Presentation by Uldis Cērps, CEO of Finance Latvia, to the American Chamber of Commerce in Latvia (Amcham) on January 8, 2025
Dear Members of Amcham,
It is a pleasure to be here today to share some thoughts on the current developments in the Latvian financial market, with a particular focus on the role of banks in promoting economic growth in the corporate sector.
We have heard from several leading stakeholders in the public sector that banks should lend more to companies and take more credit risk. Let me share my view on this.
Before we answer this question, perhaps some zooming out is in order. We need to understand that rapid credit growth cannot be the ultimate policy objective. Rather, the objective should be defined as good access to finance for creditworthy households and firms. Focusing only on achieving a high growth number, say 12% per year,[1] as implied by the government’s draft plan to facilitate bank lending, may lead to compromising sound risk management principles and may result in excessive industry concentration and large credit losses.
So what happened in the credit market last year? All the evidence suggests that we had a healthy credit growth in 2024, especially against the backdrop of poor economic performance. In a year when the GDP growth was close to zero[2], credit growth of around 5% can be considered a good achievement[3]. And let’s not forget that to keep the credit portfolio unchanged, banks need to constantly issue new loans to make up for the amortization of the existing loan portfolio. We estimate that the largest banks in Latvia issued over EUR 3 billion in new loans in 2024[4], while total loan portfolio was around 16 billion[5].
So what are the facilitating and constraining factors for credit growth?
Banks in Latvia indeed have the capacity to lend more, they are well capitalized, and their liquidity position is good. The CET1 ratio of the banking system was 20% at the end of September last year, the NPL ratio was 1.5%, the LCR was 245%, and NSFR was 161%. All these indicators are well above the minimum regulatory requirements. The banks’ return on equity was 24%, and cost/income ratio was 40%. In other words, the banking system is in good shape and able to continue financing the economy.
There are several factors that have negatively affected credit growth. The first is the current state of the Latvian economy. Economic growth in 2024 was understandably low, impacted by geopolitical risks and the absence of growth in Latvia’s main trading partners. We also see that ECB’s monetary policy stance has had a dampening effect on economic growth, as the stance remains restrictive. However, even with higher interest rates, corporate and household borrowing has continued at a healthy pace in 2024, demonstrating that the anti-inflation measures have not unduly restricted access to financing. We are likely to hear more good news in this regard this year, as market participants expect the ECB to reduce its interest rate levels to 2.15% by mid-year[6].
Another limiting factor is the tax policy. The Latvian government, against the recommendation of the IMF[7], introduced a temporary solidarity levy to be imposed on the banking sector in 2025, 2026, and 2027. The higher cost of doing banking business could be passed on to businesses and households, making credit less accessible. The tax also raises doubts about the predictability of the government’s economic policies.
When listing the constraining factors, we should also not forget that the Bank of Latvia has increased capital requirements for all banks in 2025 by raising the countercyclical capital buffer (CYCB) requirement from zero percent to 0.5 percent on December 18, 2024, and further to 1percent on June 18, 2025. We understand the policy objectives of the Bank of Latvia, which are to further strengthen the resilience in the system. Many central banks have introduced a CYCB requirement that is greater than zero in the neutral phase of the credit cycle. The idea is that this capital requirement can be released (lowered to zero) whenever banks need an external regulatory push to lend more. The idea behind the positive, non-zero CYCB in “normal times” is sound, but the timing of the introduction could have been better, as the introduction of the CYCB coincided with the imposition of the solidarity levy.
Another limiting factor is the reluctance of the corporate sector to invest. A recent study by the SEB demonstrated that in the period from 2019 to 2022, Latvian companies have increased the share of cash and short-term receivables in their balance sheet from 41% to 43%, and accordingly reduced the share of long-term investments from 60% to 58%. A recent study[8] by the Ministry of Finance confirmed that Latvian corporates are reluctant to invest by borrowing from financial institutions and finance their investments mainly from equity: from 2016 to 2022, corporate liabilities (which includes bank loans) were virtually unchanged at EUR 13.7 billion, but the equity capital has been increased from EUR 20.3 billion to EUR 32 billion during this period. It is interesting to note that the banking sector in Latvia finances about the same share of total corporate sector borrowing as in the rest of the euro area: 37% (the euro area average is 39%)[9].
From a structural perspective, the number of bankable companies in Latvia is estimated at only 21 thousand firms, or 20% of the total[10]. Of these, 4.5 thousand have already received credit[11], leaving the unbanked cohort of about 17 thousand firms. Of these 17 thousand firms, many are in less capital-intensive sectors such as ICT and services. This needs to be considered when estimating the potential for new lending. The main reason why 80% of firms in Latvia are not considered creditworthy is because of 3 factors: (1) they are too small[12]; (2) they are undercapitalized[13]; or (3) they have insufficient revenues to service the debt[14]. Latvia also has a very limited number of large companies: only 651 companies have a turnover of more than EUR 50 million. In other words, the growth potential is limited by the size of the corporate sector. SEB has estimated that the untaped financing potential of Latvian firms is currently EUR 1.5 billion.
To sum up, there are several clear indicators that that the current pace of financing the corporate sector in Latvia is not primarily explained by the supply-side constraints on the part of banks, but rather by demand-side constraints on the part of firms.
This brings us to the other topic of discussion. What can be done to facilitate access to corporate credit? And in particular, what can Amcham do to facilitate this? If we want to simplify things, I can suggest a formula that consists of three components, and all three start with an “I”: institutions, investment, and innovation.
We need stable and well-functioning institutions to support economic growth, including predictability of economic policies, a stable tax system, and fair and expedient enforceability of commercial contracts in the courts, transparent public procurement, fair competition in all sectors, reduction of the gray economy, increased efficiency, and lower cost of the public sector, improvement of tax collection and payment culture, and low level of corruption. These are all areas where further improvements are needed. By focusing on these institutional improvements, we will make Latvia more competitive internationally.
On the investment side, we need to make a big leap in developing our capital markets and increasing the risk appetite of our savings, as well as achieving greater financial literacy. This is true both in the Latvian context and in the European context, with the expected commitment of the new European Commission to promote the development of the Savings and Investments Union. We also need to strengthen the activities of the Latvian Development Agency, and I am glad that so many of these measures are already well underway.
When it comes to innovations, we need to support the whole lifecycle of innovation, from the teaching math and physics at schools and STEM education in universities, to the transferring these innovations to the business environment, to supporting the ecosystem that finances new innovative companies throughout their lifecycle – from the stage when a start-up is supported only by “friends, family and fools” and business angels, to the stage when it can attract venture capital and eventually go public or attract a strategic partner. This is not an exhaustive list of actions. But it is an example of areas where Amcham and Finance Latvia can work together with the Latvian government to help Latvia make significant progress and eventually become one of the most competitive and innovative economies in the world.
Thank you!
[1] Based on the vision to increase Latvia’s GDP twofold by 2035, and increase credit to non-financial corporates to 20% of GDP.
[2] https://stat.gov.lv/lv/statistikas-temas/valsts-ekonomika/ikp-istermina/preses-relizes/20976-iekszemes-kopprodukts-2024.
[3] Corporate lending value at the of Q3 2024 was about Eur 9.4 billion, and loans extended to non-financial firms reached EUR 5.4 billion in Q2 2024.
[4] Extrapolation from H1 2024 statistics provided by Kredītu informācijas birojs.
[5] The average tenor for the whole credit portfolio equal to about 5 years.
[6] https://tradingeconomics.com/euro-area/interest-rate.
[7][7] https://www.imf.org/-/media/Files/Publications/CR/2024/English/1LVAEA2024001.ashx.
[8] Tax Policy Strategy 2024-2027.
[9] Remaining financing is provided mainly by the owners, and to much lesser degree by capital markets.
[10] https://www.seb.lv/en/cross-sectional-analysis-latvian-companies-where-are-untapped-lending-opportunities.
[11] In addition to that, 3.5 thousand firms have received credit which are not eligible by the criteria applied by the SEB in its analysis. In total, around 8 thousand companies in Latvia have received bank loans – 4,500 companies that fulfil the minimum financial criteria and a further 3,500 that are in a relatively weaker financial position.
[12] Turnover below EUR 50 thousand.
[13] Negative equity of equity below 30% of assets.
[14] Negative EBITDA or less than EUR10 thousand.
