Most of the risks to financial stability in Estonia are low
Most of the risks to financial stability in Estonia are low. The economy has started to grow in the euro area, tensions have subsided in the financial markets, and the creation of the European banking union is advancing. The outlook for growth in the Estonian economy is good, the commercial banks operating here are well-capitalised and loan servicing ability of bank customers remains good. The main risks to financial stability are the lower quality of loans in the euro area banks and risks to the banking groups operating in Estonia stemming from Nordic real estate markets. Additional risks could also arise if the banks operating in Estonia were to abandon their conservative stance on real estate lending.
The economy in the euro area has started to grow, but the recession there has impaired the quality of the assets of the euro area banks markedly. In order to restore confidence in the banking sector, the European Central Bank and the financial supervision authorities across the euro area are assessing the balance sheets of all the biggest banks in the euro area and carrying out stress tests. If the results of the stress tests are that some European banks need additional capital, those banks will first need to raise it from the private sector, with governments only stepping in as a last resort. If there is a shortage of capital, the ability of the European banking sector to support economic recovery by lending will be restricted.
Real estate prices in the Nordic countries have continuously risen rapidly with support from loans over the past five years, in contrast to prices in other European countries, and the International Monetary Fund, the IMF, finds that prices are overvalued in Norway and Sweden in particular. This could pose a danger to financial stability in Estonia, because if the rapid rise in real estate prices is followed by a sharp fall, it may become harder for the Nordic banks to access funds from the markets. This could also lead to a recession in the Nordic countries, which are important export markets for Estonian companies. Sweden and Norway have tightened lending conditions for real estate somewhat in order to reduce the risks from the real estate market, and they have assessed the risks related to housing loans higher in the calculation of bank capitalisation.
The ability of Estonian companies and households to repay their loans remains good. This is due to the support coming from the good growth prospects for the Estonian economy, which in turn is supported by the economic recovery in the euro area. However, the unwinding of the imbalances that have built up in the euro area over the years will only be slow and this will limit any rapid recovery in demand. Growth slowed significantly in Estonia in the first half of this year, but the slowdown was not broad-based and rises in production in most industries increased employment while wages rose rapidly.
Real estate price growth has accelerated in Estonia over the past year, but unlike six or seven years ago, purchasers of real estate are putting in more own capital, and the volume of housing loans in the loan portfolios of the banks has not changed. In future it will be important that expectations for rapid growth in real estate prices be contained and that the current conservative approach to housing loans is maintained.
The new capital adequacy requirements of the European Union will start to apply next year. The minimum requirement will be 8%, but member states can add further capital requirements in order to mitigate systemic risks. Since 1997 the capital adequacy requirement for banks in Estonia has been 10%, as Estonian experience has shown that an unexpected deterioration in the economic environment for a small and open economy can lead to debt servicing problems in the non-financial sector and that the financial position of banks can worsen very rapidly. It is important for the resilience of the Estonian banking sector that the capitalisation of Estonian banks remains strong under the new regulations too. For this reason, Eesti Pank finds it is necessary to set an additional 2% systemic risk buffer for banks in Estonia when the new capital adequacy requirements are implemented.
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