Non-resident banking business in Latvia – benefits and risks
Provision of financial services to non-resident customers has been of high importance in the Latvian financial system already for 20 years. Though customer deposits (both resident and non-resident) have experienced decline as a result of the global financial crisis, gradual returning to increase in depositing has been observed in the sector since mid-2009. Currently non-resident deposits make up about a half of total banking sector deposits. The upward trend will likely continue according to the Financial and Capital Market Commission (FCMC). Since the non-resident banking business is associated not only with benefits but also with certain risks, their identification and management are of utmost importance.
At the end of September 2012, non-resident deposits accounted for 5.9 billion lats, or 49.5% of total banking deposits. In comparison with September 2011, non-resident deposits have grown by 19.7% this year. The business model of 14 Latvian banks out of 29 operating banks has been based on non-resident customer service. Considering the increased risks associated with this business model, FCMC has set the increased capital requirement for this banking group. Besides, the banks have to ensure adequate risk management, paying particular attention to the liquidity risk as well. In September 2012 the liquidity ratio for those banks was 69.5% on average, more than two-fold exceeding the FCMC regulatory minimum (30%). The capital adequacy ratio also was twice as high as the minimum regulatory requirement and reached 16.1% by the end of September.
„The Latvian financial sector operates as the regional financial centre partially, dealing with the non-resident customer money flow. Latvia differs from other historical financial centres, such as Switzerland, Luxembourg or London, where the banks are focused on attracting the inflow of non-resident customer money for longer periods and maintaining the value of deposited funds. Whereas the Latvian banks mainly provide financial logistics services to non-resident customers, i.e. they are dealing with short-term incoming cash flows. This could be regarded as export of financial services that improves also the payment balance sheet in Latvia,” FCMC Chairman Kristaps Zakulis explains.
Development of non-resident business in Latvia has been favoured by the combination of several factors – geographical location, the European Union (EU) membership that provides for a safe and regulated environment, and viewed from the international customer point of view – the possibility to access services in the Russian language. Availability of high quality banking services at affordable price is of no less importance. The Latvian banks are offering services to their customers that could be considered as innovative and advanced, for instance, online and telephone banking services (24/7), in comparison with competing banks in other EU member states where no such services are always available.
Dynamics of bank deposits
It should be noted that volatility of non-resident deposits is not higher than resident deposit volatility. In one year since the beginning of the crisis (JSC “Parex banka” excluding) non-resident deposits had reduced by par 20%, whereas the decrease in resident deposit volumes was 16% (excluding the government and financial sector deposits). In mid-2009 the non-resident deposits started returning to Latvia and cash flow gradually resumed.
Non-resident deposits broken by countries
It should be admitted that basically the non-resident deposit flow from the CIS has been serviced in Latvia. A half of total non-resident deposits comes from the EU and CIS. In September 2012, of all EU deposits 48% were from the Great Britain, but 21% from Cyprus. The banking system problems in Southern Europe have led to the considerable deposit inflow from Cyprus starting from mid-2011.
Placement of non-resident funds
The banks focused on the non-resident business are investing the funds in high-liquid assets. Though demand deposits constitute slightly more than 80% of total non-resident deposits, the amount of liquid funds (assets with residual maturity up to 30 days and liquid securities) has been maintained rather high for these banks – 50% of total assets on average. Besides, the banks focusing on non-resident business are less engaged in lending – the proportion of loan portfolio to assets is about twice as less as usually it is in universal banks (full service credit institutions).
Main benefits of non-resident business servicing
There is a range of benefits emerging in the export of high-value added financial services, namely, payment balance sheet improvement, tax revenues, and creation of high quality jobs with high value added. As regards the impact on the Latvian national economy, the non-resident business servicing in the financial sector constitutes ~1.7% of gross domestic product, according to KPMG market research for 2011.
Risks associated with non-resident business and their mitigation
For supervisory purposes, awareness of potential risks by the banks that focus on non-resident business and effective risk mitigating measures in place are of great importance for FCMC. The key risks the banks are exposed to when carrying out transactions with non-resident customers are sovereign, legal and reputational risks. The possibility of exhausting the non-resident deposits as the source of financing also should be taken into consideration.
It is worth mentioning that the risk of being engaged in the transactions involving the money laundering or the financing of terrorism is comparably higher for the banks holding non-resident funds. Therefore those banks must pay more attention to non-resident customers (for instance, acquire in-depth information about the customers and their transactions). Rules and regulations in line with the international standards are in place in Latvia, focusing on the mitigation of all types of risks, including the risks associated with non-resident business.
FCMC maintains ongoing supervision over the market participants and performs inspections of banks on a regular basis. During 2012, overall 11 inspections in the area of money laundering and prevention the financing of terrorism were carried out (both on-site and off-site inspections), paying more attention to the banks where the share of non-resident customers is higher and therefore they are more exposed to the money laundering risk. A fine of LVL 75,000 was imposed on one bank this year, as well as a warning issued regarding revocation of bank board member and requesting the bank’s senior management and board of directors to evaluate operations of responsible structural unit in order to prevent deficiencies and shortcomings in the bank activities.
For additional information:
Head of Communications Division
Financial and Capital Market Commission
Phone: +371 67774860, +371 26148001