Bankovní institut vysoká škola Praha
Estonian banking system
Bachelor´s degree work
Ilya Deriy April 2014
Bankovní institut vysoká škola Praha
Banking managment
Estonian banking system
Bachelor´s degree work
I: Ilya Deriy
Banking management Supervisor: Ing. Zbyněk Kalabis
Prague April 2014
I wrote my Bachelor’s degree work with the subject on the Estonian banking system.
Declaration:
I declare that I elaborated my bachelor´s degree work independently and I stated all the literature used.
I attest by my signature that the submitted electronic version of the work is identical with its printed version, and I am aware of the fact that the work will be archived in the library of the BIVŠ, and further, made accessible to third persons through the internal database of electronic university works.
I´s signature In Prague, or place of residence, on date I´s name and surname
Annotation
Present Bachelor’s degree work shows evolution of the Estonian banking system. The system is presented as a part of the banking sector of the European Union. Special attention in the Work is paid to harmonization of the standards in filed of banking system within the European Union. Separate work’s part gives an idea on structure of whole financial system in Estonia. It is also shown in the research work how concept of e-state is realised in Estonia. Crisis management’s approach is shown on the example of the biggest commercial bank is Estonia – Swedbank AS AS.
Key words: Scandinavian capital, e-state, harmonization, crisis management, European Union, legislation
Anotace
Předložená bakalářské práce rozebírá vývoj estonského bankovního systému. Systém je prezentován jako součást bankovního sektoru v Evropské unii. Zvláštní pozornost je v této práci věnována harmonizaci norem v rámci bankovního systému Evropské unie. Samostatné součásti práce dávají představu o struktuře celého finančního systému v Estonsku. To je také znázorněno ve výzkumné části, rozebírající koncept e-státu v této zemi. Přístup krizového managementu je popsán na příkladu největší komerční banky Estonska - Swedbank AS AS.
Klíčová slova: skandinávský kapitál, e-stát, harmonizace, krizové řízení, Evropská unie, legislativa.
Content
Introduction ... 7
Overview of banking system of Estonia ... 9
Historical facts of development of the Estonian financial market ... 9
Structure of financial system in Estonia ... 11
Legal basis for formation of banking system in Estonia ... 14
Banking sector in the Estonian economy ... 17
Estonian banking system as a part of the European financial system ... 23
Monetary policy of the European Union ... 23
Harmonization of unified standards for banking system ... 26
Overview of one of the biggest Estonian bank – Swedbank AS ... 31
Leading position of Swedbank AS in Estonian banking system ... 32
Activity analysis for the period 2008 – 2012 ... 34
Actual issues of Swedbank’s AS activity ... 41
Conclusions ... 43
List of literature ... 45
Introduction
Modern world economy is a complicated system of interconnected components. It is reasonable to say, that world economy is formulated not only by economic processes, but also by many other factors: most of social, ecological, demographic and other factors due to their increasing significance should be taken into account at both national and interstate scale.
International economic relations are of global scale now. This is contributed by technical progress’ level, which definitely helped to increase integration level, on one hand, and to speed up formation of global capital market, on the other hand. At the same time it is possible to say, that international trade volumes increased together with investments.
Thus, scientific and technical progress is asking for larger financial means. This circumstance lets to say, that a lot of factors stimulate interconnection between state and banking sector. Among these factors are: political situation, economic culture, monetary and credit policy, inflation rate, state of financial and credit sector, competition degree, degree of state regulation, level of banking technologies, the degree of demand of banking services and many others. It will be not right to exclude of that list also laws, which regulate banking activity, and to evaluate them from the point of view of bank’s profitability, level of specialisation or universalism of a bank. Considerable importance has also marketing environment and existing level of risk.
Currently money is a necessary part of banking system and efficiency of banking system depends on state regulation, what means determination of money supply and establishment of credit rates. Obviously, that role of the state means also control to make rules and avoid of problems in the system. Especially high significance at present belongs to banking management, which role considerably has grown after global economic downturn of 2008.
The above gives a possibility to designate importance of banking system for global economy. The object of the Bachelor’s degree work is to make an overview of the Estonian banking system. To achieve the goal following objectives are set:
to study stages of evolution of the Estonian banking system;
to analyze theoretical base, statistical data, essential indicators of banking system in
Estonia;
to analyze legal basis both of the European Union and Estonia concerning banking sector;
to identify trends within the Estonian banking system;
on the example of the biggest Estonian bank – Swedbank AS – to prove efficiency of crisis management in downturn period;
to formulate conclusions on the basis of the facts.
The study is based on related literature, public reports, statistics data, legislative of Estonia and legislative of the European Union, and internet resources.
Overview of banking system of Estonia
Historical facts of development of the Estonian financial market
Today Estonia is known as a country that joins Baltics with Scandinavia. Distinctive feature of Estonia for sure is growing economy, stable finance system and highly developed IT-sector.
It is possible to say about self-sufficient banking system in Estonia since the country became an independent again in 1991. However, Tartu Commercial Bank has started its activity already in 1988 and it was the first commercial bank at the territory of former USSR.
Later there were about 40 banks in Estonia, which had Iisation for banking activity (population of Estonia in 1991 was about 1, 5 million), but not all of them started their activity in banking. Unlike modern banks, Estonian banks were specialized only at currency exchange operations and speculation in early 1990-ties. That was the main reason for numerous bankruptcies that period. Unfavourable situation in Estonian economy of that period was neither good for development of loan business nor for raising funds from public.
Estonian Bank 1(Central Bank of Estonia) has been established and became very active since 1990. In conditions of over-banking Estonian Bank was forced to work on strengthening of stability of whole banking sector. The first and very significant step was requirement to increase minimum capital. The goal of the step was to increase degree of confidence to whole banking system in Estonia. Thus Estonian banks were able to overcome two bank crisis – in 1992 and then in 1994. Weak banks were made either to merge with more stable banks or to bankrupt.
Another significant fact in evolution of banking system in Estonia is monetary reform, thanks to which Estonia first in ex-USSR got its own convertible currency – Estonian kroon (June 1992). Estonian kroon was pegged to German mark at the rate 8 Estonian kroon for 1 German mark. Currency exchange market was absolutely free for both individuals and enterprises. I considers as necessary to accent the fact that exchange rate remained the same also until end of 2001 (Germany introduced euro as a local currency in 2002). To reach
1 Eesti Pank – official name of the Central Bank of Estonia in Estonian
macroeconomic stability Estonia made an accent on using of particular monetary system – currency board that had been used since Estonian kroon became a local currency. Gold and foreign exchange reserve, necessary for currency board to be able to function, were got from Bank of England, Swedish government and International Settlement Bank in restitution order.
At the beginning Estonia had 90% backing of the Estonian kroon and obligations at Estonian Bank. However, quite soon it increased up to even more than 100%. According to the law that was in force at that period whole Estonian kroon supply in circulation must be backed by gold and convertible currency reserves.
Since Germany started to use European currency euro, as of 01.01.1999 (in non-cash payments), also Estonian kroon was pegged to euro. Since January 1st 2011 Estonia became seventeenth country in European Unit, which officially started to use euro as local currency.
Initially there was a plan to adopt euro already in 2007, however, Estonia needed to fulfil Maastricht criteria in respect of inflation.
It is not possible to make an overview of banking system separately from economic situation in the country. 1990-ties are known by total downturn in economy. The cumulative decline of Estonian Gross Domestic Product during 1990 – 1994 was close to 36%2. As of 1995 period of economic growth has started. Position of the banking system was the strongest in 1996 – 1997 in Estonia, the same as the whole economy in the country. Geographically Russia is quite close neighbour of Estonia. On one hand, that fact affected close cooperation in economy between Russia and Estonia; on the other hand, decline of Estonian economy in 1999 was resulted by Russian economy crisis in 1998 too. Thanks to flexibility of the Estonian economy and to determination to the European market, there were signs of growth in Estonian economy already in 2000. Talking about problems in banking system, it is necessary to mention that due to forced mergers number of the banks in Estonia had gone from 12 (1997) to 6 (1999). Exactly by that time expansion of Swedish major banks to Estonian banking sector began. Swedbank AS was the first, which came to the market. Swedbank’s AS activity has started with investments to Eesti Hansapank, the biggest bank in Estonia of that period. SEB bank followed Swedbank AS by getting stakes in Eesti Ühispank, the second
2Source:
http://www.estonica.org/en/Economy/Transformations_in_the_Estonian_economy_in_the_1990s/Changes_in_th e_economic_structure/
largest bank after Hansapank. During next few years also Finnish capital has taken its place in Estonia. Thus, it is possible to say, that since 2001 Estonian banking system is integrated into Scandinavian banking system trough largest both Swedish and Finnish banks.
Thanks to both coming of Scandinavian shareholders to Estonian banking sector and their made investments balance sheet of the Estonian banks has obviously improved. It means that confidence in local banking system as key task of Estonian Bank had also increased.
Structure of financial system in Estonia
By financial system in frames of the Bachelor’s degree work is understood complex of subjects, which are operating at the market according to Credit Institutions Act. Structure of the Estonian financial system is shown in Chart 1.
Chart 1. Structure of the Estonian financial system
Source: legislative acts of the Estonian republic
As it is shown in the chart, European Central Bank is a central bank for Estonia as for other EU member-states. Functions and main tasks of the European Central Bank will be set
out in details in Chapter 2 of the Bachelor’s degree work.
Talking about components of the financial system at country level, it is important to mark Estonian Bank, the most significant and principal task of which is to determine and to implement monetary policy of the European Central Bank. Estonian Bank is a member of the European System of Central Banks. Among the most considerable tasks3 of the Estonian Bank are:
1. participation in the formulation and implementation of monetary policy in the euro area;
2. participation in ensuring of financial stability;
3. operation and development of reliable and well-functioning settlement systems;
4. regulation of cash circulation in Estonia and contribution to smooth cash circulation within the euro area;
5. maintenance and increase of Estonia’s official foreign reserves and other financial assets managed by Estonian Bank;
6. collection and disclosing financial-sector statistics and preparation of Estonia’s balance of payments;
7. advise the government to support stable and sustainable economic development in Estonia and cooperation with other central banks and international institutions.
The main tools that Estonian bank uses to fulfil its tasks are associated with full and thorough monitoring of activity of the subjects that are obeying to the central bank. Estonian Bank also observes the report system, supervisions and closely cooperates with both European Central Bank and other central banks.
Banks as a part of financial system, without a doubt, are the most significant element of the system. It has been already considered in the Chapter 1.1. of the research, that the Estonian banks had a fast-growing process of development after Estonia became an independent country again. There are 16 banks4 all together operating in Estonia. 11 of them are members of the Estonian Banking Association5, the organisation founded in 1992. The mission and primary objective of the Association is to promote the development of the banking activities, to improve the banking operations for its members and to follow good
3Source: http://www.eestipank.ee/en/eesti-pank/functions-eesti-pank
4 Source: Estonian Banking Association (Eesti Pangaliit)
5 at 30.11.2013.
business practice and ethics. Key activities of the Estonian Banking Association are as follows:
1. partnership with Estonian Bank;
2. monitoring of the Estonian legislature conform to EU directives;
3. anti money laundering arrangements;
4. working out and improvement of system of payments and standards;
5. guarantee fund;
6. to be a data source in field of banking sector.
Membership in the Estonian Banking Association gives a good opportunity for the Estonian banks to get actual information from other organisations like European Banking Federation and European Payments Council.
At the same time there are so called specialized financial institutions included in financial system in Estonia. Quite often these are operating as daughter companies of the banks; however, the institutions may operate also as separate entities at the financial market.
Widely spread are following field of specialized financial institutions’ services: insurance, investment funds and leasing. Estonian market of such a services is represented by both Estonian and foreign companies.
Insurance sector is represented by independent insurance companies as well as by units, reporting to banks. They are members of the Estonian Insurance Association – organisation, uniting all Estonian insurance companies and branches of foreign insurance companies, which are operating in Estonia on a permanent base. The main goal of the association is to represent common interests of its members to promote insurance business in whole economic and social environment. The association unites also members of the Estonian Traffic Insurance Fund. Thus, there are 27 members in the Estonian Insurance Association all together (16 insurance companies and 11 members of the Estonian Traffic Insurance Fund).
There are companies, based on banking capital, their daughter companies (for instance, SEB Elu – ja Pensionikindlustus AS, Swedbank AS Life Insurance SE, Swedbank AS P&C Insurance AS) operating in Estonian insurance market; also companies specialized just at insurance services (for instance, IF P&C Insurance AS, Mandatum Life Insurance Baltic SE);
Estonian companies (for instance, Salva Kindlustuse AS) as well as foreign companies (for example, Codan Forskiring A/S Eesti filiaal, ERGO Insurance SE, Gjensidige Baltic AAS Eesti filiaal). Leading companies are: IF P&C Insurance AS – 20, 5% of the market, ERGO
Insurance SE – 12, 9% and Swedbank AS P&C Insurance AS – 10, 9%6.
Investment funds have target to get a profit for investors, forming joint investment portfolio by means of raising investors’ funds. Investments are usually made either to securities or to other banks/funds, different investment tools. There are following kinds of investment funds operating in Estonia: contractual investment funds that are usually operating under the banks, and fund management companies operating as joint - stock companies. Besides, there are both mandatory and voluntary pension funds in Estonia.
Majority of the investment funds still are operating as a daughter companies of banks (for instance, Swedbank AS, SEB, LHV, Danske and Norde), especially regarding pension funds.
However, ERGO Insurance SE is managing also investment funds.
It is necessary to mention also relatively small companies, which are operating as consumer credit organisations in Estonia. Their loan services are offered to individuals through short messages (sms). I pays attention to mentioned companies due to the fact that their services partly match to bank’s services.
Currently supervising function within financial system in Estonia belongs to Financial Supervision Iity, founded in 2002 to arrange supervision of all financial market participants (banks, insurance companies, investment and pension funds as well as security market). The supervision activity itself is divided into two areas:
1. market and services supervision 2. prudential supervision
By supervision of market and services are understood initiatives having goal to ensure the transparency, reliability and effectiveness of financial services in Estonia. The objective of prudential supervision is the risk and sustainability analysis of the financial system participants.
Legal basis for formation of banking system in Estonia
Talking about banking system just in Estonia scale, it is possible to say, that it has two-level structure: first level is Estonian Bank and second level is made by commercial banks.
6 Source: http://www.eksl.ee/images/files/Kindlustusturg_2013_3kv_v1.pdf
Essential legislation for operating of all participants of banking system in Estonia is a Credit Institutions Act, which was accepted by Riigikogu7 on 09.02.1999. I likes to accent that in spite of that fact, the Act itself was accepted more than 14 years ago, it qualify to actual tendencies due to numerous amendments, asked by both changes in economic environment and taking into consideration directives and regulations of the European Union.
Briefly I sets out key ideas of the Act below.
§3 gives exact definition of credit institutions: (1) a credit institution is a company the principal and permanent economic activity of which is to receive cash deposits and other repayable funds from the public and to grant loans for its own account and provide other financing.
Important is that fact that credit institutions may operate as public limited companies or associations and the provisions of law regarding public limited companies or savings and loan associations apply thereto unless otherwise provided by Credit Institutions Act (§3 (2)).
Credit institutions have the exclusive right to receive money from the public for the purposes of depositing or to receive repayable funds in any other manner (§4 (1)).
As it was presented in Chart 1 there are financial institutions operating in Estonian financial market. The Act gives a definition of financial institution – a company, other than a credit institutions, the principal and permanent activity of which is to acquire holdings or conclude one or more transactions specified in §6 (1) 1) – 12) of the Act:
1) deposit transactions for the receipt of deposits and other repayable funds from the public;
2) borrowing and lending operations, including consumer credit, mortgage, credit, factoring and other transactions for financing business transactions;
3) leasing transactions;
4) payment services for the purpose of Paying institutions and E-money Institutions Act;
...
8) transactions and acts related to the issue and sale of securities;
...
10) money broking;
7 Legislative Iity in Estonia, Parlament
11) portfolio management and consultations on investment issues.
Credit institutions must hold a corresponding Iisation that is granted for an unspecified term. Moreover, the Iisation is not transferable and cannot be used by other persons. The Iisation is granted by the Financial Supervision Iity.
§16 define when Iisation terminates:
1. in the event of the merger of the credit institution on the basis of subsection or voluntary dissolution of the credit institution;
2. in the event of revocation of Iisation;
3. in the event of the bankruptcy of the credit institution.
§88 gives a definition of banking secrecy. It concerns data on property status, personal data or transactions of the client, as well as information on relationships, the client is admitted as owner or business partner. The managers and employees of a credit institution and other persons who have an access to the information subject to banking secrecy are required to maintain the confidentiality of such info indefinitely. In exceptional cases the information can be requested by:
1. court;
2. a pre-trial investigation Iity;
3. a tax administrator;
4. the State Audit Office;
5. a foreign financial supervision Iity.
Credit Institutions Act is not the only document that regulates banking system. Among laws establishing competitive finance and banking system are following: Commercial Code, Money Laundering and Terrorism Financing Prevention Act, International Sanctions Act, Security Market Act, Financial Supervision Iity Act, Deposit Guarantee Act, Paying Agency and E-money Act, Personal Data Protection Act, Private International Law Act and plenty of specific regulations of the Ministry of Finance of the Republic of Estonia as well as instructions of the Financial Supervision Iity. To reach maximum effectiveness and minimize the risk, there are also obligatory standards and requirements of Estonian Bank. These appear not only in regular Accounting reports, but also in annual, quarter and public reports.
Banking sector in the Estonian economy
The quality of the banking services that are offered by majority of the Estonian banks is at quite high level. Full range of the banking services is offered for both Estonian and foreign customers. Thanks to agreements concerning investment protection with many countries that Estonia has (among them are Austria, Belgium, Luxembourg, Czech Republic, Denmark, Finland, Sweden, Latvia, Norway, Holland, United Kingdom, USA and others) banking sector is getting even more attractive for foreign customers. Besides, according to the legislation, there is a special guarantee fund that protects deposits and investments of the depositors in Estonia. It means that all bank deposits and investments up to 100 000 EUR are fully protected in event of bank or investment fund bankruptcy. I accents, that participation in the guarantee fund is obligatory for all Estonian banks; talking about branches of foreign banks operating in Estonia it is important to specify that their bank deposits and investments are guaranteed by guarantee fund of the appropriate country.
It is wide-known fact that Estonia positions itself as e-state. Being a good reformer, Estonia set as a priority efficient development of state management and a project “E-riik”8was chosen as a tool to handle the result. The project concerned whole country and was made to increase a computer literacy and to provide internet availability at its first stage. So called responsibility centre of bureaucratic system was brought out at the second stage of the project;
responsibility centre was the point, which slowed the rapidity of provision of services in state sector. In framework of “E-riik” state registers were unified and a central database was established. Third stage is known by adding of data of all state institutions to single database.
In result of the project state institutions got a single electronic tool that was made to serve the population in few times faster than before. According to statistics there were 76% of Estonian inhabitants in age between 15 and 74 years who used internet as at June 2011, 74% of all households in Estonia had an internet connection (to compare: 34% in 2005). For the moment almost all of households can be connected to the internet and thanks to the state program there is a wide developed free Wi-Fi internet connection system in Estonia. Working on educational part of the “E-riik” Estonia realised few projects to increase the computer literacy level, among them were “Kьlatee”, “Oleme koos!”9 and others. Thanks to special funds, also of European origin, not only educational level was in focus, but inhabitants were able to get
8 E-state in Estonian
9 „Country Road“, „Be together!“ in Estonian
personal computers. It is necessary to mention an effect that “E-riik” had onto banking sector.
Since the banking electronic Iisation system was implemented, it became possible to pay for the state services; taxes and arrange other payments using internet tools. Today every Estonian resident is able to benefit e-system using personal ID-card10. ID-card can be used to confirm the identity still to get state services and even to take part in e-elections. Besides, using the ID-card it is possible to submit annual income tax declaration and even to register new company within 20 minutes. It is possible to say, that Estonia has its own nationwide successfully existing informational system.
The e-system concerns also banking sector in the country: there are possibility to manage bank’s account by means of IT-technologies in different ways:
1. using ID-card 2. Mobil-ID 3. phone bank
4. PIN-calculator for internet bank.
According to data of Ministry of International Affairs more than 70% of banks customers are using internet bank to arrange banking operations. Moreover, a lot of bank clients use special applications for Smartphone, that also let to access to customers’ own accounts at their preferable time.
So according to Financial Supervision Iity data there are following eight banks registered in Estonia:
- AS DNB Pank
- AS Eesti Krediidpank - AS LHV Pank
- AS SEB Pank - BIGBANK AS - Swedbank AS AS - Tallinna Дripanga AS - Versobank AS
And eight more affiliated branches of foreign credit institutions:
10 ID-card is identity document, containing all personal data at microchip
- AS Citadele banka Eesti filiaal - Bank DnB A/S Eesti filiaal - Danske Bank A/S Eesti filiaal - Folkia AS Eesti filiaal
- Nordea Bank Finland PLC Eesti filiaal - Pohjola Bank plc Eesti filiaal
- Scania Finans AB Eesti filiaal
- Svenska Handelsbanken AB Eesti filiaal.
To introduce banking sector in Estonia, I of the Bachelor’s degree work uses materials of the Estonian Financial Market Services overview of the Financial Supervision Iity, published at 25.09.2013. The overview allows using to estimate essential trends of the banking sector in Estonia comparative analysis method. Depending on data available there will be either two or three periods compared – 30.06.2012. and 30.06.2013. or 30.06.2012., 30.12.2012. and 30.06.2013. accordingly.
As it has been previously mentioned in the Bachelor’s degree work already, the banking sector in Estonia is open for both Estonian and foreign clients, that are divided into two groups – legal and private persons. According to overview of the Estonian Market Services the most popular service used by private clients in Estonia is demand deposit (current account). So there were 2 226 thousand current accounts11 held by private persons in Estonian banks. Taking into consideration total population in Estonia (1, 29 million permanent residents12) it possible to state that there are many individuals who have more than one current account is use. The second most frequently used banking service is pension funds. If compare number of individuals who had a contracts with pension fund as of 30.06.2012. with number of individuals having contract as of 30.06.2013., it went out that it increased from 739 thousands to 740 thousands.
Loans were the most actively sold service in Estonia during favourable period in economy (until 2008). Period of downturn in economy, certainly, affected also volume of the service.
As at 30.06.2013., according to Financial Supervision Iity data, there were 707 021 valid loan contracts for individuals. Consolidated loan portfolio volumed to 14,18 billion EUR.
Interesting fact is decrease of loans for individuals and companies (by 37 million EUR and 47
11 Current accounts with balance
12 Source: Statistics Estonia, population census 2011 data
million EUR accordingly) versus increase of financial institutions loans and loans to government (by 135 million EUR and 4 million EUR accordingly). Obviously, the main reason for decrease of individual loan market related with situation at employment market, with banking risk management and credit rates, which increased drastically. As a result, the volume of loans for individuals decreased in all types of loans in the first half of 2013. Table 2 shows individual loans evolution by three periods.
Loan type At 30.06.2012. At 31.12.2012. At 30.06.2013.
Housing loans 5 832 5 825 5 822
Study loans 200 195 182
Consumer loans 417 391 381
Overdraft 29 29 27
Credit cards 166 162 156
Other loans 312 303 298
Table 1. Volume of loans to individuals (in million of EUR).
Source:Estonian Financial Market Services overview, Financial Supervision Iity, published at 25.09.2013.
Paying attention to average loan volume to individuals, that amounts vary insignificantly, it is possible to say, that the loan market is stable, just the loan terms have changed. There is data on average balance for loans to individuals included in Table 2. The most noticeable changes are in part of housing loans (decrease), study loans (increase) and other loans (increase).
Loan type At 30.06.2012. At 31.12.2012. At 30.06.2013.
Housing loans 37 264 37 064 36 824
Study loans 2 147 2 183 2 192
Consumer loans 3 251 2 788 2 787
Overdraft 248 300 283
Credit cards 447 746 742
Other loans 17 695 13 574 13 871
Table 2. Average balance of loans to individuals (in EUR).
Source:Estonian Financial Market Services overview, Financial Supervision Iity, published at 25.09.2013.
Total number of loan agreements decreased in all loan types in the first half of 2013, excepting housing loan agreements and overdraft.The Estonian loan market has been divided between four major banks, which hold 91% of whole loan market. The biggest market share belongs to Swedbank AS, then SEB Pank, Nordea and Danske Bank. The remaining 9% of the loan market in Estonia is distributed between 12 participants. The Estonian loan market
shares are presented in Chart 2.
Chart 2. Structure of banking sector. Market shares by loans issued (at 30.06.2013.)
Source:Estonian Financial Market Services overview, Financial Supervision Iity, published at 25.09.2013.
Of course, not only current accounts and loans make banking system in Estonia.
Deposits made 2 981 445 valid contract in the Estonian banks as at 30.06.2013. with total deposits volume 12, 8 billion EUR. The service volume increased by 2% if compare to 31.12.2012. data. One third of the deposits are of fixed-term deposits. The greatest market share belongs to companies deposits, which made 44% of the service with a total volume of 5,6 billion EUR. Individuals held 42% of the deposits with a total volume of 5,3 billion EUR.
Deposits of financial institutions13 made up 7% of the market, government deposits – 8% of the market. It is worth to mention, that in spite of the fact, that the biggest market shares of banking services by types of services are held by Swebank and SEB Pank, the biggest participant on the government deposits service is Nordea Bank Plc Finland. Chart 3 contains data on market share by banks.
13 Insurers and pension funds, ohter financial institutions
Chart 3. Structure of banking sector. Market shares by deposits (at 30.06.2013.)
Source:Estonian Financial Market Services overview, Financial Supervision Iity, published at 25.09.2013.
Overall it is possible to say that the Estonian banking sector is quite stable and has a good potential to develop. First of all it is determinate by the stability of main share holders of the biggest banks, such as Swedish and Finnish banks. Predictability of the Scandinavian economy gives an additional confidence to the local, Estonian, banking sector. Obviously, Swedbank AS and SEB Pank will be the main participants at the market in future. Thanks to successfully developing IT-sector in the country, banks will have better opportunities for improvement of both quality and service range. If compare the Estonian banking sector to banking sector of the Czech Republic, it would possible to find a common between the systems: both are mainly based on foreign capital, therefore share of foreign assets in aggregate capital is high, and they do not have rather big potential for growing. Thanks to profitable geographical position both markets have enough big number of foreign customers.
Estonian banking system as a part of the European financial system
Monetary policy of the European Union
First of all it is necessary to give a definition of monetary policy. Monetary policy means a process of regulation that holds a monetary Iity of the country to reach stability in the economy. The main arrangements of the process are focused at money supply and interest rates. In scale of the European Union monetary policy is understood as a process having goal price stability in euro zone. To implement the European monetary policy there is a European System of Central Banks, which consists of the European Central Bank and central banks of whole European system, with no reference on obligatory joining to euro zone. Each part of the system has its own task, which should be done to whole system to function perfectly.
The core object of the European System of Central Banks is European Central Bank, which is independent in decisions making and their implementation, the same like, for example, Estonian Central Bank. However, European Central Bank manages own tasks and goals with close collaboration with all central banks of the European Union member states. As it comes out of the monetary policy goals, primary task of the European Central Bank is to maintain price stability14 within the European Union, meaning also balanced economic growth, full employment and support to economic policies of the European Union. On the practice it means that average annual level of inflation should not exceed 2%. These criteria are under ongoing control due to their significance to the European Union: stability of one member state is in interests of other member states. Reason for that is stability in the European scale.
Organisational structure of the European Central Bank is represented by three main bodies, which consist of the European System of Central Banks of 28 member states. The European System of Central Banks operates in the European Union since June 1st 1998 and it is federative by its structural nature. As other banks, also European Central Bank is legal entity with own statute capital and reserves. The operational structure, revealing the
14 Treat on the Functioning of the European Union, Article 127 (1)
mechanism of monetary policy realisation within the European Union, is shown in Chart 4.
Chart 4. Structure of the European Central Bank
Source: www.ecb.europa.eu
Governing Council is main decision-making body of the European Central Bank. It consists of 6 members and presidents of the central banks of 17 euro zone member states.
Among key tasks of the Council are:
approval of the main guidelines and making of decisions that are necessary to fulfil basic tasks of the Eurosystem;
formulation of the euro zone monetary policy. This task includes decisions in sphere of monetary objectives of the euro zone, also key interest rates, supply of the reserves as well as establishing of the guidelines, which are necessary for these decisions to be implemented.
Members of the Executive Board are president, vice-president and 4 members. Basic tasks of the body are as follows:
preparation of the Governing Council meetings;
implementation of the monetary policy according to the guidelines and decisions confirmed by the Executive Board. This institution also instructs national banks of the euro zone.
management of the day-to-day business of the European Central Bank;
exercise of the certain power that is delegated by Governing Council.
It is necessary to accent the fact that part of the Iities are of regulatory nature.
General Council consists of the President of the European Central Bank, Vice- president of the European Central Bank and representatives of national central banks of 28 member states of the European Union. President of the Estonian Bank is a member of the General Council too. Quite important is to understand transitional nature of the body, which actually is acting in field, undertaken from the European Monetary Institute, which the European Central Bank is required to perform in Stage Three of the Economic and Monetary Union, taking into account the fact, that not all member states have adopted euro yet. Thus, General Council will be dissolved from the day when all the European Union member states have euro as common currency. Nevertheless today the Council is carrying advisory functions, collects statistical information, prepares Annual Report of the European Central Bank and establishes the rules for standardisation of the accounting.
Referring to the Chart 4 I likes to accent that the European System of Central Banks is a financial regulation body, acting as supranational institution and consolidating the European Central Bank and national central banks of the member states. This two-levelled system asks all decisions to be made as a single solution and with close collaboration of representatives of national central banks.
As for environment, in which monetary policy operates, so it is significant to accent that, from one side, all member states are understood as parts of a whole in terms of finances and economy. It means that monetary policy is applied as if the European Union was one state, in which interests euro is used. From other side, taking, for instance, public finance aspect (amount of the contribution), it is absolutely clear that the European Union consists of independent states, having own finance and taxation system. Result of these own systems is different level of development of both national economy and competitiveness, also in scale of the European Union.
Another important problem of the monetary policy within the European Union is so called Maastricht criteria (price stability, government budget deficit, exchange rates, long- term rates and government to GDP debt ratio). From one side, there is an obligatory correspondence principle, when the state is not able to adopt the euro as a local currency without correspondence to the criteria; and because of difference in economic development there is no guarantee, that the member state will keep the correspondence to Maastricht criteria after euro is adopted.
Harmonization of unified standards for banking system
The key task of banking legislative of the European Union is to establish single and
“transparent” market of the banking services within the European Union. According to task there are few principles defined:
by single Iisation principle is meant that Iisation still is issued by national supervision Iity and are accepted by other member-states of the European Union;
by clearly codified control and supervision principle are established principles themselves and approaches used by finance Iities at domestic level to fulfil their supervision duties. Liquidity, paying capacity, deposit guarantees and risks are considered for the first;
among single unified economic standards the most important are such as minimum capital of credit institution, major credit risk standard and others.
The above principles are fixed up by Directive 2006/48/EC and they lay the foundation for the harmonization.
Harmonization itself is a convergence of national law of the member states and law of the European Union. As a legal instrument of harmonization process within the European Union is admitted directive – special kind of legislative act, which is not of direct application nature, but needed to be implemented in law system of the European Union member states.
Moreover, the member states have right to choose in what kind of methods and forms directives will be implemented. It means, that directives may transform into any kind of legislative documents in the legislative system of the appropriate member state.
Implementation concerns the European Union’s directives; however, conception of harmonization concerns just national law. There is a definite term of implementation fixed in
the directive. So it is important to understand, that the only in case if implementation term is not followed, directives have direct force. After directive implementation takes place, the text of the national legislative act is sent to the European Commission, which strictly monitors the harmonization process within the European Union.
Harmonization and unified standards for banking system are targeted for guaranteeing creditors’ and third persons’ rights related to economic activity. Exactly harmonization lets to take into account features of national laws. Directives, establishing rules for European legal persons in rather wide range of issues, are accepted by the European Council. Among them are also directives that regulate also procedures of establishing, reorganization and basic principles of financial reporting.
Surely the most important document in system of the European law concerning law harmonization in field of banking system is Basel Capital Accord, or Basel I. The document has been published in 1988 and significantly affected subsequent development even of global banking system. Later on New Basel Capital Accord, or Basel II, it has been appropriately elaborated, taking into account changes in the business environment. Basel Capital Accord is a document that has been worked out by Basel Committee on Banking Supervision and came into force as of 2007. Goal of Basel II is strengthening stability of the financial market.
Application of Basel II provisions within the European Union is provided by means of Directives 2006/48/EC and 2006/49/EC, which are mandatory for all member states as of 2007. Estonian banking system has adopted principles of Basel II through Credit Institutions Act and investment market – through Securities Market Act.
Speaking of Basel system’s goals and principles it is worthwhile to mention key factors that affect stability of banking system such as globalisation of banking service, i.e. banks are operating worldwide; widening of banking services and so on. These are key prepositions of growing necessity to pay attention to the problem of banks capitalization. Exactly because of that Basel II focuses at banking supervision, internal methodology; accents bigger flexibility and stimulates risk management issues. Basel I established requirements to credit risk and appropriate Risk Weighting of Assets, which should be at least at 8% level. This concerns two capital levels:
first level capital consists of regulatory capital and ploughed back profit (Tier 1 capital);
second level capital includes also additional internal and external resources, available
for a bank at long-term perspective (Tier 2 capital).
It is important to say that at least half of the bank’s capital should be of Tier 1 capital. Basel II, in turn, declares three principles (Pillars), which should ensure security and stability of the financial system:
first pillar concerns requirements to required capital depending on both credit and operational risks;
second pillar assume process of the control under risks – liquidity risk, pension risk, strategic risk, legal risk and so on;
third pillar concerns market discipline issues: accessibility of information on risk management methodology.
Basel I was a response of the banking community and supervising institutions onto numerous events of bankruptcies of the banks that took place in 1970-1980. If at the beginning Basel Capital Accord was of guidance nature, then up to date there are more than 100 countries adopted the document. Certainly, Basel I positively affected the work of the banking system not only in Europe, but also worldwide. Moreover, if at first the recommendations were elaborated for major international companies, then later on the document has been available for whole banking system, including banks and other credit institutions. Evidently, that crisis in banking system, that took place in 1990-ties, determined necessity to work on criteria of banking activity again. So, one of the most significant problems that has been solved by Basel II was compatibility of Basel system and national accounting standards.
At the time of preparation of the Bachelor’s degree work, there are also Basel III standards that were developed as a response to financial crisis of 2008. Some economists suggest that reasons for the crisis of 2008 are referred to field of national standards concerning the financial intermediaries; the standards are not qualified to present-day requirements. Therefore Basel III began with introduction of a capital adequacy ratio to increase bank’s liquidity.
Table 3 gives a very good understanding of the Basel standards evolution showing all three Basel standards in a comparative mode. Three main groups of factors are taken into account: methodology, capital requirements and risks. It is necessary to admit, that from Basel I to Basel III additional factors became more important to the finance system. It is determined by changes in world economy and by growing significance of stability of
worldwide financial markets.
Basel I Basel II Basel III
Methodology Methods of approach to regulative capital calculation and definition are established.
Orientation at
qualitative indicators of capital adequacy.
Allowance on internal banking methodologies of risks to be used.
Orientation at
qualitative indicators.
Two more indicators were added:
supervisory process and market
discipline.
Still allowed to use internal banking methodologies on risks.
Instructions on standards, which are used for payments to owners and
managers.
Introduction of requirements on banking supervision in sphere of norms for capital adequacy and market
discipline.
Capital requirements
Capital adequacy ratio is considered depending on country credit rating only.
Capital adequacy ratio’s differentiation is considered
depending on each borrower’s credit risk.
Risk management part is getting more significant.
Structure of bank’s own capital was changed.
Requirements to capital adequacy were raised.
Additional capital buffer was
introduced.
Mechanism of contrcyclic regulation was established.
Risks Only one risk is
considered.
Unified standards for risk assessment worked out by Basel Committee on
Banking Supervision.
Credit, market and operational risks are considered.
Possibility to choose an approach for risk assessment
depending on internal ratings.
Possibility to invite
Credit, market and operational risks are considered.
Possibility to choose an approach for risk assessment
depending on internal ratings.
Possibility to invite
independent rating agencies for risk assessment purposes.
independent rating agencies for risk assessment purposes.
Necessity to review separately credit portfolio risk and trading portfolio risk.
Transparency principle and information accessibility on banking risks and on risk management.
Table 3. Comparative table of Basel I, Basel II and Basel III.
Source: http://fingazeta.ru/discuss/49630
Basel II and Basel II are not the only documents which have been adopted by Estonia to make the legislative in line with the European Union. Following directives concerning banking sector are in force also in Estonia: Markets in Financial Instruments Directive, Reorganization and Winding-up of Credit Institutions Directive, Money Laundering Directive, Deposits Guarantee Schemes Directive, Financial Collateral Directive, E-money Directive and others.
Analyzing the process of harmonization in field of banking system and recognizing its significance still is necessary to put an accent onto reasons that might affect the process. First of all among them is communication problem and information exchange problem. In spite of the fact, that more than 100 countries are following Basel standards, the problem of competence, interpretation still exists. Obviously, changes in both economy and banking system will ask for Basel Accord to be revised again in future.
Overview of one of the biggest Estonian bank – Swedbank AS
Speaking about banking system is impossible to ignore banking management aspect.
Due to the fact that profit-making in combination with assets’ safety is one of the main goals of any bank’s activity, obviously a special system has to be set up to reach the goals.
Bank is working with borrowed funds; therefore risk factor should be taken into account.
Banking management is a system that handles the processes of monetary resources’
formation, or interconnected set of financial management and management of the personnel involved in banking processes. Taking into consideration the fact that business environment is fast changing one, the most significant role takes exactly risk management.
Bank is ever oriented at profit-making, at the same time this process is directly connected with risk. From that point of view ineffective risk management might raise a problems in a bank for the first; later on it may affect also companies and individuals who are clients of the bank. This is resulted by the special place banking system takes in economy. In global scale banks are involved also in processes of national currency stabilisation as well as to sphere of both material and monetary resources using in economy. In point of fact banking management, as other kinds of management, includes processes of planning, analysis, regulation and control.
Planning allows covering both strategic and tactic tasks of the bank, considers long- and short-term perspective; it is solved at all bank’s levels and also separately at departments’ level. Thus, planning is an operating bank model that takes into account competitive character of the banking service market and works up plans of bank’s activity, including aspects of its own credit, investment, personnel and other policies.
Analysis is directly related to the function of planning, first of all because of results of the analytical work, that are usually used in forthcoming budgets and plans. Analytical data are used to compare actual results with planned data; these also help to take into account eventual potential using previous period’s results. Other words saying analysis helps to identify dynamics in appropriate indicators. Analysis is also intended to compare own indicators with the same indicators of competitors, giving a full vision of the market situation. Very important feature of the analysis is possibility to correct already existing
plans and to make a strategy in appropriate kinds of activity.
By regulation in banking management is understood that part of management that concerns government supervision of the banking sector. As it has been mentioned in the Bachelor’s degree work already, this function is held by Finance Supervision Iity in Estonia. The Iity cooperates with the Estonian Bank, following regulations of the European Union in field of banking activity. Regulation concerns not only issues of Iisation, but also such an indicators as capital adequacy, liquidity, required reserves and - what is rather significant - limitations on these kinds of activity, which are of high risk.
Function of regulation is realized through following to internal instructions and normative.
Control presents both internal and external control, what are made by internal and external audit accordingly. Exactly bank internal control is a part of banking management.
The prior task of the control is to detect unfavourable trends in bank’s activity and to avoid of wrong decisions to be made.
Leading position of Swedbank AS in Estonian banking system
Giving a definition to banking management it is pertinently to pay attention to the examples of its principles implementation. Getting back to previously said in the research work, there are reasons to assume Swedbank AS as one of the biggest and the most successful banks in Estonia. To prove this I refers to the fact that according to annual research15 of TNS Emor company Swedbank AS is named by the most famous large enterprise in Estonia. Swedbank AS has got that title for the sixth time already in 2013.
SEB Pank, the second large bank in Estonia, takes eighth place of the TOP. Such a big difference might be a result of banking management policy, of strategy of its realisation.To understand how large Swedbank AS is, I refers to the statistics: having total population in Estonia by 1,3 million people, 1 million people are customers of Swedbank AS, besides, 122 thousand corporate customers are using Swedbank AS. The bank has quite wide branch net, having altogether 52 offices within Estonia employing more than 2300 employees16. Swedbank AS has issued 1,1 million payment cards.
The history of Swedbank AS begins in 1820, when the first savings bank was founded in Sweden. As for Estonian period of the bank, then it is necessary to say about
15 www.emor.ee
16 As at 30.09.2013., source: www.Swedbank.ee
Hansapank that was established in 1991 in Estonia. Hansapank had strong position at the market and bought shares of Hoiupank in 1997. Swedbank AS, bought more than 50%
shares of Hansapank in 1999. As of 2005 Hansapank is 100% owned by Swedbank AS. It has been decided at General Meeting of Shareholders to rename Hansapank. So, now the bank is known under name Swedbank AS, which is actively used in Baltics since 2008.
Today Swedbank AS is the largest bank in Sweden, Estonia, Latvia and Lithuania with a head office in Stockholm (Sweden). Swedbank AS offers specialized financial services also in Denmark, Finland, Norway, USA, Luxembourg, China, Spain and Russia.To understand present Swedbank AS operational system I uses scheme showing structure of Swedbank AS.
Chart 5. Organisation chart of Swedbank AS Estonia
Source: www.swedbank.ee
As it is shown in the above chart, Swedbank AS 100% owns four daughter companies, which are dealing with specific activity: leasing, insurance, IT-tools. That kind of the structure allows keeping all the processes under bank’s control and undertaking necessary steps in right time. Another two companies, owned by Swedbank AS at 25%, are established
together with other banks. For instance, Certification centre established in 2001 and are owned also by SEB Bank, EMT and Elion17. The company’s mission is to provide reliable and widely used electronic identity system on the market. To fulfil its mission the Certificaton centre provides certification and, validity confirmation and time-stamping services as well as develops and distributes the technology for digital signing and authentication. Background for such a subsidiary to appear is quite obvious: IT-technologies are fast growing and changing sphere and its achievements are widely used in Estonia.
Activity analysis for the period 2008 – 2012.
Using available data on Swedbank’s AS activity, I will analyze banking policy of the Swedbank in respect of crisis management, depending on both economic and market situation during period 2008 – 2012. The period has chosen due to its significance for the economy:
beginning of global recession in economy in the end of 2008 and some stability in 2012.
Comparative approach will be used to be more objective in banking management actions estimation.
2008 year has known as year of recession, or downturn, beginning in global scale.
Being a part of a global economy system, Estonia also was affected by the downturn. Much stricter credit terms were introduced and noticeably falling assets prices were fixed on the market. During three first quarters of 2008 Swedbank AS was focused at enhancing of credit processes and increasing operational efficiency. Large number of staff was involved in reaching the goals, which had to lead to simplifying and rationalisation organisational processes. Bank also made a restructure of own organisation, increasing by that operational effect of insurance business. In source of total income there was decline in net financial gains and losses due to the financial crisis. It is important to say, that after increase of Euribor (main base rate) during first 10 month of 2008, a rapid decline began in November 2008. Thus, local interest rates continued to rise. Swedbank AS, as many other credit institutions, stated increase of risk factor. As a positive moment there was a 30% increase of insurance operations income. Operating expenses mainly were brought by personnel expenses and by Basel II preparation arrangements. Swedbank AS carefully analyzed asset quality due to drastic changes in IV quarter of 2008. The context became worse, first of all, because of segment trend – loans overdue by more than 60 days increased.Getting back to banking management issue is worthwhile to put an accent on its reaction at period when downturn
17 Subsidiaries of Telecom in Estonia, companies operating at telecommucaton market
began. There was an important decision made on governmental level in source of deposits and savings – to raise a deposit protection limit. The limit was risen from 20 000 EUR to 50 000 EUR per customer in Estonia. At the same time Swedbank AS was made to state that its banking services market share felt from 53% to 49% due to the financial crisis.
It is obvious, that the biggest downturn outcome affected results of the 2009.
Following declared within Swedbank AS group principle of decentralisation, Estonian branch of Swedbank AS tried to make such a decisions, which would help to reach program concentration to the customer needs, from one side; and to get a lower risk level with continuous control of the bank’s liquidity and capitalisation. Since there was noticeable decrease of consumption at domestic level, lower volume of investments made and increased unemployment, Swedbank AS was forced to concentrate at increased risk factor. Therefore Swedbank’s AS management undertook such a response to economic downturn, which combined the focus on risks, expense control and income control. Working on customer program, Swedbank AS introduced a special website and so called institute of private finance having main target to raise educational level of the customers in field of finance. In source of total income there was a decrease by 23% due to lower net interest income. Net interest income was negatively affected by wide spread between local and euro interest rates.
Moreover, due to high risk level the bank was forced to re-price 12% of mortgage loans, taking into account actual funding cost. Insurance market also was resulted by economic situation. For instance, in life-insurance business of Swedbank AS indicator of new sales (contracts) was noticeably lower, than in 2008. Because of negative situation in economy Swedbank AS reduced staffing and improved staff’s productivity at the same time. That allowed minimizing operating expenses to optimum level. In source of asset quality, the key indicator from the banking management point of view, Swedbank AS focused on risk level.
Using already existing experience of how to react in similar economic downturn gained in other countries, a special working unit to coordinate work with customers and projects was established. The working unit had a supervision responsibility as well. Besides, it was recognized as appropriate to establish special purpose companies for managing repossessed assets in 2009.
Strategic task of the Swedbank AS in 2010 was still focused on necessity to maintain risk at minimum level. This was the bank implemented the policy of crisis management. The policy included also special plan to maintenance balance between lending and deposits.
Swedbank AS successively followed a policy of strong internal control of credit, market and
operational risks, what should ensure a qualified risk management in long-term prospect.
Since Estonia should join the euro zone as of 1st of January 2011, management of Swedbank AS was awaiting of strengthening stability in the economy. Already in 2010 there were signs of recovery in the economy: business activity increased and affected by itself market of corporate services. To be able to offer to both private and corporate customers to adopt euro as new currency Swedbank AS made investments to IT-projects 1 million EUR. In source of program oriented to reduce the risks Swedbank AS introduced new mortgage loan pricing – Mortgage Base Rate. Earlier mortgage price included a base rate and a customer margin that reflected only a specific customer risk factor. After Mortgage Base Rate was introduced, a new component in the pricing was added – the one, which reflects also external risks.
Speaking about total income of the Swedbank AS in 2010 it is necessary to say that net income was lower by 9%, mainly due to lower net interest income and net gains and losses on items at fair value. Operating expenses decreased by 8%. Ongoing work on increasing of efficiency and labour productivity, activities on processes, work and products standardization allowed Swedbank AS to maintain high efficiency in spite of low income. Already by end of 2010 management made a decision to increase in staff because of business activity recovery.
In source of asset quality bank still was working hard on improvement of credit control policy and therefore increasing that way quality of the credits.
In 2011 Swedbank AS enjoyed position of the market leader with strong focus on the customer. So, Swedbank AS introduced a new program for customer – Private customer loyalty program, which had a key target to help customers on getting maximum service package just from the Swedbank AS. Surely, this was service of another quality. Using benefits of market leadership and growing economy stability, the bank successively was working on competence improvement, increase of educational level of the personnel, all the time offering to the customers services of better quality and efficiency. That period bank was focusing not only at existing customers, but also at getting new ones. That asked for serious efforts from management to develop product service in all market segments. Swedbank AS intended to make noticeable investments in so called e-banking area, Customer Value Management and capital efficiency measurement. Since the most significant problems related to getting out of the crisis were held under control, Swedbank AS paid bigger attention to public sector. So, it had been titled as the most responsible company in the country18.The
18 According to the Estonian Corporate Responsibility index. Source: Swedbank’s AS Annual Report 2011
