Kilvar Kessler: The Estonian financial sector stands on a strong financial base, but the quality of corporate governance needs to improve
Chair of the Management Board of Finantsinspektsioon, Kilvar Kessler, presented the Finantsinspektsioon annual report for 2017 to the Riigikogu today, and gave the Estonian financial sector grades of A and C+, noting that those relatively good marks could change if the serious risks to the sector materialised.
The banks in Estonia and most of the other regulated financial intermediaries are well capitalised and stand on a strong financial footing. Finantsinspektsioon has directed them to build up large enough buffers to cover any losses that could arise from risks materialising in the future. The loan portfolios of the banks are of high quality, the combined ratio of insurers is remarkably good, and the fixed costs of fund managers are falling in relation to income from service fees.
The return on equity of the sector is generally a two-digit percentage, which is a good result in European terms. Prudential ratios are met with reasonable margin. For just its financial figures the regulated financial sector in Estonia gets a clear grade A.
The picture becomes a little less clear though when looking at the management and managers in finance, the organisation of institutions, and especially the functioning of internal controls. A common denominator here is the cost that arises from the complexity and number of norms, and the desire to make savings against this. Organisations that have a larger revenue base or are technologically more advanced are accordingly better able to to pay this cost. There should not be any illusions about this though as everything comes from the culture of an organisation and its management, and the values that they bear.
Given the size of Estonian financial intermediaries, the nature of the services they provide, and the quality of supervisory dialogue, the management, institutional organisation, and especially internal control in the regulated financial sector in Estonia as a whole deserves the grade C+. There is room for development and Finantsinspektsioon will continue its intensive work on the strategic priority of supervising corporate governance.
Those relatively good grades of A and C+ could change though if the serious risks to the sector materialise. Trends that are currently apparent are the rapid growth in credit and the increase in the importance of technology.
The central bank considers that the the main risk to the Estonian financial sector comes from the Nordic economies and the banking sector there, through the indebtedness of Nordic households, the high real estate price levels, and the sources and maturities of funding for the banks. Finantsinspektsioon tends to agree with this assessment.
This means there are direct risks for the large Estonian banks, should the Nordic parent banks want to support their operations from the buffers and capital held here. This also means there is an indirect risk should the Estonian economy be hurt by the Nordic economies to which it is closely linked, reducing the quality of credit in the loan portfolios of the Estonian banks, which would in turn be exacerbated by the relatively fast growth in loans.
Mr Kessler also noted the importance of international cooperation in his presentation, describing important projects for Estonia and speaking of risk controls for financial intermediaries and financial innovation.