EESTI PANK REVOKES THE GENERAL RISK RESERVES CALCULATION PROCEDURES

Eesti Pank has decided to revoke the decree "Procedure for calculating general risk reserve". This decree was introduced in 1997 as a means for strengthening the banks' capital base with the objective of better cushioning the impact of future economic downturns. The decree restricted distributions from banks' profits unless the amount of own funds eligible for inclusion in the general risk reserve formed at least 5% of risk weighted assets and off-balance sheet positions.

Considerable improvements in the legal and regulatory framework and the quality of internal risk management systems led to the decision to rescind the decree. The central bank is of the position that credit institutions are required to create and maintain reserves at levels which meet their individual risk profiles taking into account their size, activities and other factors which are independent of the risk reserve established by the decree. According to law and generally accepted risk management principles, credit institutions shall create reserves to cover future risks and possible losses. Also, credit institutions are clearly motivated to keep sufficient reserves. In creating additional capital buffers, credit institutions need to give primary consideration to their business strategies and possible future risks. In order to cover these risks credit institutions may stipulate in their statutes, in addition to the reserve capital (1/10 of the capital stock), the basis for creating additional reserves and any limits on distributions from profits.

Eesti Pank analyses the capitalization level of the banking sector and, where necessary, amends the regulations governing minimal capital levels to be maintained by banks. Risk levels of credit institutions can be enhanced by improving the methodology behind the capital adequacy computation, including among other things the introduction of new risk components (country risk, transfer risk) into the base. In addition, proposed new regulations dealing with the classification and provisioning of loans are expected to significantly improve the comparability of loan portfolios and the sufficiency of loan loss provisions.

In securing the stability of the financial sector and allocating responsibilities between the private and public sector, Eesti Pank places increased reliance on the transparency of banks' activities and the public disclosure of risk related issues. Significant emphasis is also being placed on improving market discipline and corporate governance structures maintained by banks. Specific requirements governing the public disclosure of risks taken by credit institutions, systems applied to manage these risks and reserves formed to cover the risks are prescribed in the public reports preparation procedure.

The risk reserve was originally established due to what were perceived as significant risks associated with the extremely rapid growth in loan and securities portfolios in the banking sector in 1997. At the time is was considered highly likely that thes erisks would materialize if the economic recession which began in the second half of 1997 were to worsen. The aim of establishing the risk reserve formation requirement was to strengthen the capital base of the banking sector and to limit distributions from own funds prior to the economic recession.