Bank of Latvia cuts reserve requirements

On Thursday, Bank of Latvia cut the reserve requirements for Latvian commercial banks from 8% to 7%.

As I've written before, Latvia's monetary policy is largerly controlled by Scandinavian banks which own most of the banking sector in Latvia. In most countries, the central bank controls the monetary policy by raising interest rates (if the economy is overheating) or lowering them (if the economy is going into a recession). In Latvia, with the lat/euro exchange rate fixed, banks can borrow euros from abroad and this effectively sets the interest rates.

During the credit boom of 2005-2007, Bank of Latvia saw that there was too much credit handed out but there was nothing that they could do. Raising interest rates on lat loans just pushed people into taking loans in euros. Then, Bank of Latvia tried requiring banks to keep more money as reserves... which did not work, either.

Now, the situation has reversed. The major Latvian banks are cutting down on new loans in a major way. The Bank of Latvia thinks that the cutbacks are too big and will hurt the economy too much but what they can do? Decreasing the reserve requirements is about the only thing. It will free about 50 million of lats (70 mln euros) which banks had to keep as reserves but will it be enough.

The financial world is increasingly unhappy about what happened in Latvia during the lending boom and Moody's rating agency has cut the credit ratings of both Swedbank and its Baltic subsidiary Hansabank (the biggest bank in both Latvia and Estonia). The possible implication is that Hansabank&Co might not too do much new lending in months to come.

Developing...