The stable outlook and ratings for Latvian banks reflect their improving credit quality, their efforts to grow market share and their good profitability, Moody’s Investors Service says in its new Banking System Outlook report for
However, they also incorporate a number of challenges facing the banks, such as maintaining a good asset quality in their fast-growing and unseasoned loan portfolios and controlling costs in a context of wage pressures and the need for further franchise investments. The foreign ownership of many participants of the banking system is also reflected in the ratings, with generally positive implications.
A large number of Latvian banks are under the control of foreign banking groups, which are gaining considerable control over the banking sector.
In Moody’s opinion, foreign strategic involvement has proved beneficial, particularly in terms of the improvement in Latvian banks’ commercial, liquidity and risk management capabilities, as well as organisational structure and efficiency.
“Although the Latvian banks demonstrate relative good credit quality and have implemented more stringent credit underwriting and supervisory practices, one of Moody’s primary concerns is the very rapid growth in loans in recent years — largely driven by commercial and residential real estate lending — which has led to less seasoned portfolios. As such, Moody’s will continue to monitor closely for a potential negative impact on the banks’ quality of assets, especially if the Latvian economy and real estate prices continue to deteriorate,” said Virginie Merlin, a Moody’s Vice-President/Senior Analyst and author of the report.
The Latvian banking system is somewhat concentrated as the four largest institutions together control more than 60% of the assets, although some further sector consolidation is expected in the future as the number of financial institutions is still high compared to the country’s population and GDP and in comparison with the neighbouring Estonian and Lithuanian banking systems.
Currently, competition remains intense against the background of rapidly expanding loan volumes. Efficiency indicators for the overall banking sector have been improving but will continue to be constrained somewhat by banks’ medium-term investments related notably to business development, wage pressures and infrastructural improvements.
Going forward, Moody’s believes that cost control will be a major challenge for Latvian banks and their ability to reduce costs will be a key driver in their ability to achieve increased competitive advantages.
Furthermore, the credit standing of financial institutions remains constrained by the less mature operating environment. This is particularly the case given Latvia’s susceptibility to external shocks, reflected by the widening current account deficit in recent years, which has been met by foreign borrowing, much of it short-term in nature.
“However, this vulnerability is mitigated by the fact that the largely foreign-owned Latvian banks borrow heavily from their respective parents and the country’s successful transition over the past decade, its low level of government debt and its strengthened financial system, although the level of the current account deficit and high inflation are sources of concern,” Merlin explained.
