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Study on the Present Competitive Performance and
Future Prospects of the Banking Industry in Latvia
Andrejs Jakobsons1
William C. Schaub1
Riga
2014
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
Table of Contents
Background.............................................................................................................................. 43
Research and Evaluation Method ........................................................................................... 43
History Of The Banking Sector Since The Early 1990’s ............................................................ 54
Banking Sector During The Last 10 Years ................................................................................ 54
Current State And Conventional Wisdom Summary ............................................................. 109
The Two Model Banking System ......................................................................................... 1211
Does the Conventional Wisdom (2 model banking) Apply? ............................................ 1211
Is This A Two Model System or Not? (Are There Banks that Do Not Fall Under The 2
Categories?) ..................................................................................................................... 1615
What are the Distinctive Features of The Current Situation? ............................................. 1817
The Risks .......................................................................................................................... 1817
The Benefits ..................................................................................................................... 1918
The Market Opportunity and The Challenges ................................................................. 2019
Conclusions.......................................................................................................................... 2221
Recommendations - Build on Best Practices ....................................................................... 2221
Annexes: .............................................................................................................................. 2423
3
Background
The Latvian banking sector has been distinct from the other Ballitic 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 who’s funding is derived from non-resident deposits. These banks also
provide significant transaction processing services as well as private banking services to the
non-resident 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),
who’s 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 anlaysis 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, view points and, 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.
4
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 which 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 mManagement 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.
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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 during 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 5 banks as the
smaller ones are not likely to provide a big impact on the top players in this industry. Overall,
the banking sector has 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.
6
Chart 2. Market Shares of Top 5 banks in Latvia in 2013.
10%
20%
Swedbank
SEB
13%
Aizkraukles
Nordea
Rietumu
14%
16%
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 bascially 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 straighforward 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%.
7
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
Table 1. A Summary of Capital Infusions in Latvian Banks in 2009.
8
Parex/Citadele
Hansabanka/Swedbank
Hansabanka/Swedbank
Unibanka (SEB)
Rietumu
Aizkraukles/ABLV
LVL (000)
139 000
256 600
87 851
65 000
77 500
-
Share Capital
Share Capital
Sub Debt
Share Capital
Share Capital
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.
9
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 2013last 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 due to the following factors:
o
There is a presumed flight from Cyprus;
10
o
o
o
o
The Latvian residency permit program for subordinated debt investments;
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 which references a KPMG 2011 study stating an approximate benefit of 1.7% of GDP
by non-resident 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 NRforeign 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.
11
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. 2 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.
12
The following chart attempts to summarize the 2 approaches taken by grouping the banks in
2 separate categories – the externally financed expansion vs. a conservative approach.
Interestingly, the banks within the 2 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 7 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.
13
Table 2. A Summary of Strategic Approaches of Top Banks in Latvia.
Parex/Citadele
Rietumu
Hansabanka/Swedbank
Unibanka/SEB
Aizkraukles/AB.LV
Nordea
Nord/LB/DnB
Source. Authors’ calculations.
Loans/Deposits
Ratio
Market Position (>5%)
Model4
<100%
<100%
High
High
<100%
Very High
Very High
Early Mover
Early Mover
Early Mover
Early Mover
Attacker
Attacker
Attacker
A
A
B
B
A
B
B
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 more aggressive practices. 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.
Chart 6. Strategic Positions of the Top Latvian Banks in 2004.
4
A - Non-Resident Deposit Model; B – Nordic Bank Model.
14
Chart 7. Strategic Positions of the Top Latvian Banks in 2013.
15
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 which 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 2 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 to 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.
Chart 8. A Summary Of Survey Responses Regarding The Perceptions Of Bank Types.
16
Survey Responses (1)
SwedBank
SEB
Rigensis
22,9%
74,3%
Rietumu
57,1%
Privat
40,0%
45,7%
Norvik
51,4%
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 2 models.
17
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 supra-national 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-boarder 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 volitile 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 dept
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.
Reputaional risk – criminal groups and corrupt officals 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 information which both the owners and regulators review regularly. The supranational aspect in this report then is really having a dialogue with the local regulator. The
18
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 availablity to the
Latvian market and therfore 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 Ratio’s for the sector.
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
19
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 administative 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?
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.
20

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 stratup banking system for the CIS newly wealthy.
21
Conclusions
Some key observations:









Several of the top ten commercial banks in Latvia in 2004 did not survive to 2013.
Rietumu had the highest cummulative 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 dialoque 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 currenly 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
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.
22
Note: There does exist in Latvia an Association of Commercial Banks of Latvia which
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 the 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 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.
23
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
28 823
55 094
41 994
-180 917
-0,382
84 134
32 290
23 748
14 537
-31 543
-9 880
38 680
23 412
43 676
107 085
-499 073
-79 878
139 148
106 950
112 847
12 174
-12 390
-4 006
2 304
1 539
-2 662
-25 106
-23 316
-2 764
7 170
7 840
15 290
1 451
4 567
0,375
-26 811
-24 950
19 028
Total
289 644
249 678
190 406
226 454
40 227
707
5 663
Source: Latvian Commercial Bankers Association and Bank Annual Reports
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%
Source: Latvian Commercial Bankers Association
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%
24
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
25
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
26
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.
27
28
29
30
31

See the research - Riga Business School

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