By the end of 1996 there were 15 commercial banks and two licensed loan and savings cooperatives in Estonia. As compared to the end of 1995, the number of banks has decreased by three. Ameerika-Balti Pank (American Bank of the Baltics) failed to meet the new requirements for the minimum size of own funds (50 million kroons) that took effect from 1 January 1996 and therefore the Board of Eesti Pank revoked its license on 9 January 1996. The former Eesti Maapank (Land Bank of Estonia), which was faced with a similar problem, merged with Virumaa Kommertspank (Virumaa Commercial Bank) on 2 January, and from 22 October they operate under the name of Eesti Maapank. On 2 September, a merger agreement was signed between Eesti Hoiupank (Estonian Savings Bank) and Eesti Tööstuse ja Ehituse Kommertspank (Estonian Commercial Bank of Industry and Construction). The main motive for the merger was achieving higher competitiveness through economizing on operating costs and reducing the network of local offices.
In Estonian banking, the year 1996 was marked by conquering of new markets and developing new services. There were no big changes in the division of traditional banking services. Commercial banks expanded their activity outside Estonia. Eesti Forekspank (Estonian Forexbank) and EVEA Pank opened representative offices in Moscow and Hansapank has a subsidiary in Riga. Several foreign countries consider Estonian banks to be the most reliable in the whole of the Baltics.
With competition toughening on the banking market, the banks have to widen their choice of services. Thus, Tallinna Pank has introduced personal banking based on the system of customer managers. Similar projects are planned by Eesti Hoiupank and Hansapank.
The Estonian commercial banks take an increasing interest in institutions offering financial services (leasing, insurance, securities and investment services). Estonian banking is characterised by consolidation, internationalization, construction of new bank offices and booming trade in stocks.
STRUCTURE OF SHARE CAPITAL AND EQUITY CAPITAL
At the end of 1996, the total volume of subscribed share capital of Estonian banks (including the Estonian Investment Bank) amounted to 1,256.8 million kroons, which is 12.5% more than a year ago.
On 30 September 1996, the share capital of the banking system stood at 1,214 million kroons and was divided between the following categories: 22.5% belonged to business associations, investment funds and non-profit institutions registered in Estonia; 19.5% belonged to foreign banks (including clients of foreign banks); 17.8% belonged to other foreign owners (business associations registered in foreign countries, investment funds, non-profit institutions and state-owned institutions); 11.2% belonged to the Estonian state (see Table 1); 7.5% to private individuals; and 0.8% to municipalities.
251.6 million kroons worth of commercial bank shares or slightly over one fifth belonged to small-time shareholders who each own less than 1% of the share capital. It is impossible to have a complete picture of all the shareholders because their number in thousands and the shareholders of banks whose shares are traded on the stock exchange can be different every day. The shares of six banks are quoted on the Tallinn Stock Exchange, the shares of Hansapank and Eesti Ühispank (Union Bank of Estonia) have reached international stock markets.
The share of the banks' equity capital, which besides the subscribed share capital includes the premiums, own shares (with a minus (-) sign) reserves and profit/loss, has not changed over the past year and remains around 10%. In terms of volume, the equity capital increased by 0.7 billion kroons over the past year. The biggest growth occurred in the size of profit, which at the end of 1996 accounted for 17.3% of equity capital, and share capital (66.1% of equity capital).
STRUCTURE OF CONSOLIDATED BALANCE SHEET
The total volume of the Estonian banks' consolidated balance sheet increased by 48% in 1996 and amounted to 21,927.5 million kroons on 31 December (see Table 2).
In assets, the share of non-residents decreased from 24% to 19% over the past year, while the share of foreign currency increased from 29% to 33%. In liabilities, the share of non-residents increased from 11% to 18% and the share of foreign currency grew from 23% to 31%.
The share of the German mark increased constantly in the overall structure of foreign currency assets, amounting to 49.8% at the end of 1996. The reason for this growth has been the granting of foreign currency loans in the same currency as the resources the bank has received. At the end of the year, 70% of foreign currency loans had been issued to customers in German marks.
Besides the German mark and the US dollar, the share of the currencies of the so-called B-zone countries (the Russian ruble, the Latvian lats, the Lithuanian litas and the Ukrainian hryvnia) increased considerably in the foreign currency assets. This tendency points to the growing interest of Estonian economic agents in the Eastern market. Commercial banks have been actively investing into the government bonds of the B-zone countries, which as a rule yield high interests. The increase in the hryvnia reserves in banks was also affected by the fact that the Ukrainian central bank dropped the restrictions under which Estonian companies were not allowed to carry out transactions in the Ukrainian local currency.
Eighty seven per cent of foreign currency liabilities were in German marks and US dollars at the end of 1996. Over the year, the share of the German marks in liabilities increased from 34.4% to 46.5%. This was due to several issues of bonds and a considerable increase in subordinated loans. The share of the Russian ruble also increased considerably, amounting to 7% of foreign currency demand deposits.
In 1996 the growth of deposits was smaller than the rapid growth in loans. The growth of deposits has been slowed down by the successful launch of the Tallinn Stock Exchange which has created an alternative and often more profitable option of placing one's savings. The deposits of customer in banks increased by 44.6% in 1996 and amounted to 14 billion kroons by the end of the year.
The modest growth of deposits has been compensated by the credit lines provided by the Government, direct loans and syndicated loans from foreign banks and bonds issued. This is mainly foreign currency resources the price of which is lower than the price of bank deposits.
The terms of customer accounts became longer over the past year. At the end of 1996 demand deposits accounted for a quarter of all deposits and their share in the total increased by 6 percentage points (see Table 3). At the same time the share of long-term loans increased from 67% to 75%. The remaining term of 70% of the funds received from foreign banks is over one year. The volume of bonds issued by banks, which also constitute a long-term resource, increased by 281.5 million kroons last year.
The share of private customers increased in the structure of both deposits and loans in 1996 (see Table 4). Besides the demand deposits linked with salary accounts, the biggest increase was recorded in time deposits with the term of three to 12 months, a development that indicates that the savings of the population are increasing.
In the assets of banks the main tendency over the past year was the increase in the share of more profitable assets; the share of funds deposited in other banks decreased and thus the loan portfolio and financial investments increased more rapidly.
The share of loans in the balance sheet increased from 45% to 53% over the past year. By the end of the year the total amount of loans reached 11.5 billion kroons, which means an annual increase of 71%. The increase in the lending activity has become possible thanks to the influx of relatively cheap and long-term resources from international capital markets, mediation of special-purpose resources and an increase in the number of customers who qualify for loans. The share of foreign currency loans increased in 1996, the terms of the loans became longer and a number of new loan products were introduced to the market. The volume of housing loans to private individuals increased rapidly. Such new loans as the young teacher loan (from the government's special-purpose funds) and the young family loan were launched, as well a loans to cover travel or medical expenses, and the consumer loans, consumer factoring, etc. There is now competition among banks to finance good projects.
The year 1996 is characterised by a considerable increase in foreign currency loans, the share of which increased from 12% to 32% in the banks' loan portfolios over the past year. The reason for this was the increase in the share of foreign currency resources. By giving loans in the same currency they received the resources, banks can avoid the exchange rate risks. Since the terms of foreign currency resources are usually longer than the terms of the kroon resources, the bulk of the foreign currency loans increase occurred in the category of loans given for more than one year (see Table 3).
From the point of the customer, the foreign currency loan is preferred because of the lower interest rate, particularly in case of a long-term loan. The increase in the foreign currency loans and their low interest rate is also expected to bring down the interest rates of the kroon loans.
Despite the danger that the rapid increase in loans could have a negative effect on the quality of the loan portfolio, the quality of loans has actually improved over the year, as can be seen from the reports provided by the commercial banks (see Table 5).
The banks' financial investments more than doubled in 1996. In the securities portfolio, the share of stocks has increased. The volume of stocks increased 3.6 times which makes 836 million kroons. The increase in the price of shares that accompanied the launch of the stock exchange created much more important possibilities for earning financial income than from dividends, using the difference between the purchasing and selling prices of the shares. Although the volume of fixed interest rate securities has increased, their share in the securities portfolios of banks decreased from 78% to 64% in favour of equity participations. In the category of investments into the securities of non-residents more money was invested in 1996 into the government bonds of the B-zone countries.
The influx of cheap resources and tightening competition also had an impact on interest rates. The interest rates of time deposits in kroons decreased by 1.91 percentage points over the past year, reaching 5.30% at the end of the year (see Figure 1). The weighted average annual interest rate of kroon loans decreased by 2.16 percentage points last year and stood at 13.76% on 31 December (see Figure 2). If we calculate the interest marginal for short-term loans and time deposits (presuming that the usual term of time deposits is up to one year), we can see an annual average decline of nearly 2 percentage points in 1996. Commercial banks have began to use a floating interest rate both for attracting resources and lending so that to secure themselves a fixed interest marginal.
PROFIT AND PROFITABILITY
The total pre-tax profit of Estonian commercial banks in 1996 was 567.5 million kroons, indicating an annual growth of 72.2% (see Table 6).
The yield of equity capital did not change in 1996 since the annual average increase in equity capital was proportional to the increase in profit (see Table 7). However, as the proportion of share capital to equity capital decreased from 80% to 70%, the yield of share capital increased. Last year, in the conditions of decreasing inflation and lowering interest rates on both local and foreign money markets, the banks managed to increase the yield of assets.
The bulk of the banks' earnings was in the form of interests which by the end of 1996 accounted for 60.7% of total earnings. The share of income from interests earned from the loan portfolio has been decreasing every year. The diversification of banking activities, on the other hand, has boosted the share of interests earned from transactions with securities and futures.
The diversification of activities is also responsible for the increase in the share of non-interest rate income which amounted to 39.3% at the end of 1996, having increased by 2 percentage points over the past year. The non-interest rate income from financial transactions and securities has increased considerably.
The interest expenses have increased at a more rapid rate than income from interests, particularly expenses on time deposits (due to the increased share of time deposits), futures as well as interest expenses on resources received from other credit institutions. Therefore, the interest marginal has been slowly decreasing.
Administration costs have recently become the banks' most important category of expenses. While in 1995 the operating costs of banks accounted for 42.2% of their income, then in 1996 the increase in administrative costs was considerably slower than the increase in income and the administration costs accounted for 36.3% of the income. Thanks to this favourable development, the banks' profit marginal increased by 2 percentage points. The share of administrative costs is smaller in larger banks.
Proceeding from the Law on Credit Institutions and the development of the banking system in Estonia, Eesti Pank introduced new rules for calculating the prudential rations as of 1 January 1996.
The liquidity rate is meant to guarantee that the credit institution is able to meet its current liabilities on time. In the framework of the new prudential ratios distinction is made between three liquidity ratios. Thus, Liquidity 1 shows the ratio of the most liquid assets (which can be cashed within two banking days) and the most short-term liabilities (up to two banking days). Liquidity 2 shows the ratio of assets that can be cashed within one month and short-term liabilities, and Liquidity 3 characterizes the relationship between the bank's liquid assets and all balance sheet liabilities and certain off-balance sheet items. Since the prudential ratios of each bank depend directly of the specific activity of the bank and finding a suitable indicator that would fit all the banks is extremely complicated, no lower limits for liquidity ratios were introduced at first. From 1 May, the minimum rate for Liquidity 2 is 35%. Indeed, Liquidity 2 is the closest to the liquidity ratio used earlier but is not quite the same (see Figure 3).
In addition to observing the volume of liquid assets, Eesti Pank also demands that the credit institutions follow their liquidity on the basis of cash flow. Each credit institution must also have a strategy of liquidity management adopted by a written decision of the credit institution's management.
Throughout 1996 the weighted average Liquidity 2 of the Estonian banking system stood between 43% and 48%. At the end of the year the liquid assets increased more rapidly than short-term liabilities. The sums of market-worthy securities and one-month loans increased the most. Thanks to the launch of the stock exchange and the rapid increase in share prices, ownership of shares has become a profitable investment also for the banks.
The capital adequacy characterizes the ratio of the credit institutions' own funds to the sum of the risk-weighted assets and off-balance sheet liabilities and the open net foreign exchange position that exceeds the level of own funds by 2%. The capital adequacy shows the adequacy of the banks' own funds to cover the loan risks. The established minimum capital adequacy is currently 8%. Eesti Pank also requires that every commercial bank have a loan risk management strategy.
For calculating the capital adequacy ratio, the banks' own funds are divided as follows:
1. The primary own funds which include:
paid-in share capital (subscribed share capital plus premiums minus transactions with shareholders);
general banking reserve;
undivided audited profit/loss of previous years;
loss or audited profit of the accounting period;
treasury stock (with the minus sign);
immaterial assets (with the minus sign);
2. additional own funds:
subordinated loans and other similar liabilities;
other capital-like items.
The primary and additional own funds together make up the bank's gross own funds. However, the capital adequacy is calculated on the basis of net own funds or simply own funds derived by subtracting shares and stocks of other credit and financial institutions from the gross own funds. The minimum rates set by the Board of Eesti Bank, concern the net own funds.
From 1996 the capital adequacy ratio also reflects the banks' ability to cover the foreign currency risk. This can be calculated by adding the open net foreign exchange position number to the sum of the risk-weighted assets and certain off-balance sheet liabilities. Due to the specific nature of its activity each bank can have different financial risks in different proportions. Thus, for example a bank specializing in foreign currency transactions has more risks associated with changes in the foreign currency exchange rates than a bank focussing on financing agriculture. Therefore, it is practical to bring different risks under one indicator so that the bank could optimize the risks it has taken.
As a result of the above methodology, from 1996 no limits are set on the open net foreign exchange position by different currencies, with the only exception being the currencies of the B-zone countries. In case of the Latvian lats and the Lithuanian litas the open net foreign exchange position must not exceed 10% and in case of currencies of the other B-zone countries 5% of the credit institution's own funds. The open position of the German mark is not included in the calculations of the capital adequacy rate.
In 1996 the weighted average capital adequacy was 11-14%, showing a tendency to decline over the year (see Figure 4). This tendency was mainly caused by the extremely rapid growth of the banks' loan portfolios while the increase in own funds remained much more modest. The weighted average capital adequacy began to increase in November. By the end of the year capital adequacy rate reached 12.1% (see Table 8). The increase can be attributed to the share issues by a number of banks, part of which were apparently arranged because of the need to increase the minimum level of own funds to 60 million kroons from 1 January 1997. This new requirement was met by all commercial banks by the end of 1996. The increase in own funds was further facilitated by the considerable increase in profit because the bulk of annual profits was earned in the last quarter of the year. The majority of banks carried out a ten-month interim audit and were thus able to include the audited part of the profit into their own funds.
Risk Concentration of Credit Institutions
The aim of following the risk concentration of the credit institutions is to reduce the possibility of one customer's financial difficulties causing problems for the bank. If the value of loans given to one customer or inter-connected customers exceeds 10% of the bank's own funds, the risk concentration of such a loan is qualified as high. The total sum of loans of high risk concentration must not exceed 800% of the bank's own funds. In 1996, Estonian banks had no problems in observing this requirement.
Investments of Credit Institutions
Under the Law on Credit Institutions the bank's significant stake in any other company must not exceed 15% of its own funds. The total of the bank's qualifying holding in other companies must not exceed 60% of its own funds. The aim of this clause of the law is to restrict the banks' economic interests outside the banking sector.
Every credit institution must have a strategy for the management of their investments approved by the credit institution's management. Investments denote the acquisition of material wealth and financial fixed assets. Financial fixed assets are interests in other companies in the form of shares or stocks and bonds that are meant for long-term possession. Investments into credit or financing institutions or auxiliaries of credit institutions are not limited in any way. The banks have to report on their investments twice a year.
Banking Statistics and Analysis Department
 The majority of them are members of the Estonian Banking Association which has set its aim at solving common problems.
 Data on the structure of the share capital is collected twice a year. (Editor's note).
 It is important to note that net own funds cannot be directly found from the bank's balance sheet.
 The difference of the assets and liabilities of the respective currency, to which are added the balances of the off-balance sheet transactions. (The author's note).