Steve Roman in Tallinn -

When Finnish lender Pohjola Bank announced in late June that it was opening a branch office to serve corporate customers in Estonia, international commentators quickly pointed to recovering Baltic markets as the reason for the move. But the real drivers were a banking sector shake-up and fundamental changes in the economy, insiders say.

There's no doubt that the economic recovery is genuinely lifting Estonia's banks out of the loan-loss doldrums that made so many headlines during the crisis. Local market leaders Swedbank and Skandinaviska Enskilda Banken (SEB) both returned to profit last year after a harrowing 2009. In early July, Fitch Ratings bumped up Estonia's long-term credit ratings from 'A' to 'A+', citing signs of increased stabilisation in the banking sector, specifically declining risks and a net profit of €70.5m for 2010.

And the process appears to be accelerating. In the first quarter of 2011 alone, the sector turned in €74m in profits, more than all of last year, the Bank of Estonia said.

Even with this level of recovery, however, Pohjola's plan, on the surface at least, seems bold given the dominance in Estonia of Swedbank and SEB.

Small steps

Pohjola's branch office in Tallinn will start by providing payment and liquidity management, working capital and investment financing, with more services to be added to the menu in coming months. The bank will open similar branches in Latvia and Lithuania by the end of 2012.

With such well-established, deeply entrenched giants roaming the Estonian banking landscape, not to mention other strong Nordic competitors such as Sampo and Nordea, one would wonder how Pohjola hopes to succeed.

Part of the answer is that Pohjola already has its own niche - it will start by serving its existing Finnish client base, mid-sized to large companies hoping to do more business in a nation many see as their own back yard. But more than that, the region's banking sector is ripe for expansion, according to Pohjola's senior executive vice president for banking, Reima Rytsaola. "It's not as saturated as you might expect," Rytsola tells bne. "Even though there are good, decent banks operating in the Baltic markets, it still seems so that there are some kind of scars from the financial crisis so there is plenty of natural demand for new players."

Blood in the water

Those scars run deep, says James Oates, CEO of the investment company Cicero Capital and a veteran figure in Estonia's financial spheres.

According to Oates, the recovery in the banking sector isn't simply a case of banks taking a hit and bouncing back to their pre-crisis positions. Rather, reaction to the crisis has actually altered the lay of the land. "Some would say that the impact of the crisis, where the leading players reduced or cut their credit lines to customers altogether, has seen many customers abandon their previous loyalties to the banks. The result has been a steady erosion of market share - notably of Swedbank," he says. "Meanwhile other relatively new players, Nordea, LHV etc., are gaining market share. I suspect that Pohjola also scents the blood in the water."

He said that the Swedish banks have not yet responded to this new competitive pressure because they themselves came under severe pressure from the Swedish central bank during the crisis to drastically reduce the operational independence of their Baltic operations. "Without a more dynamic and proactive response, I think that their market share will continue to decline, and I would not be shocked to see even Swedbank lose its market leadership position," he says.

It's a situation that can only help Pohjola. Indeed, picking up a decent supply of local customers is a key part of the expansion plan. "You can't provide credible banking services on the Baltic market just to provide services to your Finnish-based customers. You need to have local customers as well to get the scale, and also to get the feel of a local market," Rytsola said.

Seismic shifts

While the shake-up in the banking sector may have helped Pohjola decide when to leap, it was other, more fundamental changes in the market that convinced the bank's management that moving in was a good idea, according to Rytsola. "The post-crisis market is one thing, but it definitely wasn't the key driver for our strategic decision to enter the Baltic markets," he says.

That driver was demand by Pohjola's Finnish customers, who are now drawn to the Baltics in a way that they never were in the pre-crisis boom years, the health of the economies being their main motivator. "[At that time] when the economies were more or less overheating, and the economies weren't that cost efficient from a corporate point of view, Finnish corporations weren't that interested in entering or expanding Estonian operations or Baltic operations. But now it's shifting back again. It definitely seems more attractive," he says.

Other commentators have pointed to the post-crisis stability of the region as being much more positive than a simple return to business-as-usual would have been. In fact, the change from the paper-tiger growth of recent years to one based on more solid foundations was noted by Fitch in its assessment of Estonia. The economic rebound, it said, was mainly bring driven by export and investment growth. "This marks a key difference from the pre-crisis growth model, which was fueled by inflows of foreign capital in the non-tradable sector," the credit rating agency stated.

Whether the more promising growth fundamentals, as well as new opportunities in the banking market, will bring in other hopefuls in the near future is hard to say. At least one other regional player - Eesti Krediidipank - has given the markets the thumbs-up, announcing in June that it will open branches in four new Latvian cities this year, as well as expand its loan portfolio threefold to reach €10m-12m.

That, coupled with Pohjola's optimism, are certainly signs that things are changing in this corner of Europe.