Foreword of the President of Eesti Pank
FIVE YEARS OF STABLE KROON
The main objective of Eesti Pank
as the central bank of the Republic of Estonia is to guarantee
the stability of the national currency, the efficiency and
reliability of the banking system. Since the 1992 monetary reform
our monetary policy has been based on the fixed exchange rate
against the German mark and the currency board system. The aim
has been to achieve the stability of prices through a fixed
external value of the kroon. This policy has proven successful.
In 1996 the inflation rate continued to fall and the increase in
prices slowed down, in particular in the second half of the year.
The average annual inflation rate dropped to 23%, while in
December 1996 consumer prices increased by only 14.8% as compared
to December 1995. The slow-down of the price increase and
lowering of inflation expectations in their turn are
prerequisites for a sustained economic growth as can be seen from
the experience of other countries in transition.
The success of the policy of the
fixed exchange rate is based on the trust in the durability of
the kroon of the general public and all those who are active in
our economy. The trust or lack of it is in the monetary policy
terms best characterised by the developments in the Estonian
kroon interest rates which are approaching those of the German
mark. We are satisfied with the general trend of interest rates
which in 1996 indicated the persisting trust in the continuation
of the chosen policy. The inter-bank money market was stable
throughout the past year. Interests on the medium-term,
four-five-year liabilities decreased considerably on the
financial market, varying between 10 and 12% in case of the bonds
issued by companies and local governments, and dropping to 12% by
the end of the year in case of loans issued by commercial banks.
The currency board system gives
the broadest possible guarantee for the external stability of the
national currency. The issuing of money is restricted with the
increase or decrease of Eesti Pank's foreign assets. The monetary
policy environment based on such strict rules sets certain limits
to the central bank's participation in the money market and thus
increases the role of the banks' liquid assets in securing the
smooth operation of the financial system. In order to allow the
banking system to use domestic reserves in a more flexible
manner, Eesti Pank changed the rules on reserve requirement
calculation in 1996. Under the new requirement, the commercial
banks' minimum reserve requirement with Eesti Pank has to meet
the monthly average level. At the same time, it has to be
emphasized that the smooth functioning of the financial system
and credibility of the national currency is in the first place
still guaranteed by the adequate foreign reserves and the free
movement of capital.
The monetary policy based on a
fixed exchange rate cannot succeed without the government's
support in its budget policy. Although the government's fiscal
policy continued to be relatively conservative in 1996, the
overall deficit of the state budget, local budgets and off-budget
funds increased. Therefore, special importance must be attached
to the government-initiated legislative amendments, aimed at
securing the balance of the state budget and hence the stability
of prices. Those amendments are supposed to improve the
coordination of the fiscal policy of the central government and
the local governments already in 1997.
Strong and effective banking
system is one of the main pillars of Estonia's successful
monetary policy and market relations-based economic development.
Trust in the commercial banks increases society's inclination to
save and guarantees the channelling of domestic and foreign
resources into productive investments. The effectiveness of the
banking system as the main financial intermediary, its security
and reliability depends on two matters. Firstly, the activity of
the banks has to be regulated by laws with adequate precision and
the legislative regulation has to be enforced. Secondly,
decisions on loans and other business activity have to be made
proceeding from good banking practice, without external
interference. We proceeded from those principles in carrying out
our regulatory and supervisory tasks also in 1996.
In working out the legislative
framework, Eesti Pank proceeds from international and first of
all, European Union standards. The application of those standards
introduces into the Estonian banking legislation the basic
principles of the legislation of the developed market economy,
and thereby makes the banking system more secure and facilitates
the further integration of the Estonian financial system into the
financial system of the developed industrial countries.
Improvement of the Law on Credit Institutions as well as the
draft law on protecting bank deposits are aimed at the further
harmonization of Estonian legislation with the respective legal
acts of the European Union. The security fund provided for in the
proposed law on deposit protection will considerably increase the
public trust in the Estonian commercial banks, improve the
efficiency of financial intermediation and reduce the danger of a
crisis in the banking system.
The intermediation of financial
resources from depositors into the business unavoidably makes
banks dependent on the overall market situation of the economy.
Like in other business spheres, taking risks is also an
inseparable part of banking. Therefore, it must be stressed that
supervision can never totally exclude the possibility of problems
for the banks, although it is the task of supervision to minimize
the costs to society resulting from those problems. In organizing
banking supervision we believe that competition between
commercial banks, based on the principles of market economy,
equal opportunities and fixed rules, is the best way to increase
the security and reliability of the banking system. Thus, the
supervisory activities of Eesti Pank in 1996 were focussed on
monitoring and improving the banks' risk management systems and
internal audit units. The smooth functioning of both mechanisms
will guarantee the correspondence of the banks' executive
decisions with the good banking practice and existing legislation
and the use of the most extensive information in the process of
decision-making.
The efficiency of the Estonian
banking system and its role in financing the economy increased
considerably in 1996. This is characterised by the continuing
increase in the volume of loans and deposits, and the decrease in
the interest margin between loans and deposits. The continuation
of the bank mergers was part of the structural changes taking
place in the banking sector and aimed at the further
consolidation of the system and growth of the private capital in
the bank's ownership structure. The increasing competitiveness of
the Estonian banks is confirmed by the continuing
internationalization of their ownership and the expansion of the
banks on foreign markets. The increase in the financial system's
inner competitiveness and efficiency was facilitated in 1996 by
the rapid development of the leasing companies and other
financial intermediaries as well as the capital market, of which
an important characteristic feature was the launch of the Tallinn
Stock Exchange. The inner integration of the financial sector
deepened, which sets new tasks before the banking supervision.
In 1997, Estonia marks the fifth
anniversary of the reintroduction of the kroon. The development
of the economic and monetary policy after the reintroduction of
the kroon has in broad terms corresponded to the goals set five
years ago. The Estonian economy has successfully emerged from the
stabilization period and entered the stage of growth. The most
important monetary policy result of the stabilization period has
been the sudden halt of the increase in consumer prices under the
influence of the fixed exchange rate and conservative fiscal
policy. The continuation of the current policies will guarantee
the slow-down of the price increase and decline in interest rates
also in the future. However, the continuation of strong monetary
policy and the policy of a balanced budget is impossible without
the increasing competitiveness and productivity of the economy.
The prerequisites for this are the openness of the economic
system, the continuing increase in domestic savings and further
integration into the economic system of the developed industrial
countries through foreign trade as well as investments. Thus,
regardless of all past achievements, Estonia more than ever needs
the firmness of decision to fortify what has already been
achieved and to continue radical economic reforms.
Vahur Kraft
President of Eesti Pank
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