The volume of loans and leases increased by 2.8 pct year-on-year

The volume of loans and leases granted to companies and households continued to grow at a subdued pace in June, similarly to previous months. Compared to June 2013, the portfolio increased by 2.8%; its value was 15.1 billion euros.

The annual growth of the portfolio of loans and leases granted to companies was positive in almost all sectors, reaching 4.3% in June. The volume of short-term corporate loans and leases remained at a level similar to previous months, but the volume of loans and leases related to long-term loans (mainly for fixed asset investments) decreased to 170 million euros in June, while in May, the figure had been more than 230 million euros. Companies in the agricultural and industrial sector took out fewer long-term loans than in previous months.

In June, the volume of new loans issued to households remained at the level of earlier months. New housing loans totalled to 66 million euros, which is approximately the same as in the previous three months. The housing loan portfolio continued to increase slowly, with its annual growth reaching 1.7% in June.

Loan interest rates did not change considerably in June. The average interest rate on long-term corporate loans issued in June was 3.2%, while the interest rate on housing loans was 2.5%.

The loan quality of the banks continues to improve. The percentage of loans overdue by more than 60 days fell from 1.8% in May to 1.7% in June.

The total deposits of companies and households at the end of June stood at 9.3 billion euros. Compared to last month, in June the stock of non-financial corporate deposits decreased by 33 million euros and the annual growth of deposits fell to 6.8%. The volume of deposits contracted due to a decrease in corporate deposits – the volume of corporate deposits was almost 100 million euros smaller in June than in the previous month.

Banks earned 113 million euros in net profit in the second quarter. Nearly a third of it came from dividends paid out by subsidiaries. Without it, the amount of profit was similar to that earned in earlier quarters. The profitability of banks has been supported by a decrease in administrative expenses and a reduction of previously made write-downs for loan losses, but on the other hand, the net interest income of banks declined in the second quarter.

Source: Bank of Estonia

Author: Jaak Tõrs, Head of the Financial Stability Department of Eesti Pank

Companies’ increased foreign borrowing led to greater indebtedness in 1Q

The debt liabilities of Estonian companies (loans and issued debt securities) grew by 1.4% in the first quarter compared to last year. Over the quarter, total corporate debt increased by 444 million euros, which is one of the largest quarterly growths of the past years. The majority of the growth was caused by an increase in foreign borrowing; a significant part of the latter was made up of the issue of new bonds in the infrastructure sector. The share of foreign debt liabilities in total corporate debt increased somewhat and reached 37% by the end of the quarter.

Corporate leverage remained unchanged in the first quarter, as both equity and debt continued to grow. The debt-to-GDP ratio, which had been decreasing for a year, went up slightly over the quarter – from 85% to 87%.

The financial assets of households are still increasing at a faster pace than debt liabilities. Compared to last year, households’ financial assets increased almost 10% in the first quarter, while the growth of debt liabilities picked up speed and reached 1.2%. The indebtedness of households as a ratio to GDP remained at 41%.

The Estonian economy as a whole was a net borrower in the first quarter. This means that more funds were taken in from abroad than invested there. A negative balance is quite typical of the first quarter, but larger than usual corporate foreign borrowing also had a considerable impact.

Source: Bank of Estonia

Author:  Jana Kask, Deputy Head of the Financial Stability Department of Eesti Pank

Interview with governor of central bank of Estonia

Interview with Ardo Hansson, Governor of Eesti Pank and Member of the Governing Council of the ECB, conducted by Stefan Riecher and Jeff Black on 16 July 2014 in Frankfurt

On latest ECB stimulus package:

“One of the features of this set of instruments is that they are planned in a sequenced fashion. Some of the elements kicked in immediately. Others, for example, the targeted long-term loans are announced but to be implemented over two years. The first implementation will be in September, that’s when you have more detailed information about the initial take-up and it will take some time to feed in into the indicators. So I think unless something really unexpected happens that puts us on a different inflation projectory than the idea of doing something more at this stage shouldn’t be part of our baseline assumption. You need to think about contingencies and be prepared. But there’s really enough to deal with the long-term loans now and get them running and I don’t think we should, after having just announced such a substantial package, already be thinking about any next steps. Let’s take the time to get this up and running first.”

“Those measures should be enough related to our baseline scenario but, of course, there’s always possibilities to evolve a little bit more in one direction or another. So in the end you can’t rule out that things will evolve a little bit different than the baseline. But in our baseline assumptions, considering our forecasts, we think the package is pretty substantial and it is appropriate.”

On targeted longer-term refinancing operations:

“The final aim is to have an impact on prices but one of the transmission channels is the credit channel. I’m reasonably optimistic it is going to work but it hasn’t been tried so there’s maybe a bit more uncertainty than with other things that have been tried before. We don’t know much about the detailed impact as we might have known with some other instruments.”

“Had nothing else changed in the recent period, with only this instrument implemented, the effectiveness could be quite limited. But if you think about other factors, the global recovery, that might create some underlying support for investment demand. Maybe we do see a level of capacity utilization in certain sectors a little bit higher now and there’s more fundamental support for greater investment.”

“Some of my concerns were that the targeted long-term loans are operationally somewhat complex. That’s one of the reasons why you have this window of several months between the announcement and the implementation. A bunch of details have to be sorted out. There are legal acts that have to be adopted to apply this instrument. The preparations are underway and we’ll manage but it requires very detailed definitions of certain variables, of monitoring, of performances. It is operationally complex but it is doable.”

“One worry was about how you shouldn’t discourage banks from writing off bad loans if necessary. You don’t want to have a measure that looks like credit provision is declining if a bank is writing off a bad loan. Then you are penalizing them for actually doing the right thing. You want them to report accurately but you don’t want this scheme to be inducing to defer necessary write-offs to show higher lending. All these things are now being taken care off.”

“We don’t want these loans to be used for mortgages, for government bonds, for financial-sector lending. We can’t really prevent carry trades over the first two-year period but banks have to pay back the money if they don’t use it in a way intended. There’s an upfront measure related to your balance sheet and then there’s the targeted component. Without that initial part, take-up would take an awful long time, if it was all based on net increase in lending, then the volumes involved initially would rather be small.”

“You’re getting long-term money and lock it in. For somebody looking for term financing, comparing this to an option with a variable it’s obviously a bit more attractive. It’s about what kind of trend a specific bank expects.”

On further interest-rate cuts:

“You can’t rule out that there’s a little more you can do. So is it really true that you’re at the floor? Not technically. But for all practical purposes you’re very close. So at that point, it’s almost semantic how you characterize that. When you’re used to 25 basis point changes, 10 basis point changes, going forward you’re not talking about big additional things. We’re in the margin of error.”

On the timing of interest-rate increases:

“That’s not an immediate risk, we’ll have to deal with that when it arises. Every policy creates an exit issue at some point in time, but I don’t think we’re there yet.”

“There’s no single trigger. It’s a lot of factors you run through, trying to come up with a medium-term assessment. The baseline scenario foresees that inflation will remain relatively subdued for some time. If you’re to be surprised on the upside, if suddenly that were to change, it’s a contingency and you reassess the situation. But right now we don’t see that as likely for some time.”

On asset purchases:

“Technical work on asset purchases is advancing but there has been no decision. There is readiness if inflation stays too long for too long to use unconventional means but the idea now is to explore if and how you develop new tools, expand the toolbox. The tools are not sitting there already but it’s worth developing them. Then there’s the other question on if and when to implement them.”

“We haven’t set a firm deadline on an ABS program to say by date X it all has to be done and ready. I suppose if the contingency materializes over the space of a certain period of time, then maybe. But this is nothing that develops overnight.”

“Certainly, for example in the U.S., this market is more developed because there is this element of government behind it. You don’t want such purchases when you’re the only player in the market. There has to be a sharing arrangement but I think to the extent that you can develop new sources of non-bank financing it could be useful. It’s is a longer-term program but if you can get such an ABS plan going through regulatory reform, legal reform, and so on, and it has a more diversified non-bank focus, then it’s probably good for a lot of reasons. But that element alone takes time and it’s not going to help with immediate issues. It’s more of a medium-term plan somewhere down the road.”

“Of course, if you start somewhere, the trade-off is that an ABS program is going to be rather small. You may have some kind of an impact on credit allocation to certain types of firms versus others but the quantitative impact on demand is probably not going to be that large. It may be good in a very long term because you can get a market going and people gain confidence, they start issuing these securities. But that’s a very gradual process. To build up the volumes to reasonable levels, that takes some time. It’s probably not going to have much of a quantitative impact but it might help you in the more distant future.”

“If you want to have more of an impact you’ve got to be thinking about a broader set of asset classes, broader-based asset purchases. There’s work on the way on that as well but in a European context it’s very tricky to design these rules, what types of things to buy, and how much. Some of these markets are not so liquid as others. There are a lot of little issues. Some governments have issued many bonds but they are not highly traded. There’s a lot of these operational details that have to be worked through. You have to think about the effectiveness and the impact and all of that takes a lot of preparation. It’s worth preparing, it’s worth having more tools, but I don’t think Quantitative Easing is a tool that’s needed right now.”

“It would have to be a serious contingency that you see a scenario that has materially changed. If you were to see that then I think you consider it but I would say let’s focus on getting these existing, newly announced measures going. The other possible options are out there as contingencies. You certainly would want to see some real kind of sluggishness in demand, something like we saw in 2008. You’d wanna see really a much more material risk of scenarios which take you away from your target.”

On the risk of bubbles:

“I think it’s helpful when we’re reminded of those risks. Probably in other jurisdictions you see a little bit more of that because they just happen to be a bit more advanced, we are at a different point in the cycle. There the risks may be much more immediate. In Europe, there are certain jurisdictions where those risks might be real.”

“We have to think about those risks, and it’s helpful to think that when we implement certain policies there is no free lunch, and we have to be much more forceful and take this issue of macroprudential policies much more seriously. Probably a year ago I would have thought it was going to be an awful long time before we even get to the point where that even becomes an issue. But now, some asset prices are certainly high. You don’t see a euro-area wide impact on the typical financial-stability risk, property prices. But there’s a trade off: the longer you are in a low-interest-rate environment, you start getting financial stability risk. But whether at a European level or a local level, someone has to actually go beyond the rhetoric of just mentioning this, and actually combine these issues of relatively accommodative monetary policy and maybe some countermeasures to deal with financial stability risks. In other jurisdictions maybe this debate is more advanced because objective reality is already making it an issue.”

On macroprudential tools:

“Macroprudential tools are work in progress. Part of it is happening at the ESRB. Countries are already notifying the ECB of certain macroprudential measures at a local level. In Estonia, we set the systemic risk buffer at 2 percent. Given that these risks are probably growing, it’s maybe more important to develop the capacity, these instruments. It’s good to have this double system where the country or the ECB can initiate action or overrule. As a central bank, we’d like to think we have less inaction bias. But in most countries, as the government has quite a bit of a role, and for example in an election period you can have quite a bit of inaction bias. So to have an institution that can say, you’re being too slow, and you should be more front loaded with you adjustment, that’s a very good thing. Maybe that also shows how hard it is to forecast these turnarounds. A year ago I would said it would be quite a long time before it ever becomes an issue, because everything is so subdued, and now we find it is at least being raised as an issue. But a central bank has to start from its mandate, and we have to pursue the policies that we are pursuing, but then the macroprudential authorities have to be more vigilant.”

On sanctions against Russia and their impact:

“It’s a very fluid situation, obviously we’ve run scenarios on different possibilities but since the range of possible outcomes is so broad, if something where to happen it would all depend very much on specifics. Maybe the prime impact is on confidence in general. If there’s an enterprise thinking of investing in Estonia, people might have a bit more of a wait and see attitude. But in terms of trade flows we haven’t seen anything substantial yet. Obviously that situation can change. In our own economy, Russia is ten percent of our exports, but a lot of it is not high value.”

On Estonia:

“As for the latest GDP contraction, the baseline we see is that there are quite a lot of one-off factors at play. We used to have the highest inflation rate in the euro area, now we basically have negative domestic inflation. There are a lot of specific factors. We had a liberalization of power prices last year, power prices increased by almost 30 percent in 2013, now they are declining by about 13 percent. We built a power cable to Finland, and it’s cheaper to buy electricity from there. A positive supply shock. This is temporary, though, and once these one-off factors work out, we’re probably going to have inflation that is somewhat higher than the average in the euro area.”

“On the GDP side there were one-off factors that are beginning to wash out. The whole economy is a bit less balanced than it used to be. A year ago we were sitting with budget deficit of 0.2, we had a current account deficit of about 1 percent of GDP, the loan deposit ratio was about 100, everything was extremely balanced. Now we are starting to see that balance fraying a bit. Wages are growing faster than productivity, and a robust increase in property prices and a little bit of widening of the current account deficit. There’s a bit of an incipient imbalance building up, which could be a problem if it continues. However, we have lately seen a bit of a correction in the property sector and wage growth has started to come down. There’s chances of a smooth correction but it’s not guaranteed. We have this legacy of having a boom and we’re trying to work out of it, so we’d like credit growth to pick up very very gradually and not get back into a boom situation.”

“We draw some consolation from the fact that the property price increases aren’t being driven by bank credit. We’re at a very different point in the cycle from many of the euro-area countries. We are trying to use the macroprudential instruments when required, we’re trying to develop the loan-to-value ratios to have them as an option to consider. We could always be a bit of a pilot for these instruments.”

Published in: Bloomberg News
Reproduction is permitted provided that the source is acknowledged.

Published date:
17.07.2014
Published in:
Bloomberg News
Source: Bank of Estonia

Estonia joins the EU-wide insolvency registry

The European Commission launched a EU-wide interconnection of national insolvency registers, linking databases from Estonia, the Czech Republic, Germany, Netherlands, Austria, Romania and Slovenia, with others set to join at a later stage.

The database will be serve businesses, creditors and investors, who want to make checks before deciding to invest.

Alar Jäger, the deputy head of Krediidiinfo, an Estonian financial information company, said the definition of insolvency varies across the union, and the register could be a step towards aligning rules practices and definitions.

He said Estonian companies giving out credit to EU partners, such as asking for payment of goods and services after delivery, will benefit. Those type of companies make up 91 percent of businesses in Estonia.

Source: ERR News

Annual growth in housing loans remained at 1.6 pct in May

The total volume of loans and leases to Estonian companies and households was 2.4% larger in May than a year earlier.The loan and lease portfolio of the banks increased by 75 million euros over the month and stood at 15 billion euros at the end of the month.

The annual growth in the corporate loan and leasing portfolio rose to 3.6% in May. As in April, loan growth was fastest in agriculture and manufacturing. Although lending to real estate companies increased in May, repayments meant that their total loan and lease stock remained at its average of the past six months.

Annual growth in the housing loan portfolio remained at 1.6% last month. Growth in new loans slowed in May and 3% less was taken in new housing loans than in May last year. The stabilisation of the new lending volume indicates that the rapid growth seen in the real estate market in recent months has slowed to some extent.

Loan interest rates remained low in May. The average interest rate on long-term corporate loans was 2.8% in May, and that on housing loans was 2.6%. Low base interest rates mean that the rates on loans have been favourable for borrowers for some two years now. The interest margins of the banks have not changed by much during this year either.

The value of loans overdue by more than 60 days fell slightly in May. Such long-term overdue loans made up 1.8% of the loan portfolio at the end of the month. The stock of overdue loans may continue to shrink in the coming months as economic growth picks up, although the improvement in the loan portfolio has already happened to a large extent.

Annual growth in household deposits picked up to 8%. Deposits by households and companies increased during the month by 80 million euros to 9.4 billion euros. Two thirds of the increase came from corporate deposits.

Source: Bank of Estonia

Author: Jana Kask, Deputy Head of the Financial Stability Department of Eesti Pank

Men imprisoned for misleading investors

Harju County Court on May 30, 2014 sentenced four men to prison for misleading investors in a 12-million-euro investment project in Baku, the capital of Azerbaijan.

Erik Piirsalu and Tõnis Haavel, both 43 will have to serve six months in prison and accomplices Harles Liiv, 41, and Šarunas Skyrius, 36, both three months. All four men were also handed suspended sentences to take effect after release from prison. The men will also have to pay back 11.8 million euros to 31 investors, ranging from 1,000 to 4 million euros per investor.

Read more from ERR

Interview with governor of central bank

Interview with Ardo Hansson, Governor of Eesti Pank and Member of the Governing Council of the ECB, and news agency MNI, was conducted on 21 May 2014.

European Central Bank Governing Council member Ardo Hansson has signalled a preference for negative interest rates on the Bank’s deposit facility should the Eurotower decide to ease borrowing costs further to address inflation concerns in the currency area.

Speaking exclusively with MNI as the Governing Council gathered for its mid-month meeting in Frankfurt this week, Hansson, however, would not pre-commit to easing measures in June and raised questions over the effectiveness of non-standard measures aimed at kick-starting credit to the real economy.

“Personally, I see a lot of attraction in keeping a certain width of the corridor. Certainly if you do keep that corridor it is a more powerful instrument than if you were to narrow it,” Hansson, who heads the Estonian central bank said while underlining the importance of nurturing the recent normalization of money markets. “If the corridor becomes too narrow, then you drive banks towards the Eurosystem again.”

“Negative interest rates are not completely uncharted territory as some of the smaller countries have done this. The fact that it has been tried elsewhere makes you a bit more comfortable but for us it is still going into new territory,” Hansson added. “It has been said enough times that there is technical readiness to do this.”

However, Hansson would not pre-commit to any action in June and cautioned against taking a one-sided view of the euro’s strength on the inflation profile.

“You cannot look at one side of the equation alone and say the euro is strengthening therefore it is uniformly negative for our medium-term price stability. It is an exogenous shock with money flowing in from abroad which is at the same time easing monetary conditions by lowering the market interest rates,” Hansson said. “The combined effect is important to keep in mind.”

While ECB staff forecasts in June are “a very important input” Hansson also said that there would not be a “mechanical” reaction to potential downward revisions of the inflation outlook. “Everyone can have a view to whether their own assumptions are more or less optimistic than what the staff has.”

ECB President Mario Draghi during his regular May press conference said that the “Governing Council is comfortable with acting next time but before, we want to see the staff projections that we come out with in early June.”

Bundesbank President Jens Weidmann in an interview with German press earlier this week underlined that “it is not yet clear that we will have to act all.”

“If it looks like this period of low inflation kind of becomes more protracted then obviously the level of concern becomes higher,” Hansson said. “Certainly, to the extent that it is weaker towards the medium term it strengthens the case for doing something.”

Hansson also took a sceptical view on central bank measures to kick-start lending to the real economy via targeted liquidity operations

“It is not that there is necessarily this huge latent demand out there that somehow needs to be unlocked. If we talk about an output gap – a persistent one that will last for several years – the corollary has to be that there is spare capacity which then means that many companies would say that there is no need to invest if I have spare capacity. This is totally understandable,” he said.

“In some sense this sluggish growth of credit or the slight decline in credit to the extent that it is a rational response of either banks or enterprises to their current situation both balance sheet and level of demand then any attempted measures would be more like pushing water uphill. In this setting, you have to at least ask how effective it is going to be,” he added.

Designing such an operation that would ensure banks do pass on funds to the real economy would be a big challenge as well, Hansson said: “You want to make sure that you can somehow define a measure that cannot be gamed or evaded so much.”

At the same time, it must not encourage banks to delay the writing off or provisioning of bad loans, he argued.

“You could imagine if somebody said the price you get is somehow dependent on your net expansion of credit and then every time you write off your net credit provision becomes smaller then banks might say I would love to write it off but it is a financial penalty for me.”

“I think the challenge of getting this credit channel more active is actually rather high. So I think here there are real questions of possible effectiveness and operational design issues,” Hansson stressed.

At the current juncture, Hansson sees no need for unconditional liquidity operations but said that the ECB continues to monitor developments on money markets and is ready to inject additional liquidity if needed.

Hansson cautioned that the recent market developments may have further complicated possible asset purchases by the Eurotower. “I think in several jurisdictions you have these tensions between still sluggish recovery and very booming asset markets. I think this concern is something that you have to factor in,” he said. In particular, Hansson said that the “this turnaround in the bond markets in stressed countries has been rather high.”

“The more you see this bullishness in asset markets, the bigger the risks that this would lead to misallocation of credit so that the quality of credit starts declining.” While macro-prudential tools “in principle” may be a way to address such risks, Hansson cautioned that these “are rather new and untested.”

Nevertheless, Hansson said that technical work on possible asset purchases – both of private and public sector assets – is ongoing. Questioned about recent suggestions by the Bruegel institute that the ECB should consider buying up bonds from the European Financial Stability Facility and European Stability Mechanism bailout funds as well as from the European Investment Bank, Hansson said he thinks “this is narrowing in on specifics somewhat quickly.”

“The staff could first look at mapping out the entire universe of tradable securities and having a view of what is out there and then honing in on what might qualify or not. In terms of narrowing in, I would look more at the broader split between public and private,” Hansson said.

Hansson also expressed support for Draghi’s considerations to reduce the frequency of ECB monetary policy meetings. “We do not usually change things month-by-month. I do not see a lot of disadvantages in having fewer meetings. Also in terms of possible publications of the summaries it makes a lot more sense to have a longer cycle. I don’t see how you can produce meaningful high quality summaries in a space of a month that would not somehow interfere with the message,” Hansson said.

In terms of the broader economy, Hansson conceded that first quarter GDP in the Eurozone, which slowed to 0.2% from 0.4% in the final three months of last year, may have come as a disappointment to markets, but argued that it’s not clear to what extent the sluggish pace would impact longer term prospects for growth and price developments.

“We always said that the recovery is there but that it is going to be slow it is going to be fragile so you expect that quarter on quarter, some quarters may be a bit better and some may be a bit worse. In this sense, it confirms the view of a slow and fragile recovery,” he said. “All the soft data that we have had for this quarter too is more on the encouraging side so that probably we will have a fifth quarter of positive growth as well.”

Source: Bank of Estonia

Estonian banking sector in April 2014

Annual growth in the total volume of loans and leases to Estonian companies and households accelerated to 1.7% in April. The loan and lease portfolio mainly grew as corporate loans increased in volume by 76 million euros to 14.9 billion euros.

The annual growth in the corporate loan and leasing portfolio rose to 2.1% in April. Growth mainly accelerated due to increased borrowing by agricultural and manufacturing companies as the loan stock was 17% up on last year in agriculture and 9% up in manufacturing. Although real estate companies took almost a fifth more in loans from banks and leasing companies than they did a year ago, the loan stock of the sector was slightly smaller than a year ago due to repayments. Even so, loans to real estate and construction companies still make up around one third of the total volume of all corporate loans and leases.

Annual growth in new housing loans was slower in April at 26% than in the first quarter, when it was 35%. As only 2% more housing loan contracts were signed in April than a year ago, the increase in the value of the loans is explained by a rise in the average price of the apartments being purchased. The housing loan portfolio grew by 12 million euros during the month to 5.9 billion euros and its annual growth rate stood at 1.6%.

Interest rates for loans did not change much in April. The average interest rate for housing loans granted in April was 2.6%, and that for long-term corporate loans was 3.3%.

The share of loans overdue for more than 60 days accounted for 1.9 per cent of the loan portfolio. Overdue loans have remained at the same level throughout the past half year. Loans overdue by more than 60 days in the housing loan portfolio totalled 79 million euros in value, accounting for 1.3% of the portfolio.

Household deposits continued to grow rapidly in April. The annual growth in household deposits remained at the high 7.8% of the previous month, reflecting the continuation of relatively fast growth in incomes. Corporate deposits increased by somewhat less than household deposits in April, and the total value of household and corporate deposits was 9.3 billion euros at the end of the month.

Source: Bank of Estonia

Author: Jana Kask, Deputy Head of the Financial Stability Department of Eesti Pank

Central bank to toughen capital requirements for banks

Eesti Pank is to set a systemic risk buffer requirement of 2% for commercial banks from 1 August, which will raise the overall capital requirement for Estonian banks to 12.5%.

Eesti Pank this week started informing European Union institutions and other member states of the rise in capital requirements, in accordance with the Credit Institutions Act.

The central bank considers the systemic risk buffer necessary for managing the banking risks of a small and open economy. The systemic risk buffer will not lead to any major changes for banks in Estonia as their capitalisation is higher than the 12.5% that will be required from August.

“Estonia’s small and open economy means there is a systemic risk for banks because an unexpected downturn in the economy caused by external factors could very quickly lead to loan repayment problems in the private sector, and this could harm the financial position of the banks”, said the Governor of Eesti Pank, Ardo Hansson.

Mr Hansson explained that Estonia needs capital requirements that are higher than the European Union minimum because the above-average level of investments as well as smaller than the European average savings of Estonian households and companies make the Estonian economy more volatile. There is also a risk from the high degree of concentration in banking, as a large number of the banks are exposed to the risks from the same group of countries and economic sectors.

The new single capital adequacy requirement of 8% started to apply for commercial banks in the European Union from the start of 2014, and was lower than the 10% requirement that was in force in Estonia from 1997-2013. Eesti Pank finds that this loosening of the requirement is not justified for the Estonian banking sector as the systemic risk that had been behind the higher capital requirement has not declined.

In addition to the systemic risk buffer which will be required as of 1 August, banks operating in Estonia are also required by the changes to the Credit Institutions Act that came into force on Monday to hold a capital conservation buffer of 2.5%. Unlike the other buffers, if a bank does not meet the capital conservation buffer requirement, there will be restrictions on the dividends it can pay out and on bonuses to management.

The law also allows Eesti Pank to set a countercyclical buffer for local banks if it is necessary to counter risks caused by excessively fast loan growth but the central bank does not consider it necessary to set any countercyclical buffers in the second and third quarters of this year.

Eesti Pank assesses the need for capital buffers for the banking sector at least twice a year as part of the Financial Stability Review, which is published in April and October.

Analysis of the need for a systemic risk buffer and its impact can be found on the Eesti Pank website.

Read more from the Bank of Estonia website

Central bank allocated 25 pct of its profit to the state budget

The Supervisory Board of Eesti Pank decided on Tuesday to transfer one quarter, or 5.9 million, of the 23.5 million euros it made in profit last year to the state budget. The remaining three quarters of last year’s profit will go to strengthen the capital of the bank.

Chairman of the Supervisory Board Mart Laar said that the amount of capital that can be transferred is limited because Eesti Pank has relatively little capital compared to that held by the other central banks of the euro area.

“It is important for the central bank to have sufficient reserves so that if there is any problem we can cope without any help from the state. Central banks normally have problems when economies in general are in difficulties. Building up reserves reduces the risk of us needing to place any additional burden on taxpayers in time of difficulties. It is especially necessary to build up reserves at the moment, as risk factors around Estonia have increased”, said Mr Laar.

The ratio of Eesti Pank’s capital to the risk assets used for monetary policy was one of the three lowest of any of the central banks of the euro area at the end of last year. In 2012 the Supervisory Board set a long-term goal of increasing Eesti Pank’s capital ratio the average level of the central banks of the euro area. This means it is necessary to raise the level of capital by about a billion euros to 1.3 billion.

The Supervisory Board decided that the relative level of the Eesti Pank capital should increase to the average level of the central banks of the euro area, as the balance of risks to the capital of the Eurosystem as a whole is considered when joint monetary policy decisions are made.

Last year, Eesti Pank received 42.2 million euros in income from the joint monetary policy and currency issuance activities of the Eurosystem, the national central banks of the euro area and the European Central Bank. In 2012 income from this source was 51.6 million euros. Earnings from investment activities were 3.7 million euros last year, and 8.1 million in the previous year. Eesti Pank’s operating expenses increased last year to 17.4 million euros from the 16.2 million of the previous year because of the costs of issuing cash.

The net income for 2013 was reduced by general risk provisions of 6.8 million euros to cover risks, following the first such provisions last year of 11.5 million euros. Risk provisions are the first line of defence against losses on top of the reserves already held at the central bank.

Since 1992 Eesti Pank has allocated a total of 129 million euros to the state budget.

Background

Risks to Eesti Pank in monetary policy
The risks to Eesti Pank under the currency board came from the investments of the central bank and from the banking system. When Eesti Pank became a euro area central bank, it also took on the risks of the euro area as a whole, which are mainly related to monetary policy operations.

The Eurosystem is made up of the central banks of the euro area countries and the European Central Bank. The Eurosystem divides the income and costs of the single monetary policy, so that the income earned from monetary policy loans to euro area banks is divided among the central banks to match their participation in the Eurosystem, and the same is done with risks. Eesti Pank’s participation in the Eurosystem at the end of 2013 was 0.26 percent, which is the basis for the distribution of the previous year’s income and expenses. From 2014, Eesti Pank’s participation is 0.28 percent.

The Eurosystem’s monetary policy operations currently fall into two groups, monetary policy loans to commercial banks, which stood at 680 billion euros at the end of April, and the Securities Markets Programme, SMP, which stood at 220 billion euros.

Hedging of monetary policy risks
To hedge against the risks of the monetary policy loans, the central banks of the Eurosystem have the right of claim against banks that have taken loans. The content of the collateral is the equity of the bank that has taken the loan. The euro area central banks only give out loans if collateral is provided, meaning that if the bank cannot pay back its loan to the central banks, then the central banks can instead take the collateral. If even this is not enough, the credit risks for the central banks are reduced by the national authorities and their desire to recapitalise their insolvent banks.

The SMP is backed by the promises of governments to meet all their obligations in full, meaning that if governments fail to meet their obligations fully or partially, including their obligations to the central banks of the euro area, then the euro area central banks suffer the loss.

The capital of central banks and its importance
In this case, the capital of Eesti Pank and the other central banks that is meant is the wider sense of the part of the reserves and capital that the bank can use to cover losses.

The level of capital of the central bank is important because a central bank that has little or negative capital can cause two sorts of public concern. The first is the question of the central bank’s independence, if the bank needs to ask the government for additional capital. The second is the question of how much the central bank really wants to meet its inflation targets, which will then cause increased public expectations of inflation. The result of both these concerns is a loss of trust and of public faith that the central bank will be able to keep inflation under control successfully.

 

Source: Bank of Estonia

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