The Estonian financial sector as a whole is in good condition

The Estonian financial sector is in good condition and most of the risks to financial stability in the next half year are small. The assessment of financial stability shows how strong and reliable the banks are and how well they are able to cope in more difficult times.

The main risk is now of a deterioration in the external environment, which includes the conflict between Ukraine and Russia.A worsening of that environment could provoke a recession and damage the loan quality of the banks. Estonian financial stability is still vulnerable to a reassessment of the risks to the Nordic economies and banks by financial markets, which could increase the financing and liquidity risks of the banks here too. A slowdown in the growth in Estonian real estate prices has reduced the danger of excessive risks being taken in the housing loan market in the expectation of continuing rises in prices.

Economic growth in Estonia remained modest in the first half of this year, but it should speed up somewhat in the coming years. Negative developments in the external environment could still mean that growth ends up markedly weaker than forecast. The economy in the euro area has recovered more slowly than expected. The economic sanctions relating to the conflict between Russia and Ukraine have had an inhibitory effect on both trade and confidence, and this has added to the long-term problems caused by high unemployment and indebtedness in many euro area countries. The impact of the sanctions on the Estonian economy has not yet been large. A further widening of the conflict and additional sanctions could increase the risks to economic growth and financial stability.

Rises in real estate prices and growth in housing loans have continued in Sweden and the risks this poses to Estonian banks remain. The biggest bank groups in Sweden largely fund their activities with funds from the financial markets and if investors should reassess the risks to the banks, it could make the financing of bank groups much more difficult or expensive. On top of this, a fall in real estate prices could lead to lower economic activity levels because of a reduction in private consumption and investment. The Swedish financial supervisory authorities have said that Swedish banks need to increase their liquidity and capital buffers in order to bring down risks.

The good financial position of Estonian companies and households has let loan quality for the banks improve and this is expected to continue in the coming year. The improvement in the quality of the loan portfolio helped maintain the profitability of banks, and as a result the capitalisation of the banks rose. The impact of the Russian sanctions on the business sector as a whole is quite modest, even if some individual companies are affected a great deal, and so the credit risk to the banks is only limited. In any case, the banks operating in Estonia have only a small share of their assets in Russia.

The Estonian real estate market has started to stabilise. The growth in the average price of housing slowed in the second quarter and the number of transactions fell. Although wages are rising more slowly, real estate prices may start to rise too quickly if demand is boosted as interest rates remain low and incomes rise.

To reduce the risk of lending booms in the future, Eesti Pank plans to impose three limits for banks on new housing loans as a preventative measure. These are a limit on the loan-to-value (LTV) ratio of new housing loansl, a limit on the debt service-to-income (DSTI) ratio, and a limit on the maximum maturity of loans. The levels planned for the limits are based on the current conditions for housing loans issued by banks so the requirements set by Eesti Pank will not make the conditions for issuing housing loans tighter than they currently are. The purpose of the requirements is to ensure that the conditions on housing loans from the banks take sufficient account of possible risks. If the risks around housing loans increased, Eesti Pank would be able to set stricter requirements.

Source: Bank of Estonia

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