In the first three months of 2023, there was much discussion in Latvia on the topic of lending, the role of banks in boosting economic development, and their profitability. As I have been actively involved in SEB banka’s lending for 20 years, including as a member of the Baltic Credit Committee, I would like to dispel a few myths. They create a false perception of banks somehow hindering economic growth. This is a fundamentally illogical assumption because banks can only grow when new businesses are created, if they expand, if people trust the state and are willing to invest in boosting their own prosperity.
Although lending policies are similar across the Baltic region, economic performance and ambitions vary
On lending and rates. According to the European Central Bank data, the total amount of loans granted by banks to individuals and companies (residents) in Latvia amounted to EUR 11.4 billion at the end of last year, while it was about twice as high in Lithuania and Estonia, at EUR 24.18 billion and EUR 21 billion, respectively. Working with loan applications on a daily basis at the Baltic level, I can say that the bank’s policies and lending models are identical in Latvia, Lithuania, and Estonia. We do not discriminate against any of the Baltic countries, nor do we grant any of them special preferential treatment.
Unfortunately, there are also objective and negative factors in the competition for funding. Latvia is lagging behind its two neighbours in this respect. This is due to the historically deeper and more severe crisis after 2008, the reputation of our entrepreneurs and the questions regarding the origin of their capital, taxed paid and the extent of the shadow economy, and the willingness and ability of entrepreneurs to borrow. A range of these factors “add up” to a slightly higher lending rate that the bank can offer Latvian businesses compared to Lithuania and Estonia.
Furthermore, it is important to remember that lending rates in the Eurozone are extremely low. Only in Japan are interest rates even lower. Considering the development of our economy, interest rates in Latvia should rather be compared with those in Bulgaria, Romania, Hungary and Poland, where they are significantly higher. When we compare ourselves with Lithuanians and Estonians, we should keep in mind that Estonia had much fewer insolvencies after the 2008 crisis. Moreover, Estonia did not have individual insolvency administrators who enabled many to get rid of their debts, which did a disservice to the country as a whole, damaging the state’s reputation as a law-abiding and just society, as well as directly because the biggest unsecured “lender” was often the state itself - when a company wound up, no taxes were paid, and assets were diverted to another company. In Lithuania, on the other hand, interest rates are lower because the state’s liabilities were lower in the past and the rapid economic growth of recent years has given investors and lenders confidence in the economy’s growth potential. Consequently, Latvia stands out on the map of the Baltic countries as a riskier country with historically higher losses for companies and banks alike.
Decisive readiness for companies to grow
However, the slightly higher average lending rates and historical experience do not represent the only obstacles to the development of Latvian companies. The root of the problem lies deeper and is closely related to the long-standing mistrust in the state, to fiscal discipline, to investment in consumption instead of development.
An example from my daily work at the Baltic Credit Committee comes to mind. 15 years ago, we granted a loan to two similar companies –one in Latvia, the other in Lithuania. Both were doing relatively well; they came to the bank to apply for new loans, and both applications were approved. When I look at the financial data, I see that the Lithuanian company is now about four times larger and willing to borrow up to eight times more than its Latvian counterpart. It is worth noting that the Latvian company drew dividends more quickly and invested quite cautiously, while the Lithuanian company kept most of the capital and invested quite aggressively. There were other priorities, and these seemingly insignificant decisions were decisive in the end.
More and more companies in Latvia are thinking about their competitiveness and investing in their development, but compared to our neighbours we still have fewer of them, and they have developed later. This is mainly due to the state’s late decisions regarding the development of the business environment - from tax policy and the legal environment to education policy and regional development, including the late use of Riga’s potential as a regional centre. You do not have to be an economist to realise that Riga has been thinking about something other than development for many years. In purely visual terms, Vilnius and Tallinn are about 10 years ahead of us. The hope now is that development will have a higher priority than redistribution and distribution to insiders.
The deterrent effect of reputational risks
On the ability of entrepreneurs to borrow. In lending, the willingness of entrepreneurs to borrow, the willingness of banks to lend, and the ability of both parties to borrow and lend are equally important. These four components make up the Lending Index, which we are currently developing to give the public a more objective “picture” of developments in lending.
Also, in the case of Latvia, the ability of entrepreneurs to borrow is more often related to reputational risks, attitude to sustainability issues and the source of capital. In many cases, these problems discourage banks from lending. It is not even a question of the requirements of regulators being too strict but of the banks’ own willingness to expose themselves to reputational risk. It is worth taking a look at who, for example, works and can invest in the port of Klaipėda and who, conversely, has managed Latvian ports in the past and often continues to do so.
On the banks’ profits. When assessing the profitability of banks in recent years, it is important to remember that most of the big banks were loss-making for several consecutive years during the 2008 crisis (losses in the entire banking sector amounted to nearly EUR 2 billion). It took about eight years for SEB Bank to “recover”, which by then had significantly reduced its market share. From the shareholders’ point of view, it was only after these years that the bank became profitable again and was able to accumulate profits in the last years by anticipating the next downturns in the economic cycle.
The critics’ argument about “too much profit” is hard to understand, because a bank that has been losing money for a long time is a much bigger threat to a country than one that is profitable, pays taxes, invests in new jobs and develops finance-related industries. It is worth remembering that banks take into account the massive tax evasion by Latvian borrowers and partly apply this experience to possible future crises. If a profitable bank is not attractive, what would be a better alternative - how much have the “unprofitable” and liquidated banks cost the Latvian budget?
The outlook is positive – let’s continue to exterminate ghosts and not be afraid of opening borders
Although we are waking up later than our neighbours from the phase of resource distribution and redistribution and entering the phase of innovation and development, I am optimistic about Latvia’s prospects. Many Latvian companies are willing and able to borrow, and banks are happy to lend to them. This process is expanding, because we have made a number of good decisions in this country recently, but changes do not happen overnight. The fact that we overcame the difficulties caused by the pandemic relatively easily and are also coping with the side effect of the Russian war - inflation - indicates that the fear of borrowing will recede.
In recent years there have been real improvements in the political culture, in the principles of governance and in the all-important Riga Council and the country as a whole. I see a greater focus on eradicating the ghosts of the past, as economic and financial crimes are increasingly seen as crimes. This also creates a better breeding ground for companies that want to be honest and create something to succeed. A “stick” for the dishonest and a more understandable “carrot” for the honest and creative entrepreneurs.
At the same time, it will be crucial not only to clean up our internal environment but also to be open to labour, ideas and innovation from outside. The construction sector, for example, will be crucial in the coming years and will have a high investment potential. The development of many other sectors will be related to this – energy efficiency programmes and improving road infrastructure. We will not do it alone and with outdated methods – we need to be bold and open the borders to outside ideas, capital and resources in the sectors where it is crucial. It is better if capital and people want to come to us than if our people and capital want to leave us.
Finally, banks are not the only ally in financing investments. Very often, only so-called venture capital funds can provide capital in the initial growth phase. The stock market, bonds and other instruments are also available.
However, banks are the biggest funders of investments and are likely to remain so. And banks expect ambitious, transparent, long-term growth-oriented financing requests from companies - the industry even estimates that EUR 3.3 billion will be available for credit growth in 2023. Green loans, home insulation projects and public-private partnership initiatives will have great potential here. The money is literally “waiting” for development initiatives that will spur manufacturing growth, innovation and technological breakthroughs and add great value to the economy as a whole.
Kārlis Danēvičs,
Member of the Board of SEB banka, Risk Director
