POST-CRISIS EVOLUTION AND CHALLENGES OF THE BANKING SECTOR: THE CASE OF LATVIA

The economic crisis revealed a number of problems in the banking risk management. The Basel III Agreement calls for the strengthening of bank's capitals, the increase of liquid assets, and the reduction of overall level of risk of the banking activities. Because of that many authors believe that a full adoption of Basel III will contribute to a greater financial stability of banks and reduce bank profits, as well as their profitability. However, in Latvia, in the post-crisis years, an increase of banks' profits has been observed. In this article, the development of Latvian banking system in the post-crisis period in comparison with pre-crisis tendencies is analysed. The bank profitability indicators, the level of bank capital adequacy, liquidity and the credit activity are assessed. The author evaluates the reasons for bank profits and profitability increase, and appraises the sustainability of this tendency. The purpose of this research is the evaluation of the post-crisis development of the Latvian banking system and the impact of the Basel III Accord on the further development of the banking sector in Latvia. In order to establish a causal link between the profitability of banking activities and the level of bank capital adequacy, liquidity and lending rates of growth, the author constructs a VAR model. The author also assesses the sensitivity of key bank profitability indicators, using the analysis of impulse responses. The analysis reveals that profitability increase has short-term character, but full implementation of the Basel III Accord will be associated with the reduction in the bank profitability.