Vahur Kraft. Speech at Riigikogu


by Vahur Kraft, President of Eesti Pank

Dear Chairman, dear Members of Riigikogu,

Thank you for the possibility to explain to Riigikogu the present situation and current problems concerning Eesti Maapank. It has to be said at once that those who are expecting scandalous disclosures and concrete names of persons directly or indirectly guilty of the sad situation in Eesti Maapank, are sure to be disappointed.

Although Eesti Pank has a lot of 'interesting', not to say explosive material, we always have proceeded and will proceed in the future from the law according to which supervisory materials are confidential. And of course, we will avoid concrete accusations against persons until everything has been clarified. This does not mean that any breach of law will go unnoticed or concrete culprits are not being sought. This is definitely being done and the process is being helped by the initiation of bankruptcy proceeding. It may be necessary that the session at which we answer to the Members' inquiries be declared not public.


Using the opportunity, I would like to begin a bit further. Over the last weeks, once again, rumours about the forthcoming devaluation of the kroon have actively been circulated. By today, at least five dates of kroon's devaluation predicted by oracles have passed and I would like to assure through you to all Estonians, with full responsibility, that none of these rumours about possible devaluation of the kroon have any economic or other foundation. It is high time to give up such a masochistic approach - if something is wrong at all, it also has to be the kroon that is being weakened.

The same applies to panicking about the welfare of the Estonian banking sector as a whole: however serious Maapank's and its creditors' problems are, the current affairs do not influence the Estonian banking sector as a whole. Rather, it can be claimed that the purposeful and persistent liquidation of such deviations strengthens the banking sector as a whole. Especially if we are able to proceed as so far: not rescuing the whole of the failed bank and thus avoiding moral hazards that in the longer run could create an extremely dangerous situation where the owners and managers have a feeling that they can take as many risks as they like, because the state will bail them out anyway. We should concentrate on helping the depositors and creditors to a reasonable extent.


Let us proceed to Eesti Maapank case. Yesterday the Board of Eesti Pank decided to initiate bankruptcy proceeding with respect to Eesti Maapank. The proposal of shareholders' extraordinary general meeting to terminate the activities of Eesti Maapank through voluntary liquidation was rejected.

In the opinion of Eesti Pank, the initiation of bankruptcy proceeding against Eesti Maapank is the best possible solution at the moment, since it makes the process more transparent and prevents illegal transactions. Small depositors will presumably be protected by the Government implementing principles of the Deposit Insurance Fund Act.

What has led us to such an extreme solution? I would like to start with last autumn and explain what Eesti Pank has done.

In accordance with legislation, Eesti Pank supervises all credit institutions that are located and active in Estonia. We should stress at once - the aim of supervision is to monitor that credit institutions are established and that they act in accordance with laws and other legislative acts. Supervisory activities start with issuing licences to credit institutions and continue through reports presented to Eesti Pank and on-site inspections. However, Eesti Pank will never be able to assume responsibility for all decisions that a management of a commercial bank has ever taken and will take in the future. Especially if the management acts out of stupidity or straightforward malevolence and greed for profit.

The aim of supervision is definitely not to close some commercial bank down. On the contrary: the liquidation of a bank is the most extreme step that will be taken only when all other measures have failed.

Maapank has been under a special supervisory regime by Eesti Pank for a long time and until the last moment we tried to find solutions for the disclosed problems. The financial indicators of Maapank worsened in connection with extensive risks taken in the securities market. In addition, during the on-site inspections cases of mismanagement and problems in internal audit and credit department were disclosed. The findings were referred to the Board of Eesti Maapank and appropriate Eesti Pank instructions were imposed. Eesti Maapank repeatedly promised to rectify the situation but these promises were never kept. As a result, bankruptcy proceeding was initiated.

What has Eesti Pank done regarding Eesti Maapank since November 1997? Over the period from November 1997 to May 1998 three selective inspections were carried out in Maapank during which the quality and the management of bank's assets, securities portfolio and off-balance sheet activities were assessed.

As the result of the first inspection in November 1997, Banking Supervision Department of Eesti Pank pointed out necessary provisions in the amount of 150.3 million kroons that were to be made in order to cover the losses in securities portfolio. The Banking Supervision also asked Maapank to compile a re-structuring plan for, as the result of the necessary amendments, Maapank would have been unable to meet prudential ratios. Maapank presented its re-structuring plan on 15 December. However, Banking Supervision considered the proposed measures insufficient and was of the opinion that Eesti Maapank has to convene a shareholders general meeting for incorporating additional capital.

Maapank did not agree with the Banking Supervision evaluation regarding the provisions and wished to wait for the auditor's (KPMG) statement. The Board of Eesti Maapank decided to exchange the bank's securities portfolio against index-linked bonds that, in their opinion, gave the bank a possibility to carry on.

The second inspection took place in January 1998, during which the quality of assets and the securities portfolio were assessed in the context of the agreements with Hansabank,. Banking Supervision was of the opinion that the measures taken by Eesti Maapank had not rectified the situation. In addition, the bank had incurred a loss of approximately 91 million kroons from securities transactions connected with the bonds obtained under the above agreement. If this loss had been reflected in the balance sheet of Eesti Maapank, the bank's equity capital would have been negative. Banking Supervision proceeded with investigations and also decided to wait for the external auditor KPMG's assessment on the transactions in question. Eesti Pank imposed an instruction on Eesti Maapank to convene the extraordinry Board meeting not later than 16 February 1998 in order to dicuss the re-organisation or liquidation of Eesti Maapank.

On 23 February 1998 KPMG presented to Banking Supervision a preliminary assessment on the recording of Hansabank bonds and repurchase agreements with Hüvitusfond in the balance sheet of Maapank (both questions were also pointed out in the report by Banking Supervision). KPMG was of the opinion that the equity capital of Maapank was negative. In the middle of March Maapank concluded an option agreement with Hansabank the purpose of which was to cover the accounting losses with respect to the bonds.

The aim of the above option agreement was to reduce the risk from bond transaction for Maapank. Banking Supervision was of the opinion that the above agreement did not allow for that and instructed auditor Kari Mietinen from Coopers&Lybrand to assess the need for amending Maapank's balance sheet as of 31 December 1997.

Both the Banking Supervision and Kari Mietinen were of the opinion that an amendment of 54 million kroons was insufficient. Despite of their opinion, the Board of Maapank did not agree with the supervisors' proposal to include into the agenda of the next shareholders general meeting an item on finding necessary additional capital for the future functioning of the bank.

On 14 April 1998 the general meeting of Eesti Maapank shareholders took place. By a decision of the meeting, shares in the total amount of 48 million kroons were written off. Issue of new shares was declared in the amount of 50 million kroons, with the subscription date on 30 April 1998. The issue failed.

In the middle of May the third selective inspection in Eesti Maapank took place with the aim to assess the quality of Eesti Maapank assets as of 30 April 1998. The report shows the need to amend the figures of equity capital of Eesti Maapank in accordance with the materials processed during the inspection. According to the report, the own funds of Eesti Maapank formed approximately 21.3 million kroons, without the loss from the Hansabank bonds transaction. On 26 May Eesti Pank imposed the following instructions on Eesti Maapank: reserve requirement had to be met by 30 May 1998; capitalisation plan presented by 1 June 1998, minimum level of own funds had to be met by 5 June 1998 and in case the last requirement would not be met, a shareholders' extraordinary general meeting had to be convened by 15 June 1998.

On 5 June Eesti Pank reminded Eesti Maapank in a memo that a credit institution was to terminate all payments to all customers if it was not able to satisfy a rightful claim of at least one customer over one working day. On 7 June the Board of Eesti Maapank decided to convene an extraordinary shareholders' meeting on 18 June 1998 in order to decide the termination of the bank's activities.

This was a brief overview of what has been done in Eesti Maapank. As Eesti Pank saw that the management of Maapank was not able to improve the bank's position, different Estonian and Scandinavian banks as possible investors in Eesti Maapank were contacted. By the end of May it was clear that foreign investors were nowhere to be found. By the beginning of June, the situation had worsened: the previous management of the bank initiated panic among the banks' customers and a wider campaign against banking in general.


In the course of inspecting the Maapank, different schemes have been clarified through which illegal transactions most probably were made. Part of the respective materials has already been forwarded to the police. These schemes can be widely divided into several larger groups.

First, there were questionable deposits in foreign banks, e.g. Lituanian Snoras Bankas, Russian Negotsijant Bank from where money was borrowed back, using these same deposits as guarantees, and invested further in circumstances open to various interpretations. Second, money was pumped into different off-shore companies, the earned profits of which got lost and through which later on the Hansabank bond transaction was covered. Third, loan agreements and loan provisioning practices are open to questioning. Loans that could be considered well-performing, were often written off. In addition, the companies owned by the management's acquaintances and relatives were clearly preferred and problematic transactions with Maapank subsidiaries were executed.

As mentioned above, four applications for initiating criminal cases regarding concrete transactions have already been submitted and most probably, there will be more of such applications. Only during a thorough investigation it is possible to find out who were the concrete persons who increased their welfare on account of deposits taken from farmers and funds kindly placed in Maapank by the state. I am sure that we have more than one unpleasant surprise waiting for us.


By June there were two options left: to declare bankruptcy at once or to terminate the activities of Maapank through voluntary liquidation. Part of the latter would have been the restructuring of the bank's balance sheet through an instalment plan. This option was actively supported by the Government, Maapank's largest creditor. Initial data showed that, by incorporating other commercial banks, it vas a viable option and framework agreements were reached.

Up to 27 June the possibilities for selling Eesti Maapank's assets were investigated, in order to guarantee the meeting of obligations as regards to private depositors. The aim was to guarantee that deposits were paid out as quickly as possible.

By today it has become clear that all considered solutions for fully meeting the claims of private depositors by incorporating the efforts of the Government and commercial banks, have neither found satisfactory results nor have led to the conclusion of necessary agreements. Partially this is due to the fact that it is impossible to precisely assess the assets of Eesti Maapank since these are linked with liabilities the size of which is difficult to define. For example, during recent weeks it has come out that a number of Maapank's assets have been pledged and used as guarantees.

In such a situation, the implementation of the planned scheme would have cost more than reasonable. It would have cost the taxpayer more than 300 million kroons to quickly pay out 504 million kroons to the creditors. Eesti Pank can, by no means, agree to the idea that the state should use an unreasonable amount of money and pay for mistakes made by the executive managers of a bank.


All this resulted in the Board of Eesti Pank choosing the option of bankruptcy proceeding as the only clear solution. The decision was based on the fact that the assets of Eesti Maapank were insufficient to fully meet the claims of creditors that is a prerequisite for a voluntary liquidation. The Board of Eesti Pank also took into consideration the so far strict policy to avoid bail-outs of commercial bank owners and the principle that the central bank does not help problem banks with credit injections.

In the course of bankruptcy proceeding it is possible to determine the actual size of Eesti Maapank assets and liabilities, and - what is very important - to recover bank assets from the transactions and legal acts stated in the Bankruptcy Act. Also, calculation of interests and fees for overdue payments will be terminated.


When solving the Maapank problems we have proceeded from the following principles and have suggested that also the Government proceed from them:

- both former and present management and owners are fully responsible for the insolvency of the bank;
- public sector, i.e. taxpayers are not responsible for the bankruptcy of a private business and before its creditors;
- the trust in the banking sector as a whole has to be maintained;
- the reasons for the insolvency of Maapank shall be investigated by independent experts.

In order to protect the interests of Eesti Maapank depositors, Eesti Pank once again proposed that when the bankruptcy proceeding is initiated the Government implement the principles stipulated in the Deposit Insurance Fund Act. According to the Act, deposits are subject to compensation up to EEK 20000, but not more than 90% of the total deposited amount. According to preliminary calculations EEK 200 million will be needed for that.

In order to implement the above principles, it is necessary that the Government and/or Riigikogu take a clear political decision and that the necessary funds for the expenses do exist in reality. By a supplementary budget, 100 million kroons have been allocated for these purposes that allows approximately 50% of the claims to be compensated immediately. In addition, Eesti Pank has considered a possibility of a 60 million kroon allocation into state budget for this specific purpose as a prepayment from future profits.


In conclusion I would like to say a few words about the impact of the Maapank problems on the economic policy as a whole. Maapank's insolvency is not a significant risk factor for Estonian economy; the estimated final loss for state institutions is less than 1% of public sector revenue. Thus, there is no reason to change the economic or fiscal policy due to Maapank problems, nor is there a need to incorporate funds from financial markets. Similarly, in the present situation it is not feasible to use the Stabilisation Reserve Fund without obligations to restore these assets rapidly.

The damage done by Eesti Maapank insolvency as well as self-responsibility of all public sector subjects have to be reflected in all budget levels. In order to maintain trust in the economic policy of Estonia this means that public sector subjects who have lost money as a result of the Maapank bankruptcy, have to cut their costs and/or increase revenues. In order to increase revenues it is possible to sell state and municipal assets or, to some extent, increase taxes.

If, for political reasons, the above principles cannot be fully followed and there is a will to compensate for the lost funds to some public sector institutions (municipalities) more rapidly and to a larger extent than the bankruptcy proceeding allows for, the fact that money not returned to the public sector as a result of Maapank bankruptcy is forever lost for the taxpayers, has to be taken into account.

Secondly, any loan extended by the Government to municipalities has to be short-term and aimed alleviating temporary liquidity problems until the municipality has had time to make adjustments in the income and expenditures of the budget. Thirdly, it is not advisable to issue Government bonds in international or local markets - the issue could be interpreted as a signal of the end of a strict fiscal policy. In addition, the present moment in the markets is unsuitable for such an issue.

If short-term liquidity needs arise that cannot be covered from revenues, the Stabilisation Fund can issue a limited, short-term loan from its funds to the state. The Government, in its turn, takes on an obligation to restore the assets as quickly as possible, in accordance with a schedule agreed internally and with the IMF.

Vahur Kraft. Speech at Riigikogu