EU Banking and Its Impact in Baltic States

Reforming Baltic Banking - May 16, 2024

In recent decades, the banking sector of the European Union (EU) and Northern Europe has undergone significant transformations, greatly influencing sector competition in the Baltic States. This article explores the key changes in the banking sector, their impact on competition in the Baltic countries, and future directions for sustainable growth.

The Economic Context and Banking Transformation in the EU

Since 2008, the EU has faced several economic crises, starting with the global financial crisis that originated in the United States and quickly spread to Europe. This crisis led to a recession, followed by a sovereign debt crisis in various member states, causing severe consequences for economic growth, investment, employment, and fiscal positions.

In response, the EU implemented short-term measures, such as bank bailouts, and long-term reforms to improve the resilience of the financial sector, strengthen economic governance, and implement structural reforms. The COVID-19 pandemic further impacted the European banking sector, leading to revenue declines and accelerating digitalization. Banks now face new challenges, such as cyberattacks, non-performing energy-related loans, and changes in the economic dynamics of the euro area.

Banking Transformation in the Baltic States

After the fall of the Soviet Union, Estonia, Latvia, and Lithuania opened their economies to foreign banks. Estonia and Lithuania embraced international banks, particularly Swedish ones, which served both local residents and international clients. Latvia, on the other hand, aimed to become a financial hub for Russia and the Commonwealth of Independent States (CIS), attracting deposits from these regions. However, this strategy led to money laundering issues, forcing the three Baltic countries to implement stricter regulations and seek more sustainable approaches for their banking sectors, transforming their business models to be more digital and environmentally friendly.

Foreign Investment and Local Growth

Foreign investment has played a significant role in the development of the Baltic banking sector, but it has also led to a high concentration of assets. In Estonia and Lithuania, over 85% of banking assets are controlled by foreign-owned institutions, while in Latvia, the percentage is 76%. This dominance of large international banks offers stability but can limit competition within the Baltic market compared to the Nordic region. For the future, it will be crucial to find a balance between foreign investment and domestic participation to ensure a healthy and dynamic banking environment in the long term.

Banking Employment Before and After the Crisis

Before the crisis (1998-2008), the EU saw an increase in banking personnel (19%) and offices (23%). However, the Baltic and Nordic countries showed different trends. Latvia registered an impressive 76% increase in employees, followed by Estonia (38%) and Lithuania (16%). After the crisis (2009-2022), the EU experienced a significant decline in both offices (-40%) and employees (-20%). While Estonia and Lithuania continued to grow, Latvia saw a drastic 57% drop in banking personnel, the highest in Europe. This trend suggests a shift towards digitalization, focusing on efficiency and a change in customer demographics.

The Credit Paradox in the Baltic States

Despite constant criticism directed at Baltic banks for insufficient lending, the issue may not stem from a lack of resources. In fact, Latvia and Lithuania hold some of the highest deposit/loan ratios in Europe, indicating a cautious approach to lending. However, this conservatism does not translate into lower interest rates. Borrowers in the Baltic countries face consistently higher loan interest rates compared to the Eurozone average, while Scandinavia enjoys some of the most favorable rates in Europe. This stark contrast suggests a potential competition problem in the Baltic banking sector.

The Profitability of Baltic Banks

The Baltic countries boast some of the highest returns on equity (ROE) and net interest margins (NIM) across the EU, signaling high banking profitability. However, this prosperity comes at a cost to borrowers, as the Baltic countries also experience the highest loan interest rates within the EU. This suggests a focus on maximizing banking profits, potentially due to a less competitive environment, reflected in their lower cost/revenue ratio (CIR). In contrast, the Nordic countries balance profitability and competition. Their profitability remains above the EU average but does not reach Baltic peaks, possibly because they prioritize competition, evident in their slightly higher CIR compared to the Baltic countries.

Customer Mobility in Banking

Customer mobility in banking in Europe shows regional diversity. While the EU has a decent switching rate compared to the United States, suggesting a more competitive landscape, significant disparities emerge. The Baltic countries, particularly Latvia and Lithuania, are below the EU average, especially for mortgages, when compared to the leader in mobility, Sweden. This intriguing difference raises the question of whether low mortgage mobility in the Baltic countries is a cultural preference or driven by other factors such as complex switching procedures or limited mortgage options.

Beyond Profit Margins: The Profitability of Swedish Banks in the Baltic States

Analyzing financial performance indicators for Swedish banks SEB and Swedbank from 2005 to 2023 in the Baltic States (Estonia, Latvia, Lithuania) and Sweden revealed interesting results. While profitability metrics such as net interest margin and return on assets initially suggested higher returns in the Baltic States, a more comprehensive analysis presented a nuanced picture. Return on equity showed similar results across all regions. This suggests that factors beyond simple profit margins, such as potentially higher operating costs in Sweden, reflected in a lower CIR for the Baltic States, influence overall profitability. A lower CIR in the Baltic States might indicate better cost control by banks, but it could also suggest a less competitive environment. This study challenges the common perception of a clear profitability advantage for Swedish banks in the Baltic States and highlights the need to explore the underlying reasons for these regional variations, including potential differences in competition and cost structures.

Regulatory Landscape and Compliance Challenges

The regulatory landscape in the Baltic States has evolved significantly, particularly in response to money laundering scandals. Stricter compliance requirements have been introduced, affecting operational costs and influencing the strategic priorities of banks operating in these countries. The implementation of anti-money laundering (AML) measures has been critical in restoring trust and stability in the financial systems of Estonia, Latvia, and Lithuania. However, these measures have also posed challenges for banks in terms of compliance costs and operational adjustments, highlighting the need for a balanced approach that ensures both regulatory compliance and operational efficiency.

The Role of Digital Transformation

Digital transformation has become a pivotal aspect of the banking sector in the Baltic States. The rapid adoption of digital banking solutions has been driven by consumer demand for convenience and efficiency, as well as by competitive pressures from fintech companies. This shift towards digitalization has enabled banks to streamline operations, reduce costs, and enhance customer experiences. However, it also requires significant investment in technology and cybersecurity measures to protect against emerging threats. The ongoing digital transformation is expected to continue shaping the future of banking in the Baltic region, with a focus on innovation and customer-centric services.


The banking sector of the EU and Northern Europe is continually evolving, profoundly influencing sector competition in the Baltic States. To ensure sustainable growth, it will be crucial to address emerging challenges, promote a competitive environment, and balance foreign investment with local participation. The transformation towards more digital and sustainable business models represents one of the keys to the future of the banking sector in the Baltic States and beyond. The ongoing regulatory changes and the adoption of digital technologies will play a significant role in shaping a resilient and competitive banking environment that can adapt to the evolving needs of consumers and businesses.