Around 0.2 percent of corporate loans were overdue more than 60 days this fall, according to a press release. By 2023, however, this figure will likely rise to close to 2 percent if the economy develops as forecast by Estonia's central bank in September. For comparison, as many as 10 percent of loans were long-term overdue during the 2008-2010 economic crisis.

At the same time, however, there is currently a significant degree of uncertainty regarding how the economy will develop in the near term due to Russia's ongoing war in Ukraine, among other factors.

Companies will start facing problems with repaying their loans due in part to a decline in demand for goods and services as the economy cools, which will reduce their revenues, and in part due to their costs going up as inflation is high and interest rates on loans are rising. Nonetheless, the central bank believes most companies will be able to cope with servicing their loans as they can utilize financial buffers they have built up in recent years.

Around 0.2 percent of corporate loans were overdue more than 60 days this fall, according to a press release. By 2023, however, this figure will likely rise to close to 2 percent if the economy develops as forecast by Estonia's central bank in September. For comparison, as many as 10 percent of loans were long-term overdue during the 2008-2010 economic crisis.

At the same time, however, there is currently a significant degree of uncertainty regarding how the economy will develop in the near term due to Russia's ongoing war in Ukraine, among other factors.

Companies will start facing problems with repaying their loans due in part to a decline in demand for goods and services as the economy cools, which will reduce their revenues, and in part due to their costs going up as inflation is high and interest rates on loans are rising. Nonetheless, the central bank believes most companies will be able to cope with servicing their loans as they can utilize financial buffers they have built up in recent years.

Interest rate increases supporting capacity to cover loan losses

Even as the volume of problem loans rose, however, banks in Estonia have had sufficient buffers to be able to cope with these loans while continuing to lend to both businesses and private individuals. The rise in interest rates will support banks' profits and thus in turn their capacity to cover loan losses, the Bank of Estonia noted.

Russia's war in Ukraine and higher interest rates from central banks will make it more expensive than before for banks to raise funding from international financial markets. At the same time, banks in Estonia have become slightly more dependent on these international financial markets, as they have been more active in issuing bonds to raise funds from these markets in recent years.

Financial markets nonetheless have a limited effect on banks' funding and thus also the loan market, however, as the vast majority of banks in Estonia fund themselves from deposits. Funding for Estonian banks and companies from issuing bonds is made more expensive not only by rising interest rates, but also by foreign investors assessing that the ongoing war makes the region more risky.

The Bank of Estonia considers banks to be more vulnerable than before as their loan portfolios have grown rapidly and they could face bigger loan losses if the economic climate were to deteriorate. Not only housing loans, but also corporate loans have started to grow increasingly quickly, and although the real estate market is showing its first signs of quieting down, housing loans are currently continuing to be issued at historically high levels.

Countercyclical capital buffer requirement to increase

The Bank of Estonia is planning to raise the countercyclical capital buffer (CCyB) requirement for banks from 1 to 1.5 percent. The central bank believes this will help reduce the risks that accompany rapid growth in banks' loan portfolio and ensure that they are able to continue funding the Estonian economy.

The higher CCyB rate will start to apply from December 2023. The Bank of Estonia will assess the state of the loan market again in six months, and is ready to cancel the planned buffer increase if the growth in lending has clearly slowed and a deterioration in the economic or financial climate means that capital requirements are starting to excessively restrict lending.

Estonia's central bank also decided to raise the systemically important institutions capital buffer requirement for LHV Pank from 1.5 to 2 percent, as the market share of the bank has grown quickly. The higher capital buffer requirement for LHV Pank will enter into force from the start of 2023.

--

Follow ERR News on Facebook and Twitter and never miss an update!