Lending. Still the weak link?
Bank loans represent one of the investment sources ensuring economic development. It is difficult to imagine a situation where the economy can see a dynamic long-term development without lending; therefore, access to loans, especially among small and medium-sized enterprises (SMEs), is of critical importance.
Latvia's loan-to-GDP ratio is the second lowest in the euro area;
last year (in 2022), with corporate lending intensifying, the growth rate of lending improved;
against the backdrop of a short-lived recession, high costs and uncertainty, lending will, most likely, weaken in the coming cold winter and spring months;
in late 2022, following substantial interest rate hikes, household lending already witnessed clear-cut signs of deceleration;
with the government support not being permanent, the solutions regarding the energy efficiency of buildings will become increasingly more relevant.
Following the severe crisis of 2008, lending in Latvia remained weak for a long time. This was on account of the caution exercised by borrowers and banks as well as other demand and supply factors and structural problems faced by the economy (for instance, a large share of shadow economy, the segmentation of the lending market, shortcomings in the legal environment, private and public administration, unpredictable business regulation).
Since 2009, the domestic loan-to-GDP ratio has contracted almost three times (36% in September 2022). Currently, this indicator is the second lowest among all euro area countries and Latvia surely shows growth potential in this regard.
From January to November 2022, domestic loans increased. A significant rise in loans in the NFC sector should be noted. In November, the annual growth rate of domestic loans reached 8.0% . Such substantial loan increase had not been observed since the crisis of 2008. Lending growth is recorded for all largest banks.
Over the last 13 years, the corporate lending dynamics saw a short-lived growth during some periods affected by certain very sizable transactions; however, until mid-2022, the overall dynamics remained strongly negative (back in June, the annual rate of change in loans stood at –1.1%). In turn, in the second half of the year, corporate lending was rather active, and the annual growth in corporate loans already reached 10.4% in November 2022 (see Chart 1).
A surge in the corporate loan portfolio is largely determined by a higher demand for short-term funding for the provision of current assets with the overdrafts and credit lines increasing (see Chart 2). A significant rise in prices, especially in energy prices, drives up business costs and creates a need for borrowing. A more substantial overdraft and credit line increase is seen in energy, a less substantial one – in manufacturing. The growth in these short-term loans might be largely explained by the purchase of natural gas prior to the heating season.
However, in the second half of 2022, a relatively significant growth was also observed in corporate long-term loans. This period witnessed no clear-cut signs of insufficient access to loans. By sector, a substantial rise was mostly seen in real estate activities and the dynamically developing agricultural sector, while a small growth was present in other sectors as well. Real estate companies were granted several new medium and large loans. This was also partly attributable to inertia, as a loan or its share is often actually granted several months after the conclusion of the loan agreement.
Against the backdrop of a short-lived recession, high costs and uncertainty, corporate lending might, most likely, weaken in the coming cold winter and spring months.
In the household sector, lending has been very weak for several years following the crisis of 2008. It recovered very recently (in 2021), and, over the last two years, the loan portfolio expanded moderately overall (see Chart 1) facilitated by the state support programme for house purchase. However, already in late 2022, following substantial interest rate hikes, household lending witnessed clear-cut signs of deceleration. For the time being, the annual rate of change in loans is positive (4.3% in November); however, the monthly changes in November were already close to zero.
This gives rise to an ambiguous situation: on the one hand, high energy prices stimulate the purchase of energy-efficient housing in the new projects; on the other hand, higher interest rates considerably reduce the possibilities of buying more expensive properties by using loans with long maturities.
Most likely, household lending will continue decelerating in the short-term, affected by higher interest rates, shrinking economic activity and uncertainty.
 Here and below (including in Charts): excluding the one-off effects associated with the structural changes in the banking sector and sectoral reclassification for the purposes of comparison.