As a consequence of the central bank's interest rate hikes, banks' interest income and profits have been rising rapidly, with the Estonian banking sector recording the highest net interest income in the eurozone.
In 2021, the net interest income of Estonian banks was the highest in the eurozone, at 2.1 percent, but it is lower on a longer-term basis than that of Cyprus and Slovakia.
Estonian banks' earnings from interest is mainly influenced by the fact that a significant portion of loans issued here are at variable interest rates, thus interest income varies faster and to a greater extent when interest rates rise or fall.
The average proportion of loans with fixed interest rates for less than a year in the eurozone is close to 65 percent, whereas it reaches 90 percent in Estonia. Loans in Estonia are usually linked to the six-month Euribor, which means that interest rates change twice a year.
While interest rate increases also hike interest expenses, it takes longer than for interest income to grow, Mari Tamm, an economist at Eesti Pank, said.
Tamm explained that following the global financial crisis, credit losses and high operational costs have eroded the profitability of banks in the eurozone. Prior to the crisis, a significant portion of Estonia's bank funding came from foreign parent banks, but after the crisis, the need for this decreased and deposits played a greater role in bank funding. Nevertheless, due to low interest rates, the proportion of fixed-term deposits was relatively modest at the time.
During the price increases, however, interest rates on fixed-term deposits have skyrocketed to levels above the euro area average. In a competitive environment among banks, annual deposit rates have increased to 4 percent.
The European Central Bank considers that bank profitability is critical to their long-term operation. "Banks rely heavily on interest income to fund interest charges, operational expenditures and loan loss reserves. Furthermore, the excess of their expenses, i.e. profits, must be used to grow capital in order to extend their loan portfolio. If the bank is unable to earn enough money, it may be unable to lend, putting its future operations and customers' savings at risk," Tamm said.
Editor: Barbara Oja, Kristina Kersa