The outlook for the Estonian banking system is negative, reflecting the growing risk of a decline in the asset quality and/or liquidity in light of the rapid growth in loans in recent years, Moody’s Investors Service said in its new Banking System Outlook for
the Baltic nation.
It also reflects Moody’s latest outlook change for Hansapank, the largest bank in Estonia. However the outlook for Sampo Pank and Balti Investeeringute Grupi Pank remain stable. Nonetheless, the overall quality of the banking system has continued to improve.
“Estonia’s banking system remains highly integrated and characterised by considerable concentration. Nordic banks dominate the market, even more so than in other Baltic countries — the four largest banks are owned by Nordic financial groups and have an aggregate market share of 95% measured by total amount of loans and leases. Foreign banks’ branches or subsidiaries control close to 100% of total assets in the banking system,” said Virginie Merlin, a Moody’s Vice President-Senior Analyst and author of the report.
Nordic ownership has played a major role in the evolution of the Estonian banking system towards international standards, in terms of risk and liquidity management practices in particular, whilst capital injections have aided subsidiaries in strengthening their franchises. In addition, easier access to funding, combined with advanced marketing and distribution methods provided by Nordic banks, has contributed to rapid loan growth in recent years. The few small standalone players are thus at a structural disadvantage, with potentially negative repercussions in terms of operating efficiencies.
Moody’s primary concern is that the rapid loan growth has led to unseasoned portfolios with high concentration on the mortgage and real estate sectors.
“We therefore see a growing risk of a deterioration in the banks’ asset quality if the economic outlook continues to soften. The loan growth has also been exerting pressure on the banks’ liquidity given that it has outstripped the growth in deposits. The banks have therefore become increasingly dependent on access to wholesale funding (often from foreign parents), which is expected to be more difficult as well as more expensive — taking into consideration the current global deterioration in funding conditions and repricing of risks,” Merlin cautioned.
However, there are signs that the pace of lending growth is now slowing, with the larger banks having started to introduce stricter lending measures. In Moody’s view, this can contribute to the stabilisation of the banking system but also brings a potential risk should lending be restricted by too much and too rapidly, resulting in a sharper slowdown.
The Estonian economy remains constrained by its small size, a significant current account deficit and elevated inflation, albeit somewhat mitigated by the negligible level of government debt. However, following the recent transformation to a market economy, the quality of the Estonian banking system has significantly improved following the introduction of new regulations with the entry of Estonia into the European Union in 2004, and further strengthened by the Estonian regulator and through close cooperation with the Nordic banks.
