Financial Stability Report 2016

The main systemic risks to the stability of Latvia's financial system stem from the external macrofinancial environment. The increase in external risks is mainly determined by the global growth risks: slowdown of growth and imbalances in the emerging economies which impairs sustainable growth prospects in the advanced economies. External uncertainties are amplified also by the growing political risks both in Europe and on a global level. Notwithstanding the implemented macro-prudential supervision measures, the financial stability risks associated with the imbalanced development of the real estate market and the high level of household indebtedness continue to accumulate in the home countries of the largest parent banks. Latvia's economic development has decelerated; however, the creditworthiness of domestic borrowers continues to improve in general. According to the results of the macroeconomic stress test and sensitivity analysis conducted by Latvijas Banka, the credit institutions' capacity to absorb an increase in credit risk is high as the credit institutions are overall well-capitalised. The liquidity stress tests also suggest that the credit institutions' capacity to absorb potential liquidity shocks remains good since their liquidity ratios are high. Although the profitability ratios of credit institutions are sound, the downside risks to their future profitability are growing, particularly considering the declining income base. Persistently weak lending dampens both the future income of credit institutions and the growth potential of the economy.

The buoyant growth of the non-bank financial sector has been supported by increased household savings in pension funds as well as the growth of loans granted by non-bank financial institutions (mainly financial leasing granted to non-financial corporations). The amount of new loans granted to households by non-bank financial institutions also continues to grow. Meanwhile, the growth of insurance corporations is decelerating. In the low interest rate environment, the long-term profitability risk of life insurance corporations is somewhat increasing. Higher volatility observed on the global financial markets in 2015 compressed the return on investment made by insurance corporations and pension funds. Overall, the share of the non-bank financial sector assets in Latvia's financial sector remains quite small.