The risks to the financial sector in Estonia are small

  • Faster loan growth could increase the risks to banks from real estate
  • Although corporate profits were down, the ability of companies and households to repay their loans remains good
  • The rate of growth of bank loans should be in line with nominal GDP growth in the years ahead
  • The banks operating in Estonia are well capitalised
  • The risks coming to the Estonian economy and commercial banks from Sweden remain at the same level as in spring
  • The impact of Brexit on Estonian financial stability will be small, and the effect will be felt indirectly and over a long time
  • Rapid growth in the deposits and assets of savings and loan associations reduces the control that depositors have over their own investment and their understanding of the possible risks

Most of the risks to the operation of the financial sector in Estonia are low. Although the uncertainty coming from the external environment increased and risks caused by imbalance in the labour market remain, the risks to the functioning of the financial sector are reduced by the financial buffers of companies, the relatively good finances of households, and the high levels of capitalisation in the banking sector.

The economy was 0.8% bigger in the second quarter than a year earlier, which is below its long-term growth potential. Value added grew in most economic sectors however, and the main obstacle to achieving potential growth was the decline in value added in energy and mining. Uncertainty about the recovery of external demand was increased by the referendum in the United Kingdom in June in which the British voted to leave the European Union. The direct impact of this on the Estonian economy and Estonian companies will be quite modest.

The ability of Estonian companies and households to repay their loans remains good. Labour costs continued to grow fast, with the consequence that corporate profits continued to shrink, though at a slower rate than previously. The contraction of profits has not yet seriously affected the ability of companies to pay, as their loan service costs are low and they have built up financial buffers, which have been kept high because investment volumes have been small. At the same time, rapid wage growth and high employment supported credit demand from households and their ability to loan servicing.

Growth in the loan and lease portfolio of the banking sector accelerated in August to 6% over the year. Loans to real estate companies and loans for buying residential property have contributed the most to the increase in the loan stock. The share of such loans in the total loan portfolio is relatively high at 55%, though this has not changed during recent years. Rising incomes and low interest rates create the risk that Estonian real estate prices and housing loans and lending to companies in real estate may start to grow faster. This would make the banks more vulnerable to risks coming from real estate. To guard against excessive growth in the risks from housing loans, Eesti Pank has introduced requirements for the issuance of housing loans by banks, and can tighten those requirements if the risks in the credit or real estate markets should increase.

Although credit growth has sped up a little, Eesti Pank is maintaining the countercyclical buffer requirement for the banks at 0% as the debt to income of the non-financial sector has not increased. Eesti Pank forecasts that the rate of growth of bank loans should be similar to the nominal rate of GDP growth in the coming years, and no developments or trends in bank behaviour are in view that would amplify lending activity. Eesti Pank continually monitors whether risks are building up and if necessary it can set additional capital buffer requirements for the banks.

The capitalisation of the banks operating in Estonia has remained strong, and this is further underpinned by the capital buffer requirements introduced by Eesti Pank. From August this year, all the banks operating in Estonia have to hold a systemic risk buffer of 1% to mitigate the risks of a sudden fall in the economy, which arise from Estonia having a small and open economy. The two systemically important banks, Swedbank AS and AS SEB Pank, have to hold a further buffer of 2% to hedge against the risks that come from the concentration of the banking sector.

In recent years the rapid development of alternative financial intermediaries has been eye-catching in the bank-centred financial sector. Attention has been drawn to the growth in the savings and loan associations, and the activities of creditors and credit intermediaries. The relatively rapid development in the real estate market has been accompanied by quick growth in real estate funds. The risks to financial stability from all these financial intermediaries are reduced by their small size in the financial system as a whole, and their weak links with the rest of the financial sector. The risks from creditors and credit intermediaries were reduced by them being brought under financial supervision. Savings and loan associations do not come under financial supervision and the rapid growth in their membership and the spread of their activities across Estonia could overshadow the original cooperative principle behind their operation and reduce the control that depositors have over their own investment and their understanding of the possible risks.

The risks to the Estonian financial sector coming from the Swedish economy remained at a similar level to that of spring 2016. With economic growth relatively fast in Sweden, real estate prices and household indebtedness continued to increase. Swedish bank groups are made vulnerable to a deterioration in credit conditions by the large share of market-based financing in their total funding. If international investors were to reassess the risks from rapidly increasing real estate prices and loans upwards, the financing conditions for the banks could worsen. Funds received from parent banks account for around one fifth of the funding of banks operating in Estonia, meaning they have an important role in the functioning of the Estonian loan market. The conditions of market-based funding have so far remained favourable for the Swedish banking groups. The parent banks of the biggest banks operating in Estonia are subject to high capital requirements at the group level in Sweden, and that has a positive effect on the financial strength of the banks in Estonia.

Source: Bank of Estonia

Estonia stands out for its use of cashless payments

  • Like those in the Nordic countries, payments in Estonia are mainly cashless
  • The largest share of cashless payments around the world are card payments
  • Cashless payments initiated in the USA and the euro area account for half of the cashless payments made around the world

Statistics from the European Central Bank on cashless payments show 220 cashless payments were made per person in the European Union in 2015. This is more than twice as many as in 2000, when 98 cashless payments were made per person. The fastest growth was in the number of card payments, which has approximately quadrupled in 15 years, as an average of 104 card payments are made per person in the European Union.

The differences between the payment habits of residents of different European Union countries are quite marked, and the Nordic countries stand out for their large number of cashless payments. Estonia is also one of those countries where residents make more than 300 cashless payments a year. Although the payment habits of residents of Estonia are already quite set, there were still 6% more cashless payments made in the third quarter of 2016 than in the third quarter of 2015. The average Estonian resident makes 331 cashless payments a year, of which 223, or 66%, are card payments.

In countries where cashless payments are used more, it is typical that card payments are a large share of the payments. More than 60% of cashless payments in Sweden, Finland, the United Kingdom and Estonia are made by bank card, while in Denmark 81% of cashless payments are card payments. Card payments accounted for an average of 47% of all cashless payments in the European Union in 2015, while 26% were credit transfers and 21% were direct debits1. As some large countries like France, Italy and Portugal still use cheques, payments by cheque account for 2.9% of all cashless payments. In 2000 cheques were still used for an average of 18.7% of all cashless payments in the European Union countries.

Paying in cash is so established in many countries in central and Eastern Europe that cashless payments are made only a fraction as often as in the northern countries. In general the changes in payments around the world have been the same as in Europe, and the number of cashless payments is increasing constantly. Within this, the number of card payments is rising and the share of cheques is shrinking. In 2014, 387 billion cashless payments were made around the globe, which was 9% more than a year previously2. The largest share of such payments were made in the USA, followed by the euro area, Brazil, China and the United Kingdom. The number of cashless payment made in China shot up during that year and China overtook the United Kingdom, though payments per resident are still lower in China at 17 per year than in the countries in Europe with the lowest figures.

The countries with the most cashless payments per resident in 2014 were the USA, Finland, the Netherlands, South Korea and Australia. More than half of all cashless payments around the world are made by card, and other areas of the world use cards even more than Europeans. In North America for example, 71% of cashless payments were card payments in 2014, and in the developing countries of Asia, like China, India and Hong Kong, 84% were.

1 Direct debits within Estonia were replaced by e-invoice standing orders in February 2014.

2 Comparable data on all countries are from 2014: https://www.worldpaymentsreport.com/. This is why the comparison of countries uses 2014 data.

Statistics for Eesti Pank’s payment and settlement systems

Source: Bank of Estonia (see better graphs here)

Author: Tiina Soosalu, Payment and Settlement Systems Department

Regulation will allow for opening bank accounts without visiting branches

Minister of Finance Sven Sester has signed a regulation that will allow banks to open current accounts for Estonian residents and e-residents without the need for the customer to visit a bank branch.

“We will make opening a bank account easier and faster for everyone, including e-residents,” said Minister of Finance Sven Sester. “We want to make things more convenient, but also maintain the security necessary in the financial sector. The IT solutions that make it possible to identify people from a distance have existed for some time. Allowing for them to be used when bank accounts are opened certainly makes sense.

The financial sector will be able to offer e-residents with new and more convenient services. “There is no doubt that e-residents will help bring more investments and jobs to Estonia,” added Sester. “I want to thank market participants for efficient co-operation in developing the most modern and secure principles.”

The purpose of the regulation is to establish specifying standards on the basis of the amendments to the Money Laundering and Terrorist Financing Prevention Act adopted by the Riigikogu in June. According to the amendments, identifying a person with IT tools is equal to identifying them by being at the same location as the person or their representative if certain conditions are met.

The requirements for the identification and verification of people with IT tools, which are set forth in the regulation, help implement a common standard for all service providers. When the standards enter into force, it will be possible for banks and other financial institutions to identify people without being at the same location as the person or their representative. This must be done with IT tools that allow for the process to be recorded and replayed. This will create a situation on the market where the new identification and verification regime is a preventive measure and helps keep away potential offenders.

It will be possible to use a real time video bridge for identification and verification of a person, which makes it possible to compare the image of a person’s face with the data of their identification document and the data of the Police and Border Guard Board. The person will also be interviewed via the video bridge, which will help ascertain the client’s risk profile: assess their background, the origin of their financial resources and the purpose of establishing a business relationship. The entire process is recorded and the recording is preserved.

Earlier regulation required people taking part in a transaction or using a service to be identified by being at the same location as the person or their representative. If all conditions are met, identifying a person with IT tools is equivalent to the identification of a person by being at the same place as them. In the case of monitoring a business relationship, for example, the new and information technological solution is an even stronger measure than being at the same location as the person or their representative.

Banks will retain the right to identify a person by being at the same location as them. It will be up to the service provider to decide whether they want to open accounts for clients or conclude transactions with them using information technology tools. The service is meant for everyone who holds an Estonian ID card, digital ID or e-resident’s card.

Source: Estonian Ministry of Finance