Unlike most central European countries, local and regional banks dominate the Baltic and Nordic banking markets, as no large global players have entered this region. Baltic countries have been a natural choice for Nordic banks to carry out their extension plans and today Swedish or other Nordic banks own a vast majority of Baltic banks.
The Baltic banking scene is also rather concentrated in terms of business volumes. The two largest banking groups – subsidiaries of Swedbank (Hansabank) and SEB – collectively account for about 75% of lending market share in Estonia, 50% in Latvia and 60% in Lithuania, respectively. Despite the strength of dominant players, the competition is fierce among banks in both the retail and corporate sector, which results in competitive pricing and favourable terms for clients.
Cash Management in the Baltic countries
Today, many multinational companies are looking at the Nordic-Baltic region as one marketplace. Local companies expanding into other Baltic and Nordic countries are also following this trend. Companies are striving to concentrate their suppliers and service providers and also expect banks to offer more integrated cross-border services.
The Nordic ownership of Baltic banks has naturally supported the development of joint Nordic-Baltic service offerings in the region. Implementing cross-border servicing models, developing cross-border cash management products and electronic channels has been a focus for many of the previous ‘local’ banks for some time already. Large corporate treasuries are usually provided with a single contact person by the banks on the pan-Baltic level, or in the case of Nordic banks on the Nordic-Baltic level – a ‘group relationship manager’ to coordinate servicing their needs within the banking group in all countries.
Both theory and best practice say that centralisation of cash management and banking relationships makes sense and helps keep costs down. However, if we look at the Baltic and even at the wider Baltic-Nordic markets we see this might not be true.
Currency
The first complication when thinking about regional cash management in the Baltic countries is currency. Unfortunately (from the treasurer’s perspective) each Baltic country uses a different local currency, albeit Estonian kroon and Lithuanian litas are pegged to the euro at a fixed rate and Latvian lat only has very narrow (+/- 1%) fluctuation band from the euro. Adding in the four currencies of the Nordic countries and we end up managing seven different currencies in our cash pool!
Although all Baltic currencies have joined ERM-2 and exhibit disciplined state finances with large budget surpluses, the adoption of the euro is not estimated to happen before 2010. Lithuania came very close to adopting the euro in 2006, however, the country narrowly missed the target for the Maastricht inflation rate criteria. The economies of Baltic countries have been growing at an unbelievable pace over the past two years (10-11% in Latvia and Estonia, 7-8% in Lithuania). Consequential high inflation rates in all countries make it unlikely that euro adoption can take place before gradual slow-down in GDP growth rates.
Size of the Economy
The three Baltic economies, even when combined, are very small. With the population of about 7 million – compared to around 24 million in the neighbouring Nordic countries, the business volumes are much smaller. This means that Baltic countries are usually the last to be added to the pan-Nordic or pan-European cash pools – because their addition would have the least impact.
Extensive Product Offering of Local Banks
The Baltic banking market has developed very rapidly despite its relatively short history, both in terms of banks’ product offering and modern technological infrastructure. One of the positive side-effects of the banks’ late start was that some of the products or development phases were skipped altogether. For example, paper-based instruments such as cheques almost never existed, and today over 98% of the payments in Estonia are handled through electronic channels.
The intense competition among only a few banks has encouraged banks to develop a wide variety of client-friendly solutions, which are bound to satisfy the banking needs of most sophisticated corporate clients. The main cash management products available in the Baltic countries include:
- Account types – Bank accounts in the Baltics are usually multi-currency accounts, enabling easier management of currencies within one bank. Both residents and non-residents can open accounts after submitting the required documents – it usually takes just a few days. IBAN and BIC are supported as domestic account number standards in Latvia and Lithuania, while Estonia allows for parallel use of local and single euro payments area (SEPA) account number standards.
- Domestic payments and collections – Clearing of domestic payments is done through local clearing centres, where clearing takes place several times a day and all funds move with same-day value, as the banks take no float on domestic payments in any of the Baltic countries. In Estonia, for example, the central bank clears low-value local payments nine times a day. As a result, there is almost no difference to how many banks a company uses – a payment from one bank to another takes around one hour. Payments within one bank move even faster, often close to real-time. The pricing is competitive compared to many western European countries, with intra-bank payments costing about €0.10 and domestic payments around €0.35.With extremely fast and efficient domestic payment markets, the Baltic banks are also well positioned to face requirements from the single euro payments area (SEPA).Various collection solutions are available from local banks to handle domestic receivables, such as e-billing, POS terminals and direct debits. Usage of card payments is becoming more popular, with card turnovers growing at a pace of 40-60% per annum and share of cash in the economy declining steadily, especially in Estonia.
- International payments – ‘EU payments’ (SEPA compliant payments for amounts under €50,000) are available in all Baltic countries at a significantly lower price than ordinary international payments. International payments from one Baltic country to another, inside one banking group, can be done in a few hours. As most local banks belong to larger Nordic banking groups similarly favourable conditions on intra-group payments to Nordic countries are offered as well. Typically, these payments cost around €1-3 and are credited to the beneficiary with same day value.
- Electronic channels – Historically, both the Internet banking solutions (mainly for SMEs and private clients) as well as PC based banking programmes (mainly for corporate clients with large transaction volumes) are available. Today, over 95% of the payment traffic is conducted through electronic channels in all countries. Most banks also support balance reporting and transaction initiation via SWIFT, a preferred choice for many global and regional corporate treasury centres for gaining an overview and control over the group’s liquidity.Recently some banks have started offering STP solutions that enable automatic connection between clients’ ERP and bank systems (bank-for-business solutions). The use of automatic channels is a new thing in the market and to date only a few clients have implemented such connections, however in the future such seamless data interchange is expected to become a market standard for large corporate clients.
- Cash pooling – All large Baltic banks offer their clients cash pooling products for local liquidity management. Local cash pools usually support both notional pooling (balance netting), as well as zero- and target balancing functionality. Local cash pools can be managed by a client’s treasury via e-banking solutions (internet-bank and PC banking), which support intra-company interest allocation and limit setting, as well as complementary reporting.Cross-border notional pooling is complicated due to differences in legal and tax regulation of the three countries (see below), as well as different currencies. Only a few banks offer cross-border multi-currency interest compensation schemes for the benefit of their multinational clients, which provide rebate on interest margins already paid to the bank on the client group’s offsetting negative and positive balances in different countries.Cash concentration is also a popular method for cross-border liquidity management, facilitated by online transaction and balance reporting via e-banking tools, as well as cheap and fast cross-border sweeping transactions available within the same banking group.
Legal and Taxation Issues
In general, the Baltic countries have enjoyed a rather liberal legal environment, which has supported development of the banks’ offering and growth of their business over the past decade. There have been very few restrictions on the free flow of capital and on any new products the banks have launched (this does not mean that banks lacked strong supervision). With the EU accession in 2004, the Baltic legal framework today is very much in line with EU standards.
However, the Baltic countries still have a different legal and tax environment when it comes to cross-border lending and cash pooling. In Estonia, interest paid to both residents and non-residents by residents is exempt from withholding tax, provided that an arm’s length principle is adhered to in pricing. Latvia and Lithuania were granted a transitional period for implementing the EU Interest and Royalties Directive, which abolished withholding tax on intra-group lending. Latvia still imposes withholding tax of 10% for interest payments between related parties until 2008, to be reduced to 5% thereafter until 2013. In Lithuania, interest paid to non-residents by residents is subject to 10% withholding tax. Lending between related parties is subject to 10% withholding tax until 2008, and 5% thereafter until 2010. Double taxation treaties could reduce these tax rates where applicable.
Conclusion
Many multinational companies have found that local or regional banks can offer the best fit between the banking needs of their subsidiaries and global or regional treasury centres for the Baltic region.
A combination of strong local presence and local service with an extensive range of banking products help to fulfil the needs of local companies. Meanwhile cross-border reporting and consolidation tools required by corporate treasuries are available via high-quality e-banking solutions, thus enabling customers to integrate the Baltics in their global liquidity management schemes or cash pools with larger global banks. A single contact person is often available to manage the banking relationship and cater to the needs of the company covering the whole region. All this helps companies achieve the most effective cash management in the Baltic countries.