Bank of Estonia headquarters, Tallinn, Estonia (Ren12, CC BY-SA)
Chairman and co-founder of the Estonian bank Pocopay, Indrek Neivelt launched a campaign aimed particularly at the Scandinavian banks in Estonia, accusing them of generating twice as many profits in Estonia than abroad. According to Mr. Neivelt, their pension funds are far less profitable for Estonian customer than for citizens in Scandinavian countries, particularly in Sweden. This case launched a debate over the general status of banking sector and financial stability in Estonia.
Mr. Neivelt has recently been seen and heard so much in the media that politicians envied him. Representatives of at least two political forces — EKRE and Estonia 200 have stated that Mr. Neivelt’s views fall on their own, recognizing a potential populist appeal in strengthening the national banks. Thus, a narrative that unites Estonia is found in the financial sector, and Mr. Neivelt stresses he has no political ambitions, he wants to fight against harsh conditions for the Estonian banks.
According to the Estonian Banking Association, the Estonian banking sector consists of 16 banks. 8 are licensed credit institutions in Estonia, and 8 are operating as branches of foreign credit institutions. Banking sector assets constitute EUR25.2bn, 110 per cent of Estonian GDP. The Estonian banking sector is dominated by Scandinavian banking groups have 90 per cent of banking sector assets. The market is chiefly divided between Swedbank, SEB Bank and Luminor Bank. LHV Bank, the largest bank based on local capital, holds 7 per cent of banking sector assets. Banks serve 2.2 million customers through 74 branches. Estonian customers operate 1.8 active current accounts per inhabitant and 1.25 active internet accounts per inhabitant. Estonian banks have issued 1.4 million cards per inhabitant, 80 per cent of them are debit cards, and 20 per cent are credit ones. 60 per cent of retail payments are done with the use of cards and more than 99 per cent of payment orders have been initiated electronically since 2009. Only 4 per cent of the population receives income entirely or partially in cash.
After some weeks, the Estonian central bank, Eesti Pank said that banking system has to be able to function in both good and bad times, and a wide circle of owners of the banks promotes stability. The main objective of Eesti Pank is to support competition, but in a small market it may be necessary to have an oligopoly to access some products or services. Estonian banking is characterized by a relatively large market share in the hands of larger banks. Many banking products and services are offered by all banks operating in Estonia, but there are also those that are offered only by the major ones. This is partly due to the need for economies of scale in small countries, especially for products and services with high fixed costs.
For instance, mortgage is given for 20-30 years. Mortgages account for about 40 per cent of the loans to the non-financial sector, which is slightly above the average for the countries in the EU, but as a share of total assets, the volume of these loans is one of the largest in the EU. This reflects the universal banking model used by banks in Estonia, the concentration of the domestic market and the preference of households for home ownership over renting. It also indicates that the operations of banks in Estonia are less diversified than is the average in the EU. Credit growth continues to be supported by very low base interest rates and by the relatively strong competition in the corporate loan market, which has kept interest margins low.
It is easier for a larger bank to invest money for such a long time or hedge a long-term risk. It is also possible for the large bank to standardize the granting of loans and the assessment of loan applications, but a small bank has to assess the applications separately, which makes the loan product more expensive. Thus, a relatively concentrated market in a small country is inevitable. The main objective is to support competition, but in some cases, it is inevitable that the oligopolistic market provides access to at least some of the products or services, including in terms of price. The question of who is the bank’s owner is secondary here.
Estimating the profitability of Estonian banking is quite complicated due to the corporate income tax system in which banks has to reinvest profits. This has led to a situation where the capital adequacy ratio of the banks, i.e. the ratio of risk assets to equity, is over 30 per cent. Return on equity calculated at this level of capital is too low compared to reality. Internally, banks take less capital into covering risk assets in Estonia. According to the public reports of the largest banks operating in Estonia, the return on capital is about 20 per cent, which is similar to that of the same banking groups in Sweden. And when it comes to large dividends paid to Estonian parent banks by Estonian subsidiaries, this is simply the implementation of a postponed activity, because the Estonian tax system has been changed in the meantime.
Compared to other EU countries, the banks operating in Estonia, as well as the Nordic banks, are among the most profitable. This is due to the fact that the loan losses of the Nordic countries and also of the banks operating in Estonia are considerably smaller, and partly due to the use of technology the cost level is also lower. In historical comparison, profitability is currently not particularly high.
In Estonia, it is difficult to make a profit with banking, as Nordea and DnB have been looking for a potential buyer for their Estonian business for several years. Their decision to exit the Estonian market was due to the fact that, according to their estimates, the funds invested would bring higher profits elsewhere, including their banks’ home market. At the beginning of 2019, nearly 90 per cent of the Estonian banking market belongs to Scandinavian banks, and they earn a corresponding amount of profit. They entered the Estonian market when the country was transitioning to a market economy and needed additional funds. The transition process of the Estonian economy is considered one of the most successful countries of Central and Southeast Europe and one of the key factors for success was the use of foreign capital for investments.
Foreign banks supported the smooth functioning of Estonian banking. It is worth recalling that during the recent financial crisis, in Latvia a bank with a large market share, belonging to domestic investors, was struggling. To resolve this, the International Monetary Fund (IMF) proposed an aid program and the country’s debt burden increased from 18 per cent to 47 per cent in a few years.
In Estonia, the banks’ loan portfolio started to grow again shortly after the 2008 crisis, but in Latvia it took 10 years. This means that in Estonia, banking sector was able to support the growth of the economy, as financing investment (private or corporate) is the main task of banking. The rapid recovery from the crisis was partly due to the fact that Swedish owners kept their banks liquid. For the central bank, it is important that banking sector functions in good and bad times.
Vedran Obućina is an analyst and a journalist specializing in the Croatian and Middle East domestic and foreign affairs. He is the Secretary of the Society for Mediterranean Studies at the University of Rijeka and a Foreign Affairs Analyst at The Atlantic Post.