BACKGROUND INFORMATION

EESTI MAAPANK (LAND BANK OF ESTONIA)

On 28 June 1998, Eesti Pank decided to revoke the license of Eesti Maapank, the 6th largest bank by total assets, having a 3% market share. On 1 July, the City Court of Tallinn launched bankruptcy proceeding against the bank. Maapank's bankruptcy was caused by its business profile and general developments on the Estonian financial markets.

Supported by positive future prospects that prevailed in Estonia in 1996-1997, and expansive development strategy of the financial sector in the environment of deepening competition, Maapank expanded aggressively both in conventional banking activities and in the market segments new to the bank, primarily the securities market. As share prices continued to rise, trading became one of the important income sources for the bank, contributing to the expansion of positions and institutional enlargement. At the same time, the bank's management structure, internal risk management and control mechanisms failed to keep up with the developments. Moreover, Maapank was also technically unable to compete with successful universal banks. The harsh business environment in end-1997 brought out Maapank's unfoundedly extensive positions on the stock market and its managers' unrealistic enlargement strategy. Due to losses in the securities portfolio, deteriorating quality of the loan portfolio and in-house irregularities, the bank's equity became negative. Attempts to attract additional investors and involve other banks in the restructuring failed and this resulted in the revocation of the bank's license.

Maapank's bankruptcy coincided with the period of adaption to the new business environment that had evolved after the expansive development phase in 1997 and the decline in credibility of the banking sector. This was reflected in the banks' profit statements and performance indicators in disclosure of Hoiupank's Daiwa affair. The latter alerted depositors, who became more sensitive to negative signals. Although, one of the main elements of the financial system's safety net - deposit insurance - had by that time been created de jure, but became effective de facto only from 1 October 1998. Therefore, it was, on one hand, important to prevent potential financial panic, triggered by Maapank's bankruptcy, and, on the other hand, to minimize moral hazard concurrent with the compensation of deposits by preserving discipline on the market as well as owners' and creditors' responsibility that had served as one of the fundamental principles to the current economic policy.

Therefore, the Government decided to apply general principles of the Deposit Insurance Fund Act and fully compensate to private persons and companies up to EEK 20,000 deposits, the part exceeding EEK 20,000 to the extent of 80%, but not more than EEK 100,000, and deposits of local governments to the extent of 80%, but not more than EEK 350,000. To ensure full responsibility of Maapank's owners and executive management, deposits of bank's managers, financial sector and parties associated with the bank were not compensated.

In order to enhance transparency of decision-making process in public institutions and to improve the regulatory environment, the Government and Eesti Pank decided to conduct an independent inquiry of all issues related to Maapank's bankruptcy. The aim of the inquiry is to determine the reasons of Maapank's bankruptcy, to evaluate the appropriateness of the existing regulatory and legal framework with the current activities of the financial sector, as well as functioning of national supervisory institutions and investment policies of the banks and government offices and to present recommendations for the improvement of the regulatory framework, supervision and investment policy of government agencies. The inquiry will be conducted by an independent foreign expert who will present the report to Government and Eesti Pank by the end of 1998. Then the report will be made public.