Baltics fret on Nordic bank reliance

Posted on August 3, 2016

Home ownership is out of the reach of many first-time buyers, as well as swelling the debt burden for those who do buy©Bloomberg

During the 2007-08 global financial crisis, Swedish banks looked anxiously at the Baltic states. Their economic contraction hit Swedish lenders hard and caused regulators in Stockholm to worry about collapsing real estate markets in Estonia, Latvia and Lithuania.

Now, the boot is on the other foot. And the rising concern in the Baltic banking sector is another sign of the imperfections of Europe’s financial system.

    Take Lithuania. More than 90 per cent of its banking assets are controlled by foreign lenders (the numbers are little different for Estonia or Latvia).

    That has been due to a deliberate policy of successive governments to encourage transparency and competition, while driving out corruption. “The close ties between local banks and local business were too often based on corruption, and that hurt the entire economy,” said one former minister in Vilnius.

    Nordic banks flocked in. In Lithuania, the three biggest lenders are Sweden’s SEB and Swedbank and Norway’s DNB. All three stayed in the country even as gross domestic product fell by more than a fifth in dollar terms from 2008 to 2010.

    But some officials in the three Baltic countries are becoming nervous about what these banks are doing in their home markets. Stefan Ingves, the Swedish central bank governor, told a conference in July that “concerns are now going in the other direction: the Baltics are worried about real estate in Sweden”.

    Negative interest rates in Sweden — and record low rates in Norway — have led to dizzying increases in housing prices, and fears of a bubble. Risks to financial stability appear to be growing in both countries.

    And the concern in Vilnius is common to many small countries across Europe with a preponderance of foreign banks: if there is a crisis in the lender’s home market, will they stop lending or even withdraw from our country?

    “We are following what is happening in Stockholm and Oslo very closely,” says one senior Lithuanian official. “We remember that, in 2008-09, banks practically stopped lending. For the government, it was a big headache.”

    Nicolas Véron, a senior fellow at Bruegel, the economic think-tank, notes that about half of eurozone countries are faced with a similar dilemma, as more than half of their financial sector is based outside their borders.

    Countries are not without protection. SEB, Swedbank, and DNB all operate as subsidiaries in Lithuania, meaning they have their own local balance sheets and capital under separate supervision. That means the Lithuanian subsidiaries are supervised by the European Central Bank while the parent banks — all headquartered outside the eurozone — are overseen by Swedish or Norwegian regulators.

    In a crisis, the possibility of withdrawing money from Lithuania to cover losses in Sweden is there . . . We don’t want a confrontation with the banks, we just want an alternative

    – Lithuanian official

    Parent banks are still able to repatriate some of their subsidiaries’ capital, though. Swedbank, for instance, paid itself an extra dividend of €491m earlier this year from its Lithuanian subsidiary while stressing that the Baltics were still “a home market”.

    Its total capital adequacy ratio stood at 23.9 per cent after the dividend, above the minimum set by regulators but down from the 40 per cent at the end of 2015. Nordic banks also have some of the highest capital levels in Europe, as proved by the recent stress tests.

    But experts still worry that foreign banks can potentially make the system more fragile in times of a crisis — as in 2008, when many lenders closed down overseas operations. Harald Benink, professor of banking and finance at the University of Tilburg in the Netherlands, says: “It makes things more complex, more complicated. What happens if the home country [Sweden or Norway] bank gets into trouble?”

    He points out that Swedish and Norwegian banks largely avoided the fallout from the 2008 financial crisis — aside from trouble in the Baltics — meaning that their commitment to Lithuania has yet to be tested by a shock at home.

    Lithuanian officials seem to be aware of the risk and are trying to boost the alternatives to foreign banks by reforming local credit unions, boosting fintech start-ups and shadow banks, and encouraging pension funds to invest more at home.

    As the senior official acknowledges: “In a crisis, the possibility of withdrawing money from Lithuania to cover losses in Sweden is there . . . We don’t want a confrontation with the banks, we just want an alternative.”

    richard.milne@ft.com

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