Latvia Finance Profile 2012

Piecemeal steps are being taken to try and shore up Latvia's beleaguered banking sector, including a new insolvency law and the restructuring of the nationalised Parex Banka. We regard these as positive developments but believe that more is needed to revive bank lending. We also still expect the industry to contract in 2010, followed by positive but weak growth from 2012. Having been a fundamental weak point of the beleaguered economy since the credit bubble burst, the Latvian banking sector is set for significant restructuring over the medium term. Evidence that this process is starting to get off the ground comes from the introduction of a new insolvency law, approved by parliament in July 2010, which effectively shoulders banks with the responsibility of dealing with defunct loans. The law provides details on how much debt can be written off and how long an individual can be deemed insolvent, with time limits from one year to three-and-a-half years. This is in stark contrast to the previous law that forced debtors to pay off the total liability and did not give a timeframe in which to do so. By shifting responsibility on to the banks, the government hopes this will stimulate more innovation in the sector when dealing with non-performing loans. The restructuring of Parex, which was taken over by the government in 2008 and led to a EUR7.5bn bailout from the EU and the IMF, is also a significant turning point for the industry. The higher quality assets from the bank were stripped out and put into a new entity called Citadele, which was registered in July and began operations in August. Chair Juris Jakobsons has indicated that the new bank could be sold by 2011, which would take the burden off the government and reduce the degree of state involvement in the banking sector. While these developments are certainly steps in the right direction, we stress that the industry's restructuring still has a long way to go. A substantial misalignment between loans and deposits still exists, with the loan-to-deposit ratio above 200%, leaving banks highly exposed to changes in depositor confidence. In addition, with banks still in deleveraging mode, lending conditions are likely to stay unfavourable for some time yet. Although the Bank of Latvia has cut the seven-day deposit rate to from 1.00% 0.50% in July, we do not believe this will be sufficient to encourage banks to extend fresh credit to the economy at a time when balance sheets need to be reined in and uncertainties remain over international financial market stability. Given the substantial size of the Latvian banking sector, which measures up at 158% of GDP, we believe the industry has further to contract. We forecast the amount of total assets to fall by 10% in 2010 and by 2.0% the year after, before returning to positive growth in 2012. However, over the medium term we expect a marked slowdown in asset growth, with average annual expansion of 2.0% forecast for 2012- 2014, compared to 28.9% in 2006-2008.