Since the bursting of the credit market “bubble” in 2008 and the economic crisis, which in Latvia turned out to be one of the deepest in the world, bank lending has not fully recovered and remains at a very low level.
Banks have become extremely cautious in granting loans, avoiding even the smallest risk, which makes it difficult for companies to receive the funds necessary for the development of their activities.
Lending is weakening again
In the period from 2009, the share of domestic loans to the gross domestic product in Latvia decreased almost three times – in September 2022 it was 36%, which is the second weakest indicator among the eurozone countries, according to the information published by the Bank of Latvia. It is interesting that, since 2008, domestic loans of the giant in comparison to the previous year in Latvia started to grow slightly again only in 2016, but this growth has not remained stable, but has jumped like a “roller coaster”.
Already in 2018, a drop in issued loans was again observed (for companies it decreased to minus 1.5% in the month of April), while in May 2019 (for companies) it reached an increase of almost 6%. A deep decline followed again during the Covid-19 pandemic, reaching its lowest point in March 2022 (minus 8.1% for companies).
Since then, the pace of lending to companies increased rapidly, reaching a high growth of 10.4% in November last year, but experts predict that the trend is now turning in the opposite direction. The reason for this is the anti-inflation measure of the European Central Bank – the increase in credit interest rates, which makes lending significantly more expensive. The temporary recession of the economy and the general uncertainty of the macroeconomic environment in the cold winter and spring months also have an impact, according to the Bank of Latvia.
Commercial banks reject accusations of an overly conservative credit risk policy and claim that the companies themselves are not creditworthy. Some of them work in the “gray” economy sector, some lack own capital (as is known, the 2018 corporate income tax reform was introduced to solve this problem to a large extent, applying a 0% rate to reinvested profits) and business profitability, as well as potential borrowers not being able to submit business forecasts and a clear development plan.
Losing 3.2% of GDP growth
The lack of credit has a very negative impact on companies’ opportunities to develop, and experts consider it one of the main reasons for Latvia’s lagging behind Lithuania and Estonia (although there, especially in Lithuania, the situation with business lending is not at all bright and lags behind the average lending rates in the Eurozone).
Already in 2019, the Bank of Latvia has calculated that business lending in Latvia lags behind the Baltic neighboring countries by about 14%, while investments in the private business sector in Latvia would have been at least 10% higher over a four-year period, if lending were at least similar to the indicators of Lithuania and Estonia, not to mention the Eurozone . Experts have also carried out simulations that show that due to lower lending (compared to the Baltic neighbors) Latvia has lost at least 3.2% of GDP growth over a four-year period, or 0.8% per year.
Companies’ need for loans, especially short-term loans, is only growing in the current conditions. Companies need short-term financing for the provision of working capital, which has been facilitated by the rapid increase in the prices of energy resources. This facilitates the use of overdraft loans and credit line services.
Ability to access money faster
In this situation, a relatively little-known alternative in Latvia is the issuance of financing against the unpaid invoices of the company’s customers, or factoring. This mechanism solves a number of problems related to the risks of traditional lending, because essentially every financing already has a secure pledge – an expectedly payable invoice from a verified customer – and this pledge is additionally insured through insurance companies.
The Competition Council has also noted that “services provided by supply chain financing platforms are becoming more and more popular among suppliers and buyers, which offer to provide a convenient and operational invoice payment system using various invoice financing mechanisms, such as factoring, reverse factoring, invoice discounting, receivables financing etc. In addition, in the assessment of the Competition Council, this type of financing mechanism “offers distinct advantages for all participants.” While suppliers get faster access to cash, merchants have more time to pay off their balances. Both parties can use the money for other projects to ensure that their respective operations run smoothly.”
Unfortunately, Latvian businessmen also receive significantly less factoring financing than their colleagues in the Baltic neighboring countries – approximately, the proportion is two times smaller than in Estonia and almost three times smaller than in Lithuania. In this case, the entrepreneurs themselves are responsible, who apparently are not sufficiently informed and therefore do not actively use this opportunity. On the other hand, elsewhere in Europe, entrepreneurs are more knowledgeable and more actively exchange the inertness of traditional lenders for flexible invoice financing options.
