Bank of Estonia: Money laundering scandals may drive up cost of loans

Former Bank of Estonia Governor Ardo Hansson.
Former Bank of Estonia Governor Ardo Hansson. Source: Priit Mürk/ERR

The reputational damage resulting from suspected money laundering in Nordic banking groups may impair banks' financing conditions, thereby rendering loans more expensive and less accessible for Estonian people and businesses, the Bank of Estonia warned.

Thus far, the money laundering scandals have not had a significant impact on Estonia's financial stability and the financing of banks operating in Estonia. The prices of the Nordic banking groups' shares on stock markets have dropped, however, in the midst of allegations. In Estonia, banks are financed primarily through domestic deposits, which significantly lowers the impact on Estonia's financial stability, the central bank said.

The banking sector in Estonia is in a good financial situation and only subject to low risks, it noted. The value of total assets of the Estonian banking sector grew 42% last year, driven largely by structural changes in Luminor Group as the bank's subsidiaries in Latvia and Lithuania became branches of the Estonian-based head office.

Estonia's financial sector has also become more dependent on developments in the economy and banking in Latvia and Lithuania. Changes in Luminor mean that supervisory decisions must now take into greater consideration the situations in banking and economy in the other Baltic states as well. Should Luminor require emergency liquidity assistance, the Bank of Estonia as the central bank of the state of location of the group's head office should be the one to provide it. The risks resulting from changes in Luminor's structure are currently mitigated by the group's strong financial position and high share of own funds.

In Estonia, the financial sector is impacted primarily by rapid wage growth and a high level of confidence, which may increase housing demand and expedite the growth of housing loans.

"During an economically favourable period, people may overestimate their long-term loan capacity and take out unsustainable loans," the Bank of Estonia said. "In recent years, the people of Estonia have been repaying their housing loans successfully and loan losses are very small. Thus, larger banks have now deemed the need for holding capital to cover risks to be lower."

Should the economic situation worsen, however, loan losses may increase notably, the bank continued. To reduce risks relating to housing loans, the central bank intends to impose an obligation on commercial banks in accordance to which 15% of the bank's capital requirement must be calculated on the basis of the volume of housing loans.

Change to second pillar risky

The proposed government's intention to render second pillar pension funds voluntary entails risks to both financial stability and economic balance as well as to the sustainability of the state budget.

"If a number of people withdraw funds from their second pillar fund, it may reduce the value of other unit-holders' units," the Bank of Estonia explained. "The money withdrawn from the pension fund will likely be used for consumption and real estate purchases, which may increase the danger that the economy and the real estate market could overheat, also causing excessive growth in housing loans. If people do not save enough for retirement in a state with an ageing population, the state must find other solutions to ensure pension provision in the future."

Editor: Aili Vahtla

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