Another Look at Latvia's Financial Industry as it Applies to the Eurozone

Last September, we spoke to Martins Priede, Chairman of the Board at Latvian broker Renesource Capital. With Latvia applying to the enter the Euro zone last week, with a target of its entrance next year, we decided to follow up with Renesource Capital about the news and potential effects on the country’s financial industry. Although only formally making its application now, Latvia has pegged its currency to the euro since 2002, and became part of the European Union in 2004. Explaining the background and current environment, Vladislavs Masalskis, Head of Brokerage Department provided a detailed summary of the event.

1)How will entering the euro zone effect financial companies in Latvia? Will there be new laws that companies will need to follow?

Let me start with a concentrated summary, and information which will provide more insight of local thinking and analysis of joining the Eurozone.

The main skepticism is about inflation indicators that everyone is afraid of, after joining the European monetary union (EMU). I would say that this is more of a myth rather than an economically and logically sound conclusion, when taking into account our northern neighbor Estonian’s experience. Historically Latvia right now has the lowest inflation level ever.

Many local euro zone skeptics believe that the current economic situation in Greece, Spain, and Italy is not conductive and economically justified enough to join the EMU, as the euro zone isn’t experiencing the easiest time. In the meantime though, euro zone member countries have taken significant fiscal and monetary steps to improve the falling economies from further uncertainty and have made significant reforms. Particularly when Latvia’s economy shows the fastest economic growth among all other EU member countries. Latvia’s GDP grew by 5.7% in 2012, the best performer in the EU.

Latvia’s banking and financial sector has substantially gained from instability in Greece and particularly in Cyprus.

Our analytical team at Renesource Capital believes that the only logical reason to refuse joining the EMU would be an artificial – unfavorable fixed euro exchange rate against the Latvian Lat versus the current market rate. In other words, a national currency devaluation would cause an immediate collapse of national economy.

Latvia certainly will be able to avoid economic shocks such as what occurred in 2008/2009 which almost led to the devaluation of the national currency, Latvian Lat, and paralyzed the economy. The introduction of the euro currency will liquidate fears of devaluation that have been present since Latvia’s economy revived in the 90s after the Soviet system collapsed. Latvia as a small and open economy has always been dependent from external political and economic shocks – such as energy prices, banking and financial sector health and transit flows.

Devaluation has always been a major topic and played a key role particularly experiencing swings of stability in the banking industry which has been created by the foreign (nonresident) capital outflow from the banking system and business environment itself (because of political and economic volatility) thus causing concerns about incomes and savings safety.

Reduced above mentioned risks will encourage more stable economic and export growth (goods and services export). An improvement of the business environment will also contribute to a more rapid investment inflow into the country/ businesses which so far has been complicated because of different risk parameters and barriers existing such as credit rating. Latvia’s credit rating upgrade will be very positive for (by “Fitch” credit rating agency, for long term liabilities in foreign currency BBB, in local currency BBB+) new relation establishment and investment attraction which will facilitate investment banking business growth.

The systemic banks will enjoy the entrance in the EMU as this will provide them financial access to the European Central Bank Liquidity Liquidity The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent Read this Term, where in situations of distress they have lacked liquidity.

The small and middle size businesses will definitely experience lower credit charges with the introduction of euro currency (borrowing costs will be lower) and charges related to currency exchange. Businesses will enjoy much faster and cheaper money transfers in euro currency (wire transfers) to other EU Member States because EU rules require that domestic and cross-border euro payment rates must be the same.

The recent statistical data shows that more than 80% of households have borrowed in euro currency. Therefore, joining the euro currency will lessen the currency exchange related expenditures and currency risks associated.

Also, no new regulations are expected to be implemented after joining the EMU.

2)Will it impact current regulations?

No new regulations are expected to be implemented after joining the EMU. A joint monitoring mechanism will be formed with the European Central Bank (ECB) and the national regulatory authority – Financial and Capital market commission of Latvia (FCMC).

The ECB will be responsible for overall supervision of a single mechanism and it will play a key role in Latvia’s banking supervision. It will increase the banking regulation confidence level which has suffered unpleasant moments during the past 5 years.

Joining the Eurozone area, the four largest Latvian banks will be exposed under the direct supervision of the ECB. The criteria’s which banks will fall under the direct supervision of the ECB are banks relative importance in the economy and different banks indicators.

Still, the ECB direct supervision will be carried out in close cooperation with the FCMC.

The FCMN will play a significant role in macro prudential and licensing as well as license revocation proceedings of credit institutions (banks).

Sanction decision will be applied jointly between the European Central Bank and the Financial and Capital market commission of Latvia.

A compromise between the ECB and FCMC has been achieved in co-operation model which provides clarity about the practicable functioning of the joint regulation mechanism.

The FCMC will remain fully responsible for anti-money laundering (AML) issues, financial instruments market legislation and oversight.

3)At Renesource Capital, will it affect your expansion plans?

Renesource Capital shortly will become a member of the NASDAQ OMX Latvian Central Depository, thus parallel to interbank Forex Forex Foreign exchange or forex is the act of converting one nation’s currency into another nation’s currency (that possesses a different currency); for example, the converting of British Pounds into US Dollars, and vice versa. The exchange of currencies can be done over a physical counter, such as at a Bureau de Change, or over the internet via broker platforms, where currency speculation takes place, known as forex trading.The foreign exchange market, by its very nature, is the world’s largest tradi Foreign exchange or forex is the act of converting one nation’s currency into another nation’s currency (that possesses a different currency); for example, the converting of British Pounds into US Dollars, and vice versa. The exchange of currencies can be done over a physical counter, such as at a Bureau de Change, or over the internet via broker platforms, where currency speculation takes place, known as forex trading.The foreign exchange market, by its very nature, is the world’s largest tradi Read this Term, stock, CFD, futures and bond brokerage business. Renesource Capital will be expanding its custodian and investment banking product line. FOREX trading services will remain a major role among the investment services provided. This year will be based on developing FX prime brokerage solutions and electronic trading.