Recessions usually cause problems for the real estate sector and its bank loans, but the current recession that has dragged on for quite a long time is an exception to this because it has not caused serious problems in the real estate sector even though interest rates have been high, says the latest Financial Stability Review from Eesti Pank.

The persistent recession and high interest rates have made it harder for households and companies in Estonia to repay their loans, but the share of bad loans has been smaller than in previous recessions even so. So few loans have become overdue by more than 60 days that they currently make up 0.3% of the loan portfolio, where in the crisis 2008-2009 they peaked at 7.5% of the portfolio.

There are several reasons why bad loans have been only a small problem for the banks in Estonia. Companies have been helped in coping with the increased costs of their loans by the earlier good years and the buffers they have accumulated. The capacity of households to service their debt has remained good because of their earlier savings and because unemployment has risen little and wages have continued to rise. The banks in Estonia have lent substantially more to the real estate sector in relative terms than banks in other countries in the European Union, and so the relatively good performance of real estate in Estonia has also been a reason. Real estate firms are generally considered to be riskier than the average because they use more borrowed money to support their activities. Real estate firms in Estonia have coped well with higher interest rates and other expenses because the return on real estate investment in Estonia has been high enough for them to pass some of the increased costs on to their clients. They also have sufficient financial buffers and the banks have lent to them on quite conservative terms.

The level of problem loans may rise a little in the near future despite the expected recovery in the economy, as there is often some delay before problems arise with repayments of loans. 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. It will be important for the ability of companies to pay moving forwards that their sales revenues recover. Decisive for the ability of people to pay their loans will be whether their incomes are maintained, which means whether unemployment remains low.

The banks in Estonia are still exposed to the risks coming from the performance of the Swedish economy, as there are very close economic and banking connections between Estonia and Sweden. The risks to the banking sector in Sweden have been increased by the downturn in the economy and the higher cost of funding there, as these may increase the loan losses of the banks. Reduced demand from Sweden has already weakened the ability of Estonian exporters to pay their loans. The funding of the banks in Estonia is much less reliant on Swedish parent banks than it was 15 years ago during the global financial crisis, but the parent banks still affect the subsidiaries in Estonia to a large extent even so. If the Swedish banking groups hit difficulties, it could reduce the loan supply in Estonia.

The capital buffers of the banking sector in Estonia are being reduced as banks are planning to pay larger amounts out in dividends. High interest rates led to record profits for the Estonian banking sector last year, and the banks plan to pay a large part of that out to their owners together with the profits built up in earlier years. Generous dividend payments reduce the capital buffers of the banks, and that means that they will have fewer funds available to cover loan losses in a crisis. The central bank still considers though that the capital buffers of the banks in Estonia are sufficient for the near future. This has been helped by the earlier decision of Eesti Pank to raise the countercyclical capital buffer requirement for the banks to 1.5% from December 2023.

Publication: Financial Stability Review 1/2024

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