The 2008 financial crises in the Baltic countries

This paper covers the banking crises in Estonia, Latvia and Lithuania around 2008, financial authorities' responses and the ensuing structural changes in the countries' banking sectors. The paper describes how, pre-crisis, financial imbalances built up in the Baltic countries due to a credit boom that was made possible largely by the entry of foreign banks into the newly opened Baltic economies. These imbalances became harder to manage once banks came under stress during the Great Financial Crisis. The paper discusses how the footprint of foreign banks and the commitment to retain the currency peg framed authorities' options for managing the crisis. In the end, foreign banks maintained their presence with a revised, more deposit-based funding model, while authorities, in addition to restructuring some failed domestic banks, opted for an internal rather than external devaluation. The paper highlights some general lessons for bank crisis management that may be especially relevant for small, open economies with a large presence of foreign banks.

JEL classification: E58, E63, G21, G28, G33

Keywords: internal devaluation, peg, foreign banks, guarantees, default, swap lines