Annual Report 1994. Notes to the Financial Statements of Eesti Pank

PRINCIPLES OF ACCOUNTING

The Financial Statements have been prepared in accordance with the Law on the Central Bank of the Republic of Estonia and the Statute of Eesti Pank. International Accounting Standards has been adopted only where they are appropriate and applicable to the activities of a central bank.

The Financial Statements have been prepared in accordance with the historical cost basis of accounting, modified to include the revaluation of certain assets as referred to in the notes below.

The Financial Statements and notes have been prepared using accounting policies consistent with those used in 1993. The published balance sheet of Eesti Pank has been structured so that the domestic and foreign claims and liabilities can be separated. In addition, the balance sheet structure also demostrates the backing of the kroon by gold and freely convertible currency. Certain changes in presentation of items, particularly the profit and loss account, within the Financial Statements have been adopted where, in the view of the Management, this provides clearer disclosure. In those cases the 1993 comparatives have been restated accordingly.

The principal accounting policies adopted for the preparation of the Financial Statements are set out below.

INCOME AND EXPENCES

Realised income and expenses are accounted for in the relevant reporting period on an accruals basis, notwithstanding the actual date the money is received or paid. Unrealised income and expenses are accounted for in reserves.

Foreign currency translation

Transactions denominated in foreign currencies are translated into kroons, the legal tender of the Republic of Estonia, using the official exchange rates of Eesti Pank valid on the day of the transaction. Foreign currency assets and liabilities are translated into Estonian kroons at the Eesti Pank official exchange rate valid on the balance sheet date. IMF balances are translated at exchange rates calculated on the basis of the SDR basket currencies using Eesti Pank official rates. Non-convertible foreign currency assets and liabilities are translated into kroons using the official DEM exchange rate of the relevant country's central bank and the Eesti Pank official DEM exchange rate. Unrealised foreign exchange gains and losses are credited or charged to reserves.

Official exchange rates used at 31 December 1994 and 1993 were as follows:

Gold

Gold reserves are valued at market value using the quoted London Bullion Market price. Revaluation gains and losses are credited or charged to reserves.

Bonds and other securities

Treasury bills and other quoted securities denominated in freely convertible currencies are recorded at their market value. Unrealised revaluation gains and losses are credited or charged to reserves. Reverse repurchase agreements and unquoted securities are valued at adjusted cost.

Investments

Shares and other investments held for the long term are reflected at their purchase price.

Fixed assets

Fixed assets are recorded at original cost, less depreciation which is provided for on a straight line basis over the estimated useful lives of the assets at the following rates:

Building renovation costs are charged to the profit and loss account as expenses except where the expenditure results in an increase to the external floor area of the building or a change in its use, in which case such costs are added to fixed assets. Provisions are made where it is known or probable that the market value of the asset is less than the value recorded in the accounts.

Loans and provisions

Loans are reassessed periodically by the Management and specific provisions are established against those considered to be bad or doubtful due to the borrower's insolvency. Provisions are recorded as expenses of the reporting period. Loans are maintained in the balance sheet until they are repaid or written off. They are written off only after all legal measures to recover them have been taken.

Item 1 - Gold

The Bank's gold reserves of 8,250.171 ounces remained the same as at the end of 1993. The market value at 31 December 1994 was 4739.328 kroons (USD 382.50) per ounce compared to 5419.2028 kroons (USD 390.50) per ounce at 31 December 1993.

Item 2 - Convertible foreign currency assets

This comprises current account balances, over-night loans, deposits, short-term investments in gilts and securities managed by a foreign investment bank, reverse repurchase agreements and government bonds denominated in convertible foreign currency, together with accrued interest where applicable.

During 1994 convertible foreign currency reserves have increased primarily due to the inclusion in the balance of the stand-by facility obtained from the IMF. As from September 1994 these funds have been transferred to a foreign investment bank for management purposes in order to improve returns. The increase in convertible foreign currency assets also reflects convertible foreign currency purchased from Estonian commercial banks and income during the period on the foreign currency reserves.

The bank's policies for investing the foreign currency reserves of Eesti Pank allow transactions with trustworthy institutions of high international standing only. The general principles of investing the foreign currency reserves are intended to secure the value of the kroon against foreign currencies, full convertibility of the kroon versus other selected currencies, sufficient liquidity to meet the Bank's obligations and reasonable returns within the given risk restraints. To fulfill these investment policies the bank keeps its foreign reserves in liquid instruments with an average duration less than two years and low risk levels, approximately two thirds of which are denominated in DEM, with the remainder in USD and other main currencies.

During 1994 the much publicised problems of the international bond markets and the weakness of the US dollar, which is continuing, have resulted in difficulties in increasing the value of the bank's investment holdings. Interest earnings have been largely offset by unrealised foreign exchange and bond revaluation losses.

Item 3 (and item 12) - Special drawing rights (SDR's)

These items comprise the unused assets and liabilities, denominated in SDR's, arising from the loans granted by the IMF to Estonia.

In 1994 two changes took place in transactions with SDR's that have affected the balance sheet of the Bank:
- Firstly, the Government commenced issuing Systemic Transformation Facility (STF) credits through commercial banks, therefore the unused facility in the Bank's balance sheet has reduced significantly. As in 1993 the STF has been reflected as a liability of Eesti Pank, although during the reporting period Eesti Pank has acted as a Government agent when mediating the loan. In connection with this, some relatively unimportant changes had to be made in the calculation of expenses for 1993.
- Secondly, as referred to in item 2 above, the Standby Arrangement (SBA) loans received were invested more effectively than holding the money on the IMF account. At the same time, Eesti Pank retains its liability in respect of the SBA.

The following table in Estonian kroons shows the above described changes:

The differences between the balance sheet and the table are caused by the inclusion in the balance sheet totals of accrued but not received interest that at the end of 1993 and 1994 amounted to EEK 5,034,372.44 and EEK 159,900.60, respectively.

Item 4 (and item 12) - Participation in IMF

Participation in the IMF is recorded in the assets' side of the balance sheet and equals the country's quota in the IMF, which is recorded in the liabilities' side of the balance sheet ("IMF kroon accounts"). Estonia's quota in the IMF was SDR 46,500,000 (EEK 841,201,275) at the end of 1994, with the movements in the year explained as follows:

Item 5 (and item 18) - Non-convertible foreign currency assets and deposits

This item shows the accounts of Eesti Pank held with the central banks of CIS countries, Latvia and Lithuania and used for settlement of payment transactions with those countries on behalf of Estonian commercial banks and the Government of Estonia. The compensating balances with those organisations are shown as demand deposits of Estonian banks in item 18 "Non-convertible foreign currency deposits".

Item 6 - Loans

Loans, which include accrued interest totalling EEK 6,361,662.30 (1993 EEK 5,753,644.71) are analysed as follows:

Loans to financial institutions include EEK 108,181,708.03 (1993 EEK 61,954,783.68) where the Bank acts as agent and guarantor in respect of credits received from Vientiluotto OY and European Investment Bank, which have been used for loans through commercial banks to Estonian enterprises.

Compared to the end of 1993, total loans have decreased by more than one fifth. The decrease is due mainly to the establishment of provisions against or writing off of bad and non-performing loans. The principal amounts provided against or written off include the following:

• loans to the Government of Estonia;
• bad and non-performing loans related to the former activities of Põhja-Eesti Pank prior to monetary reform;
• a proportion of the loans connected to the Painküla Starch Factory, arising from the issuing of guarantees in 1993 to Donau Bank AG (Austria) and Eesti Maapank.

Home-purchasing loans to the employees of Eesti Pank are provided for a maximum of 25 years.

Eesti Sotsiaalpank
During the year, Eesti Pank granted loans totalling EEK 262,116,875 to Eesti Sotsiaalpank and Eesti Tööstuse Arengu Pank after the Government of Estonia withdrew budgetary funds from Eesti Sotsiaalpank and placed them with other Estonian commercial banks. This caused an immediate liquidity crisis at Eesti Sotsiaalpank. In order to avoid the collapse of that bank, and Eesti Tööstuse Arengu Pank which was also affected, with consequent systemic implications, the Board of Eesti Pank decided to provide loans to those banks.

Initially, it was intended that the loans would be provided jointly by the Government of Estonia and Eesti Pank. However, negotiations with the Government to cushion the effects of withdrawal of funds by spreading them over a longer period of time or providing short term liquidity loans failed. Responsibility for stabilising the situation fell primarily upon Eesti Pank.

Eesti Sotsiaalpank and Eesti Tööstuse Arengu Pank were placed under moratorium and merged. Eesti Pank took ownership of new shares in the merged bank giving it initially 50% of the voting rights, but effective control, and in due course the remaining existing shareholders will be required to give up their ownership rights. It also began to sell Eesti Sotsiaalpank's assets and branches to other commercial banks. After repayment of EEK 31,500,000 of the original loans, the loans were restructured to leave Eesti Pank with subordinated loans of EEK 38,000,000 and liquidity loans of EEK 192,616,875[1]. The Government also granted a subordinated loan of EEK 20,300,000.

Eesti Sotsiaalpank will now be liquidated and its remaining assets, including a property and its portfolio of problem loans, will be realised to the extent possible. The final outcome is uncertain but Eesti Pank expects the proceeds will not be sufficent to recover its entire remaining loans of EEK 192,616,875. A provision of EEK 74,000,000 has been established in the 1994 accounts.

Item 7 - Bonds

Bonds held in Estonian institutions are analysed as follows:

⁽ⁱ⁾ 50 interest free 10-year debentures of Eesti Maapank, aggregate nominal value EEK 5 million, maturing on 1 September 2002. The debentures were purchased for EEK 2 million and are reflected in the balance sheet at this amount.
⁽ⁱⁱ⁾ VEB Fund certificates (without maturity) with a total nominal value of EEK 103 million for which a 100% provision has been made in 1994. The VEB Fund certificates were purchased from Põhja-Eesti Pank for EEK 100 million and from the Government of the Republic of Estonia for shares in that bank with a value of EEK 3 million.
⁽ⁱⁱⁱ⁾ In August 1994 15 1.25% marketable two-year bonds of Tööstuse ja Ehituse Kommertspank were bought at their total nominal value of EEK 15 million. The amount above also includes accrued but not yet received interest.

Item 8 - Shares

Shares held by Eesti Pank comprise the following:

*Bank for International Settlements (BIS) shares with a total book value of 7,837.50 kroons are included at their historical cost that has established itself from 1930 (when Eesti Pank joined the BIS) until the end of 1994. The historical cost includes the conversions from Estonian kroons to rubles in 1940 and from rubles to Estonian kroons in 1992.
**Eesti Pank joined SWIFT on 20 August 1993 by purchasing one share for 32,000 Belgian francs (12,426.24 kroons).

Eesti Pank is committed to reducing its share holdings in Estonian banks during 1995. In accordance with a subscription agreement dated October 1994 its ownership of Estonian Investment Bank is expected shortly to be reduced to 33 1/3%.

Item 9 - Other assets

This item includes the difference between the nominal value and selling price of the Eesti Pank certificates of deposit sold to banks. In addition, prepayments for services and goods, to be provided in 1995, and the cost of Eesti Pank circulating assets are included here.

Item 10 - Fixed assets

Details of movements in fixed assets during 1994 are as follows:

The increase in the net book value of fixed assets in 1994 arises primarily due to the purchase of computer equipment, furniture and fittings as well as the renovation of buildings.

Item 11 - Foreign debts

Foreign debts, which also include accrued but not yet received interest, comprise the following:

The related assets connected to the above items are included in "Loans to financial institutions" and "Other loans", and in respect of loans secured by short-term securities in "Convertible foreign currency assets".

Item 12 - IMF kroon accounts

This item shows the Estonian kroon deposits of the IMF held with Eesti Pank, which include loans granted by the IMF to Eesti Pank and the quota of the Republic of Estonia in the IMF (see also items 3, 4 and 17).

At the end of 1993 this item included the liability in respect of the Systemic Transformation Facility (STF). In 1994 this loan was utilised by the Government of the Republic of Estonia, with Eesti Pank acting as an agent in the distribution of the STF funds.

The following table (in kroons) shows the movements of the loans obtained from the IMF and participation in the IMF.

The differences between the balance sheet and the table are caused by inclusion in the balance sheet totals of accrued but not yet received interest that at the end of 1993 and 1994 amounted to EEK 6,374,418.86 (SDR 354,120) and EEK 7,318,179.74 (SDR 404,535), respectively.

Item 13 - Accounts of non-residents

This item includes accounts held with Eesti Pank by the central banks of the CIS countries, Latvia and Lithuania, which are used for settling transactions between Estonia and those countries through Eesti Pank.

Item 14 - Notes and coins in circulation

This item shows banknotes and coins issued for circulation by Eesti Pank. An analysis of the notes and coins in circulation at 31 December 1994 is shown on page 45 of the Annual Report.

Item 15 - Accounts of other banks and other current liabilities

This includes the correspondent accounts of Estonian commercial banks with Eesti Pank. No interest is paid on these accounts, except that amounts are paid to Eesti Hoiupank, based upon their excess reserves with Eesti Pank and calculated by applying DEM interest rates.

Item 16 - Securities

The short-term Certificates of Deposit shown here are 28 day discountable papers issued to Estonian commercial banks with EEK 100,000 nominal value.

Item 17 - Convertible foreign currency deposits

The convertible foreign currency account shows demand deposits of the Republic of Estonia held with Eesti Pank. It includes the undistributed element of the Systemic Transformation Facility in SDR and German marks provided to the Republic of Estonia by the IMF, together with accrued interest payable. In 1993 the item comprised entirely an ECU loan by the European Union. Eesti Pank acts as agent in the name of the borrower - the Republic of Estonia.

The above table shows only the movement of the SDR denominated part of the loans. Before the loans were transferred to commercial banks, the SDR's were converted into German marks, EEK 159,227.26 equivalent of which remained undistributed at the year end for technical reasons. In addition, the balance sheet includes accrued but not yet paid interest amounting to EEK 161 854.36.

Item 18 - Non-convertible foreign currency deposits

This item includes non-convertible currency demand deposits of the Government of the Republic of Estonia and of Estonian banks with Eesti Pank. The deposits are related to transactions with the CIS countries, Latvia and Lithuania carried out through Eesti Pank.

Item 19 - Other liabilities

This item includes sundry other accounts payable in January 1995 for 1994 costs. A long-term credit of EEK 7,600,000 granted to the Painküla Starch Factory by Eesti Maapank and guaranteed by Eesti Pank is also provided for here. The Painküla Starch Factory having been privatised, the guarantee became a liability of Eesti Pank, as the privatisation agreement does not provide for payment of the loan by the new enterprise.

Item 20 - Capital and reserves

Capital and reserves can be analysed as follows:

In accordance with the Law on the Central Bank of the Republic of Estonia at least 25% of annual profit is allocated for increasing the fixed and reserve capital. After these allocations, part of the profit can be allocated for forming and supplementing special reserves based on a decision of the Board of Eesti Pank. The residue of the profit is transferred to the State budget. In 1992 Eesti Pank covered from the special reserve the losses arising from revaluation of rouble assets and liabilities at the time of monetary reform, amounting in aggregate to more than half a billion kroons. In accordance with the 1993 decision of the Board of Eesti Pank, the Eesti Pank reserves have to be restored from the profit of the next ten years. Thus, 50% of the 1993 profit was allocated to fixed and reserve capital in equal shares and the residue of the profit was transferred to the special reserve after payment of EEK 30 million to the State budget.

The fixed capital has also increased due to amounts received from the privatisation of State assets by the Estonian Privatisation Board. The reserve capital increased also due to transfers from the development fund which, as a remnant from the pre-monetary reform period, had lost its purpose, and therefore has ceased to be used.

The revaluations reserve includes the unrealised difference between the cost and market price of foreign securities. At the end of 1993 the market price of the foreign securities generally exceeded their cost price, whereas at the end of 1994 the situation was reversed. The main reason was the fall in market prices of bonds denominated in German marks.

The exchange rate differences reflect the results of translating the claims and liabilities denominated in foreign currencies into kroons at the balance sheet date. The fall in value of certain foreign currencies, particularly the US dollar, in 1994 has caused this item to decrease.

The fixed assets reserve reflects the 1993 revaluation of fixed assets.

Item 21- (Loss)/profit for the year

Comments on the profit and loss account
The Profit and loss account has been presented in order to show separately income and expenses on foreign and domestic assets and liabilities, consistent with the balance sheet. It is considered that this presentation, together with additional information on operating expenses and separate disclosure of exceptional items, shows more clearly the Bank's income and expenditure than the presentation in the 1993 Annual Report. Comparative figures for 1993 have been restated to be consistent with this new format.

Foreign net income and similar items
This includes principally interest income, realised exchange gains, income from the sale of securities and dividends less interest expense and losses on the sale of securities. The small fall in net income, despite increased interest income achieved through investment in higher yielding assets, reflects realised losses on the sale of securities due to the weakening in 1994 of world bond markets.

Domestic net interest income/(expense) and similar items
This includes principally interest earned on domestic loans, together with gains and losses on buying and selling kroons, interest payable on CD's issued by the Bank and interest paid to Eesti Hoiupank on the excess reserves it is required to hold with Eesti Pank. Interest earned by the Bank has fallen during 1994 as a result of the repayment of certain loans and lower interest rates. However, interest paid to Eesti Hoiupank has fallen even more (from EEK 34,924,559 in 1993 to EEK 9,440,910 in 1994) as the reserve requirements have changed. These costs are expected to be reduced still further in 1995.

Profit from the sale of gold
No further gold was sold in 1994.

Other operating income
This includes principally profits and losses on sale of fixed assets, income from the sale of commemorative coins and cheque books and sundry other non banking related income. 1993 income also included various adjustments in respect of prior year items.

Other operating expenses
Other operating expenses have been analysed by principal category, consistent with the way in which the Bank's Management budget for and monitor costs. Staff related expenses comprise not only salaries and salary related expenses, including health insurance and social security taxes, but also training and business travel expenses. The increase in staff related expenses is due to increased numbers of staff and salary rises to keep pace with inflation. The costs of making money have risen sharply due to the increase in money in circulation and the need to replenish stocks of notes and coins. Depreciation of fixed assets has also increased as the Bank's rebuilding and refurbishment programme has continued. However, renovation costs have been reduced in 1994 and are budgeted to fall further in 1995.

Provisions for bad and doubtful loans and other claims
In accordance with the decision of the Estonian Parliament and the Council of the Bank, additional provisions have been charged in 1994 against pre-monetary reform loans, loans to liquidated banks and other claims. These are analysed under items 6 and 7. In addition, a provision of EEK 74,000,000 has been established against Eesti Sotsiaalpank loans.

Exceptional items
These include items of income and expense arising on transactions of an unusual and infrequent nature including items connected with monetary reform in 1992, repayment of previously provided loans and adjustments for settlement of items in amounts differing from expectations.

Item 22 - Off-balance sheet accounts

During 1994 the Bank entered into a number of EEK/DEM forward foreign exchange contracts with Estonian commercial banks, whereby it has committed to buy DEM at future specified dates for fixed exchange rates of between 8.0010 and 8.0020. As at 31.12.94 the Bank had forward contracts amounting to EEK 674 564 596.25 maturing on various dates up to the year 2001. Such contracts, which are offered only to Estonian banks and limited to percentage of their average Estonian kroon assets less inter-bank loans reflect the Bank's commitment to maintaining reserves primarily in DEM and to the pegging of the EEK to the DEM.

[1] On 15 March 1995 the last two branches of Eesti Sotsiaalpank were transferred to Põhja-Eesti Pank, which is wholly owned by the Government of Estonia. All of Eesti Pank's subordinated loans and EEK 20,300,000 of the Government subordinated loans were also transferred, where they may in future be converted into equity. Eesti Pank expects to recover its investment in Põhja-Eesti Pank on the privatisation of that bank.

REPORT OF THE AUDITORS TO RIIGIKOGU AND TO THE BOARD OF EESTI PANK

We have audited the balance sheet of Eesti Pank as at 31 December 1994 on page 43 and the related profit and loss account for the year then ended on page 44. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based upon our audit.

We have conducted our audit in accordance with International Standards of Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates used by management, as well as evaluating the overall financial statement presentation. We believe that our audit forms a reasonable basis for our opinion.

In our opinion, the financial statements present fairly in all material respects, the financial position of Eesti Pank as at 31 December 1994 and the results of its operations for the year then ended in accordance with the accounting principles adopted by Eesti Pank and the Law of the Central Bank of the Republic of Estonia.

Tallinn 28 March 1995