Need to Enhance Competition in the Baltic Banking System

Essays - May 10, 2024

The ECR Party has published an April 2024 report on the transformation of the banking sector in the European Union and Northern Europe and its impact on sector competition in the Baltic States.

Its authors have been Gundars Bērziņš, Dean of the University of Latvia’s Faculty of Business, Management and Economics, member of the board at the SSE Riga Foundation and member of the UL Student Business Incubator Council; Ramona Rupeika – Apoga, Head of Finance and Accounting Department in the University of Latvia; Jānis Priede, Associate Professor and Reader in Applied Mathematics in the Academic Research Centre for Fluid and Complex Systems in Coventry University; and Elmārs Kehris, economist having specialized on Financial analytics, Economic research, Digitalization and project management, and CEO & Economist in KEKonsultācijas.

The report outlines different uncertainties the banking system has faced and will continue to face along the first half of the current century and across all of the European Union.  Most recently, the greatest economic threat has been inflation, with a dramatic increase in 2021 that has not been fully under control until September 2023 (Source:  Statista).  During the second half of 2023, 44 per cent of people considered rising prices, inflation, and the cost of living as an important national issue in the European Union.

As for the Baltic region, after having obtained independence Estonia and Lithuania have opened their economies to foreign banks, while Latvia originally aimed to become a financial hub for Russia and the Commonwealth of Independent States (CIS).

As a consequence, more than 85 per cent of Estonia’s and Lithuania’s banking assets are controlled by foreign-owned institutions, while in the case of Latvia the percentage lies at 76 per cent.  In all three cases, more domestic participation would enhance competition within the Baltic market in comparison to the broader Nordic region.

From 2009 to 2022, the EU has faced a significant decline in banking offices (40 per cent) and employees (20 per cent).  Estonia and Lithuania have defied this trend with a continued employee growth, but Latvia has experienced a dramatic 57 per cent plunge in banking personnel – the steepest drop in all of Europe.

Latvia and Lithuania hold some of the highest deposit to loan ratios in Europe.  However, borrowers in the Baltics consistently face loan interest rates exceeding the Eurozone average, again a suggestion that competition could be improved.

In customer mobility, Latvia (26 per cent) and Lithuania (22 per cent) lag quite behind the EU average (29 per cent).  The same trend is visible in mortgages, where the EU average is 2.4 per cent, Estonia’s 1.6 per cent, Latvia just 0.9 per cent and Lithuania a marginal 0.8 per cent.  For the third time, these poor levels of customer mobility could point to limited alternatives for customers in the Baltic region, but also to complex switching procedures – which in turn erode competition further.

With regards to the penetration rate of online banking in 2023, Estonia and Latvia have overpassed 80 per cent, while Lithuania has not reached that same percentage, at the moment.  Still, the three of them are among the thirteen Member States with higher penetration rates.

Return on equity is highest in Latvia and Lithuania, with 25 per cent (data of March 2023); Estonia’s lies at 20 per cent, still almost double the EU average (10.4 per cent).  Such profitability levels are excellent for bank shareholders and for the stability of the banking system, but it goes to the detriment of bank customers who would benefit from higher competition, as argued above.

Efficiency levels also stay at strong levels, with a cost to income ratio of just 30 per cent in Latvia, 35 per cent in Lithuania and 38 per cent in Estonia, way below 57 per cent in the whole of the European Union (data of June 2023).

Source of image:  Prof. Dr. Gundars Bērziņš (University of Latvia)