This is particularly a risk in economic sectors which are affected more by Russia's invasion of Ukraine, and the consequent sanctions, the bank says.

The war is also driving inflation further upwards from its already high levels, hurting the financial positions of companies and people.

However, banks in Estonia have sufficient buffers to cope with an increase in problem loans, to allow payment holidays if needed, and to continue lending to businesses and individuals, the Bank of Estonia continues.

Russia's war on Ukraine reduces some of the export options for Estonian companies and their ability to import some of the supplies they need. Inflation having been pushed up by the war will make the financial position of companies and people more difficult, and the risk of losing jobs will particularly threaten people working in sectors that are affected more by the war.

If growth in the economy slows at the rate that was predicted by the central bank in its March forecast, the war could cause the level of problem loans at the banks to rise from its current 0.2 percent to 1.5 percent.

This would still be well below the level in the crisis of 2008-2010, when problem loans were more than 7 percent of the total volume of loans. The central bank considers that the banks in Estonia will be able to cope with the loan losses and to continue funding the economy with credit, as their profitability is high and their capital buffers are strong, the bank says.

The growth in housing loans will remain fast moving forward, as incomes are continuing to rise and demand remains for housing. The issuing of housing loans slowed when the war started, but demand for loans is now recovering.

Real estate prices are expected to continue to rise, as the addition of new residential property to the market remains limited because of supply difficulties for construction materials plus their rapidly rising prices.

Growth in real estate prices and housing loans could increase household indebtedness, raising the risk of people facing difficulties in making their loan payments if the economy were to turn down or if higher interest rates were to make loan payments larger.

The minimum requirements set by the Bank of Estonia for issuing housing loans help to alleviate the risks from rapid growth in lending. The central bank stands prepared to tighten the requirements for issuing housing loans further, if lending continues to grow fast.

The central bank says it currently does not see a need for this, however. Neither does see any need to raise the capital buffer requirements which apply to sector, as things stand.

The direct impact on the Estonian financial sector of Russia's invasion of Ukraine is small, as the connections are quite limited. Investments related to Russia will only affect substantially a few individual investment funds and investment firms, which make up a very small part of the Estonian financial sector.

The war has increased uncertainty in international securities markets and this has made it more expensive for banks to obtain funding by issuing bonds. The largest, and increasing, source of financing is local deposits though, and this reduces the financing risks for the banks.

As in Estonia, the capacity of companies and households in Latvia and Lithuania to pay their loans is affected by the war, and this then has an impact on the financial positions of Estonian banks operating in those markets, the bank adds.

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