The Latvian banking system

Added on February 22, 2009
Latvians have been spending as if there was no tomorrow, especially buying houses and flats with mortgages they often could not afford. The world economic crisis caught them on the wrong foot. In November 2008, Latvia's largest bank, Parex, went down and had to be nationalized. The European Union, several EU member states, the IMF and the World Bank saved Latvia from bankruptcy through a 7.5 billion euro credit. The credit was tied to tough conditions, mainly to consolidate the state budget. Therefore, state salaries had to be cut by 15% and VAT increased to 21%.

Added on May 22, 2007
In November 2007, GE Money bought the Baltic Trust Bank BTB.

Article added on January 1, 2006

The advantages of Latvia's banks
Based on an interview with Ilze Jurkane, Vice-president of Baltic Trust Bank, BTB, Riga.
  
The Baltic Republics Estonia, Latvia and Lithuania have undergone dramatic change since the regained independence from the Soviet Union. Since there is no capitalism without capital and banks, a look at the Latvian banking system might offer some insights.

Therefore, I conducted an interview with a key figure in the process of the creation of the Latvian banking system, Ilze Jurkane, since 2005 Vice-president of Baltic Trust Bank (BTB), one of the middle sized Latvian banks. Since 1989, she worked as a economic and banking adviser to the National Front and the evolving Latvian government. She was even asked to become Governor of the Bank of Latvia in the summer of 1991, but declined, feeling her experience was in commercial banking not on a federal level. However, she was a Senior Advisor to the Governor. She acted as President of the Latvian Investment Bank in 1992 and 1993 and resigned after admitting to procedural errors in the issuance of investment notes - probably the only leading Latvian ever to take consequences from a scandal since this still quite corrupt country regained independence. According to her own statement, she single handedly solved the problem, and it did not cost Latvia one Santims. From 1995 to 2001, she went on to introduce the ATM and debit card systems in Latvia.

According to Mrs. Jurkane, the biggest advantage for the Latvian banking system was the possibility "to start from scratch", to leapfrog over outdated technology, products and services. The Latvian banks were able to purchase computer systems that were mini based, not expensive mainframe computers, which are expensive to maintain, require much space, are cumbersome to run and require time consuming program changes, new program and product development. The banks were able to be flexible in terms of products they offered. Programming changes were much easier to implement and required much less time. This allowed the Latvian banks to invest in ATM and branch networks, responding to and driving consumer needs.



Another advantage of the Latvian banking system is that, based on the recommendation of Mrs. Jurkane, a former American banker, the check system, which remained for over 50 years as a cornerstone of American banking, was never introduced in Latvia. The country skipped over that phase of a system, which is extremely expensive to run and maintain and instead implemented customer accounts without checks but rather with fund transfers through payment and funds transfer orders. This has been a big advantage. U.S. banks are still waging the battle to wean consumers off of checks utilizing punitive pricing. However, consumers are reluctant to abandon this product, in spite of the growth of Internet Banking. The means that the U.S. banks and the Clearing System are forced to maintain the highly costly check system, explained Mrs. Jurkane.

In the mid 1990s, the Latvian banks introduced other products, prior to their appearing in most European markets. This included for instance different Direct Debit programs, the ability to pay your bills through ATM's and adding to savings accounts through ATM's. This was a key contribution by Ilze Jurkane and the different banks and companies she serviced through the Baltic Card Center, which originally was part of Saules Bank. Internet and telephone banking appeared at the same time as well. Despite these avant-garde banking techniques, personalized service remains a key part of the Latvian banking environment, no problem considering the country's low labor cost.

In 1993 at its peak, the ability to be flexible and a low cost banking environment allowed Latvia to have up to 61 banks. In 2005, the succession of infant service industry crisis' is over, the market seems to have consolidated, the number of banks stabilized at 23.

The banks are successfully servicing customers both within Latvia and a large number of non-residents, particularly from Russian speaking countries.

For more than a thousand years, Latvia has been a trading crossroad, a bridge between the East and the West. Having warm water ports and river routes made Latvia one of the Hanseatic cities in the Middle Ages and has served it well since then. This made Latvia desirable for other countries who needed trade routes either to the east, west, north or south. Therefore, Latvia has had foreign rulers since the beginning of the 14th century - German, Polish, Swedish, Russian and Soviet.

Today, the Latvian banking system can profit from the advantages that result from the country's crossroads position. Due to the former occupation by Russia and the Soviet Union, most Latvians speak Russian. Therefore, the Latvian banks became quickly reliable banking partners and off-shores for Russia, the Ukraine, Byelorussia and other CIS countries and former Soviet Republics. Latvia, being like Switzerland a country with a minimum of natural resources, built upon this banking strength. Through the last decade, the banking sector evolved into an industry serving its customers efficiently.

After 9/11, the creation of the Patriot Act and the focus put on the financing of terrorism (AML), U.S. regulators have scrutinized the Latvian banks, since large volumes of U.S. Dollars flow through the Latvian banking system from Russia and other CIS countries. As a result, the Latvian government, regulators and the banks of Latvia have put in place stringent Anti-Money laundering legislation and procedures.

As an example of a middle-sized Latvian bank, we can take the Baltic Trust Bank. It built its initial business and branch network paralleling the Latvian Railroad, since this railway company was among its founding fathers. The bank's original name was Baltic Transit Bank, with emphasis on financing transit business and forming a bridge between the East and the West. While the emphasis now is more on small and medium size businesses, the original strategy remains as a cornerstone and the BTB successfully maintains this "Bridge", with representative offices in several Eastern countries, explained Mrs. Jurkane.

Baltic Trust Bank has grown to be an internationally recognized bank, rated Ba3 by Moody's; the rating for BTP's mortgage backed securities is Ba2. In the spring of 2005, BTB received its first international syndicated loan through Raiffeisen Zentralbank Österreich AG. Another syndicated loan is planned for 2006.

BTB is the first commercial bank in Latvia to issue mortgage backed securities, having successfully brought to market issues in both 2004 and 2005. BTB also issued subordinated capital notes in 2004. Due to market demand, the bank plans to continue issuing both mortgage backed securities as well as other securities during 2006.

The vision of the Bank is to be a universal bank providing a full spectrum of financial services to both individuals and companies, concentrating on medium to large corporations and individuals with average to high income. Domestically  Baltic Trust Bank  has the largest branch network in the country. BTB recently introduced a package of services for families and one for businesses allowing customers significant savings and many advantages, as compared to most competitors.

For their overseas customers, BTB offer the same extensive banking opportunities as for their domestic clients - asset and cash management, securities, money market, electronic banking, payment cards, investment and lending opportunities - and all with a personalized approach. TRUST is the key word in BTP's relationship with their customers and the reason it was renamed Baltic Transit bank to Baltic Trust Bank.

A history of the Latvian banking system
Based on: "Development of the Latvian Banking System" by The Association of Latvian Commercial Banks. Data: The Bank of Latvia.

Latvia's first two commercial banks since World War II were established in 1988, just three years before regaining independence. The following year, they were joined by another four banks. The organizational procedure for establishing the first banks was laborious, because the foundation licenses were issued by the USSR State Bank in Moscow. The situation only changed after Latvia regained independence in 1991. New licenses were now issued by the Bank of Latvia (the Central Bank), founded on August 31, 1990. Until 1993, the Bank of Latvia took up the functions of both the central bank and a commercial bank.

In 1993, the Bank of Latvia terminated its function as a commercial bank by privatizing its commercial branches. The same year, the first banking merger took place and licences for two banks that had not yet started their activities were revoked.

In 1994, the first foreign bank (Dresdner Bank AG, Germany) opened its representative office in Riga. The first bankruptcies appeared. As a result, the Bank of Latvia had to cancel licences for seven banks. This revealed the necessity for more intensive bank supervision and for relevant amendments in legislation, which were introduced in 1995. International bank supervision standards were introduced, a new law on Credit Institutions was adopted, and banks were subjected to international audit. In consequence, the Bank of Latvia cancelled licences of 15 banks in 1995 and of additional seven banks in 1996. Four of the top ten banks, including the country's largest bank, Banka Baltija, were closed.

According to The Association of Latvian Commerical Banks, some of the reasons for this banking crisis were the fact that, in 1992 to 1995, the bank sector developed more rapidly than the overall economy. The recession, the insufficient speed of economic reform and imperfect legislation increased the existing high banking risk even more. The insufficient quality of the credit portfolios became apparent when the the supervision of the Bank of Latvia increased. The rapid introduction of international accounting, supervision and auditing standards created problems for some of the banks. Bank staff was insufficiently trained and experienced for the new conditions. In addition, cases of mismanagement occured.

In 1997, due to insolvency, the Bank of Latvia had to revoke the licences of two banks. In autumn 1998, the Russian financial crisis affected the Latvian banking system negatively. The sector experienced total losses of 102 million Lats. Two commercial banks went bankrupt, and one became insolvent. During the year, the Bank of Latvia revoked the licences of for two banks.

At the same time, in 1998, well before 9/11, two new laws came into force: One "On the Prevention of Legalisation of Money Received from Crime", the other "On Guarantees for Deposits of Natural Persons."

In 1999, the banking sector overcame the negative influences of the Russian financial crisis. 19 of 24 banks ended the year with profit. Only one bank decided self-liquidation, another one went bankrupt.

The year 2000 brought essential structural changes, e.g. Hansabank bought and associated itself with the Untied Baltic Bank in Ventspils. Due to mergers, the number of banks was reduced from 24 to 22. The banking system stabilized, and the acceptance of the Law on Financial and Capital market Commission was a decisive legislative step forward.

2001 proved to be the most successful year in the banking sector at that point. Profits reached the record level of 46,7 million Lats, assets increased by 28.2%, loans issued by commercial banks by 50.5%. An essential event was the introduction of the united supervision in Latvia, resulting in the Financial and Capital Market Commission uniting the Credit Institutions Supervision Department of the Bank of Latvia, Latvia Insurance Supervision Inspectorate and Securities Market Commission of Latvia. Licenses to start activities were granted to two new banks. One bank became temporarily insolvent, but managed to restart its activities.

The Latvian banks take Anti-Money Laundering seriously and have established relevant legislation, regulations and procedures in 2005. The Committee that regulates the banks has done a series of audits and the banks themselves have signed a relevant declaration. I had a look at the very detailed "Anti-Money Laundering Policy" by JSC Baltic Trust Bank, as of September 2005. It ranges from identification and due diligence of customers to the refusal to perform suspicious transactions. Only transactions that are "clearly understandable, logical and which have documented economic justification, and do not arouse suspicion of possible connection with the legalization of proceeds from crime or financing terrorism" are acceptable.



The Latvian banking business has grown significantly since the year 2000, not in terms of the number of banks, which remain 23, but rather in terms of assets, deposits and loan activity. Assets have grown from 3.5 Billion Lats at the end of 2000 to nearly 10 Billion Lats in the Third Quarter of 2005 (13 Billion Euros). Deposits have grown from 1.2 Billion Lats in the beginning of 2000 to nearly 6 Billion Lats in the 3rd Quarter of 2005. Capital has increased from 200 million to nearly 800 million Lats (over 1 Billion Euros). Loan volume was 6.1 Billion 3rd Quarter 2005 as compared to 1.6 Billion year-end 2000. Profit after taxes for the banking sector was 116 million Lats for the year 2004, more than double that of the year 2001 results.

The first ATM was installed in September of 1995. At this point there are nearly 900. More than half of the population of 2.3 million people have a debit or credit card, for a total of 1.6 million cards. There are 2.5 million bank accounts for making payments and transfers. Private Mortgages have increased from 250 million Lats in the year 2000 to 1.5 Billion in 2005.

GDP growth continues to be the highest in Europe, over 10% during 2005 and is forecasted to remain over the 7% level next year. Inflation, unfortunately will still be high. It is forecasted to be around 5%, but down from 7% in 2005.

The fact that Latvia is emerging as a financial and banking center has been recognized by a number of European banks which are participating in this growth, having purchased banks in Latvia. Among them are: Skandinavska
Enskilda Banken, Nordea Bank, Norddeutsche Landesbank, Swedbank and Sampo bank.

One of the danger's for Latvia's economy and banking system is overheating, since consumption is largely financed on credit, e.g. through mortgages on houses, one of the rare ways this newly developed market economy can create the capital it desperately needs in order to grow. An other danger is the relatively high corruption level (Transparency International Corruption Perceptions Index 2005: country position 52 with 4,2) in this relatively poor country (OECD 2002 Purchasing Power Parities below 50). However, Latvia offers the lowest wages in the EU, one of the reasons why GDP is expected to continue to grow in the following years.

As members of the European Union and NATO, (Riga will be the host for the NATO Summit in the Fall of 2006, as well as the host for the Ice Hockey World Championship in May of 2006), Latvia is taking its rightful place back in Europe and the world. It is clear that the success of its rapid growth in the area of banking is playing a very important role in this evolution. After all, "Money makes the world go round!"