How are the mottle-yet-intertwined adversities impacting Latvia’s financial system and the central bank? Has Latvia improved its reputation in the eyes of the US Treasury which has scolded the Baltic State on several occasions? Have Latvians become poorer or richer over the last couple of years? The Baltic Times Magazine sat down to speak with Mr. Martins Kazaks, the current Governor of Latvijas Banka, the country’s central bank.

Amid the war, the energy crises and the latest turmoil in the US banking sector, how do you assess the viability of Latvia’s banking system? What makes you confident about it? And are there any concerns you have about it?

The events of 2007-2008 with Lehman Brothers were a bitter lesson for Europe and Latvia as well. Since then, a lot has been done to improve resiliency - the European banking sector is much stronger than 15 years ago, new institutions have been set up, it is better managed, liquidity is ample, and reserves have been established for various emergencies. The so-called Basel requirements operate in the European Union, serving as a global supervision standard, and are applied to the entire banking sector, not just the largest banks. Accordingly, all banks are subject to closer supervision, and their risk management meets uniform criteria. Of course, ECB has multiple instruments at its disposal and will intervene, e. g., to provide liquidity, if it is necessary and appropriate to do so.

Specifically, regarding Latvia, our bank profitability is good, their liquidity and capital indicators are higher than the European Union average. Our banking system is strong and resilient to weather shocks if and when they come.

Overall, the situation in the euro zone is good and controlled, but of course, attention must not be lost. Uncertainly remains high and one must be vigilant.

As for the Russia’s initiated war in Ukraine, it has a very little if any impact on the Latvian financial sector, and the reason is the vast progress made since 2018, reforming the industry, making it transparent and compliant with the highest AML standards.

In general, the impact of the war on Latvia’s economy is a topic that my colleagues - the economists of Latvijas Banka - have addressed in detail. The analysis shows that Latvia’s economy has grown half as slowly as it was predicted on the eve of the war, but commodity and service prices are about a fifth higher. Of course, it is no cost compared to what the Ukrainian people are experiencing. Each of us should provide all assistance possible to Ukrainians in their fight against aggressors.

The Latvian banking system has been in eyes of the US Treasury for alleged money laundering and illicit payments. Has the page been turned over and the stain on Latvian financial system been wiped clean?

A great job has been done in the field of AML, improving the culture and understanding of money laundering prevention and implementation. It is now at a very high standard. Our financial sector has been transformed over the last years in accordance with the highest AML standards. The war started by Russia was a good reminder that this is an ongoing process that continues.

High AML standards should be hygiene for financial markets. It’s like dirty hands - they’re either clean or dirty. And you don’t sit at the table with dirty hands.

Judging by the savings, did Latvians become richer or poorer over the last three years?

This March marks three years since we have been living in constant turbulence - not just in Latvia, Europe, but all over the world. This seems to be an unprecedented situation where one crisis is replaced by another of such magnitude. Just when it seemed like we had successfully weathered the Covid-19 pandemic and would return to our usual lives, Russia’s decision to start a war sent inflation through the roof.

Our participation in the euro zone and access to low-interest rates provided the government with an opportunity to provide significant support during these crises. Unlike in 2008-2009, the government had the opportunity to provide various support activities to compensate companies for operational restrictions, as well as to help individuals and the economy as a whole by mitigating the high cost of energy resources.

Of course, this has been a challenging time for everyone. During the pandemic, ample fiscal support was provided and there were not many opportunities for people to spend their money, so savings increased. Yet, for some sectors, the pandemic sharply cut jobs and incomes. With the war and ensuing inflation, many are forced to spend their savings. While the overall stock of savings has risen considerably, the recent upswing in inflation has reduced its real value.

While the economy has weathered the crises quite well, the risk is that inequality may have increased, which may have a detrimental effect on long term growth. So, structural changes to improve growth are as needed as ever, namely, better education and skills, and a better healthcare system and health outcomes among many other challenges.

Are high mortgage rates now a strain for new homeowners in Latvia? How many Latvians defaulted on mortgage payments last year? Will Euribor stop increasing?

Why do central banks raise interest rates? Our aim is to bring down inflation and prevent high inflation from rooting in. Headline inflation has turned, but measures of underlying inflation remain sticky and higher interest rates will be necessary to bring inflation down to our euro area target of two percent. Unfortunately, this also means raising interest rates and higher rates for borrowers. But the overall cost of high inflation rooting in for the society is considerably bigger than the impact of higher interest rates.

Over the past decade bank lending has been weak and now stands at only 28% of GDP while the euro area average is closer to 90%. Weak lending in the past means that the impact on the Latvian economy from rate increases is contained and muted. Of course, servicing existing loans and taking out new loans has become more costly. Yet the cost from high inflation is much bigger and the society would lose out more if inflation was to stay elevated for long. Resilience of borrowers is strong, non-performing loans are at low levels and do not cause challenges to the health and resilience of our banking system.