FINANCIAL STABILITY REVIEW. Problem loans will become a slightly greater concern going forward
The level of problem loans in Estonia is currently very low, but the analysis just published by Eesti Pank finds that the volume of them will probably increase a little in the near future. The factor that most affects how able people are to repay their loans is the unemployment rate, while the biggest threat to companies paying their loans is a fall in their sales revenues over a longer period.
Difficulties in repaying loans can be a serious worry for the individual households or businesses concerned, but the forecast increase in problem loans should not be a great blow to the financial sector or the economy as a whole because of the buffers accumulated earlier, says the latest Financial Stability Review from the central bank.
The level of problem loans of companies and households has fallen a long way in recent years. In early 2018, 1.4% of corporate loans were overdue by more than 60 days, but in September this year only 0.3% were, while overdue housing loans declined from 0.4% in early 2018 to 0.1% in September this year.
There are grounds to expect some increase in problem loans moving forwards though, as the economy has been weaker than usual for some time now. There is no reason to expect that the Estonian economy will recover rapidly, as the economies of Estonia’s main trading partners are similarly weak and Estonian companies have become less competitive. Estonia has a small and open economy and is very dependent on export markets and on its ability to compete in them. Unemployment has also started to rise.
Companies and households have so far coped quite well with the increase in loan payments caused by the rise in interest rates. Businesses have coped because of their strong sales revenues in earlier years and the growth in profits. The ability of households to service their loans has been supported by unemployment being relatively low and wages rising quite quickly. Interest rates rising will make it harder to repay loans, but will not on their own cause major problems with loan repayments.
Higher interest rates make it more expensive for the banks to access funding, and they will become somewhat less profitable in the years ahead. The higher rates have so far particularly boosted the income of the banks, but in the future they will act more to increase the interest expenses of the banks. Growth in deposits has slowed, so the banks have borrowed more from their foreign parent banks and issued more bonds. Tighter competition between the banks to attract deposits has caused the interest rates on term deposits to rise fast. Businesses and people have consequently put a larger part of their money into term deposits and are holding less as demand deposits.
The capital buffers of the banks remain strong, but they have shrunk in recent years. The Estonian tax system has since 2018 encouraged the banks to distribute their profit from the current year as dividends. The banks recently announced plans to distribute even more of their profits in the coming years, and there was political pressure in favour of this as well. The banks need to hold capital buffers so that if necessary they can cover any loan losses that arise while the economy is weak, and can continue to lend to companies and people during more difficult times. The capital buffers of the banks in Estonia are big enough even to cover losses that are bigger than forecast, but the additional dividend distribution planned by the banks will reduce their capitalisation and so also their capacity to cover loan losses and continue lending in a crisis.
Unexpected tax changes that have a large impact can make it harder for the banks to access funding from financial markets. If the banks are not able to get funding or if it becomes more expensive, there may be an impact on the cost of borrowing and on access to loans for people and companies in Estonia. Eesti Pank considers that policy changes of this type can cast shadows on the broader investment climate in Estonia and make investing in Estonia more difficult.
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