Looking forward: Latvia after dramatic financial industry shake
After wiping out almost one-fifth of the GDP during the crisis, the Latvian economy has managed to grow eight years in a row and heal the wound of the crisis. 2018 has been another successful year for Latvian economy managing to grow by 4.5%. During these years we have seen tremendous structural changes in the economy and managing imbalances. During the last years, the loan-deposit ratio and debt to GDP have shifted from one of the worst in Europe to one of the best. A lot of efforts have been put in developing export. One must admit that EU funds are crucial for the economic development of Latvia. Global uncertainty and severity have been triggering deleveraging process, but finally, lending is gradually accelerating.
As growth has been balanced in all three Baltic countries, we are well prepared for the next stage of the economic cycle. The development of Baltic financial sector has demonstrated positive developments and growth mainly based on good growth of the real economy. According to SEB Latvia chief economist, Dainis Gašpuitis this year GDP growth will slow down to 3.5% for Latvia, while Lithuania and Estonia SEB economists forecast growth of 3%. Private consumption is still a significant growth driver. EU funding will play as stabilizing factor, especially in construction through this sector is heating up. Weakening external demand will show up in slower export expansion. Inflation will remain rather low in Baltics. SEB economists forecast 2.9% inflation in Latvia and 2.5% in Lithuania and Estonia. Another challenge to face across the Baltics is the heating up the labor market, surging wage pressure as well as low productivity growth. With relatively low investment appetite it is crucial for further competitiveness. Another challenge is to invest in producing and exporting high-value goods.
Baltics and specifically Latvia were severely hit during the recent crisis. When the world had a financial crises Latvia faced internal real economic crises as well due to overly optimistic forecasts regarding future growth and fairly loose lending culture. Deleveraging, as well as a deep drop in real estate prices, was the negative outcome of the crisis. Lending index conducted by Finance Latvia Association reveals the banking sector ability to lend at the highest level in 10 years. Ability to borrow has peaked as well. And yet rigorous experience has profoundly changed the society’s attitude to debt that leads to a more pragmatic approach and more balances willingness to borrow by that maintaining lower leverage and utilization of loan facilities.
KYC and AML
The recent crisis has affected those banks and financial institutions working with high-risk nonresidents. Despite the forced closure of the third largest bank last year, Latvia has successfully managed risks and avoided turbulence. It has a very limited impact on GDP growth as well. A share of non-resident deposits (September 30) dropped to 20.5%, and was 3.2 bEUR, down from 8.1 bEUR beginning of 2018. Non-EU deposit share remained only 10%. Despite the high-risk nonresident deposit amount have been decreased, we see need to put more efforts in improving enforcement of the law, more focus on an investigation of economic and financial crime, as well as money laundering.
The overall change in the banking sector is ongoing from 2016. During the last 3 years, we see the turning point when the attention is focused on tackling the cause and environment of Latvia to be used for money laundering purposes. Banks previously working with high-risk country nonresidents now are revising their business models, looking for new niche opportunities in financial services.
At the end of August of the last year, European Council Moneyval committee responsible for regional supervision of money laundering prevention published the report on Latvia covering the evaluation of actions Latvia has performed to combat the money laundering and terrorism financing risks. Moneyval committee issued the evaluation in 11 areas. In two areas the evaluation was critical and not in line with the best practice. From overall 40 recommendations 13 of them were directly related to the financial sector. This one of the biggest risks to the Latvian economy. So all the attention from the government and supervising authorities should be fully concentrated to deliver on agreed action plan eliminating identified weaknesses. This has to ensure a positive evaluation this year.
Future perspective of the industry
Latvia and other Baltics countries remain early adapters in financial technologies and services. Latvia was among the first countries in Europe to introduce instant payments. We see also open banking concept as an opportunity, not a threat. One can see that start-up community support and cooperation, fintechs, hackathons are just a few of deliveries by the banking industry during 2018. We have decided to embrace the innovation with Innovation centers and accelerators. Currently, we do not see that Latvia has reached a breakthrough in artificial intelligence, but applying robotics where possible in banking and global services is something that we are extremely proud of.