Latvian Banking Crisis
Latvian Banking Crisis ~ Intro
As a result of the low entry barriers and privatization of state banking, more than 60 new, private banks entered the market between 1991 and 1993.
The government’s free market approach is reflected by the lack of government provided deposit insurance.
Little was known about the banks, the bank regulators, or even the currency (Lat) which was the basis for their business. Latvian Outcomes ~ Banking Crisis
By 1993, after two years of rapid entry into the Latvian banking market, there were 63 independent, private banks.
Bank failures in 1995 resulted in the loss of 30-40% of deposits.
Today there are about 10 independent banks operating in this market. Deposit Interest Rates in 1993
Interest rates for 1 year deposits in Rank in Interest Interest Bank Name either Lats or Size Rate Rate US$ at 6 of the Deposit in Deposit (1/94) largest Latvian Lats in $ banks are noted to the right. Baltija 1 90% 18% Komercbank 4 50% 12% Parex 5 12% 12% There were no Deutch-Lettish 9 35% 35% restrictions on Sakaru 17 40% 32% currency Latin Trade 19 72% 48% conversions.
Bank Baltija had 25% share of total deposits. Was This a Market Equilibrium?
Why was there so much variation in 1 year deposit (in Lat) interest rates? (90% at Baltija versus 12% at Parex)
Why was the interest rate for deposits in Lats higher than for deposits in US$?
Why was the difference {Interest Rate (Lats) - Interest Rate ($)} so variable? (72% at Baltija versus 0% at Parex)
Why were interest rates so high? (48% on US$)
Which banks would survive? Reform Strategies ~ Macro Stability
Latvia moved quickly to introduce their own currency (Lat) and to use tight monetary policy.
The currency was new, the central bank was new, and the central banker was 30 years old.
Credibility was low. Sitting there in 1993, what would you have predicted about the future value of the Lat? Equilibrization Starting Positions ~ Latvia
Trade Patterns ~ disruption of existing trade patters with Russia. Oil, electricity, labor, telecommunications face new border restrictions.
Aged population ~ retirees without pensions
Macro Instability ~ 1991 inflation > 1000%
Loss of Soviet subsidies to state industry, and loss of cheap oil.
Lack of information/reputations for government officials, creditors, legal system
Nationalism and cultural tensions Reform Strategies ~ Market Prices
Latvia moved quickly away from the prices set under Soviet planning to market prices.
In the case of sugar, dairy products and timber, this sent new information to Latvian producers and resulted in fairly rapid change in production decisions.
In the case of oil, transportation, electricity this resulted in economic shortages and the demise of some public services. Reform Strategies ~ Privatization
Upon “liberation” all land and housing “seized” by the Russian occupiers was returned to the “pre 1939” owners.
Ownership by foreigners was debated and remained a contentious issue.
Vouchers were allocated to Latvian citizens (not including workers sent to Latvia by Stalin), and these vouchers could be used to buy state assets. Mutual funds pooled vouchers for the purchase of large factories.
Still many state assets could not be sold. Reform Strategies ~ Intn’l Trade and Finance
The Lat was unofficially pegged to the SDR.
No restrictions were placed on currency trading
Capital flows were relatively free, FDI was encouraged.
Trade barriers were low (some protection existed in agriculture) Reform Strategies ~ Banking and Finance
Rapid dissolution of state banking.
Low entry requirements for new private banks
Market determined interest rates
No Deposit Insurance
Inexperienced, understaffed, and possibly corrupt bank examiners Outcomes ~ Latvian Real GDP
After an initial drop, Latvian GDP has grown slowly, but steadily.
The initial dip occurred for all countries associated with the USSR (Cuba, N. Korea)
Unemployment rates rose,a good sign? Latvian Outcomes ~ Trade Deficit
After an initial drop, imports and exports rose, but Latvia has a continuing trade deficit. This trade deficit partly reflects the high price of the “Lat” and capital inflows. Starting in 1991 the Latvian government implemented market reforms in the banking industry. While three state-owned banks continued to operate, the market soon became dominated by private banks. By 1993, more than 60 independent banks were operating in the Latvian market, but by 1995 the number of banks had begun to fall due to bank failures. These figures do not reflect the fact that in 1996, in the wake of the banking crisis, the Bank of Latvia only allowed 11 banks to take deposits from individual Latvians
In particular the analysis must consider the influential role played by Bank Baltija which was the largest bank, and it gained market share between 1993 and 1995. In early 1995 Bank Baltija held about 23% of all deposits and 40% of Latvian depositors held their deposits in Baltija
In May of 1995 Baltija was declared insolvent, and the Latvian government chose not to provide any funds to repay depositors.