvia and Lithuania is further increasing the risk to the Estonian banking sector, as around a quarter of the loans issued by Estonian banking groups are issued in those two countries. Growth in lending in Lithuania may accelerate even further as the savings from mandatory pensions become available to use, which could push real estate prices even higher.

Eesti Pank considers that it is appropriate in the current circumstances to maintain the countercyclical capital buffer for the banks at the level of 1.5%. This is partly because the growth in bank lending has remained fast given the rate of growth in the economy and has kept the risks to the banks at a higher level. It is also because the geopolitical tensions have increased the uncertainty about how the economy will develop in future, and so the banks need to hold larger capital buffers to maintain their resilience should there be any deterioration in the economy. Eesti Pank is however considering reducing the cyclical component of the countercyclical capital buffer this year if the risks from increased lending should diminish.

The full Eesti Pank Financial Stability Review will soon be on the website of the central bank.

Additional information:
Hanna Jürgenson
Eesti Pank
Communications Specialist
Tel: 56920 930
Press enquiries: [email protected]