FINANCIAL STABILITY REVIEW. The slower recovery of the economy could cause the level of bad loans at the banks to rise
The latest financial stability review from Eesti Pank finds that the capacity of companies and households to repay their loans has so far remained good and the level of overdue loans low despite the deterioration in the economic climate. If growth in the Estonian economy were to remain slow however, problems could emerge with repayments of loans, and the share of bad loans at the banks could increase.
Businesses have coped well so far with higher interest rates because of their strong profitability in earlier years, while people have coped because unemployment is low. The danger this time however, in contrast to earlier recessions, is that the recovery of growth in the economy may be delayed. Further growth in the Estonian economy depends on its competitiveness, which may be weakened as the energy crisis and the economic impact of the war have reduced access to several production inputs, and their prices have risen.
The central bank estimates that the banks will be able to cope if necessary with larger loan losses if the level of bad loans should start to rise. The banks have large capital buffers and their activities are supported by good profitability. Eesti Pank estimates that the capital requirements for the banks are sufficient and that it is not necessary in the current environment to take additional steps to ensure the stability of the Estonian financial sector.
The decline in economic activity will increase the risks for the banks from the real estate sector. Bank loans to real estate companies and housing loans have seen strong growth in recent years, and so their share of the loan portfolio of the banks has climbed above 60%. Interest rate rises affect the financial positions of real estate companies more than those of companies in other sectors, as borrowed money plays an important part in funding the real estate sector. The deterioration in the economic circumstances makes some borrowers more vulnerable because an increasing number of new housing loans have been taken that leave borrowers with a larger loan repayment burden relative to their income.
The banks in Estonia are increasingly using other sources of funding alongside deposits to finance their activities. Growth in deposits has slowed, and if the banks want to increase their loan portfolios then a larger part of the financing than before must come from loans from parent banks and from bonds issued by the banks themselves. The cost and accessibility of financing for the banks is increasingly affected by how risky financial markets consider the Estonian state and banks to be. The prevailing situation in financial markets at the moment of borrowing also plays a role. The financing of the banks is also affected by the financial position of the Swedish parent banks, and by the state of the Swedish real estate market and economy as a whole. The banks are also increasingly using online platforms to take in deposits from residents of other European Union countries as a source of funding.
Eesti Pank finds that the impact on the functioning of the financial sector and the funding of the economy should be considered when tax changes are planned. The stability of the funding of the economy depends on the financial strength of the banks. This is shown particularly in an economic crisis when the banks may face larger loan losses. If the banks have previously built up sufficient capital buffers, they are able to cover the losses from a crisis using those buffers and to continue lending in the difficult times. The central bank consequently recommends that the taxation of the banks should encourage the banks to hold onto the large profits accumulated during the good times and should not push them to pay out all of their profit to their owners as dividends. Balanced development of the economy furthermore requires that companies be taxed as uniformly as possible. Eesti Pank also believes it important that the interest rates paid by the banks on deposits should rise together with other interest rates.
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