BANKING SUPERVISION
GENERAL DEVELOPMENT OF SUPERVISION IN ESTONIA
The task on Banking Supervision is to protect the
interests of creditors by increasing the stability and
reliability of the banking sector. The main focus is
on the most risk-prone spheres of activity of the banks
and on separate institutions that can affect the
stability of the whole system the most. However,
Banking Supervision does not aim at taking on the duties
of bank management, that is, running the banks. Neither
can supervision guarantee avoiding problems deriving from
the mistakes of the management at any cost and in the
interests of the general stability of the banking system
it may become necessary to close some banks.
Legally, the work of Banking Supervision is regulated
by the Central Bank Act, the Credit Institutions Act,
other laws of the Republic of Estonia and the related
legal acts, the statutes of the Banking Supervision,
decisions of the Board of Eesti Pank, decrees,
regulations and instructions of the President of Eesti
Pank, international agreements, banking directives of the
European Union and methodological recommendations of the
Basle Banking Supervisory Committee.
Under the Credit Institutions Act, supervisory
activities cover all credit institutions licensed by
Eesti Pank, their subdivisions outside Estonia and
subdivisions of foreign credit institutions in Estonia.
Since 1998, consolidated supervision is carried out over
the institutions belonging to consolidation groups of
credit institutions.
The deepening integration of the Estonian financial
sector and the resulting rapid growth of non-banking
financial intermediation have raised the question of
pooling the resources of the existing supervisory
institutions. In order to seek the best solution to the
matter, a joint working group on merging supervisory
institutions was set up by the Ministry of Finance and
Eesti Pank which handed over its final report at the
beginning of 1999. Proceeding from the report, the
Board of Eesti Pank supported the idea of creating a
unified supervisory body for the entire financial sector,
combining banking, insurance and securities supervision. Taking
into account international practice and the peculiarities
of Estonia, the Board of Eesti Pank considers the most
suitable institutional form for the new body a politically
and financially independent public legal entity.
Until such a body is created, Eesti Pank should maintain
the supervisory role over the credit institutions at
least or the new supervisory body should be
institutionally affiliated to Eesti Pank.
DEVELOPMENT OF BANKING LEGISLATION
1998 was more fruitful from the point of banking
legislation development than several earlier years.
In April, Riigikogu passed the Deposit Insurance
Fund Act, which lay the foundations for the Estonian
deposit insurance system. The law, which took effect
in October 1998, defines the basic principles of the
activity of the Fund as well as the principles of
compensating for lost deposits.
At the end of November, Riigikogu passed the
Prevention of Money Laundering Act, which revoked the
respective provisions of the Credit Institutions Act. Under
the Prevention of Money Laundering Act the task of
preventing money laundering is, besides credit
institutions, expanded to financial institutions,
including insurance companies, investment funds and
professional members of the stock market. The legal act
specifies the procedure of checking personal identity,
steps to be taken in suspected money laundering instances
and provides for the creation of a separate structural
unit within the Police Department for collecting data on
money laundering and defines its rights and duties.
In 1998, elaboration of the new version of the
Credit Institutions Act and the Savings and Loan
Association Act continued. Both were sent to
Riigikogu in autumn. Riigikogu passed them in early 1999.
The revised Credit Institutions Act proceeds from the
EU directives that regulate the activity and supervision
of credit institutions and expands the rights and
authority of Banking Supervision in accordance with
internationally accepted requirements. It specifies the
tasks and scope of activities of Banking Supervision,
principles of co-operation with the respective
supervisory institutions abroad and the arrangement of
supervision. The rights of Banking Supervision in
accessing information and conducting on-site inspection
have been increased, including on-site inspection of
various businesses belonging into a consolidation group
with the aim of evaluating the correctness of information
provided by them. Banking Supervision has the right to
demand extraordinary inspection or expertise if the
reports submitted by a credit institution prove to be
misleading, incorrect or if transactions have been made
that harm the credit institution. Banking Supervision is
entitled to demand convening of meetings of the credit
institutions' management and determining the agenda of
these meetings as well as proposing rationalising
programmes in case of problems. The outside auditors of
the banks are also imposed with the obligation to inform
Banking Supervision of the aspects endangering the bank
discovered in the course of auditing. The enactment of
the new Credit Institutions Act from 1 July 1999 will
considerably improve the work of Banking Supervision.
Still missing are the new legal acts on the
securities market and insurance, which are in the
stage of being drafted by the Ministry of Finance.
MAJOR EVENTS IN THE BANKING SYSTEM
The 1998 key words in banking were mergers, inflow
of foreign capital, liquidity problems and insolvency of
some banks. Not much activity was seen in setting up
subdivisions or units of foreign credit institutions
neither in Estonia nor by Estonian credit institutions
abroad. The only such event was the opening of a
representative office of Latvijas Unibanka in
Tallinn in May.
The 1998 mergers concerned mostly Estonia's
major banks. In mid-July Eesti Pank authorised the
merger of Hansapank and Eesti Hoiupank (Estonian Savings
Bank) as well as the merger of Eesti Ühispank (Union
Bank of Estonia) and Tallinna Pank. The merged
Hansapank and Hoiupank continued under the name of
Hansapank, Ühispank and Tallinna Pank continued as Eesti
Ühispank.
In the inflow of foreign capital Scandinavian countries played the leading role. The Swedish Föreningssparbanken (Swedbank) applied for the right to acquire over 50% of Hansapank shares, which it did in October, and in
November Skandinaviska Enskilda Banken took a 34%
stake in Eesti Ühispank.
There were four problem banks in 1998.
At the beginning of July the City Court of Tallinn
launched bankruptcy proceedings of Eesti Maapank
(Land Bank of Estonia), initiated by the Board of Eesti
Pank. Maapank was declared bankrupt at the end of August.
In early October Eesti Pank asked the City Court of
Tallinn to launch bankruptcy proceedings against EVEA
Pank, which was declared bankrupt in early 1999.
Soon after the launch of bankruptcy proceedings
against EVEA Pank, an indefinite moratorium was declared
on ERA Pank, which had to be resolved in April
1999 the latest.
Due to the failure of meeting capital adequacy
requirements, Eesti Forekspank (Estonian
Forexbank) merged with Eesti Investeerimispank
(Estonian Investment Bank) in the autumn of 1998,
assisted by Eesti Pank. The merged bank continues under
the name of Optiva Pank.
Also several earlier liquidation processes were
completed in 1998. In the autumn, the City Court of
Tallinn initiated bankruptcy proceedings against NoWe
Pank and Inko Balti Pank, with the latter
declared bankrupt in early 1999. In the middle of
November, small shareholders of Eesti
Innovatsioonipank (Estonian Innovation Bank) decided
to end the activities of the bank through a compulsory
liquidation. The City Court of Tallinn issued the
respective ruling in early 1999.
Due to consolidation and closure of small banks,
Estonia had five credit institutions at the beginning of
1999 - Eesti Krediidipank (Estonian Credit Bank), Eesti
Ühispank, Hansapank, Optiva Pank and Tallinna Äripank
(Tallinn Business Bank), plus the Tallinn branch of
Merita Bank Plc. The high concentration of the banking
sector (Hansapank and Ühispank together control over 80%
of the market) sets new requirements for supervision as
well. In the next few years the issue of maintaining fair
competition will become ever more topical.
PRUDENTIAL RATIOS
The prudential ratios set on the Estonian credit
institutions correspond roughly to EU requirements and,
in view of Estonia's rapidly developing and changing
economic environment, are even stricter. Thus, for
example, the capital adequacy ratio is set at 10% (8% in
EU) and the weight of different risks, considered in
calculating capital adequacy, is sometimes higher than
required in the EU directives.
Among major changes, which took place in 1998, we
could mention the addition of market risk to the rules
of calculating capital adequacy, the introduction of the
tier 3 capital and application of prudential ratios to
consolidation groups.
The calculation of the foreign currency risk was
improved by limiting the German mark and Estonian kroon
joint position to 15% of net own funds, the same as for
all Zone A currencies. The position of the currencies of
Zone B countries is limited to 5% of net own funds, with
the exception of Latvian and Lithuanian currencies which
can account for 10% of net own funds. Due to the
introduction of the European common currency, the euro
and Estonian kroon are treated as a joint position from 1
January 1999 (15% of net own funds).
Reporting of off-balance sheet transactions was
improved which allows better overview and analysis of the
banks' off-balance sheet activities.
MANAGEMENT AND INTERNAL CONTROL SYSTEM OF CREDIT
INSTITUTIONS
The halt of the exceptionally rapid growth of bank
assets and the collapse of the stock market at the end of
1997 caused serious problems for the banks and resulted
in large operating losses by the end of 1998. As we
can see from analysis, much of what happened was caused
by shortcomings in the general management of banks and
their internal control units, which in turn derived from
either incompetence or negligence. The above
conclusions can also be found in the report on Eesti
Maapank, commissioned from the former head of the Danish
financial supervision Eigil Mølgaard, ordered by Eesti
Pank and the Ministry of Finance and published in January
1999. Mr Mølgaard makes various suggestions on the
supervisory legislation as well as institutional
build-up, both from the legal and managerial aspect of
supervision. The majority of his suggestions has already
been included in the new Credit Institutions Act and was
used in solving the problems of EVEA Pank and ERA Pank in
October 1998.
The need to improve the quality of general management
has been pointed out in analyses of the causes of banking
problems not just in Estonia but also in many other
countries. The practice of international financial
supervision puts more and more emphasis on the timely
availability of governance information and increasing the
efficiency of the internal control system. In May 1998, a
joint committee was formed of the representatives of
Eesti Pank, the European Bank for Reconstruction and
Development (EBRD) and several Estonian credit
institutions to prepare a new framework of requirements
for the management of banks. The new Credit Institutions
Act, too, specifies in detail the requirements for the
general management of credit institutions.
SUPERVISION OF INFORMATION SYSTEMS
The 1998 work plan of the supervision of
information systems featured supervision of the
banks' information systems' readiness for the year
2000. In order to co-ordinate the respective
projects of separate banks, a plan of action was
prepared for achieving the year 2000 readiness. The
work is divided into phases: designing of a strategic
approach; creating organisational awareness;
inventory of IT systems, evaluation of impacts and
creating detailed plans; renovation of systems,
applications and equipment, evaluation and repairs
through testing; application of tested and compatible
systems and planning of uninterrupted functioning.
According to the plan of action, compatibility has to
be achieved by the middle of 1999.
Banking Supervision set up a team of project
managers involved in preparing banks for the year
2000, with the aim of exchanging information and
planning joint action. During its regular
inspections, the Banking Supervision also studied the
banks' projects for readiness for the year 2000. By
the end of 1998, the renovation phase was completed
by 75%, over one third of the testing phase and less
than one third of the application phase was
completed.
INTERNATIONAL CO-OPERATION
Co-operation with the supervisory institutions of
other countries is an inseparable part of improving
banking supervision. This covers relations with the
banking supervision bodies as well as the supervision
institutions of the stock market and insurance.
Estonian Banking Supervision maintains the closest
practical co-operation with the supervision bodies of Finland, Latvia and Lithuania. In 1998, the list was
complemented by the Swedish supervision, due to
the strategic interest of Swedish banks. A co-operation
agreement has been signed with the Finnish supervision,
which allows the Estonian and Finnish supervision
officials to carry out joint inspections and monitoring
of the banking sector. The signing of a co-operation
agreement was also initiated with the Russian
banking supervision. Agreements specifying the forms and
procedures of co-operation are in various stages of
completion with a number of countries.
The consolidation of the Estonian banking sector has
considerably increased the interest of foreign strategic
investors in long-term investments into Estonian banks. In
order to secure the credibility of the Estonian banking
system it is important to check the background of
potential future owners, their previous record and
reputation. For this purpose, information is
frequently exchanged with the relevant foreign
institutions of supervision.
Another important outlet of international
co-operation is the involvement of foreign experts in
harmonising Estonian legislation with the respective EU
norms. The assistance of experts from the
International Monetary Fund and the European Union has
been used in drafting new regulations.
To keep in touch with the development trends of the
global financial system and to harmonise the
methodological basis and practical work of supervision,
the Group of Banking Supervisors from Central and Eastern
European Countries has been set up. The Group
co-ordinates relations with the Basle Banking Supervisory
Committee and passes on the views of the member countries
in banking supervision issues. Estonia has taken active
part in the work of the Group since it was established.
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