“May you live in interesting times.” This phrase is usually attributed to Confucius, but we will never know whether he said it. However, we have learned what it is like to live in times of change when humanity experiences one unprecedented crisis after another brought about by the Covid-19 pandemic, the war in Ukraine instigated by the Russian Federation, disruptions in energy and logistics, and rising inflation. We discussed with Sandis Kapitonovs, the Head of the Treasury Department of LPB Bank, how this situation affects the banking sector and what awaits us soon in the financial markets.
What is the current situation in the financial markets, and are apparent future trends emerging?
The main problem in the financial market is still inflation, and this problem is just as relevant this year as it was last year. This year, it can be observed that inflation is decreasing in developed countries, but it is still sufficiently high. The annual inflation in Latvia is still higher than in other Eurozone countries, mainly due to the rising cost of energy resources and external circumstances. The average inflation level in the Eurozone in April this year was 7%, which is significantly less compared to previous months when this indicator was close to 9%. Gas prices, the main reason for the price jump last year, have been showing a downward trend for several months and have reached pre-war levels in Europe. However, the reduction of inflation, thanks to the influence of external events will most likely be observed only in the middle of this year in Latvia, as the impact of energy resources and other external circumstances, primarily related to price reduction, is often observed with a delay. Both in Europe and Latvia, high inflation will remain, and in the winter period, it may again show an increase, but no longer as sharp as in 2021.
Of course, the question arises as to why inflation is so high. The initial cause can be traced back to the fact that the Central Bank’s stimulus to the economy was too long and aggressive. In the Eurozone, a negative interest rate has existed since 2014, thus providing the banking system and businesses with very cheap money resources, which vastly stimulated asset growth rather than economic growth, later negatively affected by Covid-19. Hindered goods delivery, which limited the availability of certain goods, caused an additional price increase. Then the war began, leading to a rise in energy prices, which affected the increase in consumer goods prices. The next aspect is the increasing military expenditures of countries, financed mainly at the expense of debt.
The bad news is that money printing is still used to combat inflation. For example, heating price increases are compensated by benefits, electricity costs are compensated by various targeted supplements, and wages are raised. Compensating costs with even more money printing cannot reduce inflation in the long term.
How long, in your opinion, could the rise in inflation continue?
The rise in inflation has been stopped. The question is, will it be sustainable? The actions of the central banks, raising interest rates, give hope. Still, raising rates is no less painful for consumers than inflation, as loan and leasing payments increase and less money is left for every day and other expenses, which is also the “system’s” goal of reducing inflation.
How has high inflation affected the operations of LPB Bank and the banking sector?
LPB Bank actively follows global economic events and the policy of central banks. The bank’s actions are prompt and in line with the policy implemented by the European Central Bank (ECB). Of course, the negative effect is that lending becomes more expensive. This can be observed throughout the commercial banking market. At the same time, with higher interest rates, the investment market becomes more interesting. The potential return on fixed-income investments (bonds, deposits) is already higher than last year, and currently, you can earn more with relatively low risk. The only note is that the return on fixed-income financial instruments will still be lower than the current inflation for most safe instruments. Why so? Because the ECB refinancing rate, despite the fastest rate hike in history, is approximately twice as low as inflation.
It should be noted that LPB Bank primarily focuses on e-commerce and FinTech services. However, even traditional banking services are sufficiently developed and working successfully. This business model allows the bank to remain stable despite crises, as the e-commerce service has a fixed commission fee rather than interest income. Another guarantee of stability is quality investments in financial instruments and diversified loans to customers when, with rising market rates, interest income from loans increases. We are confident that e-commerce will continue to develop worldwide, further enhancing our advantages over competitors.
In general, the task of banks during a crisis is to balance their asset and liability base, not lose the ability to earn in changing market conditions and adapt to new industry regulations (for example, it is known that Latvia had and has a stringent AML policy). As a result of macroeconomic events, as interest rates and inflation increase, the costs for borrowers significantly increase, affecting the solvency of Latvian borrowers. It should be considered that the cost of resources for banks also increases. If commercial banks could borrow funds from the Bank of Latvia ten years ago at a rate of 0%, now, this rate is 4%, and it is likely to increase even further.
How has client behaviour changed in the last year?
If we talk about lending, then in general, clients in Latvia are cautious when taking out loans. Historically, the risk-taking among Latvian residents is much lower than in other Baltic countries. This is also reflected in the credit statistics: Estonia and Lithuania issue more loans than Latvia. This is undoubtedly associated with the structure of individual income, business, and risk-taking. Our country’s business activity is also lower than in neighbouring countries. When evaluating credit projects, banks in Latvia mainly refuse to issue a loan, as one needs more collateral, and another’s projects seem challenging to implement and risky; therefore, the banks prefer to lend to those companies that could comfortably operate without a loan, who in actuality do not have a pressing need for a loan.
What trends can we expect in the banking sector and financial markets?
We are caught in a time of change. However, looking forward, I harbour optimism that we will overcome the challenges. Money will still be the force that propels the world forward – people will want to earn and live better, build higher houses, and buy newer cars. I hope we continue to develop and work together to create better opportunities and fulfil our dreams of a better future. In the future, I see several trends that will affect the banking and financial sector:
- Technology companies and the industry will continue to be growth leaders in financial markets as the digital economy and technology services continue to grow. Banks are also actively working on digital transformation, including developing new digital and remote services, using artificial intelligence and adapting to customer needs. This process is happening rapidly, and the digital presence of banks will continue to become increasingly important in the financial sector;
- The cryptocurrency market, including Bitcoin, Ethereum, and other alternative currency markets, will continue to grow as more and more investors and institutional players see it as a prospective investment;
- Several countries have begun to put forward the idea of transitioning to digital currency and abandoning cash. Such a transition could have advantages such as faster payment execution and more efficient tax collection. However, like any transition process, it can also create some problems, for example, in the security and privacy of digital currencies. Moreover, if a country introduced a digital currency, it could pose challenges to international trade relations and exchange rates;
- In connection with climate change and growing interest in environmental protection, the green technology and renewable energy sector will continue to grow. Banks also pay more attention to their client’s business strategies and are ready to lend to companies that implement ESG policies and actively follow the green course. Thus, companies working on environmental and climate protection and business sustainability will be able to receive financial support from banks on better terms.