The first commercial banks in Latvia were established in 1988, just three years before regaining independence. In 1989, another four commercial banks were established. After the country received independence, the Bank of Latvia (the Central Bank), which was founded on August 31, 1990, started to issue new licenses.
Until 1993, the Bank of Latvia performed the functions of both the central and commercial bank, but then its commercial bank’s functions were terminated with privatization of its commercial branches.
In 1994, Dresdner Bank AG, Germany, became the first foreign bank which opened representative office in Latvia. The same year, the Bank of Latvia had to cancel licences for seven banks, and this revealed the necessity for more intensive bank supervision and for relevant amendments in legislation, which were introduced in 1995. International banking supervision standards were introduced, a new law on Credit Institutions was adopted, and the banks in Latvia were subjected to international audit.
That year, the Bank of Latvia cancelled licences of 15 commercial banks, and in 1996 of another 7 banks. Four of the top ten banks were closed, including the country’s largest bank, Banka Baltija.
It can be said that from 1992 to 1995 the bank sector developed more rapidly than the economy in the whole. Other factors that increased the existing high banking risks were the recession, the insufficient speed of economic reform and imperfect legislation. Also, the rapid introduction of international accounting, supervision and auditing standards created problems for some of the banks. Bank staff was insufficiently trained and experienced for the new conditions.
In 1997, the Bank of Latvia had to revoke the licences of two banks because of insolvency. The financial crisis in Russia in 1998 sufficiently affected the Latvian banking system. The sector experienced total losses of 102 million lats, two commercial banks went bankrupt, and one became insolvent.
At the same time, in 1998, two new laws came into force: one ‘On the Prevention of Legalisation of Money Received from Crime‘, the other ’On Guarantees for Deposits of Natural Persons.‘
In 1999, the banking sector overcame the negative influences of the Russian financial crisis. 19 of 24 banks ended the year with profit.
The year 2000 brought essential structural changes, due to which the number of banks was reduced from 24 to 22. The banking system stabilized, and then the Law on Financial and Capital market Commission was accepted.
2001 was the most successful year in the banking sector, when profits reached the record level of 46,7 million lats, assets increased by 28.2%, loans issued by commercial banks by 50.5%. In 2001, united supervision was introduced in Latvia, resulting in the Financial and Capital Market Commission which united the Credit Institutions Supervision Department of the Bank of Latvia, Latvia Insurance Supervision Inspectorate and Securities Market Commission of Latvia.
The thing that then happened with Latvia’s economy and banking system may be called overheating, the consumption was largely financed on credit, e.g. through mortgages on houses. Also, the global economic downturn has made a significant impact on Latvia’s economy since it began at the end of 2007. The crisis triggered the near failure and take-over by the state of Latvia’s largest domestically-owned bank, Parex Bank, and to intervention by the International Monetary Fund (IMF) in the form of €7.5 billion financial assistance package to Latvia, including funding from the EU, the World Bank, the European Bank for Reconstruction and Development and a number of Nordic and individual European countries.
A number of measures was undertaken aimed at stabilization of the Latvian banking industry in the crisis period. Legislation covering bank takeovers was adopted, and the Law on Credit Institutions was amended several times. Among other measures there were: an increase of credit institution’s capital, establishment of procedures for transfers of credit institution businesses, establishment of operational restrictions that the Financial and Capital Market Commission (FCMC) is entitled to impose on credit institutions, and imposition of restrictions on state-aided credit institutions.
The nationalisation procedure of Parex Bank at the end of 2008 showed the problem of an absence of regulations stipulating the conditions and procedures for bank takeover by the state. Being prompted by Latvian government, Latvia’s parliament (the Saeima) urgently adopted the Law on Bank Takeovers at the beginning of 2009. Currently the situation with the bank has stabilized, with the increased number of deposits.
Despite economic downturn, the main performance ratios of commercial banks have remained satisfactory in 2008. Banks’ assets have increased by 6%, the loan portfolio has increased by 11.2%. Resident deposits have increased by 8.7%, while deposits of non-residents have fallen significantly by 19.2%. During 2008 the liquidity indicator of the banking sector decreased slightly to 52.8%, compared to 55.7% at the end of 2007. At the end of 2008, the average capital adequacy ratio of the banking sector was 11.8% (12.6% at the beginning of the year) — well-above the minimum requirement of 8%. Due to the increase of expenses related to provisions and costs of funding, profitability of banks has plummeted considerably — by 79%.