Latvia Commercial Banking Report

Key Issues

The Latvian commercial banking sector has been growing rapidly. This has been primarily driven by nominal GDP growth of 17.9%. Growth is from a relatively low base and in a sector that is clearly still very underdeveloped.

Aside from their holdings of bonds, most aspects of the commercial banks' balance sheets have been growing strongly. Loans have been growing significantly faster than assets, deposits or nominal GDP. The result of this is that the Loan/Asset, Loan/Deposit and Loan/GDP ratios have all risen over the last year or so even though, by most standards, they were already at fairly high levels. In fact the Loan/Deposit ratio in Latvia is now the highest of all 59 countries we have surveyed, at 202%.

BMI thinks the economy in Latvia risks overheating. Inflation is the highest in the EU at 7%, and changes to tax rates also risk further stimulating domestic demand. There have been reports of labour shortages. The country is vulnerable given it has a current account deficit of 13%. A managed currency is also a concern. Against this backdrop, the vulnerability of the banking sector has increased in the last quarter given the economic conditions and the dramatic loan growth that is occurring.

Changes To This Quarter's Commercial Banking Forecast

We have made a number of improvements to the commercial banking reports this quarter. In particular, we have collated information about banks' capital and bond portfolios.

We have looked at capital primarily because we wanted to produce a clearer picture of the banks' balance sheets and, in particular, the liabilities side. We are now much better able to quantify liabilities that are not deposits.

We collated information about the bond portfolios because we wanted to gain additional insights about the risks with which the banks are involved. Across all the countries that we have surveyed, the commercial banks are major investors in government securities. In some instances, the banks are large holders of bonds - by any standard. In other instances, the banks' holdings of securities represent a very substantial portion of their total assets.