EU banking union and the Lithuanian banking system

May 2014 | EXPERT BRIEFING | BANKING & FINANCE

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The Lithuanian banking sector plays a significant role in the financial market of the Republic of Lithuania. Lithuania has seven active commercial banks, eight branches and two representative offices of foreign banks. Currently 277 banks of the EU provide services on a cross-border basis. Banks in Lithuania are primarily universal in the sense that they provide a wide range of financial services. Even though Lithuania experienced failures of two non-systemic banks in 2011 and 2013, these events did not affect the stability of the entire banking sector. In 2011, Snoras bank, the third largest bank by deposits and the fifth largest by assets at that time, was declared bankrupt. Lithuanian policymakers made changes to the local laws to allow the bank to be split into a good bank and a bad bank. However, this strategy was not applied as Snoras bank was not liquid enough for the split to make sense. The good bank-bad bank technique was used in 2013 to resolve the failure of Ukio Bankas, the sixth largest Lithuanian bank at the time, with the part of its assets transferred to another bank.

The regulatory and supervisory actions taken by Lithuanian competitive authorities to deal with the failures have been successful and have been praised by the International Monetary Fund, as well as the main credit rating agencies. The supervision function was also improved dramatically in 2012 by merging the supervisory institutions of the financial market into one main supervisory authority – the Bank of Lithuania. Since the beginning of 2012 the Bank of Lithuania has been supervising all commercial banks, other credit and payment institutions, as well as the securities and insurance markets in Lithuania. The Bank of Lithuania is vested with the power to perform micro-prudential and macro-prudential supervision functions. In the process of resolving the failures of both banks, depositors and investors could rely on the efficient deposit insurance scheme, implemented pursuant to the Directives of the EU. The insurance scheme in Lithuania allows for compensation of deposits in Lithuanian Litas and in designated foreign currency, and repayment of securities irrespective of their denomination or cash in any currency.

Therefore, although Lithuania is doing quite well on its own in dealing with banking sector tremors, the anticipated introduction of the euro and participation in the banking union is a highly sought goal that would further strengthen and improve the supervisory and regulatory environment, resolution mechanisms, as well as transparency and public opinion.

Financial fragmentation due to the segregation of financial markets has plagued the eurozone since the beginning of the financial crisis in 2008. In addition to the evident structural differences, varied supervision, safeguard mechanisms and regulatory barriers to cross-border cash flow have been implemented throughout the EU with the aim of preventing any further financial crises. Even though the euro system cannot by itself solve the issue of fragmented markets, it can propose a solution to foster integration through common bank supervision and resolution mechanism. This is where the banking union comes in efforts to minimise the use of public funds, and ‘unionise’ the European procedures regarding supervision, resolution of banking crises and, in the long run, the proposed uniform protection of depositors’ interests by way of a common deposit guarantee scheme.

Lithuania belongs to the Nordic-Baltic banking region, a regionally integrated market. More than two-thirds of the registered share capital in the Lithuanian banking sector consists of foreign capital, which is mainly of Scandinavian origin. The structure of Lithuania’s banking sector is unlikely to change in the foreseeable future. Though some of the countries in which banks are based are in the eurozone and will be in the banking union, some have expressed their wish not to participate. As a result, the three – Scandinavian financial groups active in Lithuania – SEB, DNB and Swedbank – will be directly supervised by the European Central Bank with the remaining banks and branches of the aforementioned banks to be supervised by the local authority, the Bank of Lithuania. It is therefore important to clearly distinguish between the powers vested with the European Central Bank and the local authorities. Also, even though the adopted single supervisory mechanism is a solution for uniform supervision throughout the eurozone, non-euro countries should not be neglected if we are to achieve the all-encompassing goal of harmonisation.

If accepted into the eurozone the banking sector of Lithuania will undoubtedly welcome the many advantages the first (single supervisory mechanism) and the second (single resolution mechanism) pillars of the banking union have to offer, as well as the enormous effort put into solving the financial market fragmentation in the context of the euro system as a whole . These include the single rule book to be adhered to by all banks in the eurozone, harmonised supervisory standards, and the resolution mechanism meant to move the burden of saving ailing banks from taxpayers to the shareholders and creditors. Though the picture of the single deposit insurance scheme is still vague, it is commendable to see that EU policymakers are eager to push this instrument forward.

Given the specific nature of the structure of the Lithuanian banking sector, even in the wake of the banking union, close ties and joint supervisory strategies between banking union members and non-members should continue in order to ensure that the local authorities (which are usually in the most favourable position to detect and assess local risk factors) can, in cooperation with the European Central Bank, effectively supervise and prevent future bank failures.

Šarūnas Basijokas is an associate at Dominas & Partners. Mr Basijokas can be contacted on + 370 5 232 1111 or by email: s.basijokas@dominas.lt

Šarūnas Basijokas

Dominas & Partners