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

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