Macroeconomic determinants in credit risk measurement in transition country: Estonia

The banking sector holds the dominant position of the Estonian financial system, which is strongly integrated with the European financial markets. After the restoration of the independence in the beginning of 90-th the Estonia have suffered from at least two financial crises during last 20 years. Although these crises had different initial causes, common results of them should be constant revising and amendments of existing risk management policies providing respective credit risk management. Finding an appropriate credit risk model has become increasingly important for stability of the banking system.

We use a vector error correction model to investigate empirically and compare the influence of macroeconomic and real estate market variables on the level of non-performing loans in Estonia. A secondary goal is to analyze the effect of constant loan portfolio growth on the level of non-performing loans. The estimations are based on the aggregated quarterly data for the period from July 1997 up to December 2009 which is the longest available time series for Estonia.

The research indicates that the most significant reason for thegrowth of non-performing loans was caused by the changes in the real GDP. The increasing influence of rapid loan portfolio growth proves the assumption that banks’ credit risk management policies underestimated the changes in the macroeconomic variables during the analysed periods. Rapid growth of the real estate market played an important role, but it was not as crucial as it has been previously assumed.