Banks will remain in business
02.11.2021.

Sandis Kapitonovs, Head of LPB Bank Treasury Department

What global developments have affected banking this year, and how do you think next year’s events might unfold?

The primary aspect affecting everyone, not just banks, is inflation. Everyone’s inflation expectations have consistently come true. You can see it in the rising costs of resources and construction – and those are only the harbingers of things to come. Sovereign and corporate debt has reached record levels and can be treated as hopeless in many cases. If exceedingly low, even negative interest rates persist, this debt game could go on for years and years, but what we know from theory is this: rising inflation should increase interbank rates, i.e. cost of money. Given the volume of cumulative global debt, that remains unlikely. With anticipation and a certain degree of concern, we can wait and see how central banks respond. So far, they have stayed the course on keeping rates essentially negative. Since the 2008/2009 crisis, commercial banks have had access to money for free for over a decade now. An enormous amount of free funding has flowed into a variety of assets. What we can notice today – the sharp increase in the prices of natural resources such as oil, gas and metals – is being driven directly by these factors. The stimulatory policies of central banks have produced an excess of cash, resulting in inflation, although government bodies are treating this as a temporary phenomenon.

How should banks behave in this situation? What sort of response can we expect?

Banks have been in an exciting market situation for many years, where cash balances held with a central bank would bring negative revenue, just like yields on blue-chip bonds. At the same time, the cost of living, which reflects inflation, has been rising – with the resulting decrease in classical banking revenues, which come from interest payments. One of the options bankers has invested in is financial instruments that behave similarly to inflation. Whenever inflation was on the rise, gold prices would follow, for instance, and so would the cost of other natural resources. Bankers could invest in these types of assets, although in strict terms, this would be a speculative play, not a proper investment.

In this regard, LPB Bank is not like a classical bank with a broad network of branches and ATMs and high fixed costs. LPB Bank specialises in e-commerce, combining the best of fintech and classical banking. Our profits come largely from transaction fees rather than lending. Clients transact online, costs are low, and our performance over the years shows that this approach has been a strategic success. 

The European Union has come out with the Green New Deal and the Taxonomy Regulation, which should motivate banks to lend to environmentally friendly projects, while conventional businesses will have a much harder time attracting financing. How might this impact traditional banks?

In light of the EU roadmap, our bank has revised its approach to sustainable borrowers as well. We will be willing to grant special privileges to green businesses that have an environmental management and audit system in place.

As we analyse the economical components of a transaction, we look beyond the borrower’s solvency today. We also consider their ability to perform obligations throughout the lending lifecycle. We also pay great attention to environmentally friendly, sustainable factors. LPB Bank intends to concentrate its lending in sectors of the national economy that should help Latvia output products at high added value through sustainable operations, with stable and predictable development across diverse industries.

For example, CO2-neutral construction initiatives might bring our borrowers lower rates compared to regular housing developers. I should add, of course, that there haven’t been enough green projects in Latvia for all banks to be able to give them preference. As long as Latvian bankers prefer active lending, they can’t afford to be very selective. Besides, entrepreneurs nowadays can drive development through various alternative financing options – even if banks remain among the cheaper ones for now.

Could this approach to banking lead to blowback, just like inflation driven by negative interest rates?

The Green New Deal is only starting to affect financing, and there is no certainty about what will happen down the road. First, we should ask ourselves how green the green new deal is. We know that the production of concrete for the building industry is a highly CO2-intensive process. Once built, a structure might be green and CO2-neutral, sustainable and consistent with all modern expectations – but a lot of CO2 will be emitted before that happens. A similar situation exists in the production of renewable wind energy. Installing a single turbine takes much concrete, and the plastic blades will not biodegrade as soon as it is decommissioned. Electric cars, too, might produce no emissions on the road – but producing and recycling a battery is a resource-intensive undertaking indeed.

I think there are many open questions in this space, and now would not be the best time to lose sleep over the lack of affordable financing for ungreen, business-as-usual projects.

Fintech solutions have grown so popular that even classical banks are introducing solutions that make their services more accessible and faster to deliver. How will this competition for clients pan out? Is LPB Bank about to come out with a breakthrough solution to tip the scales in its favour? 

You can already consider LPB Bank something of a fintech company with a banking license. All our services are geared towards e-merchants. With LPB Bank, a fintech business receives access to the STEP2 European payment system for SEPA transfers (SEPA Instant is coming soon, too). We provide open data solutions and a banking service architecture that makes launching an online business a one-stop deal for fintech companies and start-ups. LPB Bank is looking forward to cooperation with licensed payment institutions as well as the bank is also considering its options for cooperation with unlicensed fintech entrepreneurs, which offer software-as-a-service (SaaS) with mobile applications and intelligent marketing roadmaps. LPB Bank constantly monitors changes in the legislation of Latvia and the EU, which affect new areas and business areas, such as crowdfunding platforms, virtual currency exchange companies, and others, to start cooperation with them in the future.

Cryptocurrencies, which deliver some degree of transaction anonymity, are still gaining strength despite government efforts to combat them in Latvia and elsewhere. How might this confrontation develop, and can the bank see some window of opportunity in this trend? 

This is a field rife with money laundering concerns (AML), so banks remain wary. One of the main risks in working with cryptocurrency is determining the source of money, especially when it comes to exchanging cryptocurrency for fiat money. On the other hand, there is a demand to buy cryptocurrency for investment purposes. In the European Union, jurisdictions are emerging that regulate the activities of companies providing cryptocurrency exchange services without coverage. In this case, the source of the funds can be clearly seen, and this direction can be considered subject to strict rules.

The introduction of the digital euro is currently being discussed. It could be similar to cryptocurrencies, and banks will join the digital euro.

What will these digital euros be like? Will residents be able to mine it on their home computers?

The concept is only at the stage of conceptual discussion at the moment. It might follow a similar principle to bitcoin, where the holder might store digital euros on their phone or other devices as part of a blockchain. Of course, this would be something regulated by central banks, with much better tracing than bitcoin. It might be a new kind of common currency, but mining it will almost certainly be impossible. The concept of a digital currency is also being discussed in the United States, but digital dollars are only ideas at this point.

It is difficult to predict how either idea might develop and would have been part of a completely new ecosystem. Politicians see the popular demand for bitcoin and are looking to offer a similar solution to consumers that would be more transparent and amenable to public regulation.

Publications: