An effective financial sector is an essential economic growth factor, that allows to channel finance into well capitalized and managed companies that do their business fairly, and at the same time to promote saving, which in turn provides the opportunity to use free funds to generate profits. Considering Latvia’s current economic situation, the conclusion is that the financial sector is not quite able to perform this function fully effectively.
Credit institutions, which among other things are tasked with performing this function, play an important role in the Latvian financial sector. They still remain the principal source of financing, while alternative sources of financing are less developed. Therefore, despite a comparatively high number of credit institutions, the Latvian banking sector still has room for improvement to enhance the financial sector’s overall performance.
Furthermore, Russia’s invasion of Ukraine has brought to attention various dimensions of economic independence, for instance, in areas like energy and finance. The current political situation has shown that we need an effective, independent local financial market that would protect Latvia against external shocks and allow the economy to use its full potential. An economically strong country can also defend itself better.
Valdis Siksnis, Chairman of the Board and co-founder of INDEXO
An industry that needs to improve
Since 2008, the portfolio of loans issued to Latvia’s residents has contracted from more than EUR 20 billion to roughly EUR 12 billion and has been stagnating at this level for some time already, even though the Latvian economy has grown significantly over that time. Moreover, loans in Latvia are among the most expensive in the eurozone, which means poorer financing opportunities and higher costs for Latvia’s residents and entrepreneurs. This, in turn, undermines Latvia’s competitiveness in the region.
At the same time, deposits made by Latvia’s residents have significantly increased, surpassing the amount of loans issued in the domestic market by around EUR 4 billion, making for one of the widest gaps in Europe. This is an unnatural situation where the savings accumulated by people and businesses by far exceed the amount of loans issued by the banks. This also means that the Latvian economy and society at large generate a fair amount of free cash that gets stuck in the banking sector and is not invested back into the economy. As a result of this, Latvia’s ratio of resident loans to GDP is among the lowest in the European Union (EU) and significantly lags countries like Estonia. According to our estimates, to achieve an average EU level, Latvian banks would have to extend at least EUR 4 billion in loans.
Here, it is necessary to bear in mind that an excessively low amount of loans is not an indication of a very prudent approach. On the contrary, these figures raise the alarm that Latvia is not using its potential and that we are catching up with the EU’s average prosperity level too slowly.
The conclusion is that the Latvian banking sector needs to significantly improve its ability to fulfil its main task, which is to support economic growth.
One of the explanations for this situation is the stagnation of the market, which is dominated by few banks.
Banks with a legacy of the past where key decisions are taken abroad
How did such a situation become possible? It can be put down to two main factors: (1) the significant importance of foreign banks in the Latvian financial sector, and (2) the cost burden and infrastructure of traditional banking operations.
(1) The Latvian banking sector is dominated by foreign banking groups, which makes the Latvian banking sector dependent on developments in their parent banks, their strategic decisions and the macroeconomic situation in the parent banks’ home countries. I believe, that events in Ukraine will make the foreign banks even more cautious in the Baltic states.
As a result, instead of following strategies customized and necessary in the local situation, the managers of local banks have for years been subject to their banking groups’ uniform business models. At least for the past 10 to 15 years, Latvia’s local capital has not been mobilized to create a really universal bank for the domestic market.
(2) Development of the existing Latvian banks is impeded by the high costs of traditional banking operations, which require maintaining huge infrastructure – from high-rise office buildings to day-to-day operations. Besides, for banks whose IT systems are extremely complex and often contain outdated systems, it is more expensive to introduce innovative services and digitalize their operations. All these costs are indirectly paid by the Latvian economy and residents.
Current market situation provides an opportunity for change
We at INDEXO believe that the current market situation hides significant opportunities to finance both individual and corporate customers, as well as demand for affordable technology-based daily banking services. In short, this is a market waiting for someone to shake it up and change, and we are ready to do that, just like we kickstarted changes in the pension management market five years ago. We believe that the creation of a new bank that would be fully rooted in the domestic market will substantially strengthen Latvia’s economic independence, as well as reduce our financial market’s dependence on developments and decisions in foreign countries.
We have already built the foundation necessary to implement these changes. With its local focus, insight and decisions taken exclusively in Latvia, modern management, infrastructure, trusted brand and over 70,000 clients, INDEXO is well positioned to challenge Latvia’s traditional banking sector. By launching an IPO, we will soon expand the circle of our shareholders, becoming an organization truly owned by its customers, and will use the capital raised through the IPO to create a new bank. To accomplish this, we of course need permission from the supervisory authorities, but we are working on this already and hope to receive our banking license before the end of this year. We will start gradually, sustainably and will first become the custodian bank for the pensions managed by INDEXO, which will ensure even lower costs for our pension customers, but the first services of the new bank will also become available to individual and corporate customers shortly after we receive our license. The goal of the new INDEXO bank will be to become the most customer friendly financial services provider in Latvia offering a full range of services to both individual and corporate customers.
More information: www.indexo.lv