The international financial environment has deteriorated significantly in recent months. Whereas financial-market tensions used to be confined to just a few euro-area countries, the debt crisis has now spread further afield. This has been accompanied by a growing lack of confidence in the European banking system, which has resulted in disturbances in the functioning of the interbank loan market and it has become more difficult for banks to obtain financing in the bond market.
While we responded to heightened inflationary pressures by raising monetary policy interest rates, we have preserved the supply of unlimited liquidity by the Eurosystem to commercial banks. Among other things, we have extended the maturities of monetary policy loans and are going to resume the purchase of covered bonds. According to the European Banking Authority, it is important to require that banks raise their capital and, if the private sector lacks funds, governments will have to take measures.
There are two main channels through which the debt crisis may affect the Estonian financial sector. First of all, if euro-area liquidity and financing problems start having a stronger effect on the Nordic parent banks, their subsidiaries and branches operating in Estonia will also face more expensive financing costs. So far, risks related to parent banks have been alleviated by the financial markets’ high confidence in the Nordic banking system and economic and fiscal policy. One of the key factors in tackling problems accompanying the transmission of the crisis is smooth cross-border crisis management cooperation. Second of all, if external demand, the primary growth driver in Estonia, were to shrink to a great extent, the banking sector’s income and the improvement in loan quality might suffer a setback. The likelihood of these risks materialising has increased in recent months.
The Estonian economy has successfully withstood global economic volatility and the past year’s economic developments have been supporting financial stability. Compared to a couple of years ago, the Estonian economy is more balanced, which means our economy’s resilience to worsening external conditions has improved significantly.
The likelihood of pessimistic future scenarios in the global economy has increased notably since the second half of the summer. The uncertain environment sets very high standards to Estonia’s fiscal policy. Thus, the preparation of the 2012 state budget should proceed from the Ministry of Finance’s economic forecast risk scenario, while adhering to the objective of exiting the fiscal deficit, which was established in the state budget strategy. In addition, it is important to avoid an excessive volatility of general-government expenditure and to ensure that reserves are sufficient.
The capitalisation of the Estonian banking sector is currently sufficient to manage with risks arising from a possible downturn. At the same time, the deepening debt crisis and deteriorating global economic environment put an additional pressure on banks’ liquidity and capital buffers in the entire Europe. Therefore, when distributing profit and managing capital and liquidity, banking groups should bear in mind that strong buffers are of utmost importance in the volatile economic and financial environment.
Read more from Bank of Estonia website