Latvia Bank Failure Dashes Hopes

(page 2 of 2)

Parex was also vulnerable because of two loans put up jointly by more than 60 banks, worth 775 million euros, which will come due in 2009.

In the worsening financial environment, it was not clear that the bank would be able to roll them over, as it could have just a year ago, and doubts about its ability to repay the loans began to create anxiety both in the bank and among its larger foreign depositors. And when the Swedish government announced on 21 October that it would provide a large support package for its banks, local depositors in Latvia also had a much safer alternative to Parex, as the first and third largest banks in Latvia are subsidiaries of the Swedish banks Swedbank and SEB.

Parex started hemorrhaging cash. According to the Latvian bank regulator, in the six weeks before the government takeover the bank lost 240 million lats ($427 million) in deposits. In the first week of November its liquidity ratio (how much cash a bank has available to cover short-term liabilities such as deposits) was only slightly above the 30 percent minimum required for the bank to be considered solvent.

Parex, with more than 500,000 clients (in a country of 2.3 million) and assets close to 20 percent of the country's GDP, was manifestly too big to fail. So on 8 November the government stepped in and promised to inject 200 million lats into the bank and guarantee any loans the bank had to take out in order to restore liquidity.

SHAKEN CONFIDENCE

Domestically the government's move seems to have worked. The run on Parex leading up to the takeover had involved large depositors pulling their money out. The population as a whole was largely unaware of the potential problems at the bank and, to everyone's relief, reacted calmly to the government's Saturday night surprise.

The same cannot be said of international observers. With the government already struggling to control a budget deficit and the economy steadily worsening, in the following days Fitch and Standard and Poor's cut Latvia's credit rating and threatened further downgrades, potentially putting Latvia's bonds over the line separating investment grade from junk. The government is talking with the banking groups that lent the joint loans, hoping to convince them to roll them over, but the complex talks are not progressing quickly.

As a result, less than two weeks after taking over Parex, on 20 November, Latvia began negotiations with the International Monetary Fund on an aid package to preserve the stability of its financial system. The fiscal discipline that the IMF is sure to impose on the imploding state budget, while necessary, will increase the pain of a recession that started this summer and is expected to continue for most of next year.

It is more than a little ironic that this crisis has been given such a powerful push by the very business model that many saw as Latvia's road to rapid economic growth. Perhaps being closer than Switzerland is not such an advantage after all.

Provided by Transitions Online—Intelligent Eastern Europe