Bank of Estonia: Number of bad loans might grow if economic recovery slow

Bank headquarters in Tallinn.
Bank headquarters in Tallinn. Source: Siim Lõvi /ERR

The Bank of Estonia finds that the ability to service loans of households and companies has remained solid despite the recession. That said, the relative importance of bad loans could start growing if recovery is slow.

The central bank finds in its financial stability overview that previous years' solid profits have allowed companies to cope with bigger interest payments on loans, while modest unemployment is helping households.

However, the energy crisis and the war in Ukraine have caused input prices to go up and affected Estonian firms' competitive ability, meaning there is risk of a slow recovery this time around.

Commercial banks are expected to be able to weather more bad loans because of robust profits and capital buffers.

The Bank of Estonia finds banks' capital requirements to be sufficient and plans no additional steps to ensure financial stability at this time.

Both housing and real estate business loan volumes have been growing in recent years, making up over 60 percent of banks' loan portfolios, which works to heighten sectoral risks. Real estate developers are also more vulnerable to interest rate hikes.

The part of income households spend on servicing new loans is growing.

Financial sector operation needs to be considered when ordering tax changes

The growth of deposits has slowed and the relative importance of other means banks have for financing themselves is rising. Loans from parent banks and bonds play an increasingly important role.

Banks' access to money and its cost is increasingly affected by how risky financial markets find the Estonian state and its banking sector. The international situation at the time of borrowing is also a factor, as is the financial position of parent banks in Sweden, that country's real estate market and economic situation as a whole.

Online platforms used to take in deposits from people in other European Union countries are also increasingly used as way to finance banks.

The Bank of Estonia suggests that tax changes should consider the operation of the financial sector and the way the economy is funded. The stability of economic funding depends on the financial resilience of banks. Banks may be looking at considerable loan losses in the conditions of the recession, which can be offset by strong capital buffers.

The central bank recommends taxing commercial counterparts in a way to motivate them to hold on to record profits and discourage dividend payments. The Bank of Estonia also prioritizes a maximally universal system of business taxation.


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Editor: Marcus Turovski

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