Bank Lending and Crisis: Evidence from Latvia

Abstract

Purpose of the paper is to study the link between bank lending and financial crisis to identify the determinants of imbalances in lending to provide possible solutions for balanced development of bank lending in Latvia.

Design/methodology/approach: the analysis is based on the examination of aggregate statistical data of Latvia and selected European countries focusing on the link between bank lending and crisis. Qualitative information is collected using face-to-face communication with staff of financial institutions. The informational and methodological basis of the paper is special economic literature, scientific and research papers, collections of statistical information, and results of research made by the author.

Findings: several European countries have experienced financial crises caused by extreme lending expansion in the 1990s. The recent developments in Latvia have shown a similar “scenario”. Based on the bank credit classification of R.A. Werner, analysis of the loans issued by Latvian commercial banks in 2004–2011 is carried out. To identify the main challenges and problems as well as to provide possible solutions for bank lending strategy that allows balanced development of banks and thus the national economy as a whole, analysis of bank lending operations is made. The analysis has shown the main determinants of imbalances in lending, including uneven structure of loan portfolio, overestimation of collateral, insufficient attention to risk adjusted loan pricing etc. Moreover, empirical study of the Latvian case has shown that growth of loans for consumption and speculation purposes resulting in inflation during the study period has exceeded the growth of banks capital more then twice, making banking system more vulnerable.

Research limitations/implications/future research: after completion of the necessary database, determination of the quantitative measures to ensure balanced development of bank lending will be carried out.

Practical implications: analyzing the course of financial crises in selected European countries (Norway, Finland, Sweden) in early 1990s and Latvia in the beginning of the 21st century, except of some country-specific features the general scenario is identified, showing common features of the course of financial crises following the link between bank lending and financial crisis in Latvia. Changing economic environment has revealed a number of imbalances in banking operations and pushed the banks to cardinally review their strategy in lending. Responsible lending as a compulsory component of bank lending strategy would allow balanced development of banks as well as would stimulate economic growth that in turn positively effects bank lending and profitability. To provide stability in bank lending taking into account the course of the previous crises, several proposals are worked out for Latvian commercial banks.