TALLINN - Increasingly concerned about "irrational exuberance" on the credit market, the Bank of Estonia and the Financial Supervision Authority, in a letter to the country's commercial banks in December, reminded banks of the need to balance the risks currently posed by overactive consumption, low interest rates and increasing competition in the financial sector.
In addition, the letter highlighted the importance of assessing the risks of a sudden rise of interest rates and clients' abilities to pay back loans in a higher interest rate environment.
Although central bank officials have admitted that the quality of commercial banks' loan portfolio was sound, they stressed that the recommendations were made to "influence the behavior of private persons, companies and banks, and to facilitate a slowing down of loan growth."
Janno Toots, public relations adviser with the Bank of Estonia, said the bank was simply reminding commercial banks of requirements for adhering to the high loan standards in place since October 2002, and the actions taken then have kept the banks well capitalized and risks covered.
In October 2003 the unprecedented growth of home mortgage loans continued, setting a new monthly record of 60 million euros.
The total loan and leasing liabilities of individuals in Estonia has exceeded 1.46 billion euros.
Thanks to KredEx, a state-owned credit guarantee foundation, young families can get a mortgage loan with just 10 percent self-financing instead of the 34 percent prior to the appearance of KredEx. From 2001 KredEx has been providing guarantees to make new apartments and houses more accessible to young Estonians. As of the end of 2003 the foundation had issued guarantees for over 8,100 loans to young professionals and families.
For some banks operating in Estonia, including Hansabank, the mortgage loans portfolio became the main driving force for their growth in 2002 stimulated by the lowest ever Euribor rates.
"KredEx guarantees may allow people to overestimate their borrowing capabilities. In case of an economic downturn excess borrowing may cause difficulties for the households. To revoke housing loan guarantees by KredEx is one of the measures Eesti Pank is suggesting to balance the situation so as to reduce the risk of backlashes in the economy," said Toots.
According to the central bank, helping people receive mortgage loans might cause long-term social problems should an economic recession occur.
The Bank of Estonia also suggested keeping obligatory reserves for credit institutions at 13 percent of total liabilities and eliminating cash-on-hand from the reserve requirement calculation base, although in some of the EU countries such a reserve comprises 2 percent to 6 percent.
The government is expected to make its decision regarding the KredEx loan guarantees for private individuals this month. However, Minister of Economic Affairs and Communications Meelis Atonen stated in December that it was consumption that needed to be reigned in and not KredEx-supported loans to young families.
Bankers said that although they already maintained a rigid risk-assessment policy for all clients, they would take into account the Bank of Estonia's recommendations.
Anneli Rouk, communications manager of Sampo Bank, said the central bank's recommendations basically boiled down to the idea that banks should maintain conservative self-financing requirements while issuing loans to customers.
"Sampo Bank considers every loan application separately, taking into account current income and the future outlook of a concrete client. We have always informed our clients about the potential risks and guided their attention to potential increase of the loan burden in the future," Rouk said.
As far as borrowers, the Bank of Estonia's letter will once again help potential consumers to analyze their economic situation properly before taking on debt, she added.
Meanwhile, Estonia's - and the Baltics' - largest bank, said that the central bank's warnings were justified.
"Today's statistics show that the share of private persons' loans in the overall loan market has gone further up. That justifies the latest warnings of the central bank," said Ando Noormets, communications manager of the Hansabank's Estonian operations.
He added that two years ago the Bank of Estonia had warned about the fast growth of loans and the potential economy overheating.
"Hansabank considers recommendations of the central bank with utter seriousness. The decisions to issue loans are guided by the recommendations of the Bank of Estonia when the present, not the future credit solvency of the lender are taken into account," Noormets said.
Regarding KredEx, the position of Hansabank was ambiguous.
"Time will give the correct estimate as to the recommendations of the Bank of Estonia after they have an effect on the growth in borrowing," Noormets said.