Read the White Paper - Riga Business School

Transcription

Study on the Present Competitive Performance and
Future Prospects of the Banking Industry in Latvia
Andrejs Jakobsons1
William C. Schaub1
1
The authors of this paper would like to thank the professionals in the banking sector who shared their
knowledge during preparation of this study – Mr. Mats Kjaer, Mr. Micheal Bourke and Mr. Jānis
Brazovskis. We highly appreciate the Peer Review comments provided by our colleagues at Riga
Business School – Dr. Raimonds Lieksnis and Mr. Raivis Lucijanovs. We would also like to thank
Mr. Rūdolfs Medvedevs for providing valuable research assistance.
1
Riga
2014
Table of Contents
Background
3
Research and Evaluation Method
3
History of the Banking Sector since the Early 1990’s
4
Banking Sector during the Last 10 Years
4
Current State and Conventional Wisdom Summary
9
The Two Model Banking System
11
Does the Conventional Wisdom (2-model banking) Apply?
11
Is This A Two-Model System or Not? (Are There Banks that Do Not Fall Under The two
Categories?)
15
What are the Distinctive Features of The Current Situation?
17
The Risks
17
The Benefits
19
The Market Opportunity and the Challenges
19
Conclusions
21
Recommendations - Build on Best Practices
21
Annexes:
23
2
Background
The Latvian banking sector has been distinct from the other Baltic countries in the number of
participants and the banking models deployed. All three Baltic countries house large Nordic
banks providing banking services to its residents. These banks provide a wide range of
consumer and corporate banking services. Latvia has in addition to the Nordic banks a number
of banks whose funding is derived from non-resident deposits. These banks also provide
significant transaction processing services as well as private banking services to the nonresident clients. Additionally (but not significantly in terms of market share) there are a host
of foreign and locally owned small banks (commonly referred to as Pocket banks), whose
business consists of banking activities for the shareholders or a small number of clients.
The two primary models provide both opportunities and risks to Latvia. This paper is a
research project that evaluates the performance of the top banks under both models over the
past ten years and attempts to identify the opportunities and risks of the two models in the
future.
Research and Evaluation Method
1. Using publicly available data capture financial statements (balance sheet and income
statement), compiling data and analysis on the top 10 banks competing in the Latvian
market.
2. Review annual reports and regulatory filings available on the top 10 banks.
3. Interview participants in the banking market, regulators, economists and other
competent sources for information, viewpoints, attitudes about the above questions.
4. Obtain publicly available research materials on the banking topics identified in the
questions above on the local, European and Global banking market.
5. Survey the RBS alumni on attitudes and perceptions of the banking sector.
6. Prepare analysis on the basis of the information obtained.
7. Draw conclusions from the information obtained and analysis performed.
3
History of the Banking Sector since the Early 1990’s
The banking sector in Latvia has gone through several stages since the early 1990’s. The initial
boom was represented by emergence of a large number of banks that either merged or
vanished as the sector went through several crises. The initial market leaders – „Banka Baltija”
disappeared after the 1995 banking crisis, while the number of banks gradually declined. The
next shock to the banking system came from abroad as the Russian financial crisis in 1998
unfolded. Several banks were significantly affected (mostly those holding Russian GKOs). A
significant change triggered by these events was the introduction of the deposit guarantee
mechanism in 1998, which initially guaranteed deposits worth up to 500 LVL, a pioneering
scheme at that time aimed at restoring the confidence of depositors after several bank runs
experienced in the past decade. By 2000, the banking sector seemed to have emerged from
the crisis once again and analysts pointed to the need to consolidate further. Foreign
ownership in the banking sector gradually became more common as foreign investors took
advantage of the privatization of Unibanka (now SEB) and took over some domestic banks. At
the same time, the banking sector around the turn of the century was still mostly making
money on commissions rather that borrowing-lending spreads, commercial lending to
individuals was underdeveloped compared to developed countries. A major source of profits
of any bank in a developed country - mortgage lending – almost did not exist due to
dominance of short-term funds and lack of regulation/experience.
Banking Sector during the Last 10 Years
The next pattern in the banking sector was marked by increasing maturities of lending
portfolios. Starting with Latvia’s entry into the EU in 2004 mortgage lending grew explosively.
The management of the sources of funds for mortgage lending differed substantially among
banks. Some of them were fairly conservative focusing on domestic resources; some viewed
foreign deposits as an area of potential growth. However, as several subsidiaries of the bigger
foreign banks „poured” foreign money into the exploding mortgage-lending sector, the rest
of the sector was left with a choice; either to lose market share or to attract foreign funds
more aggressively through other channels. Therefore, the global financial meltdown put the
banks in various positions from a financial perspective. Some of them had been able to
maintain stable positions, while others had to turn for help to either their owners (foreign
banks and other shareholders) or the government (the case of Parex). In any case, the
macroeconomic impact on the government budget was substantial and the international
rescue package included contributions from the EU, IMF, World Bank as well as the Nordic
countries.
Looking at past developments in the Latvian banking sector it becomes clear that almost none
of the crises have had a devastating impact on the whole banking sector. Rather, some banks
usually were more exposed to the risks that existed, but were not always properly identified.
Another way to phrase it is to say that the strategic objectives of the banks differed leading to
different outcomes. Therefore, one of the key objectives of this paper is to evaluate the past
trends as well as the current strategic choices to help define the key ways forward.
4
As the banking sector has gone through one crisis after another during the past 20 years, the
perception about the features embodied by a “well-managed”, „good” and „safe„ bank has
changed substantially. At the same time, the centuries-old story of risk vs. return has remained
an important part of the story. Therefore, one of the goals of this paper is to present the
options and approaches adopted by various banks to handle this issue. In order to assess the
impact of managerial decisions on the performance of the banks, we will also attempt to
evaluate the strategic choices made in the banking industry.
We looked at the banking sector the last ten years with a goal to answer the following
questions:
a. How well has the banking sector in Latvia been managed the past 10
years?
b. How was the pre-crisis performance?
c. How did the top 10 banks fair in credit and operational management
of their institutions during the crisis from the viewpoint of
sustainability?
d. How many banks were sustainable through the crisis?
e. How many needed capital infusions from their ownership to survive?
f. How large was the average capital infusion?
The following graphs provide an overview of the changes in concentration in the banking
sector over the past 10 years. We provide the market shares of the top five banks as the
smaller ones are not likely to provide a big impact on the top players in this industry. Overall,
the banking sector become slightly more concentrated.
Chart 1. Market Shares of Top 5 banks in Latvia in 20042.
6%
20%
8%
Parex
Hansabanka
Unibanka
Rietumu
16%
Aizkraukles
18%
Source. Association of Commercial Banks of Latvia, authors’ calculations.
2
This and the following charts measure market shares based on assets of top banks.
5
Chart 2. Market Shares of Top 5 banks in Latvia in 2013.
10%
20%
Swedbank
SEB
13%
Aizkraukles
Nordea
Rietumu
16%
14%
Source. Association of Commercial Banks of Latvia, authors’ calculations.
The concentration can be more formally measured by several indicators – including the
market share-based concentration ratios and the Herfindahl-Hirschmann Index3 (HHI). The
calculation of HHI for the Latvian banking sector (top 7 banks) indicates that it has increased
from 1150 in 2004 to 1276 in 2013 suggesting a slight increase in the market concentration,
which basically confirms the observations regarding the changes in the market shares of top
banks.
Next, we compare the performance of the top banks in the industry in terms of their profits.
The most straightforward way to describe the situation is to look at the cumulative profits
during the 10-year period under consideration. The performance varies considerably among
the top surviving banks as some of them suffered significant losses during the 10-year period.
Moreover, the comparison is made more difficult due to the fact that some banks have
undergone significant structural changes (for example, state intervention was carried out in
Parex), therefore, the comparisons may not be complete (also, we do not have certain
information about the Nordea Latvia branch). Nevertheless, the overall performance can be
compared for the key banks (see the following chart). The Annex of this paper also provides a
more detailed calculation of the return on assets for the top banks.
3
As the changes of the market shares of smaller banks do not considerably influence size of this
indicator, we have chosen for calculations the 7 largest banks whose market share in 2004 exceeded
5%.
6
Chart 3. Cumulative 10-year profits of the top banks in Latvia (thsd EUR, 2004-2013).
350,000
300,000
250,000
200,000
150,000
100,000
50,000
0
Source. Banks’ balance sheets, authors’ calculations.
The top performers in terms of cumulative profits represent different strategic approaches.
The leader – Rietumu Banka – is known for focusing on attracting non-resident deposits, while
SEB (the second in terms of cumulative profits) represents a mostly-domestic approach. A
similar distinction in approaches can also been seen if comparing the #3 (Swedbank) and #4
(AB.LV). This provides us an indication that the differing strategic approaches have coexisted
in the Latvian banking system in the past 10 years.
However, looking at just the cumulative profits may not be sufficient, as the banks have faced
completely different situations during the crisis in terms of their approaches to financing. An
extreme example in this case is the situation when the Latvian government had to nationalize
Parex Bank using a significant amount of taxpayers’ money. As losses filtered through almost
all the banks were forced to look for additional capital in order to continue their business.
Capital Infusions varied across the spectrum.




Most banks infused capital into common equity (Tier 1)
Some banks used subordinated debt (Tier 2)
To sustain Parex, government capital was used
Other than government, the source of capital was deposit of parent or owners
7
Table 1. A Summary of Capital Infusions in Latvian Banks in 2009.
LVL (000)
Parex/Citadele
139 000 Share Capital
Hansabanka/Swedbank
Hansabanka/Swedbank
87 851 Sub Debt
Unibanka (SEB)
Rietumu
Aizkraukles/ABLV
Source. Bank balance sheets, authors’ calculations.
Note: A tax on dividends was implemented January 1, 2010, so many Latvian companies
declared significant dividends for yearend 2009. This in turn required recapitalization of
companies with capital adequacy obligations. Rietumu Bank is one of these companies.
The overview of the general banking sector information leads us to the next step – defining
and exploring the approaches followed in the Latvian banking sector. We will begin with an
overview of the common perceptions about this industry and will then proceed to summarize
our findings.
8
Current State and Conventional Wisdom Summary
This section summarizes the popular beliefs about the way the Latvian banking sector
operates. They may sometimes be outdated, but the key focus of this section is to summarize
the perceptions about the way this industry operates.
There are 20+ banks operating in the Latvian market (20 banks and 9 foreign bank branches).
Two banking model are at play among the market leaders:
Nordic Banks dealing with resident clients (Nordic Banks)
Banks dealing with Non-Resident deposits (NR Banks)
Nordic Banks have dominated the Latvian domestic retail and corporate banking market for
over a decade. They lent aggressively and grew quickly before the financial crisis and took
very large losses on their Latvian business in 2009. The largest bank in the Latvian market took
such substantial losses that the Swedish government provided assistance to the banks and to
Latvia to survive. The Nordic Banks have slowed their lending activities since the crisis but
have grown market share by buying up portfolios and business units from banks exiting the
market. Nordic Banks controlled 66.5 percent of Latvia’s lending market at the end of March
last year, compared with 64.8 percent at the end of 2008 and 63.6 percent at the end of 2007.
The Latvian government has been critical of the lending practices of the Nordic Banks recently
(after the crisis), suggesting that their lending activities should be more substantial given their
market share. Additionally, with the opportunistic acquisitions of the Nordic Banks over the
past few years and Citadele Bank being sold in 2014, which the Latvian government has an
approximately 75% stake, government officials want to see the sale price of Citadele return a
maximum amount to the Latvian State Treasury.
NR Banks focus on attracting deposits from depositors who reside outside Latvia. These banks
are also participating in the domestic market, but their approach has usually been less
aggressive. Some facts/observations about the NR Banks are summarized in the following
paragraphs.
The non-resident deposits are significant for the banking sector:
o
o
They are 60% of all deposits for NR Banks;
But less than 10% for Nordic Banks.
According to the IMF, non-resident deposits have approximately 80% to 90% CIS beneficiaries,
although they come to Latvia primarily via European Economic Area (EEA) routes.
The benefits for Russian and other CIS clients are:
o
o
o
Geography – Riga is close to Russia (Riga is the closest EU capital to Moscow);
Language – Russian is commonly spoken in Riga;
Efficient and competitively priced banking services in an EU (and soon
Eurozone) country.
The non-resident deposit market is growing
o
o
There is a presumed flight from Cyprus;
The Latvian residency permit program for subordinated debt investments;
9
o
o
o
The continuing consolidation of power by the ruling class in Russia and its
impact on the newly wealthy;
Uncertainty in geopolitics this year has resulted in a flight of capital from
Russia which is estimated at anywhere from $60 billion to $200 billion;
According to a Report from Global Financial Integrity dated March 2010, the
Global Non-Resident Foreign Deposit Market is $10 trillion with EuropeanOffshore and Eastern European Banks controlling 18% of the market. The
report also identifies the substantial growth rates of European-Offshore
countries Malta and Luxembourg during the previous decade.
It is commonly presumed that non-resident deposits do not benefit the local economy.
According to the IMF, funds from these deposits are not invested in Latvia; approximately 50%
go into EEA MFI’s, 25% into foreign loans and 25% into foreign securities mostly issued by the
U.S., Canada or EEA counties.
This is contradicted by a comment in an FCMC press release on Non-Resident Deposit Banking
that references a KPMG 2011 study stating an approximate benefit of 1.7% of GDP by nonresident deposits.
To mitigate the risks of non-resident deposits, according to the IMF the regulators have raised
capital and liquidity requirements more on NR Banks than on Nordic banks. If true, this
imposes an additional cost on one model of the Latvian banking sector.
Our observations regarding the situation in the banking sector can be summarized as follows:





The market is getting slightly more concentrated – the smallest of the top 5 banks has
an estimated 10.2% market share compared to the 6.3% in 2004;
3 out of the top ten banks in Latvia have experienced dramatic changes (either
completely out of the market – Krajbanka, Hipoteku, or significantly restructured –
Citadele/Parex);
The top Nordic banks and top foreign deposit banks survived the turmoil (though the
approaches taken were different – discussed in the following sections);
Locally-funded banks could not compete and lost market position;
Cumulative profits across the top banks varied considerably.
10
The Two Model Banking System
Does the Conventional Wisdom (2-model banking) Apply?
In this section, we proceed in examining whether there is evidence that the previously
mentioned approaches in the banking system (e.g. the Nordic Banks and the NR Banks) indeed
exist. In order to analyze the differences we proposed to compare the leading banks by their
loan/deposit ratios. A ratio below 100% indicates that the lending of the bank is based on the
resources attracted as deposits. A ratio above 100% indicates that the bank has obtained
funds elsewhere. The following graph summarizes the patterns of loan/deposit ratios among
the top banks in Latvia. Although the dataset is not complete (for example, due to the rescue
operation of Parex), it provides a more detailed illustration of the strategies of the key banks.
Chart 4. Loan to deposit ratios of the top ten banks in Latvia (2004-2013).
500.0%
450.0%
400.0%
Swedbank
SEB
350.0%
Rietumu
300.0%
Aizkraukles
250.0%
Nordea
200.0%
Nord/LB
150.0%
Hipoteku
Lateko
100.0%
Parex
50.0%
0.0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source. Balance Sheets of the banks, authors’ calculations.
The highest levels as well as increases prior to the crisis can be mostly observed in the banks
belonging to the Nordic model. In 2004-2008, they mostly funded lending with funds available
from their respective parent banks. Two banks that clearly stand out in this comparison are
Nordea and DnB, whose loan/deposit ratios exceeded 400% in 2007-2008. As their market
shares about 10 years ago were relatively small, their strategic approach can be characterized
as aggressive in terms of penetrating the growing market. Two other banks with direct links
to Scandinavia (Swedbank and SEB) as well as the state-owned Hipoteku Banka also have the
loans/deposit ratios above 100% indicating that they were very active in expanding their
lending portfolios. Finally, several banks have consistently kept their loans/deposit ratios
below 100% indicating that their lending portfolio is based on the funds that they have been
able to attract from depositors.
11
The following chart attempts to summarize the two approaches taken by grouping the banks
in two separate categories – the externally financed expansion vs. a conservative approach.
Interestingly, the banks within the two groups differed in terms of their market position.
Chart 5. Loan to deposit ratios by group (NR Banks vs. the Nordic Banks + Hipotēku).
300.0%
250.0%
200.0%
5 banks
150.0%
3 banks (Parex, Rietumu,
AB)
100.0%
50.0%
0.0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Analysis of the loan/deposit ratios indicate that the Nordic banking model required significant
parent funding to sustain the lending activity. As it turned out during the following years, the
Nordic banking funding ratios were unsustainable post-crisis.
We now explore the strategic approaches taken by the top banks throughout the last 10 years.
As noted in the opening section, this period was marked by Latvia’s entry into the EU and the
subsequent expansion of the mortgage market. In order to characterize the strategic
approaches we split the banks into several subsets based on their loan/deposit ratios and their
market positions. The following table provides a summary for the top seven banks in Latvia.
Comparing to the calculations above, we have excluded Hipotēku Banka as it has remained
100% controlled by the state and therefore cannot be directly compared with the banks
operating under market conditions.
12
Table 2. A Summary of Strategic Approaches of Top Banks in Latvia.
Loans/Deposits
Ratio
Market Position (>5%)
Model4
Parex/Citadele
<100%
Early Mover
A
Rietumu
<100%
Early Mover
A
Hansabanka/Swedbank
High
Early Mover
B
Unibanka/SEB
High
Early Mover
B
<100%
Attacker
A
Nordea
Very High
Attacker
B
Nord/LB/DnB
Very High
Attacker
B
Aizkraukles/AB.LV
Source. Authors’ calculations.
Broadly speaking, we can divide the key banks into 2 different types (referred to as A and B in
the table above). As we can infer from the table, the banks with the highest loan/deposit ratios
(Nordea and DnB) also were “attackers” seeking to increase their market shares by using
practices that are more aggressive. At the same time, SEB and Swedbank were already in a
fairly comfortable position in terms of their market shares and did not choose to escalate their
loan/deposit ratios to a similar degree. We also provide a more intuitive description of the
strategic approaches taken by the banks through the following charts. The vertical axis
represents the loan/deposit ratio, while the horizontal axis represents the market share
among the top Latvian banks by assets.
4
A - Non-Resident Deposit Model; B – Nordic Bank Model.
13
Chart 6. Strategic Positions of the Top Latvian Banks in 2004.
Chart 7. Strategic Positions of the Top Latvian Banks in 2013.
14
As we can see from the charts, some banks have been able to significantly expand their market
shares through choosing the attacking approach (Nordea, DNB). The expansion of Rietumu
and ABLV has taken a different path with a conservative approach to the loans deposits ratio
(it has remained below 100% throughout the period). Finally, Swedbank and SEB chose to
defend their market positions by following the attackers and bringing their loan/deposit ratios
above 100%. A more detail set of graphs for each specific bank is provided in the Annex.
To summarize the conclusions, analysis of loan/deposit ratios and the strategic positions of
the banks indicate that the Nordic banking model required significant parent funding to
sustain the lending activity. When the economy collapsed, it became clear that the demanddriven Nordic banking funding ratios were unsustainable post-crisis. On the other hand, the
approach taken by the banks that chose to keep the loans/deposits ratio under 100% has
proven to be more sustainable despite some slowdown in the inflow of foreign deposits during
the crisis. It should be noted that volatility of non-resident deposits is not higher than resident
deposit volatility (FCMC, 2012).
Is This A Two-Model System or Not? (Are There Banks that Do Not Fall Under
The two Categories?)
In addition to the top banks discussed and analyzed in the previous sections, Latvia is the
home to many Pocket Banks or EU banks for Russian elites. A more detailed description of the
status quo regarding the smaller banks in Latvia is provided in a book edited by Andris Sprūds
“The Economic Presence of Russia and Belarus in the Baltic States: Risks and Opportunities”,
published in 2012. Several chapters of the book discuss the issues related to cases of small
Latvian banks being taken over by rich persons from Russia. These banks typically serve the
shareholders and their inner-circle and have very little to offer the local marketplace. The
history of these banks is mixed as some have gotten into trouble with the local regulators
(FCMC) over the years. Multibanka (now SMP Bank) was accused of money laundering in 2004;
Latvijas Krajbanka was taken over by regulators and liquidated after some inappropriate
related party transactions. While they are present in the Latvian market, and as the
Convergence Report quoted above indicates, the anti-money laundering activities of the
regulator will need to be vigorous if the foreign deposit business model is to be given the
opportunity to grow. Therefore, these smaller banks may present an indirect threat to the
leading representatives of the NR banking model by sending a signal that there are suspicious
activities performed in the Latvian banking sector.
In order to assess the perceptions of the leading banks in Latvia in terms of their business
models, we conducted a survey of RBS alumni with the first question asking to select what
type of bank 13 of the top banks in Latvia are: Nordic, Non-Resident Deposit and Pocket banks.
15
Chart 8. A Summary of Survey Responses Regarding the Perceptions of Bank Types.
Survey Responses (1)
SwedBank
SEB
Rigensis
22,9%
74,3%
Rietumu
57,1%
Privat
40,0%
45,7%
51,4%
Norvik
40,0%
42,9%
Nordea
Meridian Trade
34,3%
Latvijas Biznesa
62,9%
22,9%
74,3%
DNB
Citadele
37,1%
Baltic International
51,4%
45,7%
ABLV
51,4%
57,1%
0,0%
20,0%
40,0%
40,0%
Nordic
60,0%
ForDep
80,0%
100,0%
120,0%
Pocket
Source. Original Survey.
As the above graph indicates, there is little confusion amongst RBS alumni (all MBA’s) of the
proper description of the largest Nordic Banks, but when it comes to classifying the NonResident Deposit Banks from the Pocket Banks, things get a lot more varied. There is only
partial distinction between the banks belonging to the latter two models.
16
What are the Distinctive Features of The Current Situation?
The Risks
Just as the research for this paper was being pulled together, ECFIN, the European Union’s
Directorate General on Economic and Financial Affairs issued a Country Focus report on Latvia
entitled “Assessing business practices in Latvia’s financial sector”. This report covered four
areas: a) Non-resident banking sector in Latvia, b) Latvia’s anti-money laundering framework:
tight enough? c) Corporate tax regime: supporting ambiguous tax practices? d) Conclusion.
Several sections of that report are critiqued in this research paper as it captures the supranational attitudes toward the Latvian non-resident banking sector and the Latvian regulatory
regime. At the same time we feel that the ECFIN report somewhat ignores the ability of the
banking sector to properly identify and assess the risks.
Box 1. The ECFIN Country Report
The ECFIN Report identified seven specific potential risks of the non-resident banking sector
paraphrased below:
Credit risk – arising from cross-border lending in keeping lending in the country of origin of
the deposit funding, banks create additional credit risk.
Liquity risk – the report suggests that non-resident deposits are mostly on-demand and are a
more volatile source of funding for longer-term loans. Additionally as some banks in the nonresident lending area have a concentration of large depositors making up a significant portion
of their deposits and funding, this concentration creates a liquidity risk.
Market risk – to mitigate the threat of on-demand deposits needing to be funded immediately,
banks in the non-resident deposit model use investments in mostly debt instruments and have
much higher liquidity ratios than other banks. This exposes them to the drivers of securities
valuations.
Contagion risk – the Latvian economy is at risk if a local bank fails or by creating an asset
bubble. The report mentions this risk is mitigated by non-resident banks low involvement in
the local economy.
Reputational risk – criminal groups and corrupt officials could create fraudulent business
transactions that violate anti-money laundering laws.
USD correspondent accounts – Large US banks could consider discontinuing servicing Latvian
non-resident deposit banks.
Recapitalization risks – capital increases may be difficult, as many locally owned banks have
not demonstrated owners’ willingness to increase capital the way Nordic Banks have.
Most of the risks mentioned above are evaluated by the FCMC and the banks have a track
record in performance. Whether they are well managed is evidenced by specific and verifiable
17
information that both the owners and regulators review regularly. The supra-national aspect
in this report then is really having a dialogue with the local regulator. The obligations of the
local regulator were reiterated in the 2013 Convergence Report on Latvia in preparation for
adopting the Euro.
Interestingly the report does not see a concentration risk with so much bank-funding coming
from Nordic countries in a scale similar to the large deposits from non-residents from the CIS.
The behavior of these Nordic Banks has significantly impacted credit availability to the Latvian
market and therefore economic growth.
Our own summary of the risks of the two key models is as follows:
Key Risks of the 2 Banking Models
„Nordic” Model
„NR Deposit” Model
Home Country Credit
Foreign Deposit Flight/Volatility
Currency (SEK, NOK, DKK vs. local lending)
Currency (Mostly USD inflow, not matched by
lending in USD)
Sovereign
Sovereign
Political – devaluation vs. non-devaluation
scenarios, bailouts of the banks, international
rescue package (financing sources)
Political (domestic vs. foreign) – affects the
direction of flow
Duration issues – short-term deposits are a
tricky source of funds for lending
Product/Service Mix – domestic enterprises,
consumer loans, mortgage lending
Product/Service Mix – servicing foreign
depositors, trade finance, much less focus on
domestic retail banking
Social
Size – smaller banks are typical niche banks;
bigger ones have an opportunity to compete
with the top universal banks in Latvia
From the business perspective, most of the risks mentioned in the summary above are
monitored and handled by banks around the globe on a daily basis. It is worth mentioning that
some of the risks are clearly specific to the model. For example, the NR deposit banks did not
suffer a sharp collapse due to the extreme slowdown in domestic lending, while the Nordic
banks may have very small exposure to non-resident deposits. See the Annex for Liquidity
and Capital Adequacy Ratios for the sector.
18
The Benefits
There are several benefits related to a successful NR banking sector. First of all, the NR banking
approach provides a growth opportunity to the banks. The domestic pool of funds has proven
to be limited, therefore, banks looking for a more rapid expansion are interested to turn to a
larger market where a competitive advantage exists or can be easily built. Certainly, such
approach carries risks; however, we believe that they can be managed by the banks. An
opportunity of NR banking usually arises if a country has a better-established and/or less
restrictive banking sector than other countries. For example, the British banking system is
handling a significant share of non-resident funds. Other successful examples in the European
Union include Luxembourg, Malta and Finland. Although the causality link might be
questioned, empirical evidence suggests that the countries practicing non-resident banking
have also experienced positive trends in broader indicators, for example, the Human
Development Index (HDI).
The specific benefits provided to the Latvian economy are related to generating additional
employment and wage revenues for the employees of the sector. The Central Statistical
Bureau of Latvia estimates in 2014 that more than 19 thousand employees in the financial
sector. Moreover, this sector pays the highest average salary in Latvia estimated at more than
1700 EUR per month (gross) or more than double the average (June 2014). Additional
information on related statistics can be found in the Annex.
The Market Opportunity and the Challenges
As mentioned earlier, the benefits to the CIS customer of the Latvian banking sector include:
language, geographic proximity, EU membership, low fees for labor-intensive compliance
checks, double taxation treaties, low administrative costs for company and tax registrations
and residence permits in exchange for investments. The CIS and especially the Russian market
for foreign deposits is growing and expected to continue to grow. This trend is in sharp
comparison with the domestic market, where the growth opportunities are very limited.
While we are not saying that all of the Latvian banks are likely to pursue the strategy of
attracting foreign deposits, it certainly seems that a number of banks have been able to take
advantage of this market opportunity.
Moreover, observations suggest that the amount of capital outflows from the CIS region is on
the rise (see Figure 4 in the Annex). However, the key challenges for making this approach
sustainable are related to several aspects:

How to make foreign deposits support the local economy in a more direct way?
Currently there is a relatively weak link between the inflow of deposits and their usage for
domestic lending. Partly this can be explained by the stagnating lending market, however, in
the longer term one should certainly think of the way how Latvia can benefit more from being
able to attract foreign deposits.

How to increase the duration of the foreign deposits?
19
The most direct way to address this issue would be to provide more advanced banking and
investment products that would allow the foreign depositors to access a broader range of
banking services. The other EU countries mentioned in this report (for example, UK,
Luxembourg etc.) are perceived by foreign depositors not only as a place of just parking the
money, but also as providers of high-value investment services. In the case of Latvia, this still
remains a challenge, as most of the attracted funds are short-term.

Regulatory Issues
Certainly, successful operation of the NR banking model requires that domestic banks can
fulfill the needs of foreigners by maintaining corresponding accounts etc. In the case of Latvia,
this has proven to be an issue due to the fact that some small banks may be more likely to
violate the international principles. The key problem is that this kind of situation may have an
impact on all of the banks in the sector.

Improve the value proposition and positioning
Implement the one bank approach where the bank offers both private client and business
banking services. Expand the wealth management products and service offering to move
beyond being a StartUp banking system for the CIS newly wealthy.
20
Conclusions
Some key observations:









Several of the top ten commercial banks in Latvia in 2004 did not survive to 2013.
Rietumu had the highest cumulative income over the last ten years of the surviving
banks and all other competitors in the banking sector.
While early market entrants primarily protected market share and leveraged
prudently, late entrants drove Nordic Banking behaviors to leverage to high multiples
of deposits prior to the financial crisis. Non-Resident deposit taking banks appear not
to have followed the Nordic Bank behaviors.
There are really three banking models in Latvia despite how the European and Latvian
regulators describe it; Nordic Banks, Non-Resident Deposit Banks and Foreign Owned
Pocket Banks. Pocket banks primarily service their shareholders while Non Resident
Deposit Banks broadly market their services and compete for clients in the global
banking marketplace. There is a fundamental question; should there be a unique
„Latvian Banking Model” that should be supported?
Business People in Latvia do not recognize the distinction between Pocket Banks and
Non-Resident Deposit Banks; at the same time, the Nordic model is clearly defined
and recognized by public as well as businesses.
U.S., European and Latvian central bankers and regulators focus extensively on the
risks contained in the Non-Resident deposit-banking model and are much less vocal
about the rewards to the banking sector and the economy as a whole. While some
Pocket banks have violated some regulations in the past, European central bankers
and regulators have not been critical of the Latvian regulators to properly police the
non-resident deposit model banks. This imbalance in published commentary and
public dialogue distorts the more critical discussion of Latvian competitiveness and
opportunities in its regional markets.
The Non-resident deposit-banking model addresses a growing and profitable market
opportunity. Latvian banks appear to outperform their regional competitors in this
service and this represents a competitive advantage that should naturally be built
upon.
The Non-resident deposit model is primarily owned and operated by Latvian bankers.
The Latvian legal system currently does not provide for the types of products that
would help the deposits to be invested in Latvia, nor is it understood the banks have
the skills to offer and support the products.
The Nordic Model essentially offers lending products from Nordic deposits with a
limited product suite for the Latvian market.
Recommendations - Build on Best Practices
There is a need for a change in perception of risks and benefits of non-resident deposit
business (managing with facts) – public, political leadership, global regulatory. Non-resident
deposit banks should seek more influence in the public dialogue. Additionally, creating a
21
vehicle to collect, analyze and publish the relevant facts and data on the banking sector and
its key performance indicators would substantially assist in the above-mentioned dialogue.
Note: There does exist in Latvia an Association of Commercial Banks of Latvia that provides
data and some other services of a trade organization to the sector. Our recommendation
focuses more on additional rigor to the broader data and information for a regionally more
competitive Latvian banking sector.
Banks can lead this by adopting best practices in know your client and anti-money laundering
controls and procedures focusing on the spirit of the regulations (transparency) as well as the
letter of the law. Adopting the Wolfsberg Principles and follow the Best Practices they
recommend is a good start.
Other important steps to make foreign deposits stickier to more directly impact the local
economy include:





Expanding the trade finance commercial product suite to broaden the
offering to non-resident business using Latvia as an EU portal. This
can include trade finance, working capital, capital asset leasing and
mergers and acquisition services.
Expanding and improving the wealth management product and
service suite to help foreign entrepreneurs meet their banking and
investment needs.
More deeply leveraging the existing language, geographic and
cultural advantages Latvia enjoys in CIS markets in bringing EU quality
banking.
Moving Latvia from an entry-level foreign deposit banking system to
a more long term banking service provider.
Keeping a clear eye on the risk reward equation and challenge the
central bankers and regulators to improve their oversight and
regulatory practices to allow the industry to keep up with the
demand.
The banking industry should lobby the government to enact legislation supporting more
capital market instruments and asset management services to in a well-regulated fashion to
improve the service offering to a growing market opportunity.
22
Annexes:
Top Latvian bank Annual Net Income (Thousands EUR)
2004
2005
2006
2007
17,764
36,270
42,150
49,550
Rietumu
24,445
57,363
58,352
108,269
SEB
11,540
25,613
35,689
38,682
ABLV
47,950
57,760
90,970
142,695
SwedBank
9,524
8,774
14,043
10,927
DNB Nord
2,341
4,294
6,830
8,128
Parex/Citadele
9,514
8,469
4,612
9,783
Norvik
2008
2009
2010
2011
2012
2013
29,160
11,580
4,153
15,100
28,132
11,676
41,994
-180,917
-0.382
84,134
32,290
3,260
14,537
-31,543
-9,880
38,680
33,312
11,764
107,085
-499,073
-79,878
139,148
106,950
25,394
12,174
-12,390
-4,006
2,304
1,539
-2,662
-25,106
-23,316
-2,764
7,170
7,840
4,504
1,451
4,567
0,375
-26,811
-24,950
1,002
Total
245,535
229,190
168,394
139,001
40,227
-10,079
-12,363
Source: Latvian Commercial Bankers Association
Top Latvian Bank Return On Assets
2004
2005
SEB
1,5%
2,1%
3,7%
2,6%
SwedBank
DNB Nord
1,50%
1,52%
2,26%
3.59%.
ABLV
1,27%
1,94%
Parex/Citadele
Norvik
3,51%
3,19%
2,42%
2,69%
Rietumu
GE Money Bank
Nordea
2006
1,62%
2007
3,0%
2008
1,0%
2009
-4,3%
2010
-0,01%
2011
2,2%
2012
2,29%
0,43%
0,82%
0,41%
-2,73%
2,4%
3,0%
1,8%
-8,7%
-1,5%
3,2%
1,44%
1,61%
0,38%
5,94%
1,82%
1,20%
4,01%
2,85%
1.0 %.
-2,19
-9,88
1,2%,
2,34%
0,3%
-0,10%
-0,10%
0,2%
0,5%
1,51%
1,23%
0,20%
0,94%
0,06%
-4%
3,21%
2,83%
1,83%
0,83%
0,29%
0,78%
1,1%
1,29%
-5,56%
2013
Average
3,05%
1,1%
11,03%
2,0%
0,84%
1,7%
31,03% -166,6%
0,96%
0,8%
0,48%
0,4%
1,97%
1,8%
-17,33% -11,4%
Top Latvian Bank Capital Adequacy Ratio
2004
2005
2006
SEB
9%
9%
11%
SwedBank
11%
10%
10%
DNB Nord
8%
9%
9%
ABLV
13%
12%
13%
Parex/Citadele
12%
11%
10%
Norvik
13%
14%
13%
Rietumu
14%
14%
15%
GE Money Bank
Nordea
2007
13%
11%
13%
13%
2008
11%
14%
8%
16%
2009
13%
16%
9%
15%
14%
14%
15%
15%
12%
15%
2007
51%
64%
42%
51%
58%
54%
2008
48%
58%
39%
32%
55%
42%
2009
55%
75%
43%
58%
56%
46%
2010
16%
18%
9%
12%
13%
11%
16%
2011
20%
23%
13%
15%
13%
11%
17%
2012
20%
22%
13%
16%
12%
8%
19%
14%
2013
17%
25%
13%
14%
13%
9%
19%
17%
2010
51%
71%
45%
68%
58%
52%
80%
2011
68%
52%
49%
73%
59%
68%
72%
2012
51%
43%
53%
66%
40%
62%
56%
61%
2013
44%
41%
53%
61%
63%
63%
57%
46%
Top Latvian Bank Liquidity Ratio
2004
2005
SEB
55%
57%
SwedBank
56%
68%
DNB Nord
32%
36%
ABLV
67%
51%
Norvik
54%
45%
Rietumu
64%
49%
Parex/Citadele
GE Money Bank
Nordea
2006
60%
70%
45%
48%
60%
46%
23
Salary Information By Economic Activity 2014 (Gross EUR, 2nd quarter)
Economic Activity
(K) Financial and insurance activities
(J) Information and communication
(D) Electricity, gas, steam and air conditioning supply
(O) Public administration and defence; compulsory social security
(B) Mining and quarrying
(M) Professional, scientific and technical activities
(H) Transportation and storage
(E) Water supply, sewerage, waste management and remediation activities
(Q) Human health and social work activities
(F) Construction
(A) Agriculture, Forestry and Fishing
(C) Manufacturing
(L) Real estate activities
(N) Administrative and support service activities
(R) Arts, entertainment and recreation
(G) Wholesale and retail trade; repair of motor vehicles and motorcycles
(P) Education
(S) Other service activities
(I) Accommodation and food service activities
Average (all sectors)
Montly Gross Wage
1516
1103
933
878
825
801
773
707
697
688
672
667
650
639
620
619
616
599
471
715
Source: Central Statistics Bureau of Latvia
24
Employment by Economic Activity in 2014 (2nd quarter, NACE Rev. 2.)
Employment (thsd)
TOTAL
889.1
(A) Agriculture, forestry and fishing
63.1
(C) Manufacturing
121.1
6.9
(E) Water supply; sewerage, waste management and remediation activities 4.9
(F) Construction
78.9
(G) Wholesale and retail trade; repair of motor vehicles and motorcycles 129.5
82.3
35
27.7
19.7
24.2
35.8
27.7
56.4
(P) Education
83.7
50.5
19.6
15.1
Employment Composition by Economic Sector in 2014 (% of employed, 2nd quarter)
(A) Agriculture, forestry and fishing
(C) Manufacturing
(E) Water supply; sewerage, waste management and remediation activities
(F) Construction
(G) Wholesale and retail trade; repair of motor vehicles and motorcycles
(P) Education
25
7.1
13.6
0.8
0.5
8.9
14.6
9.3
3.9
3.1
2.2
2.7
4
3.1
6.3
9.4
5.7
2.2
1.7
Human Development Index and Growth for Foreign Deposit Banking Jurisdictions
1980
Country
U.S.A
U.K.
Luxembourg
Germany
Netherlands
Ireland
Switzerland
Hong Kong
Latvia
0,84
0,74
0,73
0,73
0,79
0,74
0,81
0,71
-
1990
0,87
0,78
0,79
0,80
0,84
0,78
0,83
0,79
0,69
2000
2005
0,90
0,83
0,85
0,86
0,88
0,87
0,87
0,82
0,73
0,90
0,86
0,87
0,90
0,89
0,90
0,89
0,85
0,78
2009
0,91
0,86
0,86
0,90
0,91
0,91
0,90
0,89
0,79
2010
0,91
0,86
0,87
0,90
0,91
0,91
0,90
0,89
0,80
2011
0,91
0,86
0,87
0,91
0,91
0,91
0,90
0,90
0,81
Rank
4
28
25
9
3
7
11
13
43
Russian Owned Latvian Banks
Rank
17
Bank Name
Primary Owner
SMP Bank (formerly Multibanka)
Arkady and Boris Rotenbergs Construction, Hotels, Banking
26 Latvijas Biznesa Banka
19 Rigensis Bank
N/A Latvijas Krajbanka
Andrei Molchanov
Igor Ciplakov
Vladimir Antonov
Primary Russian Business
Russian Political Connection
Vladimir Putin (he and Arkady attended Judo
School together)
Vladimir Putin (he and Molchanov's step father
Construction
served in the St Peterburg City Council
Banking, Freight Car Manufacture General Influence
Various
No Clear Influence or connection
Evolvement of Strategic Positions of Key Banks5 in Latvia (vertical axis – loans/deposits
ratio; horizontal axis – market share among top banks)
5
Data for Citadele/Parex not available for all the years under consideration.
26
27
28
29
30

Read the White Paper - Riga Business School

Transcription

Similar documents

Structure of Banking Industry

Dievs, svētī Latviju!

here - Eight Investment Partners

Our Credit Union Bulletin - September 2016 - St. Stanislaus

Trade Mission to Latvia Doing Business with Latvia

money matters

Private Banking

MoneyViewandMoneyDesktop!

ING Vysya Bank Ltd

Report on Operations and Activities Executive