Annual Report 1994. Estonian Banking in 1994

General trends on the banking market

By the end of 1994 there were 22 operating commercial banks and 2 loan and savings co-operatives in Estonia. There were also 2 branches of foreign banks and 2 representative offices.

During the 12 months of 1994 the total of the consolidated balance sheet of commercial banks increased by 61%, for the first time exceeding 10 billion kroons (10,304.6 million kroons) by the end of the year. More than half of the total (62.1%) fell to the 4 larger banks - Hansapank, Eesti Ühispank (Estonian Union Bank), Eesti Hoiupank (Estonian Savings Bank) and Põhja-Eesti Pank (North-Estonian Bank). At the beginning of 1994 Sotsiaalpank also belonged to this group, but it lost its position later.

There were no significant sudden changes in the structure of banks' balance sheets in 1994. With the balance sheet totals increasing, almost all the separate items increased proportionally as well (see Table 1, page 65 and Figure 1).

Figure 1. Commercial banks' balance sheet totals, deposits, loans and own funds in Jan 1993 - Dec 1994 (million kroons)

Most of the loans granted by the banks were extended to private enterprises (80.6% of loans as of the end of the year). The share of loans granted to state-owned enterprises has been consistently falling (see Figure 2, page 34). The bulk of the loans were short-term, but in 1994 a change in the credit policy of banks could be observed - the share of long-term loans increased (25.9% of the total of kroon and foreign currency loans at the beginning of the year, increasing to 50.9% by the end of December). The reason could be the increasing share of several special purpose credit lines in the banks' balance sheets. The average lending rate of the banking system continued to fall (see Table 2, page 66).

The largest share of deposits was formed by private enterprises (see Figure 3, page 34). Single individuals' deposits increased throughout the year (by 50.2% compared to the beginning of the year). The bulk of the deposits held with the banks are demand deposits. However, their share seems to be diminishing (approximately by 2.5% for Estonian kroon deposits and approximately by 17.5% for foreign currency deposits in 1994). As to time deposits, the three-to-twelve-month term was the most popular. The average interest rate of time deposits has shown a general tendency to fall during 1994 (the decrease, however, being not so clear as in case of the loan rates). The demand deposits' rate has been rather stable (see Tables 3 and 4, page 66, 67).

Figure 2. Loans granted by commercial banks in Jan 1993 - Dec 1994 by customer groups (million kroons)

Figure 3. Deposits with commercial banks in Jan 1993 - Dec 1994 (million kroons)

By 1 April 1995 the share capital of all licensed commercial banks has to be at least 15 million kroons and by 1 January 1996 the banks' own funds must be at least 50 million kroons. These requirements have formed the basis for planning in the banking sector. By the end of 1994, 12 commercial banks had already reached the 15 million share capital threshold and 3 banks were very close to it. The required minimum level of own funds that will be effective from 1996 had been achieved by 4 commercial banks.

One of the characteristic features of the Estonian banking is the large amount of deposits held in foreign banks. This was clearly evident in 1994 as well. The share of deposits held in foreign banks was nearly 20% of the banks' consolidated balance sheet throughout the year. 90% of deposits in other banks were held with foreign banks at the end of 1994. The strong influence of the commercial banks' export of capital can be also observed in the Estonian balance of payments. Perhaps it would be too simplified to see only funds that could be more profitably used for financing internal projects in the money deposited with foreign banks. The abundance of foreign deposits is an economic reality in a banking environment that is establishing more and more international contacts. It can also be explained by a) the conservative credit policy of banks; b) the need for guarantee deposits required by foreign banks when conducting international operations and c) the lack of a local securities market as an alternative way for liquidity management.

From 1 July 1993 prudential ratios were established for banks. The following 6 months were an adjustment period, due to which the weighted average capital adequacy (then - solvency) and liquidity exceeded the allowed minimum ratios. From January 1994 the first signs of stabilisation at a certain level could be observed for both ratios. Since March 1994 the average weighted capital adequacy of commercial banks has remained within 12-14%, the weighted average liquidity within 37-41% (see Figures 4 and 5).

Figure 4. Commercial banks' weighted average capital adequacy in 1994

The year 1994 was characterised by an essential diversification of the activities carried out by commercial banks, including credit cards, leasing and factoring. Most of the banks were also engaged in operations with privatisation vouchers. Mention should also be made of the increase of the banks' off-balance sheet activities, especially in the form of forwards. The market of forward (and swap) transactions grew rapidly. From the 0.3 billion kroons at the beginning of the year the volume of banks' forward transactions (selling and buying) increased up to 2.2 billion kroons by the end of the year (exceeding one fifth of the total of the consolidated balance sheet of commercial banks).

In 1994 the first Estonian bank (Hansapank) floated a share issue aimed at international institutional investors.

It is clearly evident that pressures for re-dividing the banking markets have increased during 1994. The reason can be found in the more rapid growth of larger banks compared to that of the smaller ones,and the requirement to reach a 50 million kroons own funds minimum by 1 January 1996. The foreign banks coming to the Estonian market added to the competition despite the volumes being rather small so far. At the end of the year operations were commenced by the Ukrainian INKO-Bank, branches of two Finnish banks - the Kansallis-Osake-Pankki and the Suomen Yhdyspankki and the representative office of the Russian Baltiiski Bank.

Some competition was offered to the banks by several investment funds as well. As they were able to offer higher interest rates than those of bank deposits, some of the potential bank deposits were transferred to the investment funds. There is reason to believe that this will continue. Recognising a new trend on the market, the banks started to offer services of this type as well.

The increasing competition and stricter requirements to banks clearly diminished the profits of most of the banks, compared to the year before (see Table 5, page 67). The accumulation of the necessary capital also played a role here.

Looking into the future

One can assume that Estonian banking faces internal consolidation. This will be caused by the stricter requirements on banks, including the higher level of own funds as well as the tightening competition.
Reasons for the latter could be seen in the following:

• foreign banks becoming more active on the market;
• lessening margins (especially that of interest rate margin);
• constantly widening alternative investment possibilities;
• the forthcoming possible re-distribution of government funds due to the founding of a State Treasury and a more effective placement of these funds, which, in turn, should probably offer an impetus to the development of the securities market;
• customers being more careful when choosing their bank;
• decreasing state participation in banks.

The smaller banks will probably be facing difficulties in operating on the market on an equal basis with the bigger ones. Operating within small market share causes the unit costs to be rather high and the returns on scale to be small. A need for larger banks is also reflected in the increasing number of large-scale projects worth financing, which, due to the smallness of our banks, are being financed from abroad. Although large banks have certain competition advantages, the final word lies with market where the decisive role is played by the quality of bank services.

Speaking of the future, a continuing improvement of legislation on the background of general economic rise and declining inflation rate, a further development of securities market, setting up procedures for sound placement of government budget funds and a deposit insurance scheme are of significant importance for the Estonian banking. The importance of an increase in the number of feasible loan projects and new credit lines as well as the improving skills of bank employees should also not be overlooked.

The Estonian banking system is changing. It is moving, albeit with difficulties, but consistently towards the well recognised European principles which should form a basis for an increase of public confidence in banks.