Lower debt level alleviates loan repayment risks in Estonia
Whereas slowing global growth has heightened risks to the functioning of international financial markets, the sovereign debt crisis in the euro area still poses the most serious risk. The decisions by the European Council to establish common banking supervision and to use the European Stability Mechanism to recapitalise banks, as well as the decisions by the Eurosystem (that is, euro area central banks and the European Central Bank) to lower interest rates and to introduce a new monetary policy instrument for purchasing government bonds in the secondary market have laid the foundation for smoothing the effects of the crisis. However, in order to solve the crisis, debt-ridden countries must adhere to the agreed budget plans and carry out structural reforms.
Estonia’s economic growth has been slowing since the end of 2011, but despite a deceleration in exports, strong domestic demand has ensured a faster economic growth than in the rest of the euro area countries. The environment of attractive interest rates, which has created favourable conditions for investment, has been supporting domestic demand. Our flexible labour market has also contributed to economic growth, since the recovery of employment and moderate wage growth have reinforced the confidence of households and encouraged consumption. However, the precondition for further growth and a pickup in income is an improvement in the external environment.
Risks to Estonia’s financial stability are first and foremost related to uncertainty brought about by the sovereign debt crisis and to the fear that economic growth in Europe may slow. The weakened economic stance of the euro area may exert a negative impact on the loan repayment ability in the Nordic region through a contraction in external demand. In Estonia, risks related to the loan repayment ability of enterprises and households are alleviated by reduced indebtedness. In addition, financial buffers have increased, so enterprises and households are better prepared to face economic shocks than they were prior to the 2009 recession.
The low interest level also supports the loan servicing ability. On the other hand, the low level of interest rates has prompted Estonia’s banks and other financial companies that are active investors in international financial markets to place more assets in higher-risk instruments in order to preserve their profitability. Although they are not systemically relevant market participants, it is important they be aware of the impact of the risks accompanying such investment.
The Estonian banks’ funding risks deriving from the debt crisis have, on the one hand, been alleviated by the rapid deposit growth owing to which the banks’ loan-to-deposit ratio is currently at a relatively safe level of 110%. On the other hand, the fact that major Estonian banks belong to Nordic banking groups has also supported their liquidity position. Thus, the financial standing of the Estonian banking sector is determined by risk assessments provided to the parent banks. The conservative approach taken by the Swedish authorities to impose higher capital requirements on systemically important banks and to establish liquidity requirements is a relevant measure to maintain the confidence of financial markets. The step is necessary, since the Swedish banking sector is characterised by high financial leverage and openness to risks from the external environment. In addition, the assets of banks are relatively large compared to the size of the economy.
The operating environment of banks will be significantly affected by the new capital regulation, which should enter into force in the entire European Union at the start of 2013. Unfortunately, it is still being negotiated. At the same time, the proposal to launch common banking supervision is adding new facets to it. From the viewpoint of ensuring financial stability and shaping an appropriate operating environment for market participants, it is important that the schedule of effecting changes be realistic, providing sufficient time to implement them. In addition, the goals and the core of the changes must be clear and comprehensible and rights and obligations in balance.
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