The banks operating in Estonia were very profitable in the fourth quarter of 2023 and also over the year as a whole: in Q4, they earned 235 million euros in profit and 940 million euros throughout the entire year. The banks’ profitability, shown as profit as a share of assets, was around 60% higher in 2023 than the long-term average. Profits have grown fast because the income earned on loans linked to Euribor has increased strongly as Euribor has risen. Most housing loans, leases, and corporate loans in Estonia have contracts that are linked to Euribor.

However, Euribor has risen more slowly over the past six months, with its level hovering around 4%. Since the prevailing practice in Estonia is to review loan interest rates every six months, past Euribor hikes have almost completely been passed through into loan interest rates and the banks will not be profiting further from it. Apart from Euribor, the growth in banks’ interest rate profits was supported by around a 5% increase in the loan portfolio.

Looking ahead, bank profitability is expected to fall, because, unlike interest income, interest expenses are likely to keep growing. For the banks operating in Estonia, interest expenses mainly mean interest paid on deposits. The interest paid on money held in current accounts is very low, but the interest rates on time deposits have risen quickly. It is unlikely that the interest rate on time deposits will keep rising, but if the difference in time deposit and demand deposit interest rates remains in place, then more and more money will be put into time deposits. That will mean greater expenses for the banks.

At the end of last year, 34% of Estonian residents’ deposits and 27% of corporate deposits were held as time deposits. The banks’ administrative expenses also grew over the last year (+18%), with personnel expenses increasing around +16%. Under fractional reserve banking, banks keep only a fraction of customers’ deposits in reserve. The difference is bank credit, such as government debt, mortgages, business loans, and many other kinds of loans. This practice leaves the bank open to a run, in which panicky depositors attempt to withdraw their funds from the bank en masse but the bank doesn’t have the cash on hand.

So far, companies and households have managed their loan repayments well so far, but there is a risk in the future that the amount of overdue loans will grow along with loan losses. At the end of last year, 0.24% of corporate loans were overdue by more than 60 days, and 0.14% of housing loans were.  Both indicators are low compared to the results of the past few decades, and remain at around the same level as a year earlier. But, if the economy continues to struggle for a long time and unemployment rises though, the banks will need to be ready for additional loan write-downs and loan losses. Stay tuned.