"Credit Rally" in Latvia and Lithuania Increases Risks for Estonian Banks Operating There - Bank of Estonia 0 11

The banking credit market in Lithuania and Latvia was very active last year due to lower interest rates and an improved economic situation, becoming one of the fastest-growing in the eurozone. According to forecasts, rapid credit growth is expected to continue there in the coming years. "Considering that about a quarter of the credit portfolio of Estonian banking groups is related to the markets of Latvia and Lithuania, such rapid credit growth in other Baltic countries increases risks for the banking sector of Estonia as well," said Tamm.

She noted that the activities of banking groups often have a cross-border nature, so the performance of a group's division in one country can affect the entire group and its operations in other countries. "For example, if a banking group incurs significant losses in one country, it may be forced to limit lending in other places as well. In the case of very serious problems, the functioning of the entire group may be at risk. The task of the Bank of Estonia is to continuously assess the cross-border risks of Estonian banks and their potential impact on the functioning of the local financial sector," Tamm explained.

For the banking sector of Estonia, operations in external markets became significantly more important in 2019 when Luminor Bank, created by merging two foreign banking subsidiaries, brought together business branches in Latvia and Lithuania under its umbrella. Later, other banks, mainly smaller ones, gradually expanded their operations in external markets. According to the latest data, about 69% of the credit portfolio of Estonian banking groups is issued to residents of Estonia, 18% to Lithuania, 9% to Latvia, and just over 4% to other foreign countries. "Therefore, from the perspective of the functioning of the financial sector of Estonia, what happens in the economy and banking market of Lithuania and Latvia, and how businesses are doing there, is of primary importance," Tamm said.

"Over the past year and a half, we have seen an improvement in the economic situation in Estonia and a decrease in interest rates, which has led to a revival of credit activity and an acceleration of credit portfolio growth. A similar development has occurred in Lithuania and Latvia. However, since the economies of these countries experienced a more moderate decline than Estonia last time and recovered faster, the acceleration of credit growth there has been even more rapid," Tamm continued.

If in Estonia the total credit portfolio of enterprises and households grew by 7% in 2025, in Latvia the growth reached 16%, and in Lithuania a full 18%, placing them among the fastest-growing countries in the eurozone. Although the portfolios of Estonian banking groups in these countries generally grew somewhat slower than the market, this still means that the overall risks of the credit portfolio of banking groups have increased faster than one might conclude by assessing the growth of loans issued only in Estonia.

"It is remarkable in itself when banks established in Estonia manage to conduct business in foreign markets. At the same time, it should be noted that too rapid credit growth can be detrimental both to the long-term stability of the banking sector and to the overall well-being of society. From the experience of past financial crises, we know that very rapid credit growth increases the risk that loans will be issued too recklessly and on soft terms. Thus, part of the borrowed funds may end up with enterprises, projects, or individuals who will not be able to repay the loans to the bank under more challenging economic conditions," Tamm said.

According to Tamm, the risk that individuals and enterprises may at some point be unable to repay their loans is mitigated by the fact that the debt burden of non-financial enterprises and households in Latvia and Lithuania is relatively low compared to Estonia and other eurozone countries. The debt burden is usually measured as the ratio of total loans to GDP. "It is noteworthy that, for example, in Latvia, the debt burden rose before the global financial crisis to almost the same level as in Estonia. But since the crisis shook the economy and financial sector of Latvia much more severely, it led to a years-long decline in the debt burden, which has only recently slowed down. Therefore, in the case of Latvia, for many years, the concern was rather that lending was too modest to support economic growth," Tamm said.

In both Latvia and Lithuania, measures of macroprudential supervision have been introduced to reduce risks associated with credit growth, which are broadly similar to those applied in Estonia. Maximum limits have been set on both the loan-to-collateral ratio and payments, as well as a maximum loan term. As in Estonia, banks in Latvia and Lithuania are required to maintain a countercyclical capital buffer, with a basic rate of one percent. In Lithuania, since July 1, 2022, an additional requirement for a two percent systemic risk buffer has been in effect for the housing loan portfolio. This means that in Lithuania, banks issuing housing loans must hold an additional capital buffer to cover the risks associated with these loans. The Bank of Estonia has decided to recognize the Lithuanian measure and has established a similar capital buffer requirement that all banks licensed in Estonia and issuing housing loans to individuals in Lithuania must comply with, either through a branch or directly as part of cross-border services.

When asked what will happen next, Tamm replied that, according to forecasts, the economy and investment activity in Latvia and Lithuania will continue to grow in the near future, which means that active lending is also expected to continue. "Among other things, local political decisions also affect the lending market. For example, in Lithuania, starting from early 2026, the second pension tier became voluntary, and it is estimated that about one-fifth of contributors decided to exit the system. Based on Estonia's experience in 2021, this could lead to a significant influx of pension savings into the housing market of Lithuania. This could further stimulate credit growth and accelerate housing price increases. If credit growth accelerates or remains very rapid for an extended period, the risk will also increase that, in the event of negative changes in the economy, some borrowers will be unable to repay their loans," Tamm noted.