Estonian financial stability review

The international financial environment became less confident at the start of 2016, Bank of Estonia reports in its financial stability review. The review is published twice a year.

Doubts about the outlook for global growth led to increased volatility in international securities markets and falls in the prices of financial assets. With commodities prices remaining low for a long time and inflation very low, central banks maintained their position of using accommodative monetary policy to support inflation and GDP growth. At the same time, the activities of banks in several European Union countries are continuously being affected by the problem assets that appeared at the time of the global financial crisis, and more and more by the combination of weak economic growth and low monetary policy interest rates.

There has been no reduction in the main risks to the stability of the Estonian financial sector, which arise from imbalances in the Swedish economy and from the funding of the large Nordic banking groups. Relatively strong growth continued in Sweden and the loose monetary policy environment saw rapid growth in loans with real estate as collateral and in real estate prices. Macroprudential supervisory institutions in the Nordic countries have put in place measures to support the resilience of the banks, but this has not slowed the build up of risks in Sweden. Although the larger banking groups in the Nordic countries are well capitalised by international standards, their capital buffers have not particularly increased as a ratio to total assets while risks have been increasing, and in international comparison they are around the average.

The ability of Estonian companies and households to repay their loans remains good. Rapidly rising incomes have led to increased demand for loans from households. However, indebtedness remained at the same level for the second consecutive year and the coverage of debt liabilities with liquid assets increased further. Corporate results worsened further in the second half of 2015 though because of weak demand for exports and the continuing rapid rise in labour costs. Investment activity was sluggish, and so demand from companies for loans did not increase. Although sales turnover was down, companies managed to increase their liquid assets. This means that the borrowing capacity of companies and households is being supported both by larger liquidity buffers than before and by low loan servicing costs, and also by the continuing rapid rise in household incomes.

Together with the rise in real estate prices, construction of residential property picked up, and increased supply restrained the growth in average prices in the second half of 2015. Demand for dwellings has been aided in recent years by relatively fast growth in wages, a labour market that favours households, and low interest rates, while credit growth has remained moderate. Alongside residential property, office and retail space is being developed at quite a rapid rate. The bigger banks remained fairly conservative in lending for real estate development however, and the volume of loans to real estate companies has not increased faster than volumes to other companies. However more has been lent to real estate companies by companies in other sectors than was the case before, which means that exposure to risks in the real estate market could affect businesses more broadly.

The resilience of the banks to risks remained strong. The portfolio of loans and leases was up around 5% over the year in 2015 and its quality remained generally good. The funding of the banks was mainly supported by growth in domestic deposits. The banks kept a high level of liquid assets and new liquidity requirements that started to apply from the start of 2015 will help to ensure that banks maintain their liquidity. The capital buffers of most banks increased last year and the share of CET1 capital was very large at the end of the year, standing at 35% of risk weighted assets for the banks on a consolidated basis. Although the low rate of base interest rates put pressure on the income of the banks, improved cost effectiveness means this has not really yet affected the return on assets, and profitability remained high by international standards. Weak GDP growth and low interest rates and additional legal requirements for the banking sector mean that banks will probably continue to make changes in their business operations.

Read more from the Bank of Estonia website

Source: Financial Stability Review 1/2016

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