Estonia, a small Baltic nation with a strong digital infrastructure, has become a hub for international banking operations. However, bank failure remains a concern for international creditors who fear losing money. Estonia’s banking sector operates under the supervision of the Estonian Financial Supervision Authority (EFSA), guided by the Credit Institutions Act. The Act governs the licensing, regulation, and supervision of credit institutions, including provisions for bank failures. Estonia, as an EU member, also adheres to the EU’s Bank Recovery and Resolution Directive (BRRD), which outlines the framework for dealing with failing banks.
In Estonia, a bank is considered to have failed or is likely to fail if it no longer meets the minimum capital requirements or becomes insolvent. The EFSA, in cooperation with the European Central Bank (ECB), monitors and assesses the financial stability and risk factors of banks. They can declare a bank’s failure if it is unable to pay its debts, has insufficient assets to cover its liabilities, or requires extraordinary public financial support.
The EFSA is the primary bank supervisor in Estonia, responsible for ensuring financial stability and supervising compliance with regulatory requirements. Its legal mandate is to protect the interests of depositors, investors, and consumers. In the case of a bank failure, the EFSA works closely with the ECB, following the BRRD framework and national regulations to determine the appropriate course of action.
When a bank failure is concluded, the EFSA and ECB initiate a resolution process that aims to maintain the bank’s critical functions while minimizing losses for creditors. Common reasons for bank failure in Estonia include poor management, inadequate risk management, insufficient capital, and fraud. For example, the 2019 closure of Versobank AS, primarily due to AML/CFT violations, demonstrates the significance of adhering to regulatory requirements.
The scandal surrounding Danske Bank Estonia and the failure of Verso Bank differ in the scope, nature, and impact of their respective issues. Danske Bank Estonia, the local subsidiary of the Danish financial institution, was embroiled in a massive money laundering scandal, which involved the processing of approximately €200 billion of suspicious transactions between 2007 and 2015. The scale of the Danske Bank scandal made it one of the largest money laundering cases in European history, resulting in significant reputational damage to the bank, regulatory fines, and increased scrutiny on the entire European banking system regarding anti-money laundering (AML) compliance.
In contrast, the failure of Verso Bank, a smaller Estonian financial institution, was primarily due to violations of anti-money laundering and combating the financing of terrorism (AML/CFT) regulations, as well as other shortcomings in risk management and governance practices. While both cases involve violations of AML/CFT regulations, the Verso Bank case was more confined in scale and did not involve the magnitude of illicit transactions seen in the Danske Bank scandal. Consequently, the EFSA withdrew Verso Bank’s operating license in 2018 and initiated liquidation proceedings, leading to the bank’s closure. While the Danske Bank scandal exposed systemic weaknesses in the European AML/CFT framework, the Verso Bank failure highlighted the importance of robust risk management and regulatory compliance for the stability of individual financial institutions.
In Estonia, bank supervision and resolution planning involve regular assessments of banks’ financial health, risk management strategies, and recovery plans. The EFSA ensures that banks maintain adequate capital and liquidity buffers and follow effective governance practices to prevent financial distress. Moreover, the resolution planning process focuses on preserving the critical functions of a bank and ensuring the continuation of the organization. When a bank fails, the EFSA, as the resolution authority, follows a series of steps:
- Declaration of bank failure: In collaboration with the ECB, the EFSA declares the bank’s failure based on objective criteria.
- Resolution planning: The EFSA prepares a resolution plan, considering the bank’s unique characteristics and systemic importance.
- Implement resolution tools: The plan may include reorganization, recapitalization, restructuring, or dissolution of the failed bank, using tools like the sale of the business, bridge bank, and asset separation.
Estonian law safeguards account deposits and creditor interests through the Deposit Guarantee Scheme (DGS), which guarantees deposits up to €100,000 per depositor per institution. The DGS ensures that depositors have access to their funds in the event of a bank failure, providing stability and confidence in the Estonian banking system. In addition to the DGS, creditors are protected by the principle of “no creditor worse off than in liquidation,” which ensures that they do not suffer greater losses during the resolution process than they would have in the case of bankruptcy.
Estonia’s regulatory framework emphasizes the orderly exit of non-viable firms from the market to maintain financial stability. The EFSA, in cooperation with the ECB, monitors banks for early signs of financial distress and intervenes when necessary. The BRRD provides a comprehensive set of tools and procedures to manage the exit of non-viable banks while minimizing negative impacts on the financial system.
In cases where the resolution process is deemed inappropriate or unfeasible, Estonian law provides for bank liquidation through insolvency proceedings. The liquidation process follows a defined hierarchy of claims, prioritizing secured creditors, depositors, and unsecured creditors. The liquidator, usually appointed by the court, is responsible for selling the bank’s assets and distributing the proceeds according to the hierarchy.
Estonia’s banking laws and regulations provide a robust framework for addressing bank failures and protecting the interests of international creditors. While risks of bank failure exist, the EFSA’s supervision, resolution planning, and the availability of the Deposit Guarantee Scheme offer reassurance to depositors and investors. By understanding the legal framework and taking appropriate steps, account holders can safeguard their position and minimize the impact of bank failures in Estonia.