ESTONIAN BANKING IN THE THIRD QUARTER OF 1997

At the end of September 1997 Estonia had 11 commercial banks, one investment bank and two licensed loan and savings co-operatives. On 28 August, the extraordinary meeting of the shareholders of INKO Balti Pank decided to liquidate the bank. The reason for this step was the shortage of capital which did not allow INKO Balti Pank to meet the central bank's own funds requirements. On 1 September, Eesti Pank accepted the decision of the shareholders meeting and on 2 September the license of INKO Balti Pank was invalidated. From 10 September, the Board of Eesti Pank revoked the license of Eesti Innovatsioonipank (Estonian Innovation Bank) because the bank had repeatedly provided incorrect data.

In September, the Moody's agency gave Estonia Baa1 credit rating which is the highest rating given to a Baltic country. The leading European rating agency IBCA granted Estonia the foreign currency long-term credit rating of BBB, short-term rating of A3 and the long-term local currency credit rating of A. Both Baa1 and BBB are investment grade ratings which means that the agencies consider Estonia an investment worthy country. The Moody's rating is by two and the IBCAs rating by one level higher than the lowest investment grade rating.

Eesti Ühispank (Union Bank of Estonia) received a long-term credit rating of BBB- and a short-term rating of A3 from the IBCA agency. Moody's gave Hansapank and Eesti Hoiupank (Estonian Savings Bank) a long-term foreign currency credit rating of Baa2. The banks' short-term foreign currency credit rating was Prime3 and the financial activity rating was D+.

In order to expand their activities, several Estonian banks are negotiating, in addition to Latvia and Lithuania, with banks in the Ukraine and Russia. At the end of September, Eesti Hoiupank bought the Russian FABA Bank, and a number of other deals are expected in the fourth quarter.

As a new bank service, Hansapank and Eesti Hoiupank began issuing the international Cirrus Maestro bank cards which in the future are supposed to replace the local bank cards used so far. The Cirrus Maestro cards can be used as cash cards and/or payment cards.

FINANCIAL ACTIVITIES OF THE BANKS

Increase of Assets

The third quarter in the banking sector began on an optimistic note. In the first half of 1997 the banks' assets had increased at an average rate of 5% a month, while in July the assets grew 12.1%, mainly due to the rapid inflow of the deposits of non-resident customers. In August, assets increased by just 1.9% and in September the increase was similar (see Table 1).

At the beginning of September the first signs of liquidity problems emerged. An additional 1.1 billion kroons was borrowed from foreign banks in the third quarter, half of it in September. This was even more than in the first quarter (0.9 billion kroons) which had so far been the most successful period. At the same time the deposits of a number of customers' groups decreased and the inflow of resources was below the planned increase of lending. In July Estonian banks' deposits abroad were record large - 4.6 billion kroons or 13.9% of total assets - while from August the deposits began to shrink and by the end of September they amounted to only 1.8 billion kroons which makes 5.3% of total assets (see Figure 1 and Table 2). At the same time, the loan as well as the securities portfolios increased rapidly.

On the inter-bank money market the shortage of money became felt in the first weeks of September. TALIBOR and TALIBID began to increase on 10 September and over the month went up by 1.18 percentage points in case of one-week loans and by 0.65 percentage points in case of one-month loans. The interest rate of the overnight market, which in July and August had been 3.2%, increased to 5.72% by the end of September. The price correction at the stock exchange was unfavourable to selling the securities. The liquidity problems deepened in October, worsened by the fluctuations on the global financial markets.

LOAN PORTFOLIO

At the end of September, loans to customers amounted to 17.9 billion kroons. As compared to the end of June, the loan portfolio had increased by 21.6%, and compared to September 1996 the volume of loans had doubled (see Table 3). As the assets of the banks increased by 16.4% in the third quarter, the increase of the loan stock exceeded the increase of the consolidated balance sheet by nearly a third.

Structure of Loans

9.7% of the loan stock total were claims on non-residents (7.7% at the end of the second quarter). This part of the loans granted to the financial institutions that the banks take out of the country through their daughter companies can also be potentially regarded as an outflow of funds. The increase of the share of foreign currency loans continued (see Figure 2). In the third quarter the share of foreign currency loans grew by 4.5 percentage points and reached 55.4% of all loans. As compared to earlier periods the terms of the foreign currency loans shortened in the third quarter and this led to the decrease of the share of long-term loans as a whole.

Among various customer groups the biggest share of loans went to commercial undertakings (57.9%), although the volume of loans granted to financial institutions and private individuals has been growing faster. In 1997, loans to financial institutions have increased at the average monthly rate of 9.5%. The main reason for the increase has been the on-lending of foreign resources to the banks' daughter companies on favourable terms.

In 1997, loan stock to private individuals have increased at the average monthly rate of 8,3%. The net position of the claims and liabilities of private individuals in banking decreased in the third quarter, for the first time in the past two years. At the end of September, loan stock to private individuals amounted to 3.7 billion kroons. The most common categories of loans taken by private individuals were the mortgage loans, consumption loans and student loans. The biggest category of loans to private individuals was mortgage loans (48%) which increased from 919.6 million kroons to 1,794.4 million kroons over the third quarter. Consumption loan stock increased 2.9 times during the quarter, from 447 million kroons at the end of June to 1,388.4 million kroons at the end of September.

Across the economic sectors, the largest share of loans (24.4%) had been taken by the financial sector institutions, followed by the wholesale and retail trade sector (20.2%).

Loan Collaterals

Loans with securities as a collateral have become increasingly popular this year - at the end of June such loans accounted for 6.6% of all loans while at the end of September they already made up 9.4% (see Table 4). In most banks such loans have to be guaranteed by the securities by 200%. The banks have secured themselves against the drop in the share prices with the provision in the standard repurchase agreement that in the event of the decline in the price of the collateral securities by more than 30-35%, the borrower has to provide an additional collateral that would bring the guarantee back to 200%.

Private individuals have mainly used the mortgage or building pledge[1] as loan collateral - by the end of September in case of 61% of all loans. The collaterals for consumption and student loans are mainly surety and guarantee.

The provisions made to cover loan losses amounted to 1.8% of the loan portfolio at the end of September and have stood at this level for the past five months. At the end of 1996 the respective figure was 2%. The banks have reported that 1.1% of the loan portfolio were made up of overdue loans.

Loan Interests

In the third quarter the volume of the inflow of foreign resources was the largest in July. The additional cheap resources lowered the weighted average loan interest rates - the average interest rate of the kroon loans was down by 1.66 percentage points as compared to June, reaching 7.90%. At the end of July and in August several banks lowered their basic loan interest rate. As the market situation changed, the average interest rate began to increase again in August and September and stood at 9.96 and 10.56%, respectively. The September interest rate is similar to the average rate in April. The rising interest rates on both the local and international money market will boost the loan interest rates in the fourth quarter because the interest rates of long-term loans are mostly linked to the money market interests.

Securities Portfolio

The securities portfolio of Estonian banks amounted to 6.8 billion kroons at the end of the third quarter, having increased by 43% which makes 2 billion kroons during the three-month period. The increase was the fastest in August when the deposits continued to grow at the rapid rate characteristic of this summer. The prices at the Tallinn Stock Exchange were also on the rise. The onset of the liquidity problems in September forced the banks to start selling their securities portfolios although the market situation was unfavourable. The prices of shares were going down and the financial income of banks from securities' deals can decrease.

The ratio of fixed-income securities and shares was 1:1 in the banks' securities portfolios at the end of the third quarter (see Figure 3). At the end of 1996 fixed income securities accounted for 68% of the securities portfolio and thus the portfolios have become more vulnerable to stock market fluctuations. At the end of September, half of the securities owned by the banks were listed on the stock exchange although over the third quarter the quota of listed securities has decreased by nearly 10%.

At the end of September the share of fixed income securities and shares issued by non-residents was 39 and 27%, respectively. 37% of the fixed income securities have been issued by the central governments, of which 59% were the bonds issued by foreign governments. A significant part of the latter (28%) were bonds issued by the governments of the former Soviet republics, mainly Russia and the Ukraine. The average utilization of the fixed income securities stood at around 11% in the third quarter.

As far as shares are concerned, the banks' portfolios are dominated by shares issued by credit institutions (41.8%) and by commercial undertakings (38.7%). 44% of the total securities portfolio is made up of securities issued by banks and other companies of the financial sector. In view of the fact that 33% of those companies are resident, we can see a risk concentration in the financial sector. Approximately half of the shares have been bought with the purpose of trade and 25% for long-term investment.

LOAN RESOURCES

The loan resources include amounts owed to customers and financial institutions, the government lending funds and counterpart funds, funds raised by issuing bonds and subordinated liabilities.

Amounts Owed to Foreign Banks

The banks' foreign debts continued to increase in the third quarter. The amounts owed to non-residents accounted for 27.8% of total liabilities, of which 14.7% were funds received from foreign banks. Unlike the earlier foreign funds, nearly 60% of the resources received from foreign banks in the third quarter were short-term deposits (mostly with the term of three months). This is obviously the reason for the slow-down of the increase in the share of long-term loans.

Customers' Deposits

The amounts owed to customers, or deposits, accounted for 59.2% of the liabilities and equity capital, or 20.3 billion kroons at the end of the third quarter (see Table 5). As compared to the end of the second quarter, the share of this item in liabilities and equity capital has decreased by 1.2 percentage points. The share of the deposits of non-residents was 12.0% at the end of September.

The deposit stock has increased 14.6% as compared to the end of the second quarter. In 1997, deposits increased with every month until the end of August, but decreased by 1.6% in September as compared to August.

Across the customer groups, the biggest changes took place in the structure of time deposits. The third quarter is characterised by the increase in the share of the government's time deposits which at the end of June accounted for 19.9% of all time deposits, climbing to 30.6% by the end of September. The most common term of deposit was three months. However, the increase in the government's time deposits was insufficient to compensate for the decline in the time deposits of commercial undertakings in September. The latter led to the decrease in the total volume of deposits, while the share of the commercial undertakings' time deposits in all time deposits fell from 34.6% at the end of June to 26.7% at the end of September. The growth of deposit stock of private individuals has been more stable, at an average rate of 4% a month during a year and the third quarter.

Deposit Interest Rates

Speaking of the interest rates of deposits we have to take into account the fact that the turnover of the deposits of both commercial undertakings and financial institutions was larger than usual in July. Thus, the turnover of time deposits in July exceeded the turnover of previous months by approximately 70%. As these were predominantly deposits with the term of less than one month, the July interest rate on time deposits was lower than usual. By September, the interests paid on time deposits increased to 5.25%, the highest level this year.

The increase in the average deposit interest rate was boosted mainly by the growing rates of short-term deposits. The interests paid on long-term deposits (with the term of more than one year) have been more stable but the share of such deposits in the overall volume of time deposits is small - 15.9% at the end of September. As compared to the low point reached in June (4.74%), the interests paid on the government's time deposits increased with every month of the third quarter, reaching 6.32% in September.

Other Loan Resources

The government lending and counterpart funds have been decreasing continuously since the end of June, while the case is different for bonds - compared to the end of June the bond stock had increased by a third by the end of September, from 1,126.5 million to 1,508.3 million kroons. Three banks issued bonds in the third quarter - Hansapank, Eesti Ühispank and Eesti Krediidipank (Estonian Credit Bank). The term of the bonds ranged from 6-12 months to 1-2 years.

PROFITABILITY AND PROFIT

The economic activity of the banking system was successful in the third quarter of 1997. By the end of September the banks' net profits amounted to a total of 898.6 million kroons. Comparing the profit reports for the six and nine months of 1997 (see Table 6) we can see that nearly half of the profit was earned in the third quarter.

Estonia's three largest banks, Hansapank, Eesti Ühispank and Eesti Hoiupank whose combined market share was 71.4%, earned 74.7% of the total profit of the banking system by the end of the third quarter. These three banks fulfilled their annual profit estimate by 88, 82 and 54%, respectively. All Estonian banks reported a profit, with the exception of Tallinna Äripank (Tallinn Business Bank Ltd) who in September classified part of its claims as unlikely to be paid back and thus increased the bank's expenses.

Over the past year the banks have paid more and more attention to earning opportunities in the local economic environment. The deepening of this tendency has been facilitated by the continuation of intense activity on the local lending and stock market. This was also true in the third quarter when the volume of income/expenses of resident nature increased by approximately 7 percentage points. The increase in income has been most influenced by the growing income from interests paid on futures as well as the increase in the share of income from financial operations (see Figure 4). The increase of expenses derives mostly from the loan interest expenses and the expenses from financial operations.

So far, the banks have earned most of their income from interests. By the end of the second quarter of 1997 income from interests accounted for 49.2% of the banks' total income. Despite the nearly 60% increase in the income from interests, in the third quarter both its share and volume remained below the increase in income from financial activities. The continuing rise of the share prices on the Tallinn Stock Exchange and the strengthening of the US dollar had a considerable impact on the structure of the banks' income, and by the end of the third quarter the biggest share of income (43.7%) came from financial activities. The share of interest income decreased to 39% by the end of the third quarter.

The structure of the banks' expenses underwent similar changes. In earlier periods the biggest share belonged to administrative expenses (32% of total expenses at the end of the second quarter), while in the third quarter the increase in the financial operations' expenses to 57.4% of total expenses (see Figure 5) reduced the share of administrative expenses to 23.4% and had a significant impact on all other categories of expenses.

As the increase in interest bearing liabilities exceeded the increase in interest earning assets in the third quarter and the volume of interest expenses increased more rapidly than interest income, the net interest margin as well as the price difference decreased (see Table 7). However, due to the relatively large profit earned by the banks, all their profitability indicators improved. The more modest increase of the banks' share capital and equity capital as a whole as compared to the increase of profits, gave a strong boost to the return on the share capital and equity capital. As compared to the second quarter, these indicators increased by 13.4 and 5.8 percentage points, respectively, in the third quarter. The assets utilization and profitability increased as well while net profitability increased only slightly. The income and expenses ratio remained on the same level as in the second quarter.

PRUDENTIAL RATIOS

Capital Adequacy

The principles of calculating capital adequacy of the banks were changed from 1 July. The risk weight of loans to local governments and loans guaranteed by local governments was increased from 50 to 100%. The minimum capital adequacy requirement was increased from 8 to 10% from 1 October. These changes have been prompted by the need to improve the capitalization level of the banks and to slow down the growth of the loan portfolio and at the same time estimate the loan risks of local governments more realistically.

The 8% capital adequacy requirement was met by all the Estonian banks in the third quarter. The weighted average capital adequacy had increased to 11.2% by the end of September (see Figure 6). In case of the larger banks the main reason of the increase was the need to reach the new minimum requirement. Some banks managed this by auditing their profits which allowed them to include profits into their equity capital.

If the rapid increase of the loan portfolio continues, the banks' own funds have to grow by an average of 9% a month in the fourth quarter, so that the weighted average capital adequacy would remain around 11%. The growth of the own funds should be facilitated by the planned or ongoing share issues of several banks (Eesti Hoiupank, Hansapank, Eesti Forekspank (Estonian Forexbank), EVEA Pank).

Liquidity

In the third quarter, all banks met the liquidity requirements. The weighted average liquidity was record high on 31 July - at 57.2% (the requirement is 35%). The liquidity problems in September reduced the average liquidity to 50.9% by the end of the quarter.

Eesti Pank Banking Statistics and Analysis Department

[1] Building pledge is a chattel mortgage, witnessed by the notary and registered in the state building register of the location of the building, or under the legislation in force before the Estate Act was applied, the pledge loaded on the building.