Scope Ratings analyst Levon Kameryan examines the sovereign implications for the Baltic countries relating to scandals at the local units of Denmark’s Danske Bank, Sweden’s Swedbank and Finland’s Nordea.

What are the latest developments surrounding these money-laundering scandals?

Nordic and Baltic state authorities seem finally to be getting to grips with the problem, namely that for many years, non-residents, often from Russia, have funnelled large amounts of alleged high-risk money through the Baltic branches of Nordic banks to the western banking system. Estonian authorities told Danske in February 2019 to close its operations in Estonia within eight months. Swedbank, the largest bank in the Baltics, faces a joint investigation from Estonian and Swedish authorities. Nordea faces criminal complaints.

The Baltic scandals at the Nordic banks have rattled their shareholders and regulators, but what is the main danger for the Baltic countries themselves?

Importantly, the financial sectors of Estonia, Latvia and Lithuania rely heavily on Nordic banks. Swedish banks Swedbank and SEB together with Luminor Bank – currently owned by Nordea and Norway’s DNB but set to be taken over by the Blackstone Group – account for more than 80% of total banking system assets and deposits in Estonia and Lithuania, and around two thirds in Latvia. We cannot predict the full impact of the money-laundering scandals at this point, but there is a risk of forced exit for Nordic banks as reputational risk for the banking sector has increased. At this stage it is not clear who would replace them. Estonia, Latvia and Lithuania remain small, open economies dependent on foreign investors and investment.

Why would the departure of Nordic banks present a challenge?

The Baltic countries currently benefit from having their banking systems largely owned by well-capitalised foreign lenders. The system-wide tier 1 capital ratio was 30.7% as of Q3 2018 in Estonia, the highest in the euro area. The ratio was a sturdy 19.9% and 18.5% in Latvia and Lithuania respectively. Credit quality remains high, as reflected in low and falling non-performing loan ratios, below 2% and around 3% for Estonia and Lithuania and slightly higher for Latvia.

How have investors reacted so far?

Market pricing of sovereign risk in the Baltics remains amongst the lowest in the Central and Eastern European region, as assessed by sovereign CDS spreads, which widened only slightly after the scandals.

Are investors right to be so sanguine about these countries’ creditworthiness?

Unlike the euro area periphery where balance sheets of sovereigns and banks are interlinked, the situation in the Baltics is different: public finances in these countries are in a good shape and the sovereign-banking nexus is limited. Estonia’s government debt amounts to an estimated 8% of GDP in 2018, by far the lowest in the EU. Debt-to-GDP ratios in Lithuania and Latvia stood at moderate 35% and 37% of GDP levels in 2018, with only around a quarter of government debt held by the resident banks. Scope rates Estonia at A+/Stable, and Latvia and Lithuania each at A-/Stable, underpinned by strong public finances and continued economic convergence with euro area peers. Addressing uncertainties surrounding the banking sector would be credit positive in that regard.

Contributing Author: Matthew Curtin: m.curtin@scopegroup.com