Publication: Monitor Volume: 7 Issue: 107

While many transition economies have reported a few years of economic growth, only a handful have enjoyed sustained growth in living standards accompanied by fundamental changes in companies. Financial crises and banking collapses, similar to developments in Russia in August 1998, have often kept short-term growth from becoming long-term recoveries. Domestic banks in many countries tend to be poorly regulated, and do not engage in significant lending to companies and households. In addition to slowing growth in production and investment, banks’ lack of credibility in the eyes of the public ensures that a large share of household savings and enterprise working capital remains in the informal sector. As leading transition economies such as Hungary and Poland have discovered, solving these problems requires developing a detailed regulatory system for commercial banks, and their sale to large multinational banks with strong capital bases.

Recent data on the Latvian banking sector suggest that Latvia has made good progress in straightening out its financial problems. Following the banking crisis of 1995 that required a state bailout and then the recession of 1998-1999 triggered by the Russian crisis of 1998, many Latvian banks were understandably cautious. As increasing foreign investment in the sector during the second half of the 1990s helped increase public trust in the banking system, deposits skyrocketed. But most of these funds had gone into government bonds and other safe investments, rather than into loans that entail more risk. As of mid-2000, Latvia’s commercial banks had 44 percent of their assets in liquid assets–such as vault cash, deposits at the central bank or other commercial banks–or invested in Latvian government securities. The ratio of banks’ liquid assets against current liabilities was 68 percent, which was well above the required 30 percent ratio (, “credit institutions”).

Bank lending to companies has since accelerated sharply. At the end of March 2001, private enterprises and financial institutions had loans out worth 885 million lats (US$1.4 billion), 24 percent more than a year earlier. While short-term loans fell slightly, the value of long-term loans increased 93 percent, indicating that more lending is going toward capital investment rather than working capital. Industrial loans helping to finance purchases of fixed assets and investment projects had risen to 29 percent of the banking system’s credit portfolio at the end of April 2001 (BNS, May 18).