Annual Report 1994. Estonian Financial Market

With 1993 having been the year the internal money market was launched, at the end of 1994 it can be said with full certainty that a homogenous level of overnight interest rates has been found by the interbank market. Compared to 1993 the banks have become more active in controlling their liquidity and they do not keep unprofitable hundred millions of kroons on their correspondent accounts held with Eesti Pank any more. This shows that the trust between banks that had been shaken after the banking crisis of 1992, but suffered during the 1994 Sotsiaalpank crisis as well, is being restored. Besides the overnight market being on the upswing, the banks became more active in using the possibilities for controlling their liquidity that the Eesti Pank certificates of deposit offered.

Overnight market in 1994

The first overnight loans were taken in June 1993 on the interbank market. At first the volumes were low and the participants were relatively passive. The interest rates were high on the underdeveloped money market but when the volumes increased from September 1993 the interest rates started to fall. While the turnover of the interbank market was 6.8 million kroons and the weighted average annual rate 11.24% in June 1993, the turnover had increased to 504.14 million kroons and the weighted average annual rate had fallen to 6.31% by December 1993.

During the first half of 1994, the rapid development of the interbank market continued. The turnovers were increasing month by month and reached 2644.77 million kroons by July 1994 (from 576.34 million in January). The large volume of overnight loans in the months of June and July could be explained by the liquidity problems of the Sotsiaalpank, first of all. Sotsiaalpank was the largest borrower on the overnight market, which led to an increase in the average rates for these months from 5.48% in May (the lowest level up to that time) to 5.92% in July. The interest rates of loans between other banks remained between 5.40-5.50% at the same time.

In August, after the Sotsiaalpank had temporarily left the overnight market, the interbank rate fell to 5.56% and the monthly turnover amounted to 1259.59 million kroons. During the next three months the turnovers of overnight loans fluctuated between 970.76 million kroons in September and 1434.81 kroons in November. In December the overnight interbank loans came to 952.48 million kroons and the weighted average interest rate was the lowest in the one and a half years the market had existed - 5.43%.

The turnover of the overnight market for the whole 1994 amounted to 16353.07 kroons; the weighted average annual rate - 5.67%. The development of the interbank overnight market offered no surprises. All Estonian commercial banks starting to participate in the overnight loan market could be seen as an important mark on the way to a more efficient handling of resources. The interest rate level found on the interbank overnight market is generally only 0.5 to 1.0% higher than the German mark rates on the European markets. That attests to the increasing trust between banks and their mobility on the international markets. The lower limit of the interest on loans granted is determined by the fact that the banks can easily invest their funds in low-risk German debt securities.

Development of the market for Eesti Pank short-term certificates of deposit

Eesti Pank started issuing 28-day discountable certificates of deposit (CD-s) in May 1993. These CDs are short-term instruments that offer the banks a possibility to execute secondary market transactions with a hundred-per-cent guarantee and are thus instrumental to the development of the interbank market.

The interest rate of the CDs is set on the auctions held every second week. The weighted average rate of the auctions held in December 1993 was 6.31% and the issues amounted to 504 million kroons by the end of the year. At the first auction held in 1994, the weighted average interest rate of the issue fell below 6% - to 5.94% - for the first time.The falling of the rates continued until April 1994, when it was decided to hold the auctions every week (every issue was still 30 million kroons). That led to a certain rise in interest rates because the market adapted to the larger volumes. The interest rates continued to rise until the last auction held in June, when the highest rate for the whole year, 6,37%, was reached.

From July 1994 the acutions were held once every other week again and by the end of August the interest rates had fallen to 5.72%. At the first auction held in September, the weighted average rate for the issue rose to the level of 5.82%. But after that there was a fall and the weighted average interest rate for the last auction held in 1994 (on 20 December) was 5.60%. In 1994 Eesti Pank offered deposits of certificate for 900 million kroons. 740.6 million kroons worth of certificates were sold via primary issue. The remaining CDs were bought through supplementary issues. The weighted average annual interest rate for 1994 was 5.83%.

The forwards and swaps of Eesti Pank

The overall logic of the Estonian foreign exchange market is very simple - as the Estonian kroon is pegged to the German mark, the exchange rates for the remaining currencies are determined on the basis of the market rate for the German mark. Some commercial banks offer Estonian kroon-convertible currency forwards besides that.

According to the procedures for foreign exchange transactions between Eesti Pank and authorised banks Eesti Pank buys and sells convertible currency for kroons and other convertible currencies (to authorised banks) with an exchange rate determined by Eesti Pank. Transactions of this type between Eesti Pank and banks that are not authorised to conduct foreign exchange operations can be executed only in exceptional circumstances.

From 4 April 1994, Eesti Pank has offered commercial banks an additional guarantee on the durability of the fixed exchange rate. From that date, Eesti Pank has quoted Estonian kroon-German mark forwards and swaps, but only in accordance with the above-mentioned procedures. The maximum maturity possible is 7 years from the date of the contract. As of 5 December 1994, the forward contracts amounted to 554 million kroons and at the end of the year approximately to 675 million kroons.

From 5 December 1994, Eesti Pank decided to set limits for the above-mentioned forward contracts according to which Eesti Pank would offer these instruments to Estonian authorised commercial banks only. The maximum limit for any individual bank would be 75% of its average kroon assets of residents for the last 6 months from which claims on other banks have been subtracted.

Capital markets in Estonia

From the time the first issue was officially registered at the beginning of 1994 by the newly founded State Securities Department, there has been a rapid development in this sphere. Twenty five issues worth approximately 500 million kroons were registered during 1994. By the end of the year, 200 million kroons worth of securities had been sold on the primary markets and several large issues were still being sold. Taking into account the earlier 300 million kroon issue of the securities of the Republic of Estonia, the possible volume of the secondary market would be 500 million kroons. That is too little for a functioning secondary market, but if the right measures were taken, the secondary market might still be launched in 1995. There is real interest in participating on the capital markets both on the part of those who need capital (enterprises, local authorities and central government) and possible investors. The successful issues of the loan securities of ETK and Baltika and the shares of Hansapank bear evidence to that.

The plans of the Privatisation Agency to sell several large enterprises via public share issues and the planned issuing of government bonds give reason to hope for more rapid development of the capital market in the future. The number of securities specialists working in banks and enterprises is constantly increasing as is the number of licenced brokerage companies.

Undoubtedly, the functioning capital market is a necessary component of a normal economy and thus, government should take an interest in developing the appropriate infrastructures. Founding a stock exchange would be one of the possible steps. The existence of a stock exchange in Estonia being economically justified only if the issues registered there amounted to 10-15 billion kroons, establishing it would probably have to be delayed for some time to come. Registering shares of Estonian enterprises on foreign stock exchanges would be complicated within the next few years as well because of the strict criteria for acceptance. It would be more realistic to create the necessary environment for an unlisted securities market protected by adequate legislation of the type seen in the developed countries.

The above leads to the logical conclusion that the legislative issues are most important in starting a securities market. The present legislation is insufficiently comprehensive and insufficiently detailed in its treatment of the obligations of the owners of securities in informing the market participants. With a mere shadow of a possibility that everybody participating on the market was not equally informed, the securities market would become a playground for speculation. That would naturally mean loss of the confidence of all the serious investors and the outcome would be that turnovers would fall and the development of the securities market would be checked.

The obligations of the institutions holding and managing information that could influence the securities market should be determined in equal detail.

Besides banks, investment funds and insurance companies also participate directly on the securities markets. The development ot these sectors has been relatively rapid lately, but their volumes are actually small and so is their share of the total loan market.

The total assets deposited in the investment funds increased six times, up to 180 million kroons during 1994, and several new funds were established. At the same time, two funds have been liquidated because their volume was too small to offer the necessary income to the fund manager. One-half of the sums placed with investment funds has been exported, mainly via the secure and trusted units of European investment funds mediated by Hansapank and Forekspank. That is the most important reason for the negative balance of portfolio investments in Estonian balance of payments for 1994.

From 12 August 1994, the activities of investment funds have been regulated by a Government directive. Several funds will have to reorganise their operations because of that, but in general, the supervision and several limits set for investments by the funds should increase confidence in them and their popularity.

At the end of 1994 the first privatisation fund to sell its shares for privatisation vouchers started operations.

Estonian Central Depository for Securities

One of the most important events in the development of Estonian financial markets in 1994 was Estonian Central Depository for Securities starting its operations. That should give an additional impetus to the private sector and offer the public negotiable money and capital markets instruments next year.

The main task of the Central Depository is to offer secure conditions in which to hold the securities registered in Estonia in a machine-readable form, and to execute transactions including securities. The G30 recommendation that each country should have an effectively functioning and developed central depository was taken into account when the central depository was founded. The dematerialisation and immobilisation of securities is one of the most important preconditions for an effective and risk-free netting and settlement system for the securities market.

Estonian Central Depository for Securities is responsible for all procedures connected to the securities register as well. That makes it possible to increase the effectiveness of the depository's operations. The founder of Estonian securities register, the Ministry of Finance, is one of the shareholders in the depository.

Founding Estonian Export Credit Institution

On 30 November 1994, several Estonian and Finnish ministries, the Finnish Export Credit Ltd., the Finnish Guarantee Board, Eesti Pank and the Estonian State Fund for Export Credit signed an Estonian-Finnish joint memorandum laying the groundwork for the cooperation of the two neighbour countries in the field of developing an export credit and guarantee institution. The project was prepared by Eesti Pank together with the Ministry of the Economy and the Estonian State Fund for Export Credit.

The statutes of the State Fund for Export Credit were approved by the Government in August 1993 and that marked the starting point of the development of a system for supporting export in Estonia. Estonia is a small country where the domestic market has only limited possibilities to satisfy the needs of the entrepreneurs. Therefore, market relations with other countries are extremely important to Estonia. These relations can be furthered only proceeding from the practices adopted by the rest of the world and rules formed during decades of development. The principles of crediting and guaranteeing exports have been fixed in the recommendations of the OECD and the Bern Association. Today, any practical operations in this field must be based on a modern information system of the type Estonia still lacks. The technical assistance granted by Finland is most important in this context.

With the help of the assistance offered, it is planned to develop a financial institution dealing with export credits and guarantees on the basis of the Estonian State Fund for Export Credit. The institution should be used for mediating foreign credit lines as well. Should the necessity arise in the future, this system could take on all the functions of a so-called export-import bank.

The main tasks of the export credit and guarantee institution being established should include granting export-oriented credits to enterprises and offering guarantees. The credits and guarantees offered can be divided into many different types according to their purpose. The necessary capital should come from the Government budget, special government funds, foreign loans and investments made by international financial institutions and issues of shares and securities.