Banks played a decisive role in the boom of the Baltic states. They will also have a vital part to play in preventing a “hard landing”.
In Latvia, the European Union’s fastest-growing economy, lending soared by 60 per cent a year as banks offered cheap mortgages.
This created a property bubble which has now burst, raising fears of a recession and a forced devaluation of the exchange rate, which is pegged to the euro. This would be extremely damaging as 80 per cent of loans are in foreign currencies.
The role of banks is controversial because many are foreign-owned, largely by Swedish banks. The success of Parex Banka – the second largest and last significant independent Baltic bank – ìs an exception. Foreign banks own 64 per cent of the banking assets.
Baltic states offer faster growth and greater profitability than Sweden. Swedbank, the largest bank in Latvia and Estonia, now has more clients in the Baltics than in Sweden and makes one third of its profit from the region.
Just as the Baltic states are dependent on the health and strategy of Swedish banks, the banks depend on the performance of their Baltic subsidiaries. As fears of Baltic overheating have grown, Swedbank’s share price has fallen by a third.
The worsening international credit environment has accentuated the risks but so far it has had little actual impact on the Baltic states, in large part because of the foreign ownership of the banking sector.
Parex and other local Latvian banks could lose market share as wholesale funding becomes more expensive. “Current market conditions will not allow us to raise finance at a reasonable rate,” says Martins Jaunarajs, vice-president of capital markets and investment banking.
Swedish banks were not active in subprime debt and fund their Baltic operations from deposits rather than the wholesale market.
Latvia, which has strong public finances and currency reserves, has been protected from global financial turbulence by the Swedish banks. They are unlikely to cut off funding as it would harm their investments.
However, Hansabanka and SEB had already begun scaling back lending at the end of 2006 in response to economic overheating. Government controls on lending announced last spring have forced all banks to follow the same policy. Loan growth slowed to 37 per cent last year and this year loans are expected to increase by 15-20 per cent.
“It is good to encourage people to limit their consumption and adjust it to their real capabilities,” says Ainars Ozols, chief executive of SEB’s Latvian subsidiary.
Consequently property prices have fallen by a quarter since last spring but asset quality remains good because only 17 per cent of households – typically the wealthiest – have mortgages, according to Hansabanka.
“We are already approaching the level at which there will not be much more correction downwards,” says Maris Avolins, head of Hansabanka in Latvia.
Nevertheless there are concerns that the economy is slowing too rapidly. In response, the central bank has cut its mandatory reserve requirements in the past two months to increase liquidity.
The government is also likely to relax its credit controls later this year, notably the requirement that clients must put down a 10 per cent cash deposit. “It really makes sense to take away these administrative provisions,” says Uldis Cerps, chairman of the Financial and Capital Market Commission. “It has created a lot of awkward situations.”
The focus for the banking sector now will be to mine new earnings sources as economic growth slows and financing becomes more expensive. Banks are already promoting long-term savings and diversifying their corporate lending, which has overtaken consumer lending again.
“The challenge is finding growth going forward,” says Mr Jaunarajs of Parex. “We will find some difficulty repeating the source of growth before – the availability of credit. We will need a value-added focus and that will take time.”
