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May 8 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings says that the banking sector risks in Latvia (BBB/Positive) are fundamentally different to those facing Cyprus (B/RWN) before its bail-out. However, the Cyprus fallout has raised the risks on Latvia's bid for euro accession in January 2014 amid a fluid political environment in Europe. Nonetheless, Fitch's base expectation remains that Latvia will be invited to join the euro area in January 2014.
Recent events in Cyprus following the decision to bail-in uninsured depositors have drawn attention to Latvia, given the high reliance of its banking sector on non-resident deposits. We believe that euro entry remains Latvia's overriding aim and the country will therefore be prepared to undertake targeted structural reforms to contain excessive future foreign capital flows into its banking system and perhaps submit to additional conditionality. These reforms may range from measures to tame banks' appetite for non-resident business to others reducing Latvia's attractiveness as a banking hub.
When we upgraded Latvia's FC IDR to 'BBB'/Positive in November 2012, we noted that persistent increases in non-resident deposits could exert downward pressure on Latvia's sovereign ratings, as they would render banks vulnerable to a liquidity shock in the event of a sudden deposit outflow. Non-resident deposits -predominantly from Russian beneficiaries - account for 49% of total deposits (higher than Cyprus's 37%) and are concentrated among domestic banks. In context though, non-resident deposits are only 40% of GDP in Latvia compared with about 140% of GDP in Cyprus.
Despite rapid private sector deleveraging since 2008, Latvia had the highest loan-to-deposit ratio in Emerging Europe and the second highest among Fitch-rated global sovereigns in 2012 at 196% (compared with 123% in Cyprus). Nevertheless, at 1.3x GDP, Latvia's banking sector is much smaller than Cyprus's (6.7x GDP) and the Latvian economy is less reliant on the financial services sector, which accounts for 3.5% of GDP compared with 9% in Cyprus.
Fitch believes that in case of need, the government of Latvia would support the domestic banks that are systemically important. We estimate their assets at 35% of GDP. We also expect that foreign-owned banks (two thirds of the sector) will absolve the sovereign from material contingent liabilities, as was seen in the Baltic crisis of 2008-2009.
'Latvia and Cyprus: Banking on a Different Scale' is available at www.fitchratings.com or by clicking on the link above. The report compares and contrasts Cyprus and Latvia with a focus on their banking systems' fundamental characteristics, vulnerabilities and capacity to inflict damage on the sovereign balance sheet.
Link to Fitch Ratings' Report: Latvia and Cyprus: Banking on a Different Scale