The strong financial position of Estonian companies and households supports the quality of the loan portfolio of the banks



The risks to financial stability in Estonia are small, as they were last year. The biggest risk in the coming half year is that a deterioration of the external environment could provoke a recession and damage the loan quality of the banks. Nordic real estate prices and credit levels have continued to grow relatively rapidly, increasing the funding and liquidity risks for the Nordic banks. Price rises for Estonian real estate have stabilised in the past half a year, but rising household incomes and very low interest rates mean that they may speed up again.

Growth picked up slightly in the euro area at the end of last year. Further growth in the euro-area economy is getting support from low commodities prices, monetary policy measures taken by the European Central Bank, and a depreciation of the euro. However, faster growth is facing obstacles in some euro-area countries in the form of high debt levels and long-term unemployment problems. Uncertainty surrounds the sustainability of Greek government finances and geopolitical tensions. At the same time an expansionary monetary policy could lead to the risk of asset prices starting to rise too quickly.

Despite the uncertainty in the surrounding economic environment, the Estonian economy grew by 2.1% last year. If the external environment starts to improve, then economic growth should speed up somewhat. Although the financial results of companies in some sectors have been slightly worse, partly because of the reduction in exports to Russia, most of those companies have managed to cope with lower incomes. The capacity of households to consume and to save has been supported by rapid wage growth and low inflation. The strong financial position of Estonian companies and households means that loan quality for the banks is good and it has continued to improve. Their high levels of equity and profitability make banks able to bear losses even if the economy develops in a negative direction.

The biggest banks operating in Estonia are closely linked to their Swedish parents through liquidity management, as liquidity is managed at group level and a large part of the liquidity buffers of banks in Estonia are held by the parent banks. The share of funds borrowed from parent banks has been notably smaller in recent years than it was during the years of rapid economic growth, but such funds still account for around half of liabilities at some banks. Continuing relatively rapid growth in Nordic mortgages and real estate prices could pose some risk to the banks in Estonia. A negative turn in the Nordic economies could increase the loan losses of the banking groups and reduce their funding options. The Nordic central banks and supervisory authorities have taken measures to reduce the build-up of risks and to increase the resilience of the banks, but their impact on credit growth and rising real estate prices has been limited so far.

After rising rapidly at the start of 2014, real estate prices have started to stabilise. Although the rise in prices for residential property has been faster than the rise in incomes in recent years, real estate prices are mostly in line with household income levels and the growth in mortgages has remained moderate. Rising incomes and low interest rates have permitted real estate purchases and increases in debt, but excessively fast growth in indebtedness could increase the risks for both borrowers and lenders. The requirements for issuing mortgages that Eesti Pank introduced in March have helped reduce the risks associated with excessively fast growth in mortgages.

The rise in real estate prices has allowed developers to increase construction. Though construction volumes are substantially smaller than during the years of rapid economic growth, developers may face increasing repayment risk if a large amount of new space comes into the market all at once. Banks have been granting more new loans to real estate development companies, but the share of such loans in the total portfolio has not changed much. To avoid an excessive build-up of risks, it is important that both borrowers and lenders continue to take a conservative approach to assessing the risks of real estate investment and of credit.