OCCASIONAL PAPER SERIES
No 5 / 2015
BUSINESS MODELS OF SCANDINAVIAN BANKS SUBSIDIARIES IN THE BALTICS: IDENTIFICATION AND ANALYSIS
EXERCISE EVALUATION FORECAST REAL-TIME PSEUDO A DATASETS: MONTHLY LARGE USING GDP OF FORECASTING SHORT-TERM No 1 / 2008
BANK OF LITHUANIA. WORKING PAPER SERIES PAPER WORKING LITHUANIA. OF BANK 1
ISSN 2424-3213 (ONLINE) OCCASIONAL PAPER SERIES No 5 / 2015
BUSINESS MODELS OF SCANDINAVIAN BANKS SUBSIDIARIES IN THE BALTICS: IDENTIFICATION AND ANALYSIS
by Aldona Jočienė*
* The Centre for Excellence in Finance and Economic, Bank of Lithuania, Totorių g. 4, LT-01121 Vilnius, Lithuania. E-mail: [email protected], Vilnius University, Tel. +370 698 48685.
© Lietuvos bankas, 2015 Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.
Address Totorių g. 4 LT-01121 Vilnius Lithuania
Internet http://www.lb.lt
The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania
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Abstract
Since the crisis in the Baltic countries in 2009, the question on the particularities of business models adopted by foreign-owned banks has been often raised. The business models of these banks have changed significantly, but they still remain of major concern. The aim of this paper is to identify what type of business models have been chosen by the Baltic foreign-owned banks, to assess them as well as to provide recommendations on how to address the outlined challenges. The Literature Review showed that the Business Model Canvas approach can be used for bank business model analysis. However, banking specialness should be taken into account. Empirical research was carried out using a combination of qualitative and quantitative methods for nine Scandinavian banks subsidiaries operating in the Baltics. The main focus of this research was the complex analysis of bank business model components, using the newly created system of key business model indicators. Business model analysis was based only on publicly available information, which is limited and not standardised. The main characteristics of the business model of Scandinavian banks subsidiaries established in the Baltics are as follows: retail banks operating in one jurisdiction, dependency on the parent bank decisions, aversion to risk, stronger focus on non-interest income and high efficiency due to cost cutting and e-banking, orientation on safety (banks meet prudential requirements with large reserves), and medium profitability with a negative trend for the future. It was determined that if banks keep on doing their business as they are currently, their possibilities of generating acceptable returns will be of major concern. The biggest opportunity for banks in a low interest rate environment is to focus on increasing the volume of interest bearing assets. Financing small and medium-sized enterprises (SMEs), especially in productive sectors and innovative companies, could be the best outcome for banks and Lithuania’s economy. To achieve this goal, banks need to set SMEs financing as a strategic priority, make fundamental changes in their lending policy. The EU and local governments should give financial support for SMEs to strengthen this sector, and that should encourage banks to finance SMEs more actively as well. The analysis of bank business models is a relatively new approach towards banking industry analysis. This paper is the first attempt of deeper analysis of business models of Scandinavian banks subsidiaries operating in the Baltics. This paper can serve as an eye-opener for Financial Supervisory Authorities and Central Banks, Scandinavian banks when drafting strategies for their subsidiaries and Government representatives who are responsible for the banking system strategy and strengthening SMEs sector.
Keywords: Baltic countries; foreign-owned bank; business model, sustainability, small and medium enterprises (SMEs).
JEL Classification: G21; M21.
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I would like to thank Marius Jurgilas for the invaluable comments and suggestions, Mihnea Constantinescu for scientific advice, Karina Majevska for technical support, Prudential Supervision, Financial Stability and Economics Departments of Bank of Lithuania, Latvian Financial and Capital Market Commission and Estonian Financial Supervision Authority for the data and comments.
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Santrauka
Nuo 2009 metų krizės Baltijos šalyse dažnai keliamas klausimas apie užsienio bankų verslo modelių ypatumus. Skandinavijos bankų patronuojamieji bankai, veikiantys Baltijos šalyse, taikomus verslo modelius gerokai pakeitė, tačiau jie ir toliau kelia susirūpinimą. Šio darbo tikslas – nustatyti, kokios rūšies verslo modelius yra pasirinkę Baltijos šalyse veikiantys užsienio bankai, įvertinti šiuos modelius ir jų keliamus iššūkius, taip pat pateikti rekomendacijas, kaip su nustatytais iššūkiais būtų galima susidoroti. Atlikta literatūros apžvalga parodė, kad toks metodas kaip verslo modelio paveikslas (angl. Business Model Canvas) gali būti taikomas bankų verslo modelių analizei, tačiau turi būti atsižvelgiama į bankininkystės verslo ypatumus. Empirinis tyrimas atliktas naudojant kiekybinių ir kokybinių metodų derinį ir jį taikant devynių Skandinavijos bankų, veikiančių Baltijos šalyse, verslo modeliams išanalizuoti. Koncentruojamasi į atskirų verslo modelio komponentų kompleksinę analizę, jai taikant sukurtą verslo modelio indikatorių sistemą. Verslo modelių analizė atlikta naudojant tik viešai prieinamą informaciją, kuri yra ribota ir nestandartizuota. Nustatytos tokios Skandinavijos bankų, veikiančių Baltijos šalyse, verslo modelio pagrindinės savybės: tai mažmeninis bankas, vykdantis veiklą vienoje jurisdikcijoje, labai priklausantis nuo patronuojančio banko sprendimų, vengiantis rizikos, dedantis pastangas gauti daugiau nepalūkaninių pajamų ir pasiekti didesnį veiklos efektyvumą, besiorientuojantis į banko saugumą (vykdo riziką ribojančius normatyvus su didele atsarga), jo pelningumas vidutinis ir pelningumo tendencija ateityje neigiama. Nustatyta, kad jei šie bankai veiklą vykdys taip, kaip vykdo šiuo metu, jų galimybės generuoti priimtinas grąžas ateityje bus problemiškos. Didžiausių galimybių bankams, esant žemų palūkanų normų aplinkai, teiktų palūkanas uždirbančių aktyvų didinimas. Aktyvesnis mažų ir vidutinių įmonių (MVĮ) kreditavimas, ypač orientuojantis į produktyvius sektorius ir inovatyvias įmones, galėtų duoti geriausią rezultatą bankams ir Lietuvos ekonomikai. Kad pasiektų šį tikslą, bankai turi laikyti MVĮ finansavimą strateginiu prioritetu, atlikti fundamentalius pokyčius kreditavimo politikoje. Europos Sąjungos ir vietinės valdžios institucijos, teikdamos finansinę paramą MVĮ, dar labiau sustiprintų šį sektorių, o tai skatintų bankus aktyviau finansuoti MVĮ. Bankų verslo modelių analizė yra naujas požiūris bankininkystėje. Šiame straipsnyje pirmą kartą pateikiama išsamesnė Skandinavijos bankų, veikiančių Baltijos šalyse, verslo modelių analizė. Straipsnis turėtų būti naudingas finansų priežiūros institucijoms ir centriniams bankams, taip pat Skandinavijos bankams, rengiantiems patronuojamųjų bankų strategijas, ir valdžios atstovams, kurie yra atsakingi už šalies bankų sistemos strategiją ir MVĮ sektoriaus stiprinimą.
Pagrindiniai žodžiai: Baltijos šalys; užsienio bankai; verslo modelis; tvarumas; mažos ir vidutinės įmonės (MVĮ).
JEL klasifikacija: G21; M21.
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CONTENT INTRODUCTION ...... 7 I. LITERATURE REVIEW ON BANK BUSINESS MODELS ...... 8
1.1. CONCEPT OF BUSINESS MODELS ...... 8 1.2. BANKING SPECIALNESS...... 10 1.3. BANKING BUSINESS MODELS AND FINANCIAL CRISIS OF 2008-2009 ...... 11 1.4. BANKING BUSINESS MODELS CLASSIFICATION ...... 13 1.5. BANK BUSINESS MODEL SUSTAINABILITY ASSESSMENT BY SUPERVISORS ...... 17 II. EMPIRICAL RESEARCH ON BUSINESS MODELS OF SCANDINAVIAN BANKS SUBSIDIARIES IN THE BALTICS ...... 19
2.1. RESEARCH METHODOLOGY ...... 19 2.2 OVERVIEW OF THE DEVELOPMENT OF BANKING SYSTEMS IN THE BALTICS IN 1990-2014 ...... 21 2.3. SCANDINAVIAN BANKS GROUPS AND THEIR SUBSIDIARIES IN THE BALTICS ...... 26 2.4. ANALYSIS OF THE BALTICS MARKET FACTORS ...... 30 2.4.1. Macroeconomic environment ...... 30 2.4.2. Regulatory and supervisory changes ...... 33 2.4.3. Technological development ...... 34 2.5. QUANTITATIVE ANALYSIS OF BANK BUSINESS MODELS ...... 35 2.5.1 Analysis of the main business model components ...... 35 2.5.1.1 Size and performance ...... 35 2.5.1.2 Key activities ...... 38 2.5.1.3 Key financial resources ...... 42 2.5.1.4 Revenues streams ...... 44 2.5.1.5 Cost structure ...... 47 2.5.1.6 Risk appetite and prudential requirements ...... 48 2.5.2 Correlation Analysis ...... 50 III. MANAGERIAL SOLUTIONS ON THE IDENTIFIED BUSINESS MODEL CHALLENGES ...... 55
3.1 BUSINESS MODEL CANVAS FOR SCANDINAVIAN BANKS SUBSIDIARIES IN THE BALTICS ...... 55 3.3. ENSURING SUSTAINABILITY OF THE BUSINESS MODEL THROUGH FINANCING SMES...... 59 3.3.1. Financing of SMEs should be a strategic priority of banks...... 59 3.3.2. EU and local governments risk sharing with banks for financing SMEs ...... 60 CONCLUSIONS...... 62 REFERENCES ...... 65 ANNEXES ...... 69
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INTRODUCTION
Banks have always traditionally performed their fundamental roles in the economy as credit allocators, maturity transformers, risk managers, financial infrastructure providers, and financial innovators. All countries want to build the most advanced banking systems. If each bank in the country creates value for customers, shareholders, employees, public sector and for society as a whole, that impacts the country economy growth and progress significantly. The better bank system the country has, the more competitive the country is.
Some researches in the academic world (H. Huang and P. Lin, 2012; Y. Altunbas et al., 2012; David T. Llewellyn, 2011) demonstrated that the banking industry has become too volatile, too interdependent and inflexible in the last ten years. It has become difficult to understand how banks conduct their business. Banks have been operating under non-sustainable business models.
Baltic banking sectors are dominated by the subsidiaries of Scandinavian banks. Before the crisis in 2009, these banks were part of shock creators in the Baltic countries, later they become shock absorbers. After the crisis, the question has been often raised on the particularities of business models adopted by the foreign- owned banks. Recently, the business models of Scandinavian banks subsidiaries operating in the Baltics have changed significantly; however, they still remain of major concern due to possibilities of generating acceptable returns in the future.
The analysis of banking business models is a relatively new approach towards the banking industry analysis, as well as in prudential supervision. The crisis revealed that a traditional prudential supervision approach, which mainly focuses on the adequacy of bank capital, liquidity and risk management, is insufficient. Therefore, many additional measures have been introduced. The quantitative measures cover capital buffers, Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) and leverage ratio, while the qualitative ones include recovery plan analysis, stricter requirements on corporate governance and business model analysis. This business model analysis should allow at an early stage for supervisors to assess the viability and sustainability of business models and to detect key vulnerabilities. At the end of last year, European Central Bank assumed responsibility for euro area banking and set the assessment of viability of business models and profitability drivers as the supervisory priority for 2015 (European Central Bank, 2015a).
Some research work (R. Ayadi et al., 2011, 2012, 2014; R. Roengpitya et al., 2014; M. Tomkus, 2014) has already been carried out on business model analysis of the biggest European and American banks. However, the situation in the Baltic countries was quite different compared to the advanced countries. So far, only one academic paper which analysed bank business models and the changes in Central and Eastern Europe countries during the period from 2006 until 2011 (I. Erins and J. Erina, 2013) has been written. Therefore, in this study deeper analysis of the particularities of the Baltic foreign-owned banks business models was performed: types of business models chosen by these banks were identified, their main characteristics were established, and recommendations on how to address the outlined challenges were provided.
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I. LITERATURE REVIEW ON BANK BUSINESS MODELS
1.1. Concept of business models
Recently the topic of a business model has been often discussed both in the professional and academic publications. The concept is usually used as an analytical tool to have a schematic and complete picture of organization business from a high-level perspective. The term of a business model is widely applied; however, sometimes it is used in a too narrow sense referring only to the revenue model or the operating model, and sometimes too broadly.
The academic literature provides several definitions of a business model (Table 1). Table 1 Definitions of a business model Author Definition H. Chesbrough, and “A Business Model creates value and captures a portion of that value”. R.S.Rosenbloom, Business models are summarized into six simple components: Market segment, 2000 Value proposition, Value chain structure, Competitive strategy, Revenue streams, and Cost structure.
A. Osterwalder and Y. “A Business Model describes the rational of how an organisation creates, Pigneur, 2010 delivers and captures value”. The definition involves nine building blocks of business models: Customer segment, Value proposition, Channels, Customer erelationships, Revenue streams, Key resources, Key activities, Partner network, and Cost structure. M. Tomkus, 2014 “Business model as representation of a set of components utilised to outperform the competition and to achieve optimal profit in a financial market where a similar product strategy used.” European Banking “Business models are the means and the methods used to operate, to generate Authority, 2013 profits and to grow. They result from multiple intertwined elements that reveal the way a company organizes its core activities to achieve its main objectives.” Source: formed by the author.
This demonstrates that there is no universally accepted definition, and the interpretation of a business model is very diverse. One of the most well-known definitions was proposed by H. Chesbrough and R.S. Rosenbloom (2000), the representatives of the Harvard Business School, which summarizes business models into six components. A. Osterwalder and Y. Pigneur (2010), the leaders in the field of business models innovation, carried out the revolutionary work. They introduced the concept of a business model through the generalized view of 470 practitioners from a number of different countries. They used business models in an attempt to better explain how firms do business. The business models were summarized into nine building blocks and shown visually, using a diagram called ‘Business Model Canvas’ (Figure 1). Many organizations proved that this Canvas is very practical and easy-to-use, it helps in generating new ideas by asking a few key questions:
Customer segments: Who are the group of customers? Value proposition: What is the offer for each customer segment? Channels: How to reach each of the customer segments?
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Customer Relationships: How to relate with customers over time? Revenue streams: How to earn revenues? Key resources: What resources are required to run the business? Key activities: What are the important activities/processes? Partner network: Who are the key partners and suppliers? Cost structure: What are the important costs?
Figure 1. Business Model Canvas Source: A. Osterwalder and Y.Pigneur (2010).
M. Tomkus (2014) summarized business model concepts and emphasized that the main purpose and target of a bank is an optimal financial performance. He defined the banking business concept, which he used in his study, as representation of a set of components utilised to outperform the competition and to achieve optimal profit in a financial market where a similar product strategy is used. M. Tomkus emphasized that banks develop business models to manage three main processes: 1) acquisition of necessary funds for operating activities; 2) loan service provision as a means to generate revenues; and 3) risk taking. He narrowed the definition of the business model through a performance as a centric view focusing more on economic value.
The European Banking Authority (2013) defined that “business models are the means and methods used to operate, to generate profits, and to grow”. It was highlighted that the concept of the business model is broader than the business strategy as the latter is only one component of the business model. While the business model provides insights on how an entity effectively does business at a point in time, the business strategy refers to possibilities of an entity how to do business in the future. The strategic choice could then lead to either change in the business model or to staying with the existing business model. G. Georg and A.J. Bock (2011) determined that organisations adjust and redesign their business models under the effects of a changed operational environment. The researchers highlighted that “the ability to adjust or transform the business model is regarded as one of the major features in the banking business model logic. A bank’s management is expected to change their business model as a response to foreseen short- and long-term future opportunities and threats”.
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1.2. Banking specialness
The above described business model concepts may be used for banking business models. However, banking business performs special functions in services and plays a fundamental role in the economy (Table 2). Table 2 Main areas of banks‘ specialness Infrastructure Definition Intermediation Banks are receiving deposits from retail customers (which are supposed to have a and assets liquidity surplus) and providing entrepreneurs and consumers with the amount of transformation funding they need to finance their projects (with an adequate maturity). Information costs The large size of banks and long-term relationship with clients allow the collection of information at a lower average cost (economies of scale) than doing this by individuals. Credit allocation Banks are often used as the major, and sometimes the only, source of financing for a particular sector of the economy, such as small business, residual real estate. Maturity Banks better bear the risk of mismatching maturities of their assets and liabilities. intermediation Banks are heavily reliant on retail funding resources (deposits). Profits come mostly from the spread between interests paid for short-term deposits and interests received from long-term lending activities. Risk premium Banks monitor their credit risk by incorporating a risk premium into the interest rate charged to their borrowers. Banks hold the appropriate levels of capital to cover unexpected risks. Sources: A. Saunders and M.M. Cornett (2011), European Banking Authority (2013); formed by the author.
Banks traditionally play a key function of intermediation and assets transformation between depositors and borrowers. At first glance, the business model of a bank is very simple: banks offer a lower interest rate to the depositor, a higher interest rate to the borrower and make the money from the interest rate differential.
A. Saunders and M.M. Cornett (2011) highlighted that in the traditional business model, banks competitive advantage relies on the information asymmetry between creditors and debtors. Risks associated with investment projects are very costly to monitor and difficult to assess properly for an individual creditor. By financing multiple projects simultaneously and monitoring them over a long period of time, banks can reduce monitoring costs and risks thanks to diversification and economies of scale. The original role of banks is to service the real economy. Credit allocation can be the main driver for the economic growth of the country and for bank profitability, too. J. Brunel (2015) emphasized that currently banks should perform the leading role in financing economy, and this function should be more important than profitability and returns generation. On the other hand, R. Ayadi et al. (2011) presented arguments that the performance and efficiency of the banks has a major impact on a country’s overall efficiency and economic performance. M. Tomkus (2014), having analysed the USA and EU business model changes, stated that “within past ten years, the banking industry undertook a substantial transformation: that gradually formed modern banking business models. Banking is an industry which expanded substantially and unsustainably (‘excessive financialisation’)”. He presented how business models changed in several important ways. M. Tomkus (2014) also pointed out that the importance of banks and the financial system has increased tremendously in the economy in general.
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The banking sector is unique compared to other industry sectors since the sector is heavily regulated. Many research and impact assessments (European Banking Authority, 2015; Ingves S., 2014)) have been carried out seeking to find out how regulation influences banking business and its business models. On one hand, very precise and strict regulation of banks made them much safer and prepared to withstand macroeconomic shocks and other crises; however, on the other hand, banks became averse to risk and that negatively affects economic growth of countries as well as profitability of the banks. Regulation plays an important role in shaping banking business models.
According to R. Roengpitya et al. (2014), banks seeking to be different from one another choose a business model to leverage the strengths of their organization. Each business model is unique, though common business model characteristics may be observed across institutions. Nowadays banks have been facing rapid and irreversible changes across technology, customer behaviour and regulation. The net effect is that the current shape of industry and operating business models are no longer sustainable into the future.
1.3. Banking business models and financial crisis of 2008-2009
The crisis of 2008-2009 clearly showed that certain elements of banking business models were weak. These elements became key in demonstrating banks resilience in times of crisis. According to Y. Altunbas et al (2012), “institutions with higher risk exposure had less capital, larger size, greater reliance on short-term market funding, and aggressive credit growth”. Banks as such were not able to withstand the shocks and absorb losses. In Europe many bank business models failed, some banks were nationalised (such as UK - Northern Rock, Bradford & Bingley, Royal Bank of Scotland; DE - Hypo Real Estate; BE – Fortis, Dexia (partial nationalisation); DK- Roskilde Bank, Amagerbanken, Capinordic; IC- Glitnir, Kaupthing, Landsbanki, Icebank; LV- Parex, Sweden - D.Carnegie & Co, IE - Anglo – Irish Bank, many retail banks). For example, in Ireland the domestic retail banks and subsidiaries of foreign banks experienced damage of their business models by the classic real estate bubble, a reliance on non-domestic funding and focus on growth instead of concentrating on risk management, banking culture and internal governance. As regards the Baltic banks subsidiaries, there were many similarities at that time. The Baltic banks experienced significant losses during the crisis of 2009, but parent banks covered them (this topic is presented in more detail in Section 2.2). The case of the Baltic banks has been analysed by some researchers and institutions (International Monetary Fund, 2014; S. Ingves, 2010; A. Gronn and M.W. Fredholm, 2013).
The European Banking Authority (2013) has noted certain changes in the EU banking business models before the global financial crisis: Favourable economic circumstances and the related upturn in the financial cycle together with a low interest rate environment led to the emergence of new business models based on under-priced risks, high demand for loans and short term strategies to meet the shareholders request for high returns on equity; Steadily increased collateral values also allowed for high rates of credit growth, and European banks further expanded outside their national boundaries. The enlargement of the European Single Market in 2004 and 2007 (with most Central and Eastern European countries) further improved the conditions for
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EU banks for cross-border expansions in this region. This cross-border expansion drive was clearly noted in the increase of loans from non-resident banks. In this time of expansion, European banks financed their leverage with funding from the interbank and wholesale market and less from stable funding (e. g. customer deposits). It may be stated that macroeconomic environment was favourable for economic growth, but banks failed to solve the financial challenges related to the global financial crises due to weaker bank business models.
Soon R. Ayadi et al. [2014] presented a more radical summary of the factors that led to the crisis. “The previous decades saw a frenetic race to high returns on equity coupled with excessive risk taking, encouraged by lax monetary policy and liberal banking regulations”. It could be noted that R. Ayadi et al. [2014] openly criticised the activities of banks for expanding their activities in performing the role of the intermediator too much and thus failing to manage them responsibly and properly. Consequently, real economy lacked financing, and a threat of systemic instability occurred. This led to major changes in the way banks conduct business. Banks stretched the traditional intermediating role up and beyond its limits and also extended their proprietary activity. This resulted in a ballooning banking sector that attached less value to financing the real economy and put systemic stability at risk. “The failure of several banks with unsustainable business models spurred contagion and contributed to the global financial crisis”. However, not all types of banks are facing the same challenges or responding in the same way to crises – it depends a lot what business model was used (R. Ayadi et al., 2014). Many researchers emphasized (D.T. Llewellyn, 2010; Y. Altunbas et al., 2012) that the main reasons for the crisis may be considered the following ones: the systemic under-estimation and under-pricing of risks because of the favourable economic situation and the collective euphoria which was prevailing due to active borrowing of customers and banks readiness to issue as many loans as possible.
D.T. Llewellyn (2010) focused more on banks that they adopted more short-term strategies to maximize the rate of return on equity due to various reasons, including the nature of the competitive environment at the time. He provided arguments that profitability was enhanced not by superior banking performance, but by banks raising their risk threshold and moving up the risk ladder. Another reason, stressed by D.T. Llewellyn (2010), is that internal reward and bonus structures created a bias towards short-termism and also towards excess risk-taking.
The European Banking Authority (2013) defined that more than five years after the beginning of the financial crisis, bank business models still remain a major concern. Banks face great challenges to adapt to the new economic, financial and regulatory reality. The current drivers of change can be divided into a set of exogenous factors (e. g. market pressures, new regulatory measures) that are influencing business models and endogenous factors (such as search for more sustainable profits) which further enhance pressures on banks to adjust. After the crises in the Baltic countries a question has been often raised, what was wrong with the way business had been conducted in banks (S. Ingves, 2010). The funding structure of the banking sector has changed dramatically after the crisis. Before the crisis, almost half of loans in Lithuania provided by Nordic
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banks were financed by parent banks. This was clearly not sustainable. More reliance on local funding, what is being observed nowadays, should mitigate sudden swings in capital flows. Crisis also showed that banks need to seek higher diversification on assets side of the banking sector (not focus on one sector, such as real estate). Credit risk strategy should allow banks to focus on most profitable credit segments, looking from a risk-return perspective. Banks short-term insistence on earning fees and commissions needs to be considered thoroughly.
1.4. Banking business models classification
As bank business models analysis is a relatively new approach in analysing banking industry, some researches on business models classification and how various factors impacted different business models were carried out after the crisis.
R. Ayadi et al. (2011) were among the first researchers who performed a unique, systematic and comprehensive empirical study of different bank business models and their implications on risk characteristics, system stability, bank performance, efficiency, and governance issues. In this pioneering study the results of the first exercise of the business models of 26 major European banking groups (they accounted for 55% of total EU banking assets, the period of 2006-2009 was covered, giving 108 bank-year observations) before and after the crisis were presented. One of the main findings of R. Ayadi et al. (2011) study was the assignment of each of the sampled banks to one of the three distinct business models: retail banks (using customer deposits as a primary source of funding and providing predominantly customer loans), investment banks (more engaged in trading and derivatives activities), and wholesale banks (more active in interbank markets) using the state-of-art methodology and detailed statistical analysis. The study offered valuable insights into how the crisis differentially impacted banks with different business models, retail banks being affected less than the other two models, especially the wholesale bank model. The results also showed that the performance of retail banks has in general been superior to the other two models. They were also less prone to the need for state support during the crisis. The retail banks continued to support the economy by continuing to extend loans to customers, despite the crisis.
The second phase of R. Ayadi et al. (2012) pioneering work provided some key findings. Firstly, it added a new category of business models to the three previously identified: diversified retail banks (using diversified sources of funding and providing predominantly customer loans). Secondly, it provided evidence that diversified retail and retail-focused business models are clearly safer than others, as measured by the distance from default (Z-score), amount of loss-absorbing capital and the long-term liquidity risks (NSF ratio). On the regulatory side, the report called for stricter capital requirements on less diversified banks, including the retail-focused, wholesale and investment banks. On leverage ratio, it was found that wholesale and investment banks and some diversified retail banks more heavily leveraged than the retail-focused ones. In terms of liquidity management, many recommendations on LCR and NSFR were proposed in the report. Moreover, the report included various measures to enhance disclosure requirements.
R. Ayadi et al. in 2014 initiated an annual monitoring exercise on bank business models in the EU. The Banking Business Models Monitor 2014 was the first edition of a new series of publications and extended 13
the previous research of the authors under R. Ayadi et al. (2011&2012). Based on their balance sheet structures, 147 European banking groups that account for more than 80% of the industry assets were categorised in four business models, using a novel clustering model using SAS programming, 1126 bank- year observations. The Monitor emphasised the ownership structures and assessed the financial and economic performance, resilience and robustness, before, during and after the financial and economic crises across retail diversified-, retail focused-, investment-, and wholesale oriented banks. The main observations of these four business models are summarised in Table 3. Table 3 Main observations on European bank business models (2006-2013) Model Ownership (Financial) activities Financial and Risk economic performance Model 1 – Largest share of Largest banks. Least dependent on net Average distance to Investment shareholder Holding large trading interest income. Low default. Most (188 obs.) value banks. Mostly assets and funded earnings during crises. leveraged. Lowest listed. through debt securities Declining customer average risk-weight. Barely any and negative loans. High loan losses cooperatives derivative positions. Relatively inefficient. during the crisis. Internationally Least stable funding. oriented. Model 2 – Primarily Among smallest Most dependent on net Average distance to Wholesale stakeholder value banks. Most active in interest income. default. Low risk- (145 obs.) banks. Few listed interbank lending and Exposed to large weight. Least risk banks. Largest share borrowing. Least trading losses during cost. High leverage. in private block- funding from customer the crisis. Relatively Limited stable owners. Most deposits. Domestically efficient. funding. cooperative and oriented. state owned banks. Model 3 – Least share of state Average sized. Most Most profitable. Largest distance to Diversified owned banks. customer loans Relatively stable default. High risk- retail outstanding and debt returns during the weight. Moderate (303 obs.) liabilities for funding. crises. Receiving leverage and loan Internationally largest share from losses. Lowest reg. oriented. trading income. capital. Low Average efficiency. volatility in share returns. Stable funding. Model 4 – All ownership Among smallest Least profitable and Limited distance to Focused indicators banks. Primarily decline in loans during default. Highest risk- retail around sample providing customer Euro crisis. Trading weight. Low (490 obs.) average. loans funded by income relatively leverage. Highest customer deposits. unimportant. loan losses and Domestically Average efficiency. market risk (i.e. oriented. CDS), especially during Euro crisis. Stable funding. Source: R. Ayadi et al., 2014.
R. Ayadi et al. (2014) found that banks that engage more in traditional retail banking activities with a mix of funding sources (diversified retail) fared well as compared to other bank models during the different phases
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of the crisis. R. Ayadi et al. (2014) concluded that the focused retail banks have performed remarkably worse than their peers during the recent global financial crisis. About half of these small domestically oriented institutions are shareholder-value (SHV) banks. Most institutions providing traditional services such as customer loans are funded by customer deposits. This is also reflected in the income, which consists mostly of net interest income and commission and fees, while trading income is only a minor component. During the crisis banks suffered the highest risk-costs, median return on assets was close to zero, and negative in 2012. Banks are least leveraged, the model is closest to default. The customer loans have been declining for the past three years.
Business models of parent banks of Baltic subsidiaries were also examined by R. Ayadi et al. (2014). The results are presented in Table 4. All three banks are identified as diversified retail banks, but SEB has features of three business models: diversified retail, focused retail, and investment. Table 4 Business models of parent banks of Baltic subsidiaries Rank Name Country Type of Total assets Change in Coverage Business ownership (Euro assets (%, (period, Models million) first-last years) year) 26 DNB NOR NO Savings 285,715 78% 2006-13 D Bank Bank 28 Skandinaviska SE Commercial 280,484 31% 2006-13 I, D, F Enskilda Bank Banken 35 Swedbank SE Commercial 205,530 37% 2006-13 D Bank Source: R. Ayadi et al. (2014).
R. Ayadi et al. (2014) found that transparency and public disclosure practices remain an important concern – the disclosure practices of banks were largely incomplete and incomparable. Since the previous two studies (2011&2012) the situation has not changed much. R. Ayadi et al. (2014) noted that public dissemination of supervisory as it is already done in the US and the implementation of standard disclosure formats, i. e. XBRL, could solve most of the data related issues. However, there is an issue with the application of different accounting standards as well as the coverage and depth of the information.
R. Roengpitya et al. (2014) identified three business models: a retail-funded bank, a wholesale-funded bank, and a capital markets-oriented bank. Many technical aspects from R. Ayadi et al. (2014) were used in methodology for classifying, but they differed in terms of the judgmental elements and the data used. The core of the methodology is a statistical clustering algorithm. In contrast to R. Ayadi et al. (2014), which focused only on Europeans banks, R. Roengpitya et al. (2014) used balance sheets data for 222 banks from 34 countries, covering the period between 2005 and 2013. 1299 bank-year observations were used. Drawing rough parallels with the classification of R. Ayadi et al. (2014), the capital markets-oriented bank corresponds to the investment bank model, the two wholesale models correspond to each other, and the retail-funded model corresponds to the diversified and focused retail banks.
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R. Roengpitya et al. (2014) found that the popularity of business models were different according to bank’s nationality (Table 5). Table 5 Distribution of business models in 2013
Retail-funded Wholesale-funded Trading Total North America 16 - 6 22 Europe 36 22 9 67 Advanced Asia Pacific 11 3 3 17 (Australia, Japan) Emerging market 45 2 3 50 economies Source: R. Roengpitya et al., 2014.
One third of the European banks had a wholesale-funded model (data as of 2013). The research showed that in North America retail-funded banks dominated, although actually in this region wholesale-funded banks prevail; therefore, the classification of banks by R. Roengpitya et al. (2014) could be the result of sample bias. In emerging market economies the retail-funded model is clearly preferred (90 %).
R. Roengpitya et al. (2014) determined systemic differences and similarities in the performance of banks with different business models (Table 6). Table 6 Characteristics of business models1
Retail-funded Wholesale-funded Trading All banks Return-on-assets (RoA) 1.16 0.45 0.98 0.94 Risk-adjusted RoA 0.68 0.09 0.57 0.48 Return–on-equity (RoE) 12.49 5.81 8.08 9.95 Risk adjusted RoE 8.76 2.57 -9.55 4.29 Share of fee income 22.11 23.28 44.30 25.84 Capital adequacy 14.56 12.23 17.29 14.27 Cost of equity 12 3 11 9 Total assets (in USD bn) 361.5 321.6 787.8 417.1 Memo: number of 737 359 203 1299 banks/years Source: R. Roengpitya et al., 2014. In was determined that the retail-focused banks exhibit the least volatile earnings. Regardless of the profitability metric, the retail-funded model, engaging in traditional activities, is the top stable performer, and their model has recently gained in popularity. Wholesale funded banks are the most efficient, but they have the thinnest capital buffers, and the lowest cost of equity. Trading banks struggle to consistently outperform the other two business types.
1 Average values of ratios in percent 16
Many other researches on bank business models classification have been carried out (Table 7).
Table 7 Business model classifications done by researchers Author Identified bank business Implications on model types R. Ayadi et al., 2011, 2012, 2014 Investment Ownership Wholesale Financial activities Diversified retail Financial and economic performance Focused retail Risk I. Erins and J. Erina, 2013 Investment ROE Wholesale ROA Retail Universal M. Tomkus, 2014 Investment - Retail Universal R. Roengpityaet al, 2014 Trading Bank performance Wholesale-funded Retail-funded Source: formed by the author.
These business models classifications can be helpful to understand very generally how bank business models differ; however, the results from previous researches significantly vary depending on the number of the banks chosen for the research, market (region), period of research, etc. Bank business models identification through simple labels such as retail banks or investment banks is not sufficient for decision making (especially for supervisors).
1.5. Bank business model sustainability assessment by supervisors
Bank business models analysis and assessment of their viability and sustainability is a new approach in prudential supervision and it goes beyond the traditional approach, which mainly focuses on the adequacy of bank capital, liquidity, and risk management. For the supervisors, business model analysis is part of the supervisory review and evaluation process (SREP), and it allows to detect at an early stage when a bank may generate risks that ultimately lead to its failure. Moreover, it is used for forming forward-looking supervisory judgments (European Banking Authority, 2014d).
Before the crisis, supervisors focused on whether the institutions meet minimum regulatory requirements, paid some attention to external vulnerabilities such as macroeconomic issues, risks associated with financial markets and the situation of partners (counterparts, borrowers) but featured less prominently. The crisis revealed that certain characteristics of weak business models were one of the main causes of the turmoil and that they also turned out to be key determinants of banks’ resilience.
Then crisis showed that traditional prudential supervision approach was insufficient; consequently, many additional measures were introduced, including business model analysis. In European Banking Authority document “Guidelines on common procedures and methodologies for the supervisory review and evaluation
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process (SREP)” (2014d) it is indicated that this analysis should allow for supervisors to assess at an early stage business model viability (current) and sustainability (future) and detect key vulnerabilities that ultimately can lead to its failure.
European Banking Authority (2014d) defined that determination of business model sustainability means the institution’s “ability to generate acceptable returns over a forward-looking period of at least three years, based on its strategic plans and financial forecasts”.
As supervisors have power to receive all the information needed for supervisory purposes and have other instruments for banks supervision (e. g. on-site examinations, off-site supervision, meetings with banks management), objective assessment of business models and determination of key risks and vulnerabilities is a very important supervisory measure.
Supervisory approach requires identification of banks businesses in depth and assessment of each business model component. Such approach allows a better identification of risks and vulnerabilities associated with the overall bank business model.
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II. EMPIRICAL RESEARCH ON BUSINESS MODELS OF
SCANDINAVIAN BANKS SUBSIDIARIES IN THE BALTICS
2.1. Research methodology
In order to identify what type of business models are chosen by Scandinavian banks subsidiaries in the Baltics and to assess them, empirical research was carried out, using qualitative and quantitative research methods.
Before identifying the business models, qualitative analysis in three areas was performed: 1) in order to understand how the current systems dominated by Scandinavian banks were formed, analysis of the development of banking systems in the Baltics in 1990-2014 was conducted; 2) to understand the strategic role of parent banks in the activity of subsidiaries in the Baltics, another analysis of parent bank groups was carried out; 3) to realize how market factors (e. g. macroeconomic environment, regulatory and supervisory changes, technological development) impact business models of the Baltic subsidiaries, their analysis was performed.
Business model identification and analysis was carried out using three quantitative methods: a system of key business model indicators was created; correlation analysis and simple linear regression were used.
All nine Scandinavian banks subsidiary groups operating in the Baltic countries were selected for the analysis (Table 8). Table 8 Scandinavian banks subsidiaries in the Baltics Country Name of the bank Short name in this paper Lithuania AB SEB bankas SEB LT “Swedbank“, AB SW LT AB DNB bankas DNB LT Latvia JSC “SEB banka“ SEB LV “Swedbank“ JSC SW LV JSC DNB banka DNB LV Estonia AS SEB Pank SEB EE Swedbank AS SW EE AS DNB Pank DNB EE Source: Banks Annual Reports, 2014, formed by the author.
In each Baltic country three subsidiaries from three different banking groups operate. Subsidiaries were analysed on the consolidated level (composition of their groups is presented in Annex 1).
The three largest banks (SEB, Swedbank, and DNB) hold 68.6 % of the Lithuanian banking sector, 71.4 % of Estonian and 35.9 % of Latvian (Figure 2).
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Figure 2. Share of Scandinavian banks subsidiaries in the Baltic banking system, 31/12/2014 Sources: Banks Annual Reports, 2014; Bank of Lithuania, 2014a; Financial and Capital Market Commission, 2014; Estonian Financial Supervisory Authority, 2014; formed by the author.
Research data
In order to perform the analysis of banks business models, data covering the period from 2006 to 2014 as of 31 December of each year was collected.
The data extracted from publicly available information: banks annual reports, disclosed information on individual banks in websites of the Baltic central banks and Financial and Capital Market Commission of Latvia, Financial Supervision Authority of Estonia, the Associations of Commercial Banks of Lithuania, Latvia and Estonia; data from 2014 ECB Comprehensive assessment (stress tests) results on individual banks, BANKSCOPE data, SNL data, as well as other online documents from the websites of the analysed banks.
Quantitative research methods
Business model identification and analysis was carried out using three quantitative methods:
The system of key business model indicators was created. This system was used to perform the analysis of the main business model components in order to identify business models and their sustainability; Correlation among subsidiaries in each bank group was chosen for the analysis (SEB, Swedbank, and DNB) to identify whether subsidiaries in each bank Baltic group acted in the similar way or not; The system of key business model indicators was created mainly based on European Banking Authority documents (2013, 2014d) as well as personal knowledge and experience. This quantitative analysis focused on P&L and balance sheet analysis, providing understanding of bank performance in the context of its risk appetite. To have a standardised approach for nine banks analysis, key business model indicators (ratios) were selected for each business model element. The key indicators were selected using two priorities: 1) the most suitable for nine subsidiaries business model analysis; 2) the most important for business model analysis.
Four business model elements correspond to Business model Canvas elements:
Key activities element - focus on assets structure (composition of assets and detailed analysis of loans portfolio);
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Key resources – focus on capital and funding structure (composition of liabilities and detailed analysis of customer deposits and debt from parent banks); Revenues streams – focus on income structure (composition of income and sources of net interest income, net fees and commission income, other income); Cost structure – focus on cost structure (composition of cost and sources). Based on European Banking Authority (2013 and 2014d) a new element called Risk appetite and performance was introduced to understand bank financial performance in the context of its risk appetite. It was focused on prudential requirements (capital, liquidity), quality and riskiness of assets, the split of RWAs, growth rates of assets, loans, and deposits.
Ratios of key business model indicators are presented in Annex 2. Some key business model indicators were compared with the secondary data from the literature (e. g. EU average, parent banks indicators, EU survey data).
As the data available (annual data for the period 2006–2014) is not sufficient to perform an accurate and comprehensive regression analysis, correlation analysis among subsidiaries in each bank group (SEB, SW, DNB) was performed in two stages:
Stage 1: Five indicators were used in the analysis (Balance sheets): Correlation in Growth of Loans and Advances; Correlation in Growth of Securities; Correlation in Growth of Due from Banks; Correlation in Growth of Customer Deposits; Correlation in Growth of Due to Banks.
Stage 2: Four indicators were used in the analysis (P&L): Correlation in Growth of Net Interest Income; Correlation in Growth of Net Fees and Commissions Income; Correlation in Growth of Administrative Expenses; Correlation in Growth of Impairment.
Simple linear regression was chosen to estimate relationship (trend) between Interest Income Growth and Loans and Advances Growth (the covered period was from 2006 to 2014).
Limitations and assumptions
As subsidiaries disclose very limited information about their strategies (strategic plans and forward-looking forecasts), business model analysis and sustainability assessment were based on quantitative analysis of publicly available information.
Business model analysis involved four main components from Business Model Canvas; however, five components (Value Proposition, Customer Relationship, Customer Segments, Key Partners, and Channels) were not analysed deeply due to not available information.
A lack of standardised information was a major issue concerning the data collection for this research.
2.2 Overview of the development of banking systems in the Baltics in 1990-2014
To understand the formation of the current Baltic banking systems dominated by Scandinavian banks subsidiaries, key facts on the development of these banking systems were collected (Annex 3). Summarising
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the development of these banking systems, a lot of similarities were identified due to the Soviet past and Scandinavian bank entry. Six stages of the Baltic banking system development were distinguished (Table 6). Table 6 Stages of the Baltic banking systems development in1990-2014 Stage Year Main features I 1990–1993 Transformation of former Soviet banks into commercial banks; rapidly growing number of new banks II 1992 Banking crisis in Estonia 1995 –1996 Banking crisis in Lithuania and Latvia III 1998 – 2002 Strengthening of the remaining banks, consolidation in banking sectors, foreign bank acquisitions of major Baltic banks (including state-owned banks) IV 2003 –2008 Rapid growth of banking V 2009 Crisis in economies of the Baltic countries (hard landing of economies, explosion of the real estate bubble) VI From 2010 Recovery after the crisis Source: formed by the author.
After the collapse of the Soviet Union in 1990, the initial stage of formation of the banking systems in the Baltics started. Former Soviet banks transformed into commercial banks, a lot of new banks were established (at the end of 1993, Lithuania had 27 banks, Latvia had 66 banks, and Estonia had 42 banks before the crisis in 1992).
The systemic banking crisis in 1992 in Estonia and in 1995-1996 in Latvia and Lithuania was a serious blow to the economies and financial systems of the countries. According to the researchers (A. Fleming et al., 1997, T. Kim, 1998) the main causes of the banking crises were the following ones:
. The banking sector developed more rapidly than the economic environment; . The real estate market was weak, it was difficult for banks to obtain a real collateral for their loans; . Both bankers and businessmen lacked experience in how to work in the market economy; . Business plans of borrowers were assessed incorrectly, “new” businesses had no credit history; . Shareholders tended to regard banks as a source of finance for their own businesses; . Falsification of bookkeeping entries and submission of false information to supervisors was a problem. According to the statement of a Latvian regulator L. Vojevoda (2000), “at that time regulatory authorities introduced Western principles and approaches, but they were “too civilized“ to be able to detect direct fraud and other explicitly criminal activities“. After this crisis, banking sectors stabilized and became stronger and more conservative in lending.
As the banking sector was dominated by state-owned banks, which the countries needed to privatize, the privatization of these banks progressed slower than it had been expected initially. Since 1993, the interest of foreign banks in buying Baltic state-owned banks was diminished. Some foreign banks opened representative offices in 1993-1995.
In 1997, all the three Baltic countries started to actively prepare for privatization of state-owned banks. Estonian Eesti Houipank (Savings bank, Estonia) acquired controlling stake in Latvijas Žemes Bank (Latvian
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Land Bank). In Lithuania, the Government also attempted to privatize the State Agricultural Bank, but failed due to Russian crisis in 1998 (four banks were interested in privatization of this bank).
At the same time consolidation started in the banking sectors. In Estonia, the merger of Hansabank and Hoiupank created the largest financial institution in the Baltics, and the merger of Uhispank and Tallinna Pank created the second largest bank in Estonia (these 2 new banks controlled 85 % of the Estonian banking market). In Lithuania, the State Commercial Bank was merged with the State Savings Bank in 1997, AB Vilniaus Bankas merged with AB bankas Hermis in 2000.
In 1998, after banking consolidation, leading banks of Scandinavia invested in Estonian banks: Swedbank invested in Hansapank and SEB in Uhispank. SEB also invested in Lithuanian AB Vilniaus Bankas and in Latvian Unibanka.
The remaining state–owned banks were privatized later. In 2000, Pirma Latvijas Komercbanka (former Rigas Komercbanka) and in 2002 Lithuanian State Agricultural Bank were sold to Norddeutsche Landesbank Girozentrale (Germany). In 2001, State Lithuanian Savings Bank was sold to Hansapank (Estonia).
Until 2002, the Baltic banking sectors were mainly dominated and run by Scandinavian banks and are still up to now. Estonia played a key role in attracting Scandinavian banks in the Baltics as the country has had the strongest link with Scandinavian investors (they account for more than half of total Estonian FDI) (International Monetary Fund, 2014). The inflow of foreign capital, strong links between the Scandinavian and Baltic countries, mergers of smaller commercial banks, and a more conservative approach of prudential supervision strengthened the domestic banking systems.
Rapid growth of banking took place between 2003 and 2008, especially after Lithuania, Latvia and Estonia became part of the European Union. The banking sectors experienced a phenomenal credit boom. By 2006, annual credit growth reached more than 50 %, by 2007 about 40 %. The main driver was strong competition for lending, primarily using foreign funding (from Sweden and other Nordic countries). Real GDP and Credit growth in the Baltics 2006-2013 is presented in Figure 3.
year-on-year percentage change
Figure 3. Real GDP and Credit growth in the Baltics 2006-2013 Source: International Monetary Fund, 2014.
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All the banks suffered significant losses during the hard landing of the Baltic economies and the explosion of the real estate bubble (especially in such sectors as real estate and transport) in 2009. The Scandinavian banks covered the financial losses of subsidiaries by additional contributions and ensured business continuity. However, as a result of this crisis, further development of the Baltic banking sectors slowed down. Banks tightened lending standards, gave more attention to the work with problem loans, focused more on their activities on banking safety (well-capitalised, over liquid). However, the input of Scandinavian bank subsidiaries in the Baltic countries economy recoveries was too little.
Since the crisis, the activity of three banks in the Baltics was terminated. In Latvia, systemically important bank Parex Bank (which operated in Lithuania through its subsidiary as well) collapsed in late 2008. In Lithuania, the licences from two not systemically important banks were withdrawn: from AB bankas SNORAS (which also operated in Latvia through its subsidiary Latvijas Krajbanka and in Estonia through a small branch) in 2011 and from AB Ūkio bankas in 2013. As the collapse of these banks was related to irresponsible actions of the banks‘ shareholders (with certain criminal elements), the domestic banking systems in Lithuania and Latvia became more transparent and sound.
Analysing the size of banking sectors, Lithuania among the three Baltic countries has the smallest banking sector compared to GDP (the country has had the largest GDP among the Baltics). Latvia has the largest banking sector, which differs from other Baltic countries by the substantial number of local banks with specialization on taking non-resident deposits. The differences in banking sector assets per capita are even more significant (Figure 4).
Figure 4. The Baltic countries banking sector assets per GDP and per capita Sources: Bank of Lithuania, 2014b; Financial and Capital Market Commision (Latvia), 2014b; Estonian
Financial Supervisry Authority , 2014; Statistics Lithuania, Latvia, Estonia, 2015; formed by the author. The size of the Baltic banking sectors is still significantly lagging behind the average of EU (Figure 5). Lithuania stands second to the last among the EU countries (Romania is the last one).
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Figure 5. EU countries banking sector assets/GDP, 31/12/2014 Sources: European Central Bank, 2015b; Statistics Lithuania, Latvia, Estonia, 2015; formed by the author.
For presentational purposes the y-axis was truncated at 800 %. The values for Luxemburg is 2083 %. In Table 7 below some indicators of the banking sectors of the Baltic countries are presented. The banking sectors of these countries have a lot of similarities: financial sectors are bank-based, banking sectors are dominated by Scandinavian bank subsidiaries, banks are well-capitalised. However, it is also visible that the structure of banking sectors is not the same and other indicators are diverse. Table 7 Key indicators of the banking sectors2 of the Baltic countries, 31/12/2014 Indicators Lithuania Latvia Estonia 81.1 89.2 92.1 Banking sector/Financial sector,%
Number of banks 7 17 7 Number of foreign banks branches 8 9 8 Number of Employees in banking sector 8 835 9 845 5 639 mln. Euro 24 077 30 816 21 205 Total Assets banking sector % of GDP 66.3 128.3 108.6 ,mln. Euro 14 742 14 666 15 094 Total Loans banking sector % of GDP 40.6 61.0 77.3 ,mln. Euro 16 293 22 192 14 879 Total Deposits banking sector % of GDP 44.9 92.2 76.2 ROA ,% 0.92 1.11 1.57 ROE, % 8.05 11.07 12.30 Capital adequacy ratio, % 21.3 20.8 24.03 Population 2 963 103 1 998 102 1 312 300 Sources: Bank of Lithuania, 2014b, 2015a; Financial and Capital Market Commision (Latvia), 2014b; Estonian Financial Supervisry Authority , 2014; Association of Lithuanian Banks, 2015a; Association of Commercial Banks of Latvia, 2014; Statistics Lithuania, 2015; Statistics Estonia, 2015; Central Statistical Bureau of Latvia, 2015; formed by the author.
The banking sector of Latvia stands out by a number of banks and the largest banking sector. As in all the Baltic countries, the Latvian banking sector is dominated by Scandinavian-owned banks, which rely on resident deposits and on funding from parent banks. Domestically-owned banks in Latvia are largely
2 Consolidated data were used 3 Transitional floor is considered (without the transitional floor ratio, it would be 35.7 %) 25
dependent on non-resident deposits and mostly specialise in provision of financial services to non- residents. In Latvia, non-resident banking is the prominent issue, in which the country has a long tradition and enjoys several competitive advantages (non-resident deposits account for nearly half of all the deposits in the banking system or 40 % of GDP); however, this business model requires strong anti-money laundering policies (European Commission, 2014a).
Lithuania and Estonia have the same number of banks and foreign banks branches and are highly concentrated (Latvia is less concentrated). The Estonian banking sector dominated by Scandinavian banking groups holds about 95 % of the banking sector assets, foreign bank branches, for example, Nordea plays a significant role in the banking system. The Estonian banking sector assets and loans in the absolute value are a little lower than in Lithuania, but significantly larger compared to GDP (in Estonia assets account for about 109 % of GDP; loans account for about 77 % of GDP). The Estonian banking sector is a leader in providing loans to customers (in the absolute value and compared to GDP), although it has the smallest population.
In Lithuania, after revoking the licenses of two banks, the number of participants of the banking sector decreased, and assets and loan portfolios shrank. Lithuania having the largest GDP and the greatest population has a relatively small banking assets and loans volume.
In all the three Baltic countries bank supervision authorities have different development stages and different type of institutions. In Lithuania, the central bank was responsible for banks supervision from 1991. However, after the reform in 2012, it became responsible for the supervision of the entire financial market and financial services. In Latvia and Estonia, central banks were responsible for banks supervision from 1991 until 2001 and 2002, respectively. Later separate institutions were created for supervision of national financial sectors. Since 4 November 2014, Latvian and Estonian banks and from 1 January 2015 Lithuanian banks have been supervised not only by the national supervisory authorities but by the ECB, the European supervisor, as well. Evolution of bank supervision authorities in the Baltics is presented in Annex 4.
Summing up this overview, it is important to highlight that current Baltic banking systems are the result of twenty-five years of their development. After the privatisation of the state-owned banks and acquisition of other major local banks, the Baltic banking sectors are dominated by the subsidiaries of Scandinavian banks.
2.3. Scandinavian banks groups and their subsidiaries in the Baltics
In order to understand the strategic role of parent banks in the activity of subsidiaries in the Baltics, the analysis of parent bank groups was performed.
Two Swedish banks, SEB and Swedbank, came to the Baltic countries in 1998 by acquiring major local banks (including the state-owned banks). Much later, only in 2006 the Norwegian bank DNB also came to the Baltics. In Lithuania and Latvia, DNB was as the shareholder of DNB NORD banks together with the German bank NORD/LB, and only in 2010 it acquired the residual shares from the German bank. In Estonia, DNB started its operations as a branch, and in 2008 it changed its status to a subsidiary. More detailed information about the history (key developments) of Scandinavian subsidiaries in the Baltics is presented in Annex 5. 26
According to the assets, SEB bank is the largest bank in Sweden, whereas Swedbank is the second one (Figure 6).
Figure 6. Swedish banking system structure (assets), 31/12/2014 Sources: Bloomberg; European Central Bank, 2015b; formed by the author. Solo bank data (only in Sweden market) was used.
If we compare banking groups, Nordea and Handelsbanken groups are larger than SEB and Swedbank groups as they have been working more internationally (Table 8). Table 8 Largest banking groups in Sweden and Norway, 31/12/2014 Bank’s group mln. Euro Sweden Nordea group 669 342 Svenska Handelsbanken group 297 233 SEB group assets 278 720 Swedbank group assets
223 852 Norway DNB group assets 291 862 Source: SNL; formed by the author. DNB group is the largest banking group in Norway as well as the largest parent bank group operating in the Baltics (Figure 7).
Figure 7. Market shares of DNB in Norway, 31/12/2014 Source: DNB group, Norway, 2015.
These three Scandinavian bank groups have a well-known brand, treated as reputable internationally active banks, financially strong, and their shares are listed on the Stock exchanges.
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Since 2009 Swedbank share price have been increasing more rapidly than SEB (Figure 8). Share price of Handelsbanken, as the competitor of SEB and Swedbank, is the highest and growing; nevertheless, this bank has been using different business model (decentralised business model, beyond budget approach, etc.) (Kroner N., 2011).
Figure 8. Stock prices of major 4 Sweden banks, 2006-2015 Source: Bloomberg; formed by the author.
More information about parent bank groups is presented in Annex 6. It was mentioned in the Annual Reports of the banks that Baltic subsidiaries are treated as their home markets by Scandinavian banks. In DNB group, Baltic subsidiaries have the smallest share of assets and generate the lowest share of the operating profit (Table 9). For Swedbank group, Baltic subsidiaries are more significant (in 2014, having 9.2 % of parent group assets they generated quite large pre-tax profit of the parent group (17.9 %). Table 9 Share of Baltic subsidiaries in parent groups, 2014 Ratio Assets Pre-tax profit 3 SEB Baltic banks/ Parent group, % 5.6 7.1 17.9
3 SW Baltic banks/Parent group, % 9.2 3 DNB Baltic banks/Parent group, % 2.3 1.4 Source: Banks Annual Reports, 2014; formed by the author.
Having analysed the information provided on the websites, it was determined that all the subsidiaries use Mission, Vision and Core values of the parent banks (they are not adapted to local markets) (Annex 7).
It may be noted that all the banks are creating a customer-centric culture. However, as all the banks are divers, their visions are quite different: SEB as the leading Nordic corporate bank, focuses more on the trusted partnership with customers; Swedbank having its roots in the saving bank, gives a priority to creating the ability to grow; and DNB as the largest financial services group of Norway, concentrates on creating value through the art of serving the customers. Core values also differ among the groups: SEB and DNB focus more on professionalism, experience and commitment, while core values of Swedbank are oriented on simplicity, openness and caring. These differences can be seen in each banking group and are essential to understanding their organisational culture.
Strategic priorities and financial targets of the parent banks (Table 10) were analysed. 28
Table 10 Strategic priorities and financial targets of the parent bank groups Bank Strategic priorities Financial targets
SEB group 1. Long-term customer relationships Return on equity: 15 % 2. Growth in areas of strength o Large corporate and industrial business in the Nordic Capital adequacy: CET1 13 % countries and Germany Dividend payout ratio: >40 % o Small and medium- sized enterprises in Sweden (also in the Baltics) o Savings offering to private individuals and institutions 1. Resilience and flexibility Swedbank Strategy: Return on equity: 15 % Group 1. Accessible full-service bank Cost efficiency: market –leading 2. Decision making close to our customers Capitalisation: solid. 3. Low risk 4. High cost efficiency Priorities: o Improve customer value o Increase efficiency o Integrate one structural unit DNB 2. Capital Return on equity: >12 % Capital Group o achieve financial targets adequacy: CET1 14 % o remain among the most cost-effective banks Dividend payout ratio: >50 % 3. Customers o improve its corporate reputation and ensure better customer experiences o cover a broader range of customer needs increase the degree of self-service o meet customers with a common brand image 4. Culture o become the best among Nordic banks in terms of leadership communication and employee engagement o ensure adaptability and change capacity o cultivate an improvement culture
Sources: SEB group, 2015; Swedbank group, 2015; DnB group 2015; formed by the author.
The compared financial targets of parent banks reflect their long-term ambitions to generate high profitability (SEB and Swedbank targets of return on equity are 15 %, and DNB target is more than 12 %) and to meet the regulatory requirements for the size of capital with reserves (DNB set the highest target ratio CET1 14 %, SEB set CET1 13 %, and Swedbank did not set the exact quantitative target). In 2014, parent bank groups complied with the set financial targets and had ambitions to achieve high return on equity, to maintain CET1 capital ratio above regulatory requirements and to achieve long-term dividend growth. It should be noted that returns on equity of subsidiaries is considerably lower than of their parent banks.
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One of strategic targets of SEB group, declared in Annual Report 2014, is growth in the small and medium- sized enterprises (SMEs) segment in Sweden (in the Baltics as well). SEB set a goal to adapt the bank’s services and advice for large corporates to the needs of SMEs. SEB started focusing more on understanding challenges and needs of SMEs in parallel with its efforts to build long-term partnerships. The strategic target of SEB group is very relevant for the Baltic countries (especially to increase lending to SMEs); however, this target is no emphasized in Annual reports and websites of the subsidiaries.
Swedbank group evidently presented that their strategy is low risk and high cost efficiency. It is obvious that recently Swedbank subsidiaries have been focusing on their efficiency improvement, increasing low risk clients base, cost cutting and e-banking development.
As Baltic subsidiaries are part of the big international Scandinavian banking groups, the decisions regarding the strategy and the business model are made at the parent banks level. These decisions during the period of the Baltic economies upturn (when an aggressive lending was implemented) as well as during the period of the Baltic economy downturn (when a significant decrease in lending volumes, unduly conservative approach to the credit risk assessment and to formation of special provisions were done) were insufficiently consistent and adequate in the environment of the banks operating in the Baltic market. These two types of approaches increased the reputation risk of the subsidiaries in the Baltics. Former Latvian Prime Minister V. Dombrovskis commented on Latvian ties with Swedish banks: “We have a mixed history with the Swedish banks. Before the crisis, Swedish banks were more part of the problem than part of the solution because it was a very easy lending spree that they created helping to overheat our economy and helping a real estate bubble develop. With the global financial crisis they suddenly cut our countries off and we had a hard landing” (Magnusson N. and Eglitis A., 2013).
As subsidiaries suffered a record net loss in 2009, Scandinavian parent banks covered a large portion of the financial losses by additional contributions or increasing capital to ensure business continuity. One of the reasons for these actions was a powerful position of the Sweden Government.
In summary, the strategic role of parent banks in the activity of subsidiaries is key. Because of strong presence of Scandinavian banks in the market as well as their well-known brands, it is good for Baltic subsidiaries to be a part of the internationally reputable bank groups. This ensures Baltic banks capital and liquidity needs (especially in unexpected shock situations). Moreover, strong dependence on the decisions of parent banks can also have negative consequences on the countries financial stability (if the parent bank is not able to support its subsidiary) and on the economy (if the parent banks make inadequate decisions that are not beneficial for the situation of the country).
2.4. Analysis of the Baltics market factors
2.4.1. Macroeconomic environment
Macroeconomic environment in which Baltic subsidiaries operate and seek to generate profits has a major impact on banks business; therefore, key developments in the forward-looking banking business environment and key macroeconomic variables in the Baltics were analysed.
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As the sovereign credit rating indicates the risk level and financial strength of a country best, all the Baltic countries have relatively high evaluation from all rating agencies (Table 11).
Table 11 Sovereign credit ratings of the Baltic countries, 09/05/2015 Country Moody‘s Standard&Poor‘s Fitch Ratings Foreign Currency Long-term A- A- Lithuania A3
Latvia A3 A- A-
Estonia A1 AA- A+ Sources: Moody’s, 2015; Standart&Poors, 2015; Fitch Ratings, 2015; formed by the author.
Majority of the Baltic countries have Upper Medium Grade ratings, only Standard&Poor‘s gave a higher rating to Estonia (High Grade High Quality). All rating agencies upgraded countries ratings after the adoption of the euro in all the Baltic countries and due to positive recovery of economies (Moody’s changed Lithuania’s rating from Lower Medium Grade to Upper Medium only 8 May 2015).
Having analysed the external factors, which could mostly affect the activities of the Baltic banks, the main external factors and impact areas were identified (Table 12). Table 12 The main external factors impacting Baltics subsidiaries business Factor Impact High geopolitical risk from events in Strategic decisions of parent banks on limited subsidiary activity Russia and Ukraine (to finance only low risk customers, subsidiaries growth should be moderate) in this uncertain and challenging macroeconomic
situation.
Subsidiaries proved that they have not yet seen a significant effect on the banks’ credit quality; they have been working proactively and closely with customers whose business was sensible to this geopolitical situation. Lower Capital expenditure and credit demand in the Baltics.
Record-low interest rates environment Significantly affect the income base of banks. ECB‘s stimulus measures to increase As Baltic countries are Eurozone countries, strong alignment in opportunity for credit growth in the Baltics with monetary environment with the Eurozone. Eurozone by pumping enormous Uncertainty on effect of the stimulatory efforts for Baltic amounts of liquidity into the economy countries and banks. Sources: Bank of Lithuania, 2015b; Bank of Latvia, 2015; Bank of Estonia, 2015, formed by the author.
Having examined key macroeconomic indicators (Annex 8), which may impact business of Baltic subsidiaries, it was identified that economic development of the Baltic countries has a strong macroeconomic platform for the banks activities.
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In 2014, the World economy showed signs of stabilisation; however, the recovery has been slow. The global recovery was unbalanced. The US continued to grow, while the Eurozone was threatened by slower activity and deflation. Growth rates of the Baltic countries economies has been among the strongest ones in the EU. During the last mission in the Lithuania, International Monetary Fund (2015) concluded that “comeback of economy of Lithuania over the last five years has been impressive”. Baltic banks are benefiting from strengthening economic fundamentals.
As household financing (lending) is very important for banks, household finance and the determining factors are of key importance for them. Recently, the factors affecting household finance have been improving in all three Baltic countries: declining unemployment (but still high unemployment level remains in Lithuania and Latvia), gradually increasing wages, and very low inflation (deflation). The increase in wages in Estonia has been especially significant (after the introduction of the euro since 2011, wages have been growing by 6 % each year) (Annex 9). In addition, due to record low interest rates, the financial burden of households to repay loans has decreased; moreover, conditions to borrow have become favourable.
IMF highlighted that “the experience from the boom-bust cycle has left companies and banks averse to risk and external uncertainty weighs on the willingness to invest in the near term” (International Monetary Fund, 2015).
Low demand for companies’ investments impacts credits negatively. The latest Bank of Lithuania Survey of non-financial enterprises on business financing (Bank of Lithuania, 2015c) showed that the greater part of companies to finance their activities used only internal resources, but in the future they plan to borrow more actively. These loans should be mainly used to purchase equipment, machinery, vehicles, raw materials, and to construct buildings. There are signs that companies are preparing for making investments more actively to develop their activity.
For large companies, access to financing is not an issue. All banks want to credit large low risk companies. The harder time is for SMEs in the climate of risk aversion. Scandinavian subsidiaries need to play a bigger role in the Baltics regarding SMEs financing. The ECB in the euro area bank lending survey presented that “changes in lending conditions (easing of credit standards and better banks’ risk tolerance) continue to support a further recovery in loan growth, in particular for enterprises” (European Central Bank, 2015c).
Innovation by firms is an important driver of long-term economic growth. European Union Innovation Union Scoreboard 2014 (European Commission, 2014b) demonstrated that Lithuania and Latvia are the weakest ones in innovations among the EU Members States, whereas Estonia is among innovation followers (Annex 10).
A lack of critical size in implementation and oversight of innovation promotion remain important challenges for the Baltic countries. As Scandinavian countries are innovation leaders, the Baltic countries should follow them (Estonia is doing that). European Bank for Reconstruction and Development (2014) emphasized that banks can play a significant role in financing innovative companies.
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Currently, there are about 280 thousand SMEs in the Baltic countries (Statistics Lithuania, Estonia, 2014; European Commission, 2014c). This sector has a huge potential for developing and applying business innovation. If the innovative SMEs receive financing from banks, they can increase productivity, recover the slowdown in exports, especially now, when companies are looking for new markets after the introduction of the EU sanctions against Russia.
2.4.2. Regulatory and supervisory changes
As large influx of new regulations and significant changes in supervision create new conditions for banks and impact banks business models, their analysis was performed.
The aim of a large volume of new regulations is to strengthen stability in the financial market and in every individual financial institution, to protect society against the costs of another financial crisis. Banks argue that the costs for running a bank are considerably higher now than before the financial crisis. Banks need to implement the changes in customer services, processes and systems. These new requirements will increase operating costs for banks (especially for compliance, risk functions and IT). At the same time the Regulatory authorities are adopting measures for improved functionality and infrastructure in the financial markets while enhancing consumer protection.
Having analysed the relevant EU regulations, the main regulations that will have impact on Baltic banks are presented in Annex 11.
The new regulatory framework (CRDIV/CRR) requires that banks work with higher capital and liquidity reserves. Implementing these new regulations the Baltic regulatory authorities have already set additional capital buffers for banks:
Estonia - capital conservation buffer of 2.5 %, implemented since May 2014, and systemic risk buffer of 2 %, implemented since August 2014 (FSA (Estonia), 2014);
Latvia - capital conservation buffer of 2.5 % as of May, 2014 (FCTC (Latvia), 2014b);
Lithuania – capital conservation buffer of 2.5 % June, 2015 (Bank of Lithuania, 2015).
As all the analysed banks comply with the new regulations on capital adequacy, these regulation can impact bank business models in the future (cost of capital and liquidity will increase).
The EU has also started to focus more on strengthening consumer rights by proposing bigger choice and increasing transparency requirements. This is opening up opportunities for new players to enter parts of the banking market and will make price, service and availability even more important competitive factors in the future. Other initiatives in the EU (Capital market union, payment institutions, SEPA) increase the competition for banks as well. Regulation on Interchange Fees (MIFs) and Directive on comparability of payment account fees, payment account switching and access to a basic payment account (PAD) encourage banks to ensure transparency on fees for electronic payments and to reduce fees.
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In summary, the large influx of new regulations has a positive effect on strengthening stability of the financial markets but, on the other hand, implementation of these regulations increases operating costs and costs of capital. New EU initiatives also put pressure on decreasing fees for financial services.
Significant supervisory changes can have impact on bank activity and legal form change. As all the Baltic countries are the euro area countries and participate in the Single Supervisory Mechanism, all these banks are subject to supervision by the European Central Bank (ECB) in cooperation with national financial supervisory authority.
DNB LV and DNB EE were identified by the ECB as less significant institutions. The supervision of these two institutions will further be the responsibility of national financial supervisory authorities (Latvian and Estonian), while the participation of the ECB in the supervision of these banks will be indirect and proportionate to the size of the bank and the levels of risk exposure (the ECB has the right to take over the direct supervision of them under certain circumstances). What is specific for DNB group (Norway) is that only DNB bankas (Lithuania) is under direct supervision of the ECB. For example, in the ECB Join Supervisory Team (JST) for every significant banking group was established; however, in case of DNB, this team was established only for DNB Bankas (Lithuania), and the JST coordinator is the same person for DNB bankas (Lithuania) and SEB Baltic.
Other Scandinavian bank subsidiaries in the Baltics are identified as significant supervised entities under direct supervision by the ECB. In SSM the Baltics significant bank supervision is organised differently from other euro zone significant banking groups (the idea of SSM was to create JST for every significant banking group). As parent banks are outside the eurozone, JSTs were created for SEB and Swedbank Baltic banks. Some vulnerabilities can arise, and the ECB supervision can be less efficient due to the specifics of these subsidiaries (Annex 12).
2.4.3. Technological development
As the banks business landscape is changing due to digitalisation, a short overview of their impact on bank business models was done. Rapid digital development is giving rise to new demands on services, accessibility, and efficiency. Banks need to develop and improve their technical solutions, simplify services for customers. New IT technologies should develop online services, mobile payments, electronic signature technology, and cards. Digital developments in the banking sector are being driven by customer expectations and growing demands. Everyday banking services are handled almost in digital channels, increase interaction with customers while at the same time creating economies of scale. New opportunities are opening up for the banks, which quickly adapt to changes in the market.
In the payments area, a lot of new solutions are done among competitors. This is creating opportunities to improve services and accessibility in costumer offering, simplify and improve the efficiency of bank processes. Ongoing changes also affect customers. Banking is becoming more of a digital service, making it for customers both more convenient and less costly. Customers want to do increasingly more of their banking via mobile devices bank (apps (mobile applications) for smartphones and tablets) and through
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seamless and integrated interfaces with them. Digitisation is creating new, more cost-effective ways to automate and distribute products and services.
Increased digitalisation is structural and requires that business models are evaluated and adapted if banks can stay competitive and profitable and manage the risks associated with the new environment.
In summary, the macroeconomic, regulatory changes and technological developments, on one hand, continue to challenge the banks but, on the other hand, create new opportunities. This creates the need for constant change. Profitability is pressured in certain areas, but new revenue sources are opening up in others. Understanding the need to adapt to the changing expectations and demands of customers, ability to quickly adapt an organisation and innovative thinking will be even more important in the future.
2.5. Quantitative analysis of bank business models
Quantitative analysis allowed to identify and evaluate the applied business models with certified (by external auditors) data.
2.5.1 Analysis of the main business model components
2.5.1.1 Size and performance
A large balance sheet (Assets volume) is a key indicator of systemic importance, influencing banks business models. Scandinavian banks operating in the Baltics have different positions in these countries based on their size (Figure 9). The SW EE takes the leading position in the Baltics, which stands out compared to other subsidiaries. SW has the leading positions in Estonia and Latvia and holds the second position in Lithuania. SEB is the largest bank in Lithuania; however, it has the second position in Latvia and Estonia. DNB LT has the third position in Lithuania (the gap between them and SEB LT and SW LT is quite large). In Latvia and in Estonia, DNB subsidiaries are less significant institutions (according to the ECB identification). DNB EE is one of the smallest banks in the Baltics, operating only for 4 years as a subsidiary.
Figure 9. Size of Scandinavian bank subsidiaries in the Baltics (31/12/2014)
Source: Banks Annual Reports, 2014; formed by the author.
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SEB and SW subsidiaries in all the three Baltic countries are the largest banks, playing a leading role and benefiting from being the largest in the countries; however, they pose a systemic risk in each country they operate in. Profitability of Scandinavian banks operating in the Baltics has varied markedly across banks (Figure 10) as well as over time (Annex 15). Since the crisis in 2009, when all operating banks suffered losses (all banks experienced very large losses in 2009 and modest losses in 2010), gaining a relevant level of profit, and ROE became a big challenge.
Figure 10. Profit drivers of Scandinavian bank subsidiaries in the Baltics (2014)
Source: Banks Annual Reports, 2014; formed by the author.
Since 2011, the banks carried out their activities in two different ways seeking to increase income and at the same time to reduce costs. One of the strategic priorities for all the banks became the improvement of the operating efficiency. In fact, moderate results were achieved by increasing non-interest income and escalating operational expenses. Before the crisis, banks focused more on traditional banking business deriving profits from the interest income.
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Figure 11. ROAE ratios, 2014
Sources: Banks Annual Reports, 2014; European Banking Authority, 2014c; formed by the author.
Comparing the performance results across the banks analysed (Figures 11 and Annex 13), the highest ROAE and ROAA were reported by all SW subsidiaries. SEB LT and SEB EE fell behind slightly from SW subsidiaries; however, SEB LV fell behind even more sharply. SW subsidiaries and SEB LT and SEB EE had ROAE higher than the EU average, however, with a decrease in 2014 (except for SEB LT). The lowest ROAE and ROAA were fixed in all DNB subsidiaries (lower than the EU average). This shows that major differences exist between banking groups which policies have more influence on bank performance than the country specific factors.
Comparing the profitability ratios of the subsidiaries in 2014 with the parent bank group ratios, the generation of returns on equity in subsidiaries was markedly worse. Moreover, the parent bank target ROAEs are significantly higher (SEB and SW – 15 %, DNB >12 %) than their subsidiaries. These subsidiaries generate sharply lower returns compared to their historic performance before the crisis in 2009 (Figure 12).
SEB SW DNB
Figure 12. ROAE ratios, 2006-2014 Source: Bankscope, Banks Annual Reports; formed by the author.
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Before the crisis, all the banks generated strong returns (from 15 to 36 %). In 2008, there was a sharp fall of ROAE (the biggest fall was fixed in SEB LT: minus 85 %). From 2012, the banks started to generate moderate returns.
In summary, Scandinavian banks subsidiaries in the Baltics are medium profitable, ROAE is higher than the EU average, but markedly worse than in a parent bank group and at the pre-crisis level.
2.5.1.2 Key activities
The main elements of bank asset structure (Loans, Securities and Due from banks) were analysed.
From 2006 to 2014, all the banks analysed went through the business cycle. Before the crisis in 2009, assets grew rapidly (on average 40 % each year), during the crisis the volume of assets shrank, and from 2011 only some banks showed a growth trend (Estonian subsidiaries and Lithuanian SW and DNB subsidiaries). In 2014, there was a positive trend for all Estonian subsidiaries, but declining trend was for Latvian subsidiaries (Annexes 14 and 15).
It might be noted that there is some diversity among SEB subsidiaries in the three Baltic countries. There was no growth trend in Lithuania from 2012. In 2011, there was sharp growth due to selection of the SEB LT for payments of the deposit insurance compensation to depositors of bankrupted Bank Snoras AB. In Latvia SEB LV the volume of assets in 2014 drastically decreased (after some increase in 2013 before the adoption of the euro). In Estonia, SEB EE showed consistent growth from 2012. Having analysed the bank assets growth country by country, a negative trend is evident in Latvia. One of the reasons was that Latvia experienced stronger impact of the geopolitical risk factors related to Russia. In Lithuania, the growth in 2014 was driven by the significant amount of deposits which came into banks together with the approaching adoption of the euro. It showed that country specific factors had more influence on bank assets growth than the bank group policy.
In Annual reports the analysed banks declared that they have opportunities to finance companies and private individuals due to recovering economies, at the same time they want to ensure sustainable growth. To achieve this task, banks need to work consistently to reach new and maintain the already existing customers due to high amortisation of loans portfolios.
Having analysed the composition of each bank‘s assets (Figure 13), some similarities and some differences influenced by groups or specific aspects of the country were established.
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Figure 13. Composition of bank assets of subsidiaries in the Baltics, 31/12/2014 Source: Banks Annual Reports, 2014; formed by the author. The great majority of all banks‘ assets consist of a loan and leasing portfolio (65 – 88.9 %), while the remaining assets are funds held within parent banks, within central banks and also held in debt bonds. All DNB subsidiaries and SEB subsidiaries (SEB EE and SEB LV) have the highest share of loans in total assets (more than 70 %), whereas SW subsidiaries have the lowest share. In 2014, the lending portfolio grew slightly in all Estonian subsidiaries, and Swedbank and DNB subsidiaries in Latvia and Lithuania.
Subsidiaries held securities for liquidity purpose more (2-8 % of assets) as income from the trading activity and interest income decreased significantly. These securities (as all the Baltic countries are members of the Eurozone) provide to banks direct access to the ECB’s open market operations (these securities can be used as collateral).
Parent banks determine the common policy for securities for their Baltic subsidiaries. SEB and DNB subsidiaries invested only in the Government bonds of the operating countries. Swedbank group policy allows to invest in highly liquid graded securities (Government bonds and debt securities). SW subsidiaries debt securities portfolio is quite well diversified. SW is not allowed to invest in the Government bonds of the operating jurisdiction.
As the Estonian Government bonds market is very limited, SEB EE investments in Government bonds were very low (some increase was only in 2013), DNB EE did not invest in bonds.
Recently, some subsidiaries have had slight increase in debt securities (Annexes 14 and 15). However, parent banks (SEB and DNB) investment policies allowing subsidiaries to invest only in the Government bonds of the operating countries can have two negative effects: firstly, banks have limited possibilities to increase their portfolio due to insufficient supply of the countries’ Government bonds in auctions, and, secondly, this policy results in high concentration of bond portfolios booked within the bank.
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After the financial crisis, banks began to hold significant funds within the parent bank (10-15 % of assets). As loan portfolio showed moderate growth, a local deposits increase was transferred to parent banks (Annex 16). It was observed that at the end of 2013 and 2014, big amounts were temporarily transferred from parent banks to central banks (in Lithuania these actions were related to the adoption of the euro) (Annex 17).
This parent bank policy – holding large amounts of very low interest bearing assets in parent banks – has a negative effect on the results of subsidiaries: these assets generating very low income for subsidiaries, high concentration of these assets increase dependence on parent banks. Therefore, for the more sustainable business model of the subsidiary, which is operating in their own jurisdiction, it would be better to find opportunities to invest local deposits in local assets (to increase loan portfolios).
Having analysed Loans and leasing portfolio composition, it was determined that SEB subsidiaries focus more on Corporate financing than Households financing (Annex 18). SEB subsidiaries are usually positioned as corporate client banks. The parent bank strength is Large corporate and institutional business financing.
Almost half of net lending in Swedbank and DNB (except DNB EE) subsidiaries is households financing, mainly in the form of mortgages. It is also related to the particularities of Swedbank subsidiaries: their roots in the Baltics are from saving banks, which usually work with individuals. Banks argue that Residential mortgage financing remains as a very important product for banks: this product allows to provide the customer with many other related services; mortgage provides for banks long-term employment opportunity of banks resources; and even in the crisis situation the quality of mortgage loans is usually better than of any other loans (G. Nausėda, 2014).
In terms of economic sector concentration, the bank’s corporate portfolio remains rather concentrated within construction and real estate sectors (Annex 19). Over past few years the decrease of this sector was observed (as a result of the finishing workouts and of high amortisation), but not significant (banks continue to finance new commercial real estate projects). Banks’ addiction to prioritize real estate lending was explained by several factors (S. Krėpšta, 2015): real estate serves a special type of collateral, which has an important income-generating capacity; much safer compared to lending for specific R&D investments. Academic papers have already determined that the episodes of decreasing real estate prices are relatively rare, mostly related to systemic and large-scale financial crisis (A. Turner, 2014). In addition, the real estate lending bias may potentially lead to self-reinforcing credit and housing cycles, which eventually have very adverse effects on the real economic growth, as it was in the Baltic countries in 2005-2009.
In the Baltic countries around more than 50 % of net lending (mortgage loans, real estate& construction sector financing) is directed into the real estate sector (Annex 20). Scandinavian countries (Sweden, Norway) have also high real estate sector financing ratios (Annex 21).
Banks further express interest in financing the real estate sector “Business confidence has been gradually improving and the optimism in the construction and real estate market is rising” (SEB LT, 2015). However, some investors express that banks need to introduce innovations for financing real estate. The traditional real estate financing products parameters are often inadequate and archaic (term, periodical cash flow
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requirements, and covenants). Loan for financing real estate as a financial product should comply with the reality, be adequate investment projects (A. Anskaitis, 2015).
In the last couple of years, banks increased the loan portfolios to public authorities and entities. For example, public entities lending portfolio at Lithuanian banks DNB LT and SW LT comprise 23 % of the Corporate portfolio. These loans are usually large and less risky (usually banks receive state guaranties). For banks this sector became very attractive. All the analysed banks compete for financing public entities; therefore, this competition influences interest margin (less risky, but less profitable loans).
Corporate lending to the “productive” sector is quite low. Retail&Wholesale trade and manufacturing industries are prevailing. Recently, banks have significantly increased exposure in energy and water supply segment. DNB LT priority is to finance the agriculture, forest sector, and other banks are willing to finance the agriculture sector as well. The transport sector was influenced by the geopolitical situation.
The growth of credits towards “productive” sectors, innovations financing should became one of the priorities of the Baltic banks and add value more significantly to the economic capacity and growth potential. In the current low interest rate environment, there is a source of future income: focusing on these sectors, they can increase the volume of the loan portfolio.
Competition for large corporate clients with low to medium risk profiles (target market of all the Scandinavian banks) is extremely tight. Loans to SMEs often pose a great challenge in managing credit risks; therefore, banks need to take much effort to find flexible SMEs financing solutions.
SEB finances more Large corporates (also public, infrastructure) but also wants to finance SMEs; whereas Swedbank and DNB finance more SMEs but would also like to have large low risk clients, and public entities.
One of the strategic priorities of the SEB parent bank is to develop and expand SEB’s offering to SMEs through building on SEB’s reputation as the leading corporate bank in Sweden. The parent bank emphasizes how many new SME clients should be attracted and what lending volume to SMEs should be achieved. However, in SEB LT website there is no information about this target. Moreover, in Annual Report 2014 there is no information about this target as well when SEB LT activity plans and forecast were presented.
Banks policy to finance low risk clients, which meet bank’s conservative lending standards, is proved by the European Commission survey (Annex 22). High rejection rates were reported in Lithuania (24 %). It means that about ¼ of SMEs had their application rejected. One of the problems can be is that banks focus more on the historical financial situation of the client and a suitable collateral rather than on the value of the future project.
To sum up, recently in subsidiaries loan portfolio share in assets has shrunk, growth of loan portfolio has been modest, subsidiaries have become averse to credit risk, they have been focusing on household financing, corporate portfolio involves significant real estate& construction financing, public entities and large low risk clients.
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2.5.1.3 Key financial resources
The purpose of key resources analysis was to find out the charges that took place in the structure, dynamic and their influence on banks income.
Scandinavian bank subsidiaries use two sources of funding: local customer deposits and funding coming from parent banks. The funding structure has undergone significant change in recent years.
Figure 14. Liabilities of Scandinavian bank subsidiaries in the Baltics (31/12/2014)
Source: Banks Annual Reports, 2014, formed by the author. Most of banks liabilities consisted of the attracted customer deposits.
Figure 15. Composition of bank liabilities of Scandinavian bank subsidiaries in the Baltics (31/12/2014)
Source: Banks Annual Reports, 2014; formed by the author.
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For several years now, the customer deposit portfolio in banks has shown a growth trend – the volumes of deposits have reached record heights (especially in Latvia and Lithuania, where the adoption of the euro worked as a positive impetus for the growth of deposits). As loan portfolio growth was modest, this prompted some banks to reduce liabilities to parent banks (SW subsidiaries) or some banks to increase volume of the funds within parent banks (SEB and DNB subsidiaries).
SW subsidiaries have reduced funding from parent bank up to negligible amount. Still the funding coming from parent bank is essential for DNB subsidiaries (DNB LV – 43 %, DNB LT and DNB EE – 36 %). SEB LT and SEB EE also has significant due to parent banks (21 % and 24 %).
Different funding structures determine different funding costs. As funding from the parent bank is more expensive (and longer term) SEB and DNB subsidiaries have much higher funding costs compared to Swedbank subsidiaries that rely mostly on local deposits (mainly demand deposits) (Annex 23).
A considerable share in interest expenses was from deposit insurance fund payments, which vary in the Baltic countries. According to the current requirement of Deposit Insurance Fund, all the banks in Lithuania have to make annual deposit insurance fund payments of 0.45 % for deposits of private individuals and corporate customers (this rate should decrease together with the new EU directive implementation), in Latvia – 0.2 %, in Estonia – 0.12 %.
With interest rates being exceptionally low, the depositors tended to replace term deposits with non-maturity deposits (money transferred to a current account upon expiry of the term deposit period). Transformation from term to current deposits is evident in majority of analysed banks (higher share of term deposits left in DNB EE and DNB LV).
Although the deposits held in banks are short-term (or demand deposits), they still comprise a sustainable financial resource (it was proved by several shocks in the Baltics during the last decade). Nonetheless, funding sustainability risk exists. Predominance of retail deposits associate with deposits run-off risk in shock situations (geopolitical issues, rumours about one bank (local or parent), deposits may become more volatile with growing competition on interest rate between credit institutions, also alternative investment possibilities for depositors can increase (EU initiatives to create Capital Market Union). However, non- diversified source of funding raises a concentration risk. Banks should not over-rely on one funding source. Well-diversified funding structure is essential in guaranteeing banks capacity to overcome stress events.
Some banks (SEB, SW subsidiaries) issued long-term bonds. The amount of these bonds has been very low yet.
The importance of the long-term bonds in the future should grow significantly. They will facilitate the balance of the funding term structure for banks with a high demand deposits share in total deposits. Therefore, EU initiatives to create the Capital Market Union, to have liabilities (MREL) capable of being
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bailed (Recovery and Resolution Directive requirement) will encourage banks to diversify liabilities in the future.
Secured funding is another alternative funding source for the Baltic banks, which may become popular in the future. In some EU countries, secured funding has proven to be a lifeline during the period of stress, as it allows for diversification of funding sources and decreases counterparty risk (ECB Bank funding).
Summing up the key resources components of banks, it is important to highlight that currently low interest rate environment and the funding structure based on demand deposits allow banks to work with very cheap resources. Banks benefit from this favourable situation, but it will not last for a very long time. Banks need to prepare their business models for funding source diversification in local markets, introducing new funding products.
SEB and DNB subsidiaries have a possibility to increase profitability netting assets due and liabilities from parent banks.
In summary, customer deposits were the main sources of financing, transformation from term to current retail deposits was performed (interest expenses were decreased). Banks have been reducing funding from parent banks (this funding is more expensive than deposits of local customers).
2.5.1.4 Revenues streams
Banks have two revenue streams: the first one is the interest income from lenders; and the second one is the fees and commissions that they charge for different kinds of operations. These two revenue streams were analysed.
Net interest income is the main source of income, but from 2011 the share of non- interest income increased significantly (Annex 24). In 2014, all banks (except DNB EE) have substantial non-interest earnings, most from fees, commissions, and other earnings (Figure 16).
Figure 16. Composition of Income of Scandinavian bank subsidiaries in the Baltics (2014)
Source: Banks Annual Reports, 2014; formed by the author. 44
In recent three years, Net interest income level stayed on average the same (with modest growth or slight decrease) in majority of banks (an increase was in DNB LV and DNB EE) (Annex 25).
The volume of Interest income, especially comparing pre-crisis income level, shrank significantly. Recently, banks have received more than 90 % of the interest income from loans and advances to customers and on finance lease receivables, and very small part from other assets (due from banks, securities).
Moderate growth of the loan portfolios and the currently low interest rate environment makes pressure on the interest income generating capacity.
Banks can increase their interest rate by increasing the volume of the loan portfolio or by increasing an interest rate (margin). Without usual attempts to increase loan portfolio, some banks did special activities, which had influence on the interest income. SW LT actively did loan portfolio reprising which resulted in slight increase of the interest income. In low interest environment, banks have a limited possibility to an increase interest rate (margin) for loans.
As DNB EE works as a subsidiary only for four years, the total income in 2014 increased by 10 %, which was supported by 9 % increase in net interest income (lending volume increased by 3.4 %, this growth was mainly delivered by corporate lending and leasing).
In 2012 and 2013, banks reduced interest expenses significantly. Different funding structures determine different funding cost in banks. These transformations (from the parent bank funding to local deposits, from term to current deposits) allowed to reduce interest expenses significantly.
In summary, the decreasing funding cost was the main driver of the quite stable Net interest income level. Without significant growth in the loan portfolio and amid the prevailing low interest rates environment, the possibilities for banks to increase their income is limited.
The stable (decreasing) level of net interest income has been accompanied by growth in net fee and commission income (Annex 26). Especially steady growth was in Latvia before the adoption of the euro in 2013, and in Lithuania in 2014. The growth of net income from commissions and services was mainly influenced by higher activity of the Bank‘s customers, which stimulated the quantitative growth of the performed bank operations.
After the adoption of the euro, Net Fees and Commissions in Latvians banks decreased slightly due to the reduced payment transfer fees. More negative impact was on the operating income in 2014 (Annex 27). In Latvian banks, Operating income in 2014 decreased by 10-17 % compared to 2013 operating income, payment transfer fee – by 15-26 %. The biggest impact was for profit from FX exchange – it decreased by 62-82 %. Banks can be expected similar impact in Lithuania in 2015 and later. Banks will lose profit from FX exchange and commission income from payment transfers.
Composition of Net Fees and Commissions shows that in Lithuania Net Fees from Payment transfer is a significant source for all subsidiaries. However, this income source can shrink considerably in Lithuania in 2015 (after the adoption of the euro) and in all subsidiaries after SEPA launch in 2016.
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The customers were more active in using our bank’s services, and the number of e-transactions was increasing. Like every year, in 2014 alongside with an increase in the number of our customers who prefer more transparent and safer electronic payments and discover advantages of payment by card, we saw a consistent decline in the number of cash transactions. customers were more active in using our bank’s services and the number of e-transactions was increasing. Like every year, in 2014 alongside with an increase in the number of our customers who prefer more transparent and safer electronic payments and discover advantages of payment by card, we saw a consistent decline in the number of cash transactions.customers were more active in using our bank’s services and the number of e-transactions was increasing. Like every year, in 2014 alongside with an increase in the number of our customers who prefer more transparent and safer electronic payments and discover advantages of payment by card, we saw a consistent decline in the number of cash transactions.customers were more active in using our bank’s services and the number of e-transactions was increasing. Like every year, in 2014 alongside with an increase in the number of our customers who prefer more transparent and safer electronic payments and discover advantages of payment by card, we saw a consistent decline in the number of cash transactions.
Figure 17. Composition of Net Fees and Commissions, 2014 Sources: Banks Annual Reports, 2014; formed by the author. SW EE did not separate Net payment Cards services fees. Another significant income source is Net Fees from Payment Cards Service in SEB and SW subsidiaries. These subsidiaries were active in encouraging clients to use more payment cards with their brand (Annex 28).
In absolute value, DNB LV and EE net fees income from the payment card services are moderate compared to SEB and SW subsidiaries. DNB LT declared that in 2014 it granted over 180 thousand new payment cards to its individual and business customers (DNB Lt payment cards topped 520 thousand), the turnover of cards rose by 25 % year-on-year due to the increased number of active payment users and higher average spending).
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EU initiatives and regulations will also influence some fees and commissions rates and will have a negative impact on the volume on this income. EU Regulation on Multilateral Interchange Fees (MIFs) set the cap on interchange fees at 0.2 % and 0.3 % for debit and credit card transactions respectively. In the Baltic countries where the current level of interchange fees is well above the caps, the Regulation should have a substantial impact on banks (Annex 29).
Also, majority of the banks (SEB LT, SW LT, DNB LT, DNB LV, SW EE) reported a significant share of other income (net gain on operations with securities and financial derivatives, net FX result, net gain on sale of property). However, this income is not sustainable (for example, DNB LT in 2014 received net gain from financial derivatives 4.6 mln. Euro, but the same amount was showed as loss from financial derivatives in 2013; SEB LV also had 6.4 mln. Euro profit from trading with financial instruments, but in 2014 it experienced 0.5 mln. Euro loss).
Summing up the key revenues streams, it is important to highlight that as loans portfolio growth is moderate, from 2011 banks started to focus more and more on non-interest income activities. Non-interest income is more sensitive to the market and regulatory changes and has a limited growth possibility. Moreover, in the race towards higher profits, banks can unbalance their business base by paying too much attention to non- interest income activities, not focus on traditional banking business, deriving profits from interest income.
2.5.1.5 Cost structure
The cost structure for subsidiaries was analyzed. Since the crisis in 2009, all banks have given particular attention to the improvement of their operating performance by using the same cost cutting policy (banks strictly limited their expenses). To improve operating efficiency, the banks have been reducing operating costs through the promotion of e-banking development. At the same time banks have been reducing the number of customer service units and putting self-service centres in place, shifting more operations to Internet and to mobile phones use. In this way banks seek to optimise retail network and the related costs.
Figure 18. Composition of costs of Scandinavian bank subsidiaries in the Baltics 2014 Source: Banks Annual Reports, 2014; formed by the author.
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Most banks decreased the number of their employees (especially SW subsidiaries); however, personnel expenses were not significantly reduced (Annex 30). To solve profitability problems, the banks also focused on the optimisation of the branch network. Seeking to cut costs, many banks closed some of their branches (customer service units) and reduced the number of employees (Annex 31).
As banks significantly reduced physical meeting places for customers, they started to move actively to digital banking services. The Baltic countries are advanced in the use of information technology and telecommunications innovations, but according to the Survey performed by Social Information Centre in Lithuania (at the end of 2014) in the field of banking services is still a beginner level (Association of Lithuanian banks, 2015b). Lithuanian banking association commented that the Survey showed that a large part of the population relationship with the banks is quite superficial. Most of the respondents (83 %) have a current account, a debit card (72 %); bank transfers carried out by 43 % population; only a tenth of the population uses credit cards. It means that banks need to invest in the clients’ financial education in order to promote the use of digital services proposed by the bank.
Scandinavian banks are more oriented towards the advanced Customer‘s habit of doing their day-to -day banking digitally which is gaining foothold. Banks have been investing in the improvement of the digital accessibility: IT systems, online banking smart phones, ATMs.
The shift from branches to mobile and internet banking places higher demands on protection against external threats. Banks need to implement a wide range of measures, from electronic securities and active shutdown of fictitious and infected websites to providing information directly to customers. Its banks long term work to modernise, consolidate and improve efficiencies in the IT infrastructure, which limit operational risks.
Preparation for the euro introduction in Latvia in 2013 and in Lithuania in 2014 increased costs for IT systems. Some banks (SEB LT, DNB LT) introduced new core banking platforms, which provide a solid technological basis for sustainable growth of the banks in the long-term perspective but increased costs. There are plans to introduce new core banking platforms in all SEB and DNB subsidiaries. Due to these projects, the costs will increase in the future.
To sum up on what was outlined, search for cost-effectiveness changed bank business models – they changed focus from physical meeting places to Digital. In this stage banks need to invest more (cost will increase) in other areas like IT and security, new digitals support, customers education to us new types of services.
2.5.1.6 Risk appetite and prudential requirements
The analysis of banks performance in the context of their risk appetite was performed. Banks did not clearly disclose overall risk appetite and risk tolerance in their Annual Reports, but they only declared that they concentrate on new lending to low risk clients. In this paper not all types of risk (level and management) were analysed due to the lack of publicly available data. Therefore, it was focused on how the analysed banks comply with prudential requirements and on assets quality ratios.
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The most significant prudential requirement is capital adequacy. Banks need to have an adequate level of capital against the risks associated with their activities and to cover unexpected losses, especially in shock situations. Capital adequacy ratios of all the analysed banks are well above the minimum level (Figure 19).
Figure 19. Capital adequacy ratios, 31/12/2014 Sources: Banks Annual Reports, 2014; European Banking Authority 2014c; formed by the author.
SW subsidiaries hold the highest capital adequacy ratios, whereas DNB subsidiaries hold the lowest ones. It could be noted that DNB LV is below the EU average.
The high-level quality of capital in all the analysed banks has been maintained by the key element of bank equity. CET1 capital currently corresponds with the Tier 1 capital in all banks. The actual level of capitalisation of banks currently implies that they do not have any difficulties in complying with new CRD IV/CRR requirement (regulatory authorities have a possibility to introduce additional capital buffers4 for banks, in addition to the minimum capital adequacy ratio). From 2006, banks used annual profit to strengthen their capital. Only from 2013, some banks decided to distribute half of its profit as dividends (Annex 32).
Scandinavian subsidiaries in the Baltics are well-capitalised and can contribute to economic growth of the countries by providing the needed financing to corporations and households. Since Scandinavian banks subsidiaries in the Baltics are averse to risk, they should change into more risk tolerant banks, more adaptive to local countries environment and contribute more to the economic recovery.
High capitalisation of the analysed banks demonstrates that the newly introduced leverage ratio is well exceeded. In Annex 33, leverage ratios for 31/12/2013 are presented when banks reported the data to the ECB for Comprehensive Assessment. Now the EU has an indicative requirement at 3 %, which has not been established officially. It may be noted that all banks comply with this indicative ratio with large reserves.
In Annual Reports banks declared that they met the new liquidity coverage ratio requirement (in all the Baltic countries LCR ratio requirement is 100 %), but majority of banks did not disclose this ratio. The Net
4Capital conservation buffer 2.5 %, Countercyclical capital buffer (CCB) 0-2.5 %, buffer for Other Systemically Important institutions (O-SIIs) 0-2 %, Systemic risk buffer 0-5 % 49
Stable Funding Ratio (NSFR) requirement is scheduled to be implemented in 2018, which will give banks sufficient time to adjust the structure of their assets and liabilities to ensure compliance with this requirement. National liquidity requirements were established in Latvia and Lithuania (liquid assets/current liabilities >30 %).
Loan to deposit ratios have improved (Annex 34). The loans being issued by the local banking system are increasingly financed through local deposits. In the long term, this should ensure sustained development in the Baltic banking sectors, which should be based on fundamental factors. The highest ratios were in DNB subsidiaries because of having a high share of funding from their parent bank. SEB LV and EE loans to deposits ratios also remain high enough (higher than EU average).
Another important factor is to maintain high quality of assets. Recently assets quality indicators of the loan portfolio have continued to improve (Annex 14). The main reasons are that banks have written-off a lot of bad loans, the financial standing of borrowers continues to improve, and new lending is focused on clients with low risk profile. After reaching the peak in 2010, the non-performing loan ratios decreased significantly. Banks were finishing clearing their balance sheets of illiquid and no income generating financial assets.
In 2014, the national supervisory authorities of the Baltics in cooperation with the ECB (prior to becoming the supervisor of the Eurozone banks) completed an in-depth assets quality review of all the analysed banks (except DNB LV) and stress tested their resilience to likely shocks (called Comprehensive Assessment). This review was carried out according to the ECB’s quite stringent methodology. Once it was carried out, no significant change in loan value was established for all the analysed banks. This means that accounting at the banks is done conservatively; risk is assessed comprehensively and accurately. In addition, the preparedness of these banks to act in the event of an adverse scenario of three year duration was assessed according to the common methodology of the Eurozone countries. Stress testing also revealed that these banks would be able to withstand a significant shock. Even in the adverse scenario the banks’ capital adequacy ratios would exceed the required minimum capital adequacy ratio by more than two times. The results of the ECB Comprehensive Assessment confirmed the capital strength and asset quality transparency of the analysed banks (Annex 35).
Decrease of risk weighted assets shows that banks have become averse to risk (Annex 36). The clearest risk weighted assets declining trend was in all SW subsidiaries and SEB LT. DNB LT situation was quite controversial, in 2011-2013 risk weighted assets and assets grew similarly, but in 2014 risk weighted assets decreased significantly.
2.5.2 Correlation Analysis
As the data available (annual data for the period 2006–2014) is not sufficient to perform accurate and comprehensive regression analysis, correlation among subsidiaries in each bank group was chosen for analysis (SEB, Swedbank, and DNB) to identify whether subsidiaries in each bank Baltic group acted in the similar way or not. The analysis was performed in two stages. 50
Figures 20 and 21 present pairwise correlation coefficients of the five selected growth indicators among subsidiaries of one bank group operating in Lithuania, Latvia and Estonia. The red line in all the three graphs demonstrates the area where r = 0, i. e. there is no correlation between the variables. Therefore, the values that are inside the red pentagon show a negative correlation between the variables, and the values outside the pentagon indicate the positive one.
Stage 1. Figure 20 demonstrates the results of correlation analysis of the five selected growth indicators from balance sheets.
Figure 20. Correlation of the selected indicators of growth (Balance sheet) in bank groups.
Source: Bankscope, Banks Annual Reports, 2006-2014; calculated and formed by the author.
Having analysed SEB Baltic Group, it was established that there is quite a strong positive relationship among SEB subsidiaries of all the three countries in four of five dimensions. Differences exist only in correlation among the growth of securities between SEB LV and SEB EE. The main reason is that for a long time SEB EE had acquired a very small quantity of securities. This was due to the SEB policy encouraging the subsidiaries to invest in the securities of the country that they operate in. As Estonia issued Government bonds in limited volumes, only from 2013 SEB EE slightly increased the volume of the bonds (up to 136 million euros). The volumes of SEB LV securities were also not large and were continuously decreasing,
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whereas SEB LT has always maintained a relatively large volume of Lithuanian Government bonds portfolio (as of 31 December 2014, it was 423 million euros). Therefore, it may be stated that SEB subsidiaries of all the three countries implement similar policy regarding Loans and advances, Due from parent banks and Due to them as well as management of Customer Deposits. For example, before the crisis all three SEB subsidiaries operating in the Baltic countries borrowed a lot from their parent bank, and after the crisis they gradually reduced their debts; however, these debts are still quite significant in all three subsidiaries. The situation is the same regarding the growth of the loan portfolio: before the crisis the growth of loan portfolio was quite significant in all subsidiaries, during the crisis the loan portfolios shrank, and there is not any significant growth in SEB Baltic group (small increase is observed in SEB EE). The lowest but positive correlation was observed between SEB LT and SEB EE.
Having analysed Swedbank Baltic group, it was established that the strongest positive correlation among subsidiaries is of two indicators: growth of Loans and Advances and growth of Due to banks. This demonstrates that in these areas subsidiaries implement a very similar policy. Growth of Customer Deposits shows a positive correlation between subsidiaries as well. However, change of volumes of SW LV Customer Deposits in separate years differs from SW EE and SW LT. For example, in 2009 a volume of SW LV deposits had reduced (in by 6.3 %) while in SW LT and SW EE it had increased by a similar amount; a very significant growth in deposits in SW LV before the introduction of the euro in 2012 and 2013 was observed. This indicates that banks implement a similar policy in the field of attracting deposits; however, events taking place in the respective country make some influence, too. A positive correlation was also established in Growth of Due from Banks, but the strongest was between SW LT and SW LV which was caused by the nuances of the introduction of the euro (big amounts were temporary transferred from parents banks to central banks). Differences exist in the investment in securities: a small positive correlation between SW LT and SW EE is observed, whereas in other pairs of banks correlation is negative (there are differences among countries according to volumes (SW LT invested most), and large volatilities of volumes are evident because these securities are obtained for liquidity purposes and are sold on demand. In summary, operations of Swedbank Baltic group are very similar in four of the five dimensions analysed in all the Baltic countries, and this demonstrates that a similar business model of Swedbank is applied to all three countries.
In DNB Baltic Group, a weaker correlation between the selected indicators was established in most cases, especially correlation with DNB EE. Such results of correlation analysis could have been determined by a too short time series of DNB operating in Estonia as the bank was set up in 2011 only (the structure of its assets and liabilities and growth trends differ from banks operating for a long time as well as the peculiarities of their operations in the post-crisis period). A positive correlation was established between DNB LT and DNB LV in four indicators, the strongest of which is correlation between Growth of Loans and Advances and Growth Due to Banks. A negative correlation was identified in Growth of Customer deposits. However, a positive correlation is seen among growth in securities and Growth of Due from banks of all the countries. A weaker correlation among subsidiaries operating in separate countries can be influenced by such factors as the absence of a separate Baltic division in the group (SEB and SW groups have such divisions and strongly coordinate activities at the level of the Baltic countries), the size of the banks in the market (smaller banks 52
are impacted by the country specifics much more). Therefore, it can be stated that DNB subsidiaries in Lithuania and Estonia operate according to a similar business model, but because of their smaller size in the market they are more sensitive to the country specifics, and DNB EE is at the stage of the entrance to the market.
In summary, the identified positive correlation in four of the five dimensions in SEB and SW Baltic groups indicated the areas in which subsidiaries acted in the similar way. The strongest correlation was in Growth of Loans and Advances. In SEB, more coordinated actions were in Growth of Due from Banks, and in SW was Growth of Due to Banks. Growth of securities correlated weakly or negatively among the subsidiaries in both bank groups. In DNB Baltic group, a weaker correlation between the selected indicators was established in most cases.
Stage 2. Figure 21 shows the results of correlation analysis of the four selected growth indicators from P&L.
Having analyzed the relationship among SEB subsidiaries operating Lithuania, Latvia and Estonia, it was established that there is a positive correlation according to all the selected variables (the strongest correlation is in Growth of Net Interest Income, while the weakest correlation is in Growth of Administrative expenses). A strong correlations in the income area shows that the subsidiaries operate very similarly in earning income (as Net Interest Income decreases, Net Fees and Commissions Income increases).
Figure 21. Correlation of the selected indicators of growth (P&L) in bank groups. Source: Bankscope, Banks Annual Reports, 2006-2014; calculated and formed by the author.
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In Growth of Impairment, the largest correlation was established between SEB LT and SEB LV (in 2009 subsidiaries too conservatively assessed credit risk and made high impairments, later they profited from impairment reversals). SEB EE Growth of Impairment was less volatile (during the crisis the impairment was lower), while correlation between SEB LT and SEB LV in this area is weaker.
Swedbank operates very similarly in three of the four analyzed dimensions in all Baltic countries (a positive correlation). The strongest correlation established in Growth of Administrative Expenses shows that all subsidiaries were purposefully reducing operating costs. Greater differences (a negative relationship) are only between SW LT and SW LV in Growth of Impairment. The strongest correlation in Growth of Net Fees and Commissions was established between SW EE and SW LV, but the weakest one with SW LT. This was determined by the fact that in SW LT income was growing during the entire period (decrease in income was only in 2010), whereas growth was more volatile in other countries.
Similarly to the Stage 1 of correlation analysis, a weaker correlation was established in DNB Baltic group compared to the above analyzed groups. A strong positive correlation was observed among DNB subsidiaries in Growth of Administrative Expenses. A strong correlation was found between DNB LT and DNB LV in two dimensions: the already mentioned Growth of Administrative Expenses and Growth in Net Interest Income.
In summary, a set positive correlation according to all the selected variables in SEB group and in three of four dimensions in SW group showed that subsidiaries acted in the similar way. The strongest correlation was in Growth of Net Interest Income. In DNB Baltic group, a weaker correlation between the indicators selected for analysis was established in most cases.
Correlation analysis among subsidiaries in each bank group demonstrated that subsidiaries in SEB and Swedbank groups implement very similar policies in three Baltic countries. Each group has a separate Baltic banking division, which strongly coordinates activities at the level of the Baltic countries. Banks in Lithuania, Latvia and Estonia are strongly dependent on the decisions of parent banks for Baltic region. The implication of this policy to the bank of the country can be positive if the group innovations are implemented in the Baltic region. However, the implication can also be negative if the parent bank makes inadequate decisions to the situation of the country and does not take into account the needs of the country or the local bank.
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III. Managerial solutions on the identified business model challenges
Having completed the literature review, qualitative analysis of market factors and quantitative analysis of key business model components of Scandinavian banks subsidiaries in the Baltics and considering the findings derived from both previous parts, business models challenges as well as the need for some changes to ensure their sustainability were identified.
3.1 Business Model Canvas for Scandinavian banks subsidiaries in the Baltics
A summary of the key analysed components of bank business models, which shows common features of business models and different approaches in some banks, banking groups, countries is presented (Annex 37). Business models of all the analysed banks can be classified in one group. The summarized results of the Baltics banks business model are presented in Business Model Canvas Figure 23.
Key Partners Key Activities Value Relationships Customer Loans Propositions Long term Segments Many partners: . Modest growth recently Offering to relationship Suppliers and . Averse to risk customers: Automation Households business partners Securities Loans where possible, (as technology . Hold for liquidity purpose Savings online (virtual) and . Invest in the country’ Investments Personal telecommunicatio Government bonds Payments assistance (Face Enterprises n vendors, cash Due from banks Securities to face, more Large and safeguard . Hold large amounts within Insurance focus on corporates services parent banks Other financial advisory) and providers, etc.) Other financial services services& institutions, Channels Clearing advisory
institutions, stock Key Resources Branch offices SMEs markets Financial: ATMs, . Customer deposits Internet Financial - Main source of financing Mobile Devices regulators, ECB - Transformation from term to Call centres Government current retail deposits institutions . Due to banks - Reducing funding from parent Other banks banks Associations, - More expensive than local deposits Institutes, . Capital Universities - Are well-capitalised - Strengthened capital by annual profit Other (employees, IT systems, branch offices) Cost Structure Revenue Streams Personnel Expenses, Other administrative expenses Net interest income Focus on higher operating efficiency: . Main source of income, share decreased . cost cutting (decreased number of employees, . Stable in absolute value branches) . In low interest environment there are indications . e-banking increased to decrease Limited possibility for further cost cutting, need for Net Fees and Commission and other income higher investments in digital security . Non-interest income share increased Impairment charges . Have limited possibility to grow and have Banks still benefit from impairment reversals indications to decrease
Figure 24. Business Model Canvas of Scandinavian banks subsidiaries in the Baltics
Source: formed by the author
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If R. Ayadi et al. (2014) cluster analysis of six components (Loans to banks, Trading assets, Bank liabilities, Customer deposits, Debt liabilities, Derivative exposures) was used for classifying Scandinavian banks subsidiaries in the Baltics, it would be clear that all these subsidiaries were classified as focused retail banks (Table 13). Table 13 Comparison of business models Main observations on bank business models Main indicators R. Ayadi et al.(2014) focused retail Baltics foreign-owned bank business model business model Ownership All ownership indicators around Foreign-owned banks. sample average: - 50 % of small domestically oriented Dependent on parent banks (capital, liquidity, institutions are shareholder-value group strategy and decisions) (SHV) banks; - 20 % are cooperative banks; - 25 % are savings banks. Financial Among the smallest banks. Among the largest banks in the country. activities Primarily providing customer Use local customer deposits for providing loans loans funded by customer to low risk clients, invest in local Government deposits. bonds, hold large amounts within parent banks. Domestically oriented (provide financial Domestically oriented. services in one jurisdiction) Financial and The least profitable and decline in Medium profitable, to generate acceptable economic customer loans during the euro crisis. returns in future are in concern performance Trading income Decline in loans portfolio during the crisis, Relatively unimportant recently modest growth Average efficiency Trading income is relatively unimportant Focus on higher efficiency (cost cutting, e- banking). Limited distance to default Probable large distance to default (can receive Highest risk-weight financial support from parent banks) Low leverage Focus on low average risk-weight. Highest loan losses and market risk Low leverage (i.e. CDS), especially during Euro High loan losses during the crises, recently crisis. reversal impairment Stable funding. Recently stable funding (focus on local deposits), but before the crisis significant funding from parent banks were received Source: R. Aydi et al., 2014; formed by the author.
However, only a deeper analysis of each subsidiary business model components allowed for understanding of these business models and identifying the main features and challenges related to them.
Having analysed the research of R. Ayadi et al. (2014) on focused retail business model and the Baltics foreign-owned banks business model, a great number of similarities were identified in financial activities. For example, both types of banks are domestically oriented; they use local deposits to provide customer loans; customer loan portfolios declined during the crisis; and trading income is relatively unimportant. The biggest differences exist in risk taking and financial performance. Baltic foreign-owned banks are risk
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averse, they focus on high efficiency (cost cutting and e-banking), they are well-capitalised and liquid, but medium profitable with a negative trend to generate acceptable returns in the future.
In summary, the Baltic foreign-owned banks business model is mainly focused on banking safety, and capability of withstanding future shocks (banks meet prudential requirements with large reserves). Banks are well-capitalised, liquid and can successfully provide financial services (including lending) to enterprises and households according to their needs. Due to being risk averse, banks do not play a key role in financing the economies of the Baltic countries as they should, especially small and medium enterprises. European Union initiatives (Quantitative Easing, Single Capital market, “Junker plan”) promote and activate credit activity, and banks need not remain aloof towards the common goal. As banks are medium profitable with a negative trend to generate acceptable returns in the future, banks need to refocus their business models so that income bearing assets generate higher returns or find other profitability drivers. 3.2 Potential key profitability drivers for foreign-owned banks in the Baltics
As Scandinavian banks subsidiaries in the Baltics are medium profitable in the context of the economic landscape, current regulatory changes and technological developments, to generate acceptable returns in the future are of concern. Today’s acceptable financial performance is no guarantee of tomorrow’s performance. A negative trend has already been observed. A significant challenge therefore is to understand what actually drives future profitability, not just what worked well in the past. All banks need to find suitable key profitability drivers and review their business models. Based on the results of the performed quantitative analysis of business models components, key profitability drivers were summarised in Table 14.
Having analysed opportunities and vulnerabilities of key profitability drivers, it was determined that banks have the possibility to increase the volume of financial services or their price. As it was presented in Table 14, a price increase for financial services can negatively impact bank business: 1) in a low interest rate environment, a price increase can be unacceptable by customers and enhance reputational risk; 2) new EU initiatives focus on the decrease of financial service rates, and banks must comply with these regulations; 3) banks provide more and more financial services in a digital way, and this trend towards further digitalisation is increasing; customers expect lower prices due to digitalisation; 5) competitors from the non-banking sector provide financial services at lower prices; and 4) after the adoption of the Euro, the rate of payment transfer fees decreased.
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Table 14
Key possible profitability drivers for Scandinavian banks subsidiaries in the Baltics Key Profitability Rate of Drivers Opportunities Vulnerabilities impor- tance Increase the volume of loan Possible bigger credit losses portfolio, focus on SMEs Higher operational expenses due to Volume financing (productive sectors, costly customer (project) risk Net innovative companies) assessment using more flexible Interest approach In line with EU initiatives Income Increase interest rate (margin) Interest rate (margin) increase in the Price for new loans, reprising low interest rate environment can previously issued loans enhance bank reputation risk
Increase penetration rate Limited possibility to increase the (payment cards, payment volume of financial service transfer, other financial operations due to operating only in one jurisdiction. Volume services)
Net Fees Banks need to invest in the and customer financial education Commiss ions Increase fees and commissions Fees and commissions rates increase rates for financial services can enhance reputational risk; Price Pressure of new EU regulation and initiatives to decrease these rates After adoption of the euro payment transfer fees decreased Other income Focus on non-traditional After adoption of the euro profit from banking – trading activities, FX exchange decreased derivatives Limited possibility in the low interest rate environment to increase income from securities, derivatives Cost cutting (further decrease Limited possibility to cost cutting of employees, branch offices, due to unbalance business base buildings) Need higher investments in digital Cost Efficiency security, IT, against cyber criminality Automation where possible Need higher investments to comply with regulatory requirements, risk management, internal control and governance Increase a risk tolerance level Banks capital allows to increase risk Risk-taking (credit, tolerance only in the areas where operational) banks can generate higher returns and create value for society (as lending to economy) Source: based on results of the Research, formed by the author.
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A price increase can be successful if the bank’s competitive advantage is differentiation (banks invest money in their brand and the ability to differentiate). Subsidiaries benefit from bank group brands, but they do not focus enough on differentiation of products and services. They focus more on cost efficiency (leadership).
Another possibility to increase profitability is to increase the volume of their loan portfolio or the quantity of bank financial operations. The peak of growth of performed financial operations in Latvia and Lithuania was before the adoption of the Euro (in 2013 and 2014, respectively). As it has already been mentioned, the survey done on the use of bank financial services showed that a large part of the population in relationship with banks is quite superficial; therefore, it is necessary to invest in customer financial education in order to increase financial service penetration rate. Banks have the possibility to increase their volume of operations and increase fees and commissions rate, but there are some limitations when the bank operates only in one jurisdiction (limited number of population and companies).
In summary, the key profitability driver and the biggest opportunity for banks is the increase of the volume of their loan portfolio.
3.3. Ensuring sustainability of the business model through financing SMEs
Banks have an opportunity to focus on SMEs financing, especially on more productive sectors and innovative companies. According to EUROFI (2015) document on EU policy, “traditional banks will undoubtedly remain an important financing partner for industry in the future. SME relationship is among the highest priorities for banks. Financing industry and trade lies the origin of the banking industry and is central to banks’ role in fuelling economic growth” This statement only confirms that banks should play a leading role in funding SMEs and should not leave room for the initiated Single Capital Market. On the other hand, the EU initiative regarding Single Capital Market may encourage banks to start financing SME projects much more actively. The lack of available access to finance SMEs is a widely discussed topic.
In order to increase loan portfolios, the banks should make fundamental changes in their lending strategy and increase risk tolerance. The EU and local governments should give financial support to SMEs to strengthen this sector and encourage banks to finance SMEs more actively.
3.3.1. Financing of SMEs should be a strategic priority of banks
As Scandinavian bank subsidiaries in the Baltics have a risk-averse approach for financing companies, banks can choose a less risky and a more in line with risk appetites approach for two or more segments of SMEs financing.
Working with start-ups, banks can start building long-term relationships. When the company opens its bank account for payments, banks start to collect information on the profile of the company and try to understand its business and needs. Moreover, banks can offer advice on financial risk and other issues. For example, they can stimulate innovation on the company level for two years without financing projects. Banks can also benefit from establishing partnerships with venture capital funds, which finance start-ups projects, and continue cooperating in the future. During this period, banks can provide short term loans or overdrafts.
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Working with mature SMEs, banks can finance innovation on the company level by adapting the existing products and processes that are new for a particular company, but not worldwide. Innovation is not just R&D, it can take on many different forms, for examples, new services, new distribution channels, new brand image, new marketing schemes, new systems, new ways of operating, etc. Banks are too conservative on using new technologies and other intangible assets as collateral. Therefore, they should become more adaptive to the changing environment and to digitalisation.
Setting SME financing as a strategic priority should allow for banks to focus on this area, allocate adequate resources, adapt their organisational structure, processes, products and hire the right people. The main changes that banks should make are presented in Table 15.
Table 15 The main changes needed in banks for more active SMEs financing Infrastructure Main changes Policies . Risk tolerance level should be increased (without a negative impact on capital adequacy targets). . Customer segments should be defined (for example, start-ups, mature small enterprises, and mature medium-sized enterprises). . Acceptable productive economic sectors should be defined and the limit reviewed. . Acceptable innovative company profile should be defined. Organisational . Organisation structure should be adapted to the strategic priority (necessary structural structure units for implementation of this strategic priority should be established). Processes . Risk assessment system should be based on information analysis and more forward- looking (focus on customer profile received from digital financial services, important long-term relationship, which allows to deeper understand a borrower, the business plan and new technologies). Products . More flexible products should be introduced: - With flexible repayment schedules of loans (for companies which generate volatile cash flows, at least initially); - With a possibility to collateralise intangible assets, new technologies (not only real estate). . More active advisory services should be introduced. People . Employees should have skills needed to assess early-stage technologies and other innovation projects, evaluate intangible assets, and recognise value added projects. . Complex assessment services can be outsourced (for example, technical expertise). Source: Formed by the author.
The communication of the strategic priority is also very important for SMEs in order to learn about the willingness of banks to lend to them. The main performance measures can be newly attracted SMEs and increased lending volume to them. 3.3.2. EU and local governments risk sharing with banks for financing SMEs
As SMEs dominate in the Baltics, they play an important role in the economic development of the country: ensure economic growth, decrease unemployment, increase export levels, and is a source of competitiveness. The most important role of SMEs is their contribution to innovation as well as to the development of the high value-added based economy. Banking, as an independent business, generating value added, could do without state support in financing SMEs. Banks in the Baltic countries have the resources; they are sound and 60
financially capable of lending money to SMEs, which create jobs and value added. However, the policy of parent banks encourages the subsidiaries to stay risk averse and to finance low risk SMEs or the SMEs that have state guarantees. There are frequently raised questions regarding the role of the state in financing SMEs: why should the state assume a part of the credit risk of SMEs, why do banks not assume all the risk? The answer may be that SMEs can make a significant contribution to the country's economic growth and prosperity as well as creating jobs. Therefore, it is useful for both the EU and local governments to strengthen this sector (especially innovative SMEs) and to share the assumed credit risk together with the banks seeking consistent and steady growth of long-term entrepreneurial level through SMEs. Thus, one of the current priorities for the EU and local governments is to provide the necessary funding (guarantees) to SMEs, and this situation is very useful for banks as regards risk sharing with the state.
In 2014, a new EU programme for the Competitiveness of Enterprises and SMEs (COSME) for 2014–2020 was launched with a planned budget of 2.3 billion Euro (European Commission, 2015c). In the Baltic countries, more active distribution of money will start from 2016. This money will be provided for funding through risk capital or loan guarantees for SMEs using financial engineering instruments. COSME, together with Horizon 2020 research programme, will replace the current Competitiveness and Innovation Framework programme (CIP). The Association of Lithuanian Banks urged the Government institutions to provide a more significant role of banks in SMEs financing. The Association noted that allocation plans of EU structural funds for 2014–2020 possibilities of banks to participate in financing such programmes are unjustly underestimated, regardless of the financial capabilities of the banking system and currently very favourable lending conditions on the market as well as. It was emphasized that it is necessary that new rules would allow, if needed, to increase the share of loan guarantees (Association of Lithuanian banks, 2015c).
Many institutions have emphasized (Ministry of Finance of the Republic of Lithuania, 2015) that experience of the previous 2007–2013 EU funding period demonstrated that financial engineering instruments in the form of loans and guarantees were popular and used efficiently, and the borrowed funds were returned successfully. There were two main models of business funding: Funded Risk Sharing Product (FRSP), in which banks finance half of the amount needed, and the First Loss Portfolio Guarantee (FLPG), when the state guarantees up to 80 % of the loan amount. Loan guarantees helped SMEs to receive needed financing from banks (having only 10 % of own money) for acquiring tangible and intangible assets, financing working capital needs.
The Governments are preparing for the implementation of Investment Plan for Europe (called as “Junker Plan”), which is designed to spur private investments through risk sharing with the public sector at the European level (European Commission, 2015b).
In summary, The EU and local governments financially support SMEs to strengthen this sector, and that should encourage banks to finance SMEs more actively as well. Banks should be the leaders in financing SMEs. Risk sharing with the public sector using EU Structural Funds, loan guarantees using financial engineering instruments in the COSME programme and “Juncker Plan” resources should encourage them to do that. 61
CONCLUSIONS
The current Baltic banking systems are the result of twenty-five years of their development. After the privatisation of the state-owned banks and acquisitions of other major local banks, the Baltic banking sectors are dominated by the subsidiaries of Scandinavian banks. The strategic role of parent bank groups in shaping the business model of subsidiaries is key. Because of the strong presence of Scandinavian banks in the market as well as their well-known brands, it is good for Baltic subsidiaries to be a part of internationally reputable bank groups. This ensures Baltic banks capital and liquidity needs (especially in unexpected shock situations). Moreover, strong dependence on the decisions of parent banks can also have negative consequences on the financial stability (if the parent bank is not able to support its subsidiary) and economy (if the parent bank makes inadequate decisions that are not favourable for the country’s situation) of the country.
The analysis of market factors revealed that the macroeconomic environment, regulatory and supervisory changes, and technological development have strongly affected business models of Baltic subsidiaries. The current economic development of the Baltic countries is a strong macroeconomic platform for the banks activities; nevertheless, there are some weak points such as a high geopolitical risk related to the events in Russia and Ukraine and certain internal factors (e. g. insufficient development of small and medium-sized enterprises (SMEs) in value-added sectors, weakness in innovations). The large influx of new regulations has a positive effect on strengthening stability of the financial markets; however, on the other hand, the implementation of these regulations increases operating costs and costs of capital, and new EU initiatives put pressure on decreasing fees for financial services. Supervisory changes (the ECB involvement, parent banks outside the SSM) can also accelerate the business model changes (e. g. transformation of subsidiaries into branches). The increased digitalisation requires that business models should be evaluated and adopted for banks to remain competitive and profitable and manage the risks associated with the new environment.
Using the system of key business model indicators, complex analysis of business model components of each Scandinavian bank subsidiary operating in the Baltics was performed. The main conclusions of this analysis are the following:
Majority of the analyzed banks are significant banks in each country and pose a systemic risk;
Recently, medium profitability was achieved by increasing non-interest income and escalating operational expenses. Subsidiaries ROAE is higher than the EU average, but markedly worse than in a parent bank group and at the pre-crisis level. A negative trend of profitability was established for the future;
Loan portfolio growth was modest, and loan portfolio share in assets shrank. Sharp decrease of risk- weighted assets, the loan portfolios increase to public entities, high rejection rate of credit applications, banks declarations that they are low risk banks showed that banks became averse to risk. More than 50 % of net lending is directed into the real estate sector (Mortgage loans, Real estate& Construction sector financing); however, corporate lending to the productive sectors and innovative companies is
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quite low. Banks hold a large amount within parent banks, which did not generate adequate income for subsidiaries;
Banks have been reducing funding from parent banks (this funding is more expensive than deposits of local customers). Customer deposits became the main source of financing, transformation from term to current retail deposits was done (interest expenses were decreased). Banks are well-capitalized, and each year banks strengthen their capital by profit;
Net interest income (NII) was not growing, and a share of NII in income was decreasing. From 2011 banks started to focus more on non-interest income activities, the income is more sensitive to the market and regulatory changes and has a limited growth possibility;
Banks focus on higher operating efficiency. Due to cost cutting, the number of employees and branches decreased. Banks reduced operating costs through the promotion of digital banking services. In this stage banks need to invest more in IT security;
Banks have low risk appetite, meet prudential requirements with large reserves, loan to deposit ratio is improving, NPL ratio decreased, and assets quality was tested by the ECB.
The research showed that subsidiaries business models are more oriented towards banks safety, but their sustainability perspective on acceptable return generating capacity is on concern.
Correlation analysis among subsidiaries in each bank group demonstrated that subsidiaries in the SEB and Swedbank groups for the most part behaved in a similar way. However, in the DNB group a weaker correlation was established.
Summarizing the analysed key components of bank business models, the main characteristics of the business model of Scandinavian banks subsidiaries in the Baltics were established: retail banks operating in one jurisdiction, dependency on parent bank decisions, aversion to risk, stronger focus on non-interest income and high efficiency, orientation towards safety, medium profitability with a negative trend for the future. Comparing the identified Baltic foreign-owned banks business model with R. Ayadi’s et al. (2014) identified focused retail business model, the biggest differences are observed in risk taking and financial performance.
Having analysed opportunities and vulnerabilities of key profitability drivers, it was determined that the biggest opportunity for banks in a low interest rate environment is to focus on increasing the volume of interest bearing assets. Financing SMEs, especially in productive sectors and innovative companies, could be the best outcome for banks and Lithuania’s economy. To achieve this goal, banks need to set SMEs financing as a strategic priority, and make fundamental changes in their lending policy. The EU and local governments should give financial support for SMEs to strengthen this sector, and that should encourage banks to finance SMEs more actively as well.
Further research should consider the limitations of this study. It is the first attempt to empirically examine Baltic bank business models for identification and sustainability. Deeper empirical analysis of each bank business model component would be very useful in the future. Moreover, recommendations require further
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deeper analysis of the role of banks and local governments in financing SMEs. Transparency and public disclosure practices remain an important concern. Disclosure practices of banks, which are of the utmost importance to comparing banks, were incomparable and incomplete. Many researchers have already raised this problem; however, the situation has not changed significantly.
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ANNEXES
ANNEX 1. Composition of subsidiaries groups Name of Group companies 2014-12-31 subsidiary group
SEB LT Group AB SEB bankas5 UAB “SEB investicijų valdymas“ Core activities: various investment management services, consultancy services. UAB „SEB Venture Capital“ Core activities: own asset investment into other companies equity and asset management on trust basis. SW LT Group Swedbank, AB Swedbank lizingas, UAB Core activities: Leasing (financial and operating lease) and factoring services. Swedbank Valda, UAB Core activities: Real estate rental and maintenance services. DNB LT Group AB DNB bankas UAB „DNB investicijų valdymas“ Lithuania Core activities: management of pension and investment funds. AB „DNB lizingas“ Core activities: provides vehicle, agriculture machinery, equipment and real estate leasing services to corporates and private individuals. UAB „DNB būstas“ Core activities: provides brokerage services in the country’s real estate market. UAB „Industrius“ Core activities: management of foreclosed real estate assets marked not for further development status. UAB „Intractus“, ji turi patronuojamąją įmonę UAB „Gėlužės projektai“ Core activities: management of foreclosed real estate assets. SEB LV Group JSC SEB banka SEB atklātais pensiju fonds Core activities: provide additional retirement pension capital investing the contributions made by and on behalf of the pension plan participants. SEB Wealth Management Core activities: investment management SEB līzings Core activities: leasing and factoring services SEB Dzīvības apdrošināšana Core activities: life insurance services. Latectus Core activities: acquire properties which have been used as collateral for SEB loans. SEB Trygg Liv Holding AB, Riga branch Core activities: SW LV Group “Swedbank” JSC SIA “Swedbank Līzings” Core activities: leasing services AS “Swedbank Atklātais Pensiju Fonds” Core activities: pension funds SIA“Swedbank Īpašumi” Latvia SIA “HL Līzings”
5 November 23, 2013, AB „SEB lizingas“ was merged to AB SEB bank
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DNB LV Group JSC DNB banka SIA DNB līzings Core activities: lease of motor cars, commercial vehicles and industrial equipment as well as factoring services. IPAS DNB Asset Management Core activities: manage of the 2nd pillar pension funds, taking care about stable growth of the pension capital of its clients, as well as provides investment fund management services. SEB EE Group AS SEB PANK AS SEB Varahandus Core activities: investment management and distribution of investment funds and investment management of institutional portfolios. AS SEB Liising Core activities: car and home leasing to private individuals and a wide range of leasing services and factoring to business customers. AS SEB Elu ja Pensionikindlustus Core activities: life and pension insurance
SW EE Group Swedbank AS AS Swedbank Liising Core activities: leasing services Estonia AS Swedbank P&C Insurance Core activities: property insurance services (comprehensive insurance, home, apartment building, traffic, travel insurance products) SE Swedbank Life Insurance Core activities: life insurance services OU Swedbank Support Core activities: computer software DNB EE Group AS DNB Pank OÜ DNB Kindlustusmaakler Core activities: insurance services Source: Banks Annual Reports 2014, formed by the author.
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ANNEX 2. Key business model indicators Business model elements Key business models indicators
Share of total assets (% total assets banking sector) Share of net loans (% net loans banking sector) Size Share of Customer deposits (% Customer deposits banking sector)
Share of loans net, due from banks, securities, cash and balances with the central bank, other assets (% total assets). Share of loans by counterpart (Households/Private legal entities/Public entities (% net loans). Corporate loans by sector exposures (Construction &Real estate, Trade, Manufacturing, Key activities Agriculture, Transport and storage, Public entities, Other (% Corporate loans (including (assets structure) public entities) Corporate loans by segment (Large corporate vs SME (% Corporate loans (including public entities) Loans for real estate (mortgage loans, Construction &Real estate) (% net loans)
Level of equity (% total assets); share of subordinated debt (% equity). Share of deposits from banks/Customer deposits (% total liabilities); Share of Customer Key resources deposits (% total assets) (capital and Share of customer current deposits/ term deposits (% total liabilities) structure of Debt securities issued (% total liabilities) funding) Share of insured/uninsured customer deposits (% customer deposits)
Share of interest income/non-interest income (% total operating income) Share and source of net interest income (% total operating income) (Source of interest income: on due from banks; on loans; on securities)(Interest expense: on due to banks, on customer deposits, on debt securities issued, payments to Deposit Insurance Guarantee Fund) Revenues streams Share and source of net commission and fees income (% total operating income) (Source: (structure of Net Payment transfer services, Net payment cards services, other income) income) Share and source of other income (% total operating income) (Source: net gain on sale property, rent of property; operations with securities and derivatives, etc.) Share of Reversal of Impairment (% total operating income) Net Interest Margin %
Share of Staff expenses (% Total Non-Interest Expenses (administrative expenses) Other administrative expenses ((% Total Non-Interest Expenses (administrative expenses)) Cost structure Share of Cost related with office facilities, IT (technology) cost, Consulting and professional fees (% Other administrative expenses) Loan impairment charges (% Total GOP (gross operating profit))
CAPITAL: Capital adequacy ratio, CET 1 ratio, Leverage ratio LIQUIDITY: Loan to deposit ratio, LCR, NSFR. PERFORMANCE: ROAE, ROAA; Cost to Income ratio; QUALITY AND RISKINESS OF ASSETS: Risk-weighted assets (% total assets), Non- Risk appetite and performing loans (NPL)/net loans; Net allowances for credit losses/net loans; NPL performance impairment Coverage ratio (specific allowances for loans (% total gross impaired loans). THE NATURE AND SPLIT OF RWAS: RWA/Assets, RWA Credit risk /RWA; GROWTH: Annual market share growth: annual growth rates of assets, total loans, customer deposits.
Source: formed by the author.
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ANNEX 3. Development of banking systems in the Baltics in 1989-2014 Year Lithuania Latvia Estonia
1989- 3 banks evolved from the 1991-1993 during 3 years 1989 Tartu Commercial Bank, formed by co-operatives 1991 Soviet Union (State Bank of Latvia (BoL) and state firms, became the first commercial bank. Agricultural Bank, State granted licences to 66 banks From State bank (Gosbank) 5 specialized banks (Bank of Industry and Construction, Agricultural Bank, Housing Commercial Bank, and (1991-14 banks, 1992- 36, and Social Bank, Saving Bank and Foreign Trade Bank State Saving Bank) were 1993-16). (later Vneshekonombank)) were transformed into state reorganized into state commercial banks. commercial banks. At the end 1990, 12 banks had licences. 1992 At the end 1992, 42 banks had licenses. Banking crisis. Many banks were forced to close: In November 1992 BoE intervened into 3 largest banks (it was announced a moratorium) – Tartu Commercial Bank was closed and liquidated, the other two banks were merged, recapitalized and new state bank Northern Estonian Bank was created; 10 smaller banks merged to Eesti Uhispank; 8 banks lose their licenses; 2 smaller banks went to bankruptcy with no bail-out of depositors. The number of banks decreased from 42 (end 1992) to 22. 1993 At the end of the year In 1993 9 branches of BoL Privatization/sale of a third of state Savings Bank to there were 27 licenced were sold to private banks, Hansapank; later EBRD acquired another 30 %. banks. 15 branches were consolidated into 8 independent banks, and remaining 21 branches were formed into the state-owned Latvijas Unibanka. At the end of the year 66 banks had licences. 1994 Lithuanian Development At the end of 1994, 55 First licences to foreign banks KOP and SYP of Finland Bank founded by banks had licences. and INKO Baltic Bank of Ukraine; Government and EBRD. First bank (Hansabank) listed on foreign stock markets (share issue to US and British investment funds); Eesti Pank acquired state Social Bank. 1995 Banking crisis Banking crisis BoL revoked State Social bank license withdrawn (remaining asset Moratorium was the licences of 15 banks, recovery agency), transfer of its deposits and part of its announced on two of the including largest bank, assets to North Estonia Bank (4th largest). Social bank larger private banks Banka Baltija. First foreign was Estonia’s largest bank at that time. (Lithuanian Innovation bank Societe Generale, Bank and Litimpeks opened a branch. Bank). 1996 Withdrawal of licences Unibanka (largest state- - from a number (smaller owned bank) privatized by private) banks. foreign investors (including Restoration of operations EBRD); of Litimpeks Bank. Hansabank (Estonia) Recapitalization of three acquired Deutsh-Lettishe state-owned banks Bank (third-largest in launched. Latvia) – became Hansabanka (Latvia). 1997 Privatization of state- Privatisation of Latvijas Eesti Uhispank (Union bank of Estonia) acquired the controlled banks (State Krajbanka (Savings Bank) North Estonian Bank and become the second largest bank Agricultural Bank, State launched in the country. Commercial Bank, State Eesti Houipank (Savings Saving Bank) launched. bank, Estonia) acquired State Commercial Bank controlling stake in Latvijas was merged with State Žemes Bank (Latvian Land Saving Bank. Bank)
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1998 Sweden SEB purchased As direct consequence of Mid-year – Estonian Rural Bank, known as Maapank, 42 % of Vilniaus bankas the Russian financial crisis, collapsed, Central bank withdrawn licences from (second largest bank) two smaller banks were medium-sized and small banks; closed, while the 5th largest July: Consolidation in banking sector: the merger of bank (Rigas Komercbanka) Hansapank and Eesti Hoiupank created the largest bank was declared insolvent, but in the Baltics; the merger of Eesti Uhispank and Tallinna in 1999 was reopened under Pank created the second largest bank in Estonia. the new name Pirma Leading banks of Sweden acquired controlling stakes in Latvijas Komercbanka. Estonian banks - Swedbank in Hansapank (September), SEB in Uhispank (December). Sweden SEB takes 32 % Central bank recapitalized Forekspank, merged with stake (subsequently raised other credit institution, and renamed into Optiva Bank.
to 44 %) in Unibanka (Latvia). 1999 Withdrawal of licence of Latvijas Investiiju Banka 1999 – Preatoni bank, owned by Estonian capital, was Litimpeks bankas purchased by Nordea established. Government sells its controlling stake in Latvijas Krajbanka. 2000 Vilniaus bankas and 90 % of Pirma Latvijas Central bank sells its 58 % in Optiva Pank to Sampo Bankas Hermis merge; Komercbanka sold to Finance (Finland). Government sold majority Norddeutsche Landesbank stake in Lithuanian Girozentrale; Development Bank to Sweden SEB acquired the Sampo Finance left shares in Unibanka. 2001 State Lithuanian Savings Bank (second-largest bank) sold (90 %) to Hansapank (Estonia) 2002 State Agricultural Bank (third-largest bank) sold (76 %) to Norddeutsche Landesbank Girozentrale 2008 New bank AB bankas Finasta was established. Nationalisation of Subsidiary of Parex bank systemically important operated in Lithuania. Parex banka. 2009 Crisis in the Baltic countries. Scandinavian banks subsidiaries in the Baltics suffered significant losses which were covered by parent banks. 2010 After Parex banka restructuring, new bank licence was granted to JSC Citadele, which took over a substantial part of Parex Banka’s good assets and liabilities. 2011 AB bankas Snoras went Subsidiary of AB bankas A small branch of AB bankas Snoras was closed. bankrupt. Snoras Latvijas Krajbanka went bankrupt. 2013 AB Ūkio bankas went bankrupt, good assets and liabilities were transferred to AB Šiaulių bankas; AS UniCredit Bank Lithuania branch was AS UniCredit Bank Latvia AS UniCredit Bank Estonia branch was closed. closed; branch was closed. Pohjola Bank Plc Lithuania branch started operating. 24 Finasta group was Latvian Government sold acquired by Lithuanian AS banka Citadele to company Invalda LT AB. private investors USA based Ripplewood Holdings. Sources: Bank of Lithuania, Bank of Latvia, Bank of Estonia, Estonian Financial Supervision Authority, Financial and Capital Market Commission (Latvia) Annual Reports; Kim T., 1998; Fleming A. et al., 1997; formed by the author. 73
ANNEX 4. Evolution of bank supervision authorities in the Baltics Lithuania Latvia Estonia
Authority National supervisors: National supervisors: National supervisors: responsible The Bank of Lithuania Financial and Capital Market Financial Supervision for banking (the central bank) – micro Commission (an autonomous Authority (an autonomous supervision and macro prudential public institution) – micro public institution) micro supervision. prudential supervision. prudential supervision. The Bank of Latvia (the Eesti Pank (the central central bank) - bank) - macroprudential macroprudential supervision. supervision.
European supervisor: European supervisor: ECB European supervisor: ECB SSM. SSM. ECB SSM.
Short From 1991 – The Bank of From 1991 The Bank of From 1991 Eesti Pank history of Lithuania (Credit Latvia (Credit Institutions (Banking Supervision the national Institutions Supervision Supervision Department) was Authority) was supervisor Department) was responsible for prudential responsible for prudential responsible for prudential supervision of banks. supervision of banks. supervision of banks.
In 2012 the new In 2001 the Financial and In 2002 Financial Supervision Service at the Capital Market Commission Supervision Authority Bank of Lithuania was started its activities as a joint was launched, joined the established after the supervisor after the merger of functions of Eesti Pank's merger of Securities Credit Institutions Banking Supervision Commission and Supervision Department of Authority and the Insurance Supervisory the Bank of Latvia, Latvia Ministry of Finance's Commission, as well as Insurance Supervision Insurance Supervision the Credit Institutions Inspectorate and Securities Authority and Securities Supervision Department Market Commission of Inspectorate. of the Bank of Lithuania. Latvia. Since January 2015 – Since November 2014 – ECB ECB SSM. 3 banks have SSM. been supervised directly 3 banks have been supervised Since November 2014 – by ECB: Swedbank, SEB directly by ECB: Swedbank, ECB SSM. and DNB. SEB banka and ABLV Bank. 2 banks have been supervised directly by ECB: Swedbank and SEB. Sources: Bank of Lithuania, 2014b; Financial and Capital Market Commision (Latvia), 2014b; Estonian Financial Supervisry Authority , 2014; formed by the author.
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ANNEX 5. Subsidiaries history Name of History (major events) subsidiary SEB LT 1990, Spaudos bankas, a commercial bank has been registered that was lately renamed Vilniaus Bankas AB. 1998, SEB (Sweden) acquired 42 % of Vilniaus bankas AB shares 2000, Vilniaus Bankas AB merged with AB Bank Hermis. 2000, SEB (Sweden) acquired remaining shares of Vilniaus Bankas 2005, Vilniaus Bankas AB changed its name to SEB Vilniaus Bankas. 2008, SEB Vilniaus bankas changed its name to AB SEB bankas. SW LT 1996, Hansabank (Estonia) established its presence in Lithuania, by establishing Hansa Leasing Lithuania. 1999, Hansabank (Estonia) opened branch in Lithuania.
2001, an agreement on purchasing 90.7 % of Lietuvos Taupomasis Bankas (LTB) was concluded between Hansabank (Estonia) and the Lithuanian State Property Fund (LTB was reorganised, merged with Hansabankas, new name Hansa-LTB introduced). Lithuania 2003, the name was changed to Hansabankas. 2009 Hansabankas in Lithuania changed its name to Swedbank. DNB LT 1924, The start of the bank‘s history - Žemės bankas was established. 1993, The bank reconstituted as Lietuvos žemės ūkio bankas. 2002, Germany‘s NORD/LB becomes the strategic investor of the bank. 2006, The bank becomes a member of DNB NORD financial services group jointly owned by Norway‘s DNB NOR Bank ASA and Germany‘s NORD/LB. DNB NOR Bank ASA becomes the sole shareholder of the bank. 2010, Germany‘s NORD/LB sold its 49 % minority stake to majority shareholder Norwegian Financial Group DNB NOR. All banks that are part of Norway’s largest financial services group worldwide start operating under the same DNB name sending a clear signal to the market – one brand, one strategy. SEB LV 1993, The AS Latvijas Universālā banka was founded. 1999 the material consolidation of SEBs Latvijas Unibanka stock holdings. 2005 Latvijas Unibanka had been rebranded to SEB Unibanka. 2008, the bank change the name to SEB banka.
SW LV 1995, Hansabank started operations in Latvia. 1996, Hansabank acquired 100% of Deutsche-Lettische Bank in Latvia.
Latvia 2009 Hansabankas changed its name to Swedbank. DNB LV 2003, Pirma Banka, Riga (Latvia) became NORD/LB Latvija. 2006, The bank becomes JV DNB NORD jointly owned by Norway‘s DNB NOR Bank ASA and Germany‘s NORD/LB. DNB NOR Bank ASA becomes the sole shareholder of the bank. 2010, Germany‘s NORD/LB sold its 49 % minority stake to majority shareholder Norwegian Financial Group DNB NOR. SEB EE 1997, Eesti Uhispank acquired the North Estonian Bank. 1998, Eesti Uhispank merged with Tallina Pank. 1998, SEB (Sweden) acquired Eesti Uhispank (Estonia). 2008, Eesti Uhispank changed its name to SEB Pank. SW EE 1991, Hansabank established in Estonia. 1998, Hansabank merged with Eesti Hoiupank and since then the new legal name of the bank has been AS Hansabank. 1998, Swedbank (Sweden) acquired Hansabank (Estonia).
Estonia 2001, Hansabank (Estonia).acquired State Lithuanian Savings Bank 2009, Hansabank changed its name to Swedbank. DNB EE 2006, DNB Pank started its operations in Estonia as a Latvian DNB Banka Estonian branch. 2008, Estonian DNB Pank branch became a Danish branch with the legal name - Bank DNB A/S Eesti filiale. 2012, AS DNB Bank, which belongs to the largest Norwegian financial group, began its activities in Estonia as a local credit institution (subsidiary). Source: formed by the author, based on the information provided in banks websites.
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ANNEX 6. Parent bank groups Parent bank Assets, ROE Long Overview on banking groups group mln. % Term Euro Ratings 31/12/2014 SEB Group 278 720 15.3 Standard & Stockholms Enskilda Bank (SEB) was founded in Poor's: 1856 by André Oscar Wallenberg as the first A+ private bank in Stockholm. Fitch: A+ In 1972, the bank merged with Scandinaviska Moody's: Banken and become Scandinaviska Enskilda Bank. A1 SEB is the leading Nordic bank for large corporations and financial institutions (a corporate bank). Traditionally, SEB’s market position has been particularly strong in Sweden. In recent years, the bank has grown significantly in the other Nordic countries and Germany. Customers are served in local markets through SEB’s presence in more than 20 countries around the world. In Sweden and the Baltic countries SEB is positioned as a universal bank providing universal banking services (the Baltics are treated as SEB home markets). In Denmark, Finland, Norway and Germany SEB is positioned as a corporate bank and provides banking services to large corporate and institutional clients.
Swedbank 223 852 15.2 Standard & Swedbank was founded in 1820 as the first savings Group Poor's: bank in Sweden. Over the years, there have been A+ many mergers and acquisitions that have resulted Fitch: A+ in the bank's current group (significant influence Moody's: from cooperative agricultural bank traditions, and a A1 significant role of Hansabank in the Baltic countries). Sweden, Estonia, Latvia and Lithuania are home markets of Swedbank. To support bank group customers Swedbank also performs operations (branches or representative offices) in Norway, Finland, Denmark, the US, China, Luxemburg and South Africa.
DNB Group 291 862 13.8 Standard & DNB was established in 1822, and it is the oldest Poor's: private bank in Norway. A+ DNB is the largest Norwegian financial services Fitch: No group, the largest investment bank, and one of the rating largest in the Nordic region in terms of market Moody's: capitalisation. A1 DNB is one of the world’s leading shipping banks, a major international player within energy finance, and it also has a strong position in the fisheries and seafood industry. DNB has subsidiaries in the Baltics, private banking in Luxemburg, a number of international branches and representative offices. Sources: Bloomberg; SEB group, Swedbank group, DnB group websites; formed by the author.
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ANNEX 7. Mission, Vision and Core values of the parent bank groups Bank Mission Vision Core values SEB To help people and To be the trusted Continuity - We learn, challenge group businesses thrive by partner for and take action based on our long providing quality advice customers with experience.
and financial resources. aspirations. Mutual respect - We are open and Meaning that we listen, always strive to earn the trust of share our knowledge and Meaning that we others as well as from each other. meet our customers’ believe most Professionalism - We make it easy needs and expectations. people have for people to do business with us by Through our customers’ ambitions for their sharing our knowledge and being success, we contribute to future. We work to accountable for our actions. making communities and earn their trust as a societies grow and partner every day, Commitment - We are dedicated flourish – and it makes in good times and to having everything we do create our work meaningful. bad, and help them stronger customer relations. fulfil their ambitions.
Swed- We promote a sound and We enable people, Simple bank sustainable financial businesses and We make banking easier Group situation for the many society to grow. We make the complex simple households and We bring clarity to complexity enterprises Open We are open up to new ideas and people We are honest & straightforward Caring We are service-minded, warm and helpful We strive to build strong, lasting relationships DNB N/D Creating value Helpful Group through the art of serving the Professional customer. DNB will create Show initiative value for customers, owners, employees and society. Sources: SEB group, 2015; Swedbank group, 2015; DnB group 2015; formed by the author.
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ANNEX 8. Key macroeconomic indicators impacting Baltics subsidiaries business, 31/12/2014 GDP Unemployment Inflation, Government debt growth, % growth rate, % % (% GDP) 2014 2015 2014 2015 2014 2015 2014 2015 Lithuania 2.9 2.8 10.7 9.9 0.2 -0.4 40.9 41.7 Latvia 2.4 2.3 10.8 10.4 0.7 0.7 40.0 37.3 Estonia 2.1 2.3 7.4 6.2 0.5 0.2 10.6 10.3 EU 1.4 1.8 10.2 9.6 0.6 0.1 88.6 88.0 World 3.4 3.5 ------Sources: European Commission, 2015a; formed by the author. European Commission Spring Forecasts for 2015 were presented.
ANNEX 9. Wage Change in the Baltics 2010-2014
Source: Statistics Lithuania, Latvia, Estonia, 2015; formed by the author.
ANNEX 10. EU Member States’ innovation performance
Source: European Commission, 2014b.
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ANNEX 11. Key EU regulatory measures Items already adopted or Adopted Aim of Regulation to be adopted Capital and Liquidity 2013 To put in place a comprehensive and risk-sensitive Requirements framework framework and to foster enhanced risk management (CRD IV/CRR) amongst financial institutions Bank Recovery and 2014 To establish a framework for the recovery and Resolution Directive resolution of banks, give complete set of tools for (BRRD) prevention of bank failure and possible resolution Deposit-Guarantee Schemes 2014 Update the existing Deposit Guarantee Schemes for Directive (DGSD) banks, in particular rules on funding across the EU To be To strengthen EU rules and ensure consistency with Anti-Money Laundering adopted the approach followed at the international level Directive (AMLD) 2015 (incorporate FATF recommendations) Mortgage Credit Directive 2014 To create a Union-wide mortgage credit market with a (MCD) high level of consumer protection Market in Financial 2014 To strengthen market transparency and bring more Instruments Regulation derivatives onto organised trading venues (MiFID/MiFIR) 2013 To update previous Directive and further develop Payment Services Directive electronic payment services, raising the bar on (Single Market Act) (PSD II) transparency, prudential and security requirements
while fostering innovation Regulation on Interchange 2015 To ensure transparency on fees for electronic Fees (MIFs) payments, to reduce fees for consumer cards 2014 To establish transparency requirements for fees Directive on comparability of charged by payment service providers in relation to payment account fees, services offered on payment accounts; to guarantee payment account switching that bank accounts should accessible to all citizens in and access to a basic the EU and that consumers have appropriate means payment account (PAD) to choose the product which best fits their needs. European Market 2012 To reduce the risks posed to the financial system by Infrastructure Regulation derivatives transactions (EMIR) To be To ban proprietary trading in the biggest banks and to Banking Structural Reform adopted give supervisors the power to require those banks to (Post-Liikanen legal 2015 separate other risky trading activities from their initiative) (BSR) deposit-taking business Items for consideration To be To raise capital adequacy ratio, revise risk weightings, adopted emphases in simpler or standardised models rather Basel IV 2017 than banks' internal models for calculation of capital requirements, raise requirements on disclosure To be To create deeper and more integrated capital markets Single Capital Union adopted in the 28 Member States of the EU; improve access 2019 to finance for businesses, particularly SMEs. Sources: European Commission, 2015d; formed by the author.
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ANNEX 12. Baltic subsidiaries under SSM supervision Banks SI / ECB Direct Vulnerabilities Less Supervision/ SI* National supervision SEB LT SI ECB direct The ECB direct supervision can be less effective due to the SEB LV SI supervision, following reasons: SEB EE SI JST for all these Parent banks are outside the SSM; absent of deep subsidiaries understanding of the whole cross-border bank group SW LT SI ECB direct business model, strategy, etc.; SW LV SI supervision, Supervision only of separate group entities does not fully SW EE SI JST for all these comply with the main idea of the ECB direct supervision; subsidiaries These subsidiaries are too small for the ECB direct DNB LT SI ECB direct supervision: not enough attention and insufficient supervision, resources can be allocated, ”one-size-fits-all“ approach JST only for this increases the reporting burden for subsidiaries. subsidiary The ECB direct supervision can accelerate parent banks for the branching process. DNB LV Less SI National supervision (Latvia) DNB EE Less SI National supervision (Estonia) *ECB identification: SI -Significant supervised entity or Less SI - Less significant supervised entity Source: European Central Bank, 2015d; formed by the author.
ANNEX 13. ROAA ratios, 2014
Sources: Banks Annual Reports 2014; European Banking Authority, 2014a; formed by the author.
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ANNEX 14. Ratios of key business model indicators
SIZE Name Share of total asset Share of net loans Share of customer deposits of the (% total assets banking (% net loans banking (% customer deposit banking bank sector) sector) sector) 2013 2014 2013 2014 2013 2014 SEB LT 30.5 28.0 31.7 31.8 27.8 27.4 SEB LV 14.8 11.7 18.6 17.5 10.9 9.4 SEB EE 22.6 24.4 25.1 26.3 20.0 21.4 SW LT 25.3 26.1 24.8 28.0 31.3 30.8 SW LV 17.5 16.5 21.2 23.2 19.0 17.3 SW EE 45.4 43.9 39.2 41.1 43.7 43.2 DNB LT 15.5 15.6 17.9 18.6 13.1 12.9 DNB LV 8.4 7.7 11.3 11.0 5.6 4.9 DNB EE 2.9 3.1 3.3 3.7 2.4 2.3
KEY ACTIVITIES (ASSET STRUCTURE) Name Share of loans net Due from banks Securities Other assets of the (% total asset) (% total asset) (% total asset) (% total asset) bank 2013 2014 2013 2014 2013 2014 2013 2014 SEB LT 70.3 69.5 15.6 3.6 5.2 6.3 3.1 3.5 SEB LV 66.2 71.4 13.7 3.2 2.0 2.7 2.1 2.8 SEB EE 85.8 76.5 7.7 1.0 2.8 2.6 1.0 0.9 SW LT 68.4 65.7 3.2 1.8 14.5 8.8 3.6 0.1 SW LV 65.5 67.0 1.0 2.9 4.6 8.8 2.4 2.3 SW EE 68.5 66.6 3.8 2.6 10.7 6.9 4.7 5.1 DNB LT 77.9 72.7 7.0 3.8 7.3 6.2 3.8 7.6 DNB LV 81.6 88.6 2.2 1.7 3.1 2.3 5.1 5.1 DNB EE 80.6 88.9 5.0 1.2 0 0 6.5 1.4
KEY ACTIVITIES (ASSET STRUCTURE) SHARE OF LOANS BY COUNTERPART Name Households Private legal entities (% net Public entities of the (% net loans) loans) (% net loans) bank
2013 2014 2013 2014 2013 2014 SEB LT 39.8 42.2 56.1 55.0 4.1 2.8 SEB LV 35.8 36.9 63.2 62.2 1.0 0.9 SEB EE 47.9 47.0 47.6 49.6 4.6 3.5 SW LT 47.7 46.0 41.2 41.5 11.2 12.5 SW LV 48.5 49.5 46.4 50.9 2.7 1.9 SW EE 51.3 51.4 42.7 42.2 6.0 6.4 DNB LT 43.4 49.0 46.2 41.0 10.5 11.4 DNB LV 67.4 66.2 29.1 30.8 3.5 3.0 DNB EE 17.3 18.7 81.6 80.3 1.1 1.0
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KEY ACTIVITIES (ASSET STRUCTURE) Name CORPORATE LOANS BY SEGMENT of the Large corporate SME bank (% non-financial corporations) (% non-financial corporations) 2013 2014 2013 2014
SEB LT NA NA NA NA SEB LV NA NA NA NA SEB EE NA NA NA NA SW LT NA NA NA NA SW LV NA NA NA NA SW EE NA NA NA NA DNB LT 59.7 60.5 40.2 39.4 DNB LV NA NA NA NA DNB EE NA NA NA NA
KEY RESOURCES (CAPITAL AND STRUCTURE OF FUNDING) Level of Share of Share of deposits Share of Share of Name of equity subordinated from parent customer customer the bank (% total assets) debt banks deposits deposits (% equity) (% total liabilities) (% total liabilities) (% total assets) 2013 2014 2013 2014 2013 2014 2013 2014 2013 2014 SEB LT 11.0 11.8 0 0 34.2 21.4 63.0 75.1 56.0 66.2 SEB LV 10.2 12.2 0 0 41.8 31.3 55.3 66.2 49.7 58.1 SEB EE 17.4 16.5 0 0 23.1 23.9 74.3 73.7 61.3 61.5 SW LT 16.9 17.0 0 0 3.3 1.3 91.9 95.7 76.4 79.4 SW LV 20.2 22.4 0 0 7.1 0.6 90.6 96.6 72.3 74.9 SW EE 21.2 21.8 0 0 6.8 3.7 84.6 88.2 66.7 69.0 DNB LT 12.1 11.5 0 0 39.7 36.3 59.2 62.9 51.8 55.7 DNB LV 9.7 10.8 0 0 41.1 44.5 50.0 51.3 45.1 45.8 DNB EE 17.3 15.8 0 0 27.5 35.8 70.3 62.2 58.2 52.4
KEY RESOURCES (CAPITAL AND STRUCTURE OF FUNDING) Name Share of customer current Share of customer term Share of insured customer of the deposits deposits deposits (% customer bank (% total customer deposits) (% total customer deposits) deposits) 2013 2014 2013 2014 2013 2014 SEB LT 72.6 77.3 27.4 22.7 NA NA SEB LV 76.6 78.6 23.4 21.4 NA NA SEB EE 78.9 86.2 21.1 13.8 NA NA SW LT 67.1 73.2 32.9 26.8 NA NA SW LV 70.5 77.6 29.5 22.4 NA NA SW EE 71.8 75.6 28.2 24.4 NA NA DNB LT 70.5 79.4 29.5 20.6 NA NA DNB LV 57.8 63.5 42.2 36.5 NA NA DNB EE 4.4 5.1 95.5 94.8 NA NA
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REVENUES STREAMS (STRUCTURE OF INCOME) Name Share of net interest Share of net commission Share of other Net interest margin of the income (% total and fee income (% total income* (% total % bank operating income) operating income) operating income) 2013 2014 2013 2014 2013 2014 2013 2014 SEB LT 49.3 51.4 33.7 32.2 17.0 16.5 1.3 1.4 SEB LV 56.0 67.2 24.8 28.8 19.2 4.0 2.0 1.8 SEB EE 63.6 64.0 32.2 32.1 4.2 4.0 1.9 1.8 SW LT 50.8 53.8 32.8 36.4 16.4 9.9 1.8 1.9 SW LV 56.2 54.8 28.6 30.1 15.1 15.5 2.9 2.4 SW EE 52.2 57.5 18.7 21.2 29.1 21.3 2.2 2.3 DNB LT 58.4 56.5 26.0 24.4 15.6 19.4 1.9 1.85 DNB LV 70.8 74.7 21.5 20.5 7.7 4.7 2.1 2.0 DNB EE 87.0 90.6 7.4 6.9 6.3 2.5 2.3 2.0 *including reversal of impairment
Name of COST STRUCTURE the bank Share of Other Impairment Share of cost IT (technology) Consulting and personnel administrative charges (% related with office cost (% other professional expenses expenses non- facilities (% other administrative fees (% other (%non-interest (%non-interest interest administrative expenses) administrative expenses) expenses) expenses) expenses) expenses) 2014 2014 2014 2014 2014 2014
SEB LT 45.6 47.7 6.7 NA NA NA SEB LV 34.9 38.2 26.9 NA NA NA SEB EE 66.4 33.6 0 NA NA NA SW LT 48.5 51.5 0 NA NA NA SW LV 51.9 48.1 0 NA NA NA SW EE 56.7 43.3 0 NA NA NA DNB LT 36.0 64.0 0 NA NA NA DNB LV 53.6 46.4 0 NA NA NA DNB EE 57.5 42.5 0 NA NA NA
Name RISK APPETITE AND PERFORMANCE of the CAPITAL bank Capital adequacy ratio Core tier 1 ratio Leverage ratio 2013 2014 2013* 2014 2013* 2014
SEB LT 15.6 20.4 15.4 19.9 8.2 NA SEB LV 15.1 18.6 15.3 18.6 8.9 NA SEB EE 23.6 25.5 23.3 25.5 14.0 13.3 SW LT 22.5 29.9 22.5 29.9 15.0 NA SW LV 28.1 34.3 32.6 34.3 18.0 NA SW EE 42.3 51.7 32.6 53.2 18.7 NA DNB LT 16.7 16.7 17.1 16.6 10.3 NA DNB LV 12.3 13.8 12.3 13.8 13.0 NA DNB EE 18.7 20.8 20.0 20.8 16.0 NA *ECB Comprehensive assessment data 83
Name RISK APPETITE AND PERFORMANCE of the LIQUIDITY bank Loan to deposit ratio LCR NSFR 2013 2014 2013 2014 2013 2014
SEB LT 125.5 104.9 NA NA NA NA SEB LV 133.2 122.6 NA NA NA NA SEB EE 140.0 124.3 NA NA NA NA SW LT 90.1 88.7 NA NA NA NA SW LV 76.3 88.7 NA NA NA NA SW EE 102.7 96.5 NA NA NA NA DNB LT 150.1 130.3 NA NA NA NA DNB LV 156.9 148.3 NA NA NA NA DNB EE 152.9 154.0 NA NA NA NA
RISK APPETITE AND PERFORMANCE Name PERFORMANCE of the ROAE ROAA Cost-to-income bank 2013 2014 2013 2014 2013 2014 SEB LT 8.5 9.3 0.9 1.1 51.1 44.2 SEB LV 6.0 5.3 0.6 0.6 45.7 54.9 SEB EE 11.0 9.8 1.8 1.7 45.3 41.6 SW LT 13.1 10.7 2.1 1.8 46.6 44.3 SW LV 11.7 10.8 2.3 2.3 39.8 38.8 SW EE 20.7 9.6 3.8 2.1 41.2 37.9 DNB LT 3.1 3.8 0.4 0.5 NA 77.9 DNB LV 3.3 4.5 0.3 0.4 65.3 65. 0 DNB EE 4.2 3.3 0.8 0.5 NA NA
RISK APPETITE AND PERFORMANCE QUALITY AND RISKINESS OF ASSETS Name Non-performing Loan loss NPL impairment of the loans (NPL) / net provisions /net coverage ratio (specific bank loans loans allowances for loans (% total gross impaired loans) 2013 2014 2013 2014 2013 2014 SEB LT 6.8 NA NA NA 47.7 NA SEB LV 5.4 NA NA NA 39.2 NA SEB EE 2.2 NA NA NA 47.7 NA SW LT 3.5 NA NA NA 41.5 NA SW LV 4.3 NA NA NA 64.8 NA SW EE 1.7 NA NA NA 23.8 NA DNB LT 15.3 NA NA NA 33.3 NA DNB LV NA NA NA NA NA NA DNB EE 7.2 NA NA NA 36.1 NA
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RISK APPETITE AND PERFORMANCE THE NATURE AND SPLIT OF RWAS Name of the RWA Credit risk/ RWA/Assets bank RWA
2013 2014 2013 2014 SEB LT 64.6 50.5 NA 90.3 SEB LV 60.1 57.2 NA 91.5 SEB EE 48.2 38.7 94.7 92.2 SW LT 62.1 48.4 NA 91.5 SW LV 60.5 56.8 89.3 88.6 SW EE 46.9 37.8 92.0 87.6 DNB LT 67.0 103.2 NA 86.8 DNB LV 72.6 68.7 91.7 91.1 DNB EE 87.4 70.8 96.9 96.1
RISK APPETITE AND PERFORMANCE GROWTH
Annual growth rate Annual growth rate Annual growth rate in assets in net loans in customer deposits
2013 2014 2013 2014 2013 2014 SEB LT 2.0 -1.2 -3.3 -2.5 3.2 16.7 SEB LV 12.1 -15.8 10.2 -9.2 17.6 -1.4 SEB EE 6.2 16.7 6.4 3.9 3.4 17.1 SW LT 3.4 11.1 4.6 6.7 0.7 16.0 SW LV 4.8 0.4 -4.3 -5.9 19.0 3.5 SW EE -0.3 4.3 1.6 1.5 6.6 7.9 DNB LT 3.9 8.0 8.0 0.8 6.1 16.2 DNB LV 7.9 -2.6 14.3 5.8 16.6 -1.2 DNB EE 16.9 14 13.0 3.4 45.6 2.6
Sources: Banks Annual reports 2014, 2013; SNL database; European Central Bank, 2014; Bank of Lithuania, 2013,2014b; Association of Lithuanian banks, 2013,2014; Association of Commercial banks of Latvia, 2013,2014; Estonian Financial Supervision Authority, 2013,2014; Financial and Capital Market Commission 2013, 2014a.
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ANNEX 15. Subsidiaries assets, liabilities, income and costs in 2006-2014 Assets
SEB LT SEB LV
SEB EE SW LT
SW LV SW EE
86
DNB LT DNB LV DNB EE
Liabilities
SEB LT SEB LV
SEB EE SW LT
87
SW LV SW EE
DNB LT DNB LV DNB EE
88
Income and Costs
SEB LT SEB LV
SEB EE SW LT
SW LV SW EE
89
DNB LT DNB LV DNB EE
Sources: Banks Annual reports; SNL database; Bankscope; Bank of Lithuania, 2012-2014b; Association of Lithuanian banks, 2006-2014; Association of Commercial banks of Latvia, 2006- 2014; Estonian Financial Supervision Authority2006-2014; Financial and Capital Market Commission 2013, 2014a.
ANNEX 16. Funds within and from parent banks, 2006-2014
SEB LT SW LT DNB LT
SEB LV SW LV DNB LV
90
SEB EE SW EE DNB EE
Source: Bankscope, Banks Annual Reports, 2006-2014; formed by the author. ANNEX 17. Due from banks of Lithuanian subsidiaries, 2013-2014 Due from Banks, Mln. EUR 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 SEB LT 887 909 1069 1069 1059 1054 1136 241 SW LT 871 706 651 181 748 325 253 110 DNB LT 291 389 299 245 268 403 338 142 SEB LV NA NA NA 584 825 673 NA 115 SW LV NA NA NA 51 238 691 445 146 DNB LV NA NA NA 312 NA NA NA 527 SEB EE 330 328 342 343 667 660 599 53 SW EE 938 901 882 339 921 1374 1612 243 DNB EE NA NA NA 6 NA NA NA 32
Source: Bank of Lithuania, 2013-14a; SNL database; formed by the author. ANNEX 18. Share of loans by counterpart, 2013-2014
KEY ACTIVITIES (ASSETS STRUCTURE) SHARE OF LOANS BY COUNTERPART Name of the Households (% net Corporates* (% net bank loans) loans)
2013 2014 2013 2014 SEB LT 39.8 42.2 60.2 57.8 SEB LV 35.8 36.9 64.2 63.1 SEB EE 47.9 47.0 52.1 53.0 SW LT 47.7 46.0 52.3 54.0 SW LV 48.5 49.5 49.1 52.8 SW EE 51.3 51.4 48.7 48.6 DNB LT 43.4 49.0 56.6 52.4 DNB LV 67.4 66.2 32.6 33.8 DNB EE 17.3 18.7 82.7 81.3 *including public entities Source: Banks Annual Reports, 2014; formed by the author.
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ANNEX 19. Loans to corporates by economic sectors, 31/12/2014
*SEB LT did not disclose data by economic sectors Source: Banks Annual Reports, 2014; formed by the author.
ANNEX 20. Lending for real estate activities in the Baltic banks, 31/12/2014
Source: Banks Annual Reports 2014, formed by the author.
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ANNEX 21. Lending for real estate related activities
Sources: Jorda O., Schularick M., Taylor A. (2014) ANNEX 22. Rejected applications for banks loans in the EU
Source: European Commission, 2013.
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ANNEX 23. Interest expenses on Due to banks and on Customer deposits (mln. EUR)
Banks Due to Liabilities Interest Average Payments to banks/ 31/12/2014 expenses interest rate Deposit Due to 2014 (%) Insurance Customers 2014 Guarantee Fund 2014 SEB LT Due to banks 1272 22.0 1.3
Due to 4468 2.4 0.06 16,8 Customers SW LT Due to banks 65.6 3.1 4.7
Due to 5013 13.5* 0.3 NA Customers DNB LT Due to banks 1211 7.5 0.6
Due to 2101 2.3 0.1 8.7 Customers SEB LV Due to banks 986 5.8 0.5
Due to 2 093 2.1 0.1 5.2 Customers SW LV Due to banks 22 8.6 4,3
Due to 3799 11.3 0,3 6.0 Customers DNB LV Due to banks 937 6.3 0.7
Due to 1082 2.1 0.2 2.9 Customers SEB EE Due to banks 1033 7.1 0.7
Due to 3189 6.8* 0.2 NA Customers SW EE Due to banks 273 7.7 2.0
Due to 6429 16.1* 0.2 NA Customers DNB EE Due to banks 195 1.7 0.9
Due to 339 1.9 0.6 0.3 Customers *as payments to Deposit Insurance Guarantee Fund are not disclosed, this payments can be included in Interest expenses Source: Banks Annual Reports, 2014; formed by the author.
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ANNEX 24. Income structure of Scandinavian banks subsidiaries in the Baltics, 2006-2014 SEB LT SW LT DNB LT
SEB LV SW LV DNB LV
SEB EE SW EE DNB EE
Source: Banks Annual Reports, 2014; formed by the author.
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ANNEX 25. Interest income and interest expenses, 2006-2014
SEB LT SW LT DNB LT
SEB LV SW LV DNB LV
SEB EE SW EE DNB EE
Source: Bankscope, Banks Annual Reports, 2014; formed by the author.
ANNEX 26. Net Fees and Commissions, 2012-2014
Source: Banks Annual Reports, 2013, 2014; formed by the author.
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ANNEX 27. Income decrease in Latvian banks after the adoption of the euro, 2014/2013 Banks Operating income Payment transfer fee Profit from FX exchange SW LV 10 % 15 % 67 % 21 mln. Eur 3 mln. Eur 18 mln. Eur
SEB LV 17 % 26 % 82 % 20 mln. Eur 2 mln. Eur 14 mln.EUR
DNB LV 14 % 15 % 62 % 10 mln. Eur 1.3 mln. EUR 3.8 mln.EUR
Source: Banks Annual Reports, 2014; formed by the author ANNEX 28. Number of Payment cards issued by banks Bank Payment cards, 31/12/2014 SEB LT 916,164 SEB LV 557,106 SEB EE 543,000 SW LT 1,746,574 SW LV 978,274 SW EE 1,099,827 DNB LT 519,918 DNB LV 191,144 DNB EE NA Sources: Association of Lithuanian Banks, 2015; Banks Annual Reports, 2014; formed by the author. ANNEX 29. Domestic MIFs by country
Source: European Commission, 2015d. 97
ANNEX 30. Changes of employees and personnel expenses, 2008/2014 Banks Number of employees Personnel expenses (mln.Euro)
2014 12 31 Change 31/12/2008 In Change % Number 2014 2008 (%) SEB LT 2395 -0.7 -16 38,6 -9,8
SW LT 2207 -31.5 -1015 44.6 -26.3 DNB LT 1158 -11.7 -154 29,8 + 9,4 SEB LV 1120 -29.2 -463 24.9 +0.8 SW LV 1484 -43.9 -1161 38.0 -38.9 DNB LV 722 -17.8 -156 18,7 +8.8 SEB EE 1218 -22 -344 34,8 +12.3 SW EE 2268 -23 -682 67,9 +23.5 DNB EE 111 - - 5,3 - Sources: Association of Lithuanian Banks, Banks Annual Reports 2008, 2014, formed by the author. ANNEX 31. Changes of branches, 2008/2014 Banks Number of branches (including Customer service units) 2014 12 31 2008 12 31 Change (%)
SEB LT 46 77 -40.3 SW LT 68 120 -56.7 DNB LT 60 84 -28.6 SEB LV 44 63 -30.2 SW LV 49 NA - DNB LV 27 NA - SEB EE 27 61 -55.7 SW EE 47 NA - DNB EE 1 - - Sources: Association of Lithuanian Banks 2008, 2014; Association of Latvian Banks 2008, 2014; Banks Annual Reports 2008, 2014; formed by the author.
ANNEX 32. Dividend paid by banks Bank group Decision to pay dividends for the year (mln. EUR) 2013 2014
SEB LT 30.0 65.3 SW LT - 64.8 DnB LT - - SEB LV - - SW LV - - DnB LV - - SEB EE - 10.0 SW EE - - DnB EE - - Source: Banks Annual Reports 2014; formed by the author.
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ANNEX 33. Leverage ratios, 31/12/2013
Source: European Central Bank, 2014; formed by the author. ANNEX 34. Loan to deposits ratio, 31/12/2014
Source: Banks Annual Reports, 2014; formed by the author. ANNEX 35. Comprehensive assessment results B Main results of the comprehensive SEB SEB SEB SW SW SW DNB DNB assessment (CA) LT LV EE LT LV EE LT EE B1 CET1 Ratio at year end 2013 15.36 15.31 23.32 22.54 32.61 32.55 17.06 20.02 including retained earnings / losses % of 2013 Basis B2 Aggregated adjustments due to the -49 -202 -61 -15 -19 -70 -72 -580 Points outcome of the AQR Change AQR adjusted CET1 Ratio B3 % 14.87 13.29 22.71 22.39 32.42 31.85 16.34 14.22 B3 = B1 + B2 B4 Aggregate adjustments due to the 2 -13 90 81 -28 105 -10 -4 outcome of the baseline scenario of Basis the joint EBA ECB Stress Test Points to lowest capital level over the 3-year Change period B5 Adjusted CET1 Ratio after Baseline 14.89 13.16 23.62 23.20 32.13 32.90 16.24 14.18 Scenario % B5 = B3 + B4 B6 Aggregate adjustments due to the -154 -139 62 46 -62 110 -369 -239 outcome of the adverse scenario of Basis the joint EBA ECB Stress Test to Points lowest capital level over the 3-year Change period B7 Adjusted CET1 Ratio after Adverse 13.33 11.9 23.34 22.85 31.80 32.95 12.75 11.83 Scenario % B7 = B3 + B6 Source: European Central Bank (2014)
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ANNEX 36. Risk weighted assets 2011-2014 SEB LT SW LT DNB LT
SEB LV SW LV DNB LV
SEB EE SW EE DNB EE
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ANNEX 37. Main features of the identified business models and different approaches
Business models elements Main features of business Different approaches in some Quantitative analysis model banks, banking groups, countries Large significant banks in each country Less significant institutions are DNB LV, Size Playing a leading role and benefiting DNB EE from being the largest in the country Medium profitable ROAE higher than EU average, but In DNB subsidiaries ROAE lower than EU markedly worse than parent bank average Performance groups and pre-crisis level ROAE decreased in 2014, and there are ROAE in SEB LT slightly increased in 2014, indications to continue decrease in a but was lower than SW subsidiaries and SEB three years period EE. Loan portfolio share in assets shrank The highest share is in DNB EE (81 % of (average 66 %) assets) Modest growth of loan portfolio Slight decrease in SEB LT, SEB LV, SW LV Focus on households (mortgage) The lowest share in DNB EE – 18.7 %, SEB Loans (average 47 % of loan portfolio) LV – 36.9 % Focus on real estate& construction companies, public entities (35-52 % of Key activities corporate portfolio) and large low risk (assets structure) corporates financing. Averse to risk Hold for liquidity purpose (2-8 % of The lowest investments in Estonian assets) Government bonds Securities Invested in the country’ Government Swedbank group policy – to invest in highly bonds liquid graded securities (not in the country’s Government bonds) Due from Large amounts are held within parent banks banks (average 10-15 % of assets) Main source of financing Swedbank subsidiaries have the highest share Customer Share in liabilities increased (51-97 %) in liabilities (88-97 %) deposits Transformation from term to current retail deposits Key resources Banks are reducing funding from parent Swedbank subsidiaries reduced funding from (capital and banks (average 3-49 % of liabilities) the parent bank up to negligible amount structure of Due to banks Funding from parent banks is more Funding from the parent bank is still funding) expensive than local customer deposits essential for DNB subsidiaries Banks are well-capitalised SEB LT and EE, SW LT distributed part of Capital Each year banks strengthened their their profit as dividends capital by profit Main source of income SW LT has only 50 % of operating income, Share in income is decreasing (50-67 % non- interest income share increasing of operating income) DNB EE has 88% of operating income Net Interest Stable in absolute value Income In low interest environment there are Revenues streams indications to decrease in three years (structure of period income)
Net Fees and Increased share of non- interest income The highest share of non-interest income in Commission, (12-50 % of operating income) SW LT (50 % of operating income) Other income Has limited possibility to grow and has The lowest share of non- interest income in indications to decrease in a three years DNB EE (12 % of operating income)
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Business models elements Main features of business Different approaches in some Quantitative analysis model banks, banking groups, countries period
Personnel Personnel and other administrative Expenses expenses were reduced Number of employees decreased Other Number of branches decreased Administrative Digitalisation increased (e-banking) Expenses Limited possibility to cost cutting, higher investments in digital security, Cost structure IT, against cyber criminality needed Banks benefit from impairment In 2014, reversal impairment was higher than reversals impairment charges in all banks, except SEB LV and SEB LT Impairment In 2014, SEB LV had high impairment charges for loans due to Liepajas Metalurgs problems Low risk appetite Meet prudential requirements (capital, liquidity, leverage) with large reserves Loan to deposits ratio improving DNB subsidiaries have the highest ratio Risk appetite and performance (DNB EE (154 %) and DNB LV (148 %) Non- performing loan ratio decreased, DNB LV did not participate in assets quality was tested by ECB Comprehensive assessment performed by the ECB Source: formed by the author.
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