Latvia Commercial Banking Report Q3 2008

Over the last year the crisis in the inter-bank market and the soaring prices of oil and other raw materials tended to obscure several other important trends. In most of the developing world (i.e. the vast majority of the countries whose banking industries are surveyed by BMI), lending has been growing quickly. In many emerging markets inflationary pressures have been boosted by a rapid increase in credit, and in a number of emerging markets macro-economic imbalances are evident.

The figures on the tables above provide a snapshot of the banking sector in Greece and the changes that have taken place within it over the last year. To place the figures in context, it may be useful to bear in mind certain aspects of the 59 countries whose banking sectors are currently surveyed by BMI. Across this sample the median growth in assets in local currency terms was 21.3% (in Colombia), the median loan growth was 21.6% (in India), and the median growth in deposits was 17.9% (in Brazil).

On their own, the ratios of loans to deposits, assets, and GDP mean little; however, they can provide useful hints when combined with other data. Across the 59 countries the median loan/deposit ratio was 92.3% (in Greece), the median loan/asset ratio was 56.0% (in Poland), and the median loan/GDP ratio was 63.9% (in India).

From 3Q08, we have included a new section that examines the risks associated with each country's banking sector in a new way. We have essentially sought to ask to what extent the banking sector will likely need source funding from banks in the rest of the world over the course of 2008. Given that the answer is not necessarily meaningful on its own, we have looked at other key issues such as the size and recent movement in the loan/deposit ratio, macro-economic developments, and recent movements in financial markets.

In general, the first half of 2008 has been kind to fixed-income investors and money market participants in Central and Eastern Europe. Inter-bank lending rates have come down thanks to the actions of the European Central Bank and the Federal Reserve, among others. Benchmark bond yields have generally fallen in absolute terms and, in some cases, relative to yields in developed countries. This is in spite of the fact that in many of the countries in the region, the statistics from the banking sector are worrying given the economic imbalances that persist.

As in previous reports, we include a SWOT analysis for Latvia. A major theme of this report is that, overall, the weaknesses of the banking system predominate. Major and well-capitalised foreign banks are far less dominant in Latvia than they are in the rest of Central and Eastern Europe. We assess that the Latvian banks will be substantially dependent on funding from banks outside the country if they are going to increase lending in absolute terms by anything like the amount that we envisage for 2008. This is at a time when the macro-economic imbalances are alarming and that some kind of hard landing appears inevitable.

Since Q108 we have calculated on a consistent basis a Commercial Bank Business Environment Rating (CBBER) for each of the 59 countries surveyed. The CBBER includes an assessment of the limits of potential returns: it does this by taking into account the size, growth potential, and bancassurance potential of the banking sector, as well as aspects of the economy in 2007. The CBBER also depends on an assessment of the risks to the realisation of potential returns. This reflects BMI's assessments of overall country risk, together with the regulatory and competitive environment.

Latvia's overall CBBER of 56.2 is towards the middle of the countries in the Central and Eastern Europe region that are surveyed by BMI. This score is particularly held back by a weak score of 42.5 on the heavily weighted banking market structure element of the limits to potential returns. This reflects the small scale of the Latvian economy and of the domestic deposit base available to the banking system.