On additional measures for enhancing the financial system stability

Banks' adequate capitalisation and sufficient liquidity have been the cornerstones of the Estonian financial system's credibility and its sustainable development. The strong economic growth and the relatively short history of the financial system conceal in itself specific financial risks, the perception of which by banks' themselves could be insufficient. Taking into account the general economic conditions and in particular the continuing rapid growth of domestic credit and recognising the difficulties in banks' risk aversion due to strong competition, Eesti Pank considers it necessary to take additional measures to foster the financial system. We stress that while drafting our actions we continue to pursue the policy to keep our markets open to international competition and capital flows.

Short term measures

As a temporary measure, with the purpose of enhancing liquidity buffers and supporting reduction of credit growth, we impose an additional liquidity requirement to banks' average balance with Eesti Pank. The requirement will be valid from 1 November as two per cent of reserve requirement base in November and three per cent since December.

In order to stabilise the banks' intra-month kroon liquidity, Eesti Pank, from 1 November increases the daily minimum reserve requirement to four per cent from the present two per cent. The daily minimum reserve requirement can be utilised for settlements only when penalty interest is paid on them.

In order to increase the banks' incentives to maintain liquidity in Estonian money market and to decrease the discriminative impact of the above measures on banks, the interest paid on balances exceeding the reserve requirement (including additional liquidity requirement), will be increased up to the Deutsche Bundesbank discount rate.

Despite the recent tensions in Estonian money market, the imposed requirement can be easily met by a slight adjustment in the banks' asset structure.

Long term measures

Besides the above short term measures, Eesti Pank will take several steps of longer-term impact, most of them aimed at the strengthening of banks' capitalisation.

The rapid growth of banks assets and changes in their operational environment were the main reasons for the higher than international minimum capital adequacy ratio of ten per cent that was announced in April and implemented in October.

Eesti Pank will critically review the banks' internal regulations on asset evaluation and especially loan provisioning. If necessary, we will demand that these regulations be strengthened. In addition, a requirement for establishing a general banking reserve starting from end-1997 in the amount of no less than five per cent of the banks' total risk weighted assets and off-balance sheet items will be imposed. We also stress that if necessary, we are ready to take additional measures, including the further increase in capital adequacy.

In the present situation where banks, via subsidiaries, are active in the securities, leasing and insurance markets, it has become necessary to impose prudential requirements to the whole banking group. Eesti Pank has decided to establish consolidated prudential ratios starting from 31 December 1997.

In parallel with implementing consolidated supervision, Eesti Pank will, from 1 April establish a capital requirement for banks' market risks. The methodology for calculating capital requirement will be in line with the European Union Capital Adequacy Directive.

The imposed package of precautionary measures will create additional buffers for covering possible future losses connected with changes in the economic environment without jeopardising the financial system credibility.

Considering the above said and the growing competition, we stress that besides the measures taken by Eesti Pank, self control and good banking practices applied by market participants is an important prerequisite for securing the sustainable development of the Estonian financial sector.