Opinion of the European Central Bank of 2 February 2023 on the phase out of savings and loan associations (CON/2023/3)

OPINION OF THE EUROPEAN CENTRAL BANK of 2 February 2023 on the phase out of savings and loan associations (CON/2023/3) Introduction and legal basis

On 12 January 2023 the European Central Bank (ECB) received a request from the Estonian Ministry of Finance for an opinion on a draft law amending the Law on savings and loan associations (hereinafter the ‘draft law’). The ECB’s competence to deliver an opinion is based on Articles 127(4) and 282(5) of the Treaty on the Functioning of the European Union since the draft law contains provisions affecting the ECB’s tasks concerning the prudential supervision of credit institutions pursuant to Article 127(6) of the Treaty. In accordance with the first sentence of Article 17.5 of the Rules of Procedure of the European Central Bank, the Governing Council has adopted this opinion.

1. Purpose of the draft law

1.1 As noted in the explanatory memorandum accompanying the draft law , the main objective of the draft law is to increase the transparency of savings and loan associations and to ensure a more efficient protection of their members, i.e. depositors, with a view to phase out savings and loan associations. 1.2 Under current Estonian law, commercial associations (tulundusühistu) may generally provide financial services either: (1) as savings and loan associations ; or (2) by obtaining a credit institution licence and functioning as an association bank ; or (3) by obtaining a licence for performing insurance activities and functioning as an insurance association . 1.3 Under Estonian law, association banks are regulated as credit institutions and are subject to prudential supervision .

1.4 Savings and loan associations are a specific category of commercial association whose legal status, activities and the procedure for the foundation and dissolution of which are set out in the Law on savings and loan associations . Under the Law on savings and loan associations, savings and loan associations may conclude with their members the following transactions: (1) deposit transactions to raise savings and other repayable funds; (2) loan transactions, including consumer credit, mortgage loans and factoring; (3) lease transactions; (4) intermediate securities, guarantees, benefits and earmarked repayable funds offered by foundations, structural funds or payment agencies founded by the European Commission or States that are contracting parties to the European Economic Area Agreement or other similar persons, or by credit institutions, financial institutions or insurers; (5) give advice regarding economic activities; and (6) other transactions similar to the foregoing . Additionally, savings and loan associations may perform currency exchange services, cash transfers and other payment services in accordance with the provisions of the Law on payment institutions and e-money institutions to unspecified persons (i.e. not its members) . 1.5 Savings and loan associations are non-regulated financial institutions that fall outside the scope of Directive 2013/36/EU of the European Parliament and of the Council (hereinafter the ‘CRD’). As noted in the explanatory memorandum, the reason for this non-regulation has so far been the understanding that members of savings and loan associations control and actively exercise supervision over the activities of the associations, which should function based on the principle of social control . However, there have been problems with savings and loan associations, and many of them have introduced procedures that essentially exclude members from active supervision of, and participation in, the activities of savings and loan associations . 1.6 The draft law would ultimately phase out savings and loan associations under Estonian law following a three-step transition process. The first step, which involves amendments that will enter into force following the draft law’s adoption, includes a prohibition on establishing new savings and loan associations and, starting from 1 July 2023, a prohibition on displaying interest rates on deposits in advertisements . The purpose of the second step is to: increase the transparency of savings and loan associations and reduce conflict of interest risks; increase the rights of savings and loan associations’ members to receive information about the associations’ activities; set limits on the granting of credit to certain individuals; specify the rules of authorisation to increase member participation in savings and loan associations; increase the minimum share capital; and specify the rules for conducting audit reviews. These amendments are scheduled to enter into force on 1 January 2024 . As a third step, all savings and loan associations would be required to obtain a credit institution licence by 31 December 2027 in order to continue providing deposit-taking and

lending services and would thereafter continue operating as association banks . Alternatively, if a savings and loan association has not submitted a credit institution licence application, or the competent authority has refused to grant such licence by that date, the savings and loan association must cease to provide regulated financial services and terminate relevant agreements according to their terms. Thereafter, it may continue operating as a regular commercial association without the right to accept deposits and would have to obtain a licence or authorisation in order to provide any regulated financial services . 1.7 The draft law establishes a transitional period in order to facilitate the phase out of savings and loan associations and to enable them to apply for a credit institution licence. The draft law prohibits savings and loan associations from accepting new members and from concluding new, or prolonging the validity of existing, deposit or consumer credit agreements from 1 January 2026 and until they have obtained a credit institution licence. According to the draft law, savings and loan associations wishing to carry on deposit-taking and lending activities must obtain a credit institution licence by 31 December 2027. However, if an association has submitted a credit institution licence application and the competent authority has not decided on such application by 31 December 2027, the association may continue operating, and will not be deemed to be operating without a licence within the meaning of the Estonian Penal Code. However, such a savings and loan association may not conclude new contracts or prolong existing contracts for providing certain specified services or accept new members as from 1 January 2028 until it has received a credit institution licence. The Law on savings and loan associations is scheduled to become invalid on 1 January 2028. 1.8 The draft law also proposes certain technical amendments to the Law on credit institutions aimed at specifying and clarifying the treatment of association banks. Among others, the draft law specifies the number of management board members of an association bank and the procedure for becoming an association bank’s management board member . 1.9 Finally, the draft law reduces the minimum initial capital requirement applicable to association banks from the current EUR 5 million to EUR 1 million in line with Article 12(4) of the CRD . According to the explanatory memorandum, the aim of reducing the initial capital requirement of association banks is to incentivise the development of association banking in Estonia .

2. General observations

The ECB notes that, within the framework of the Single Supervisory Mechanism (SSM), which is composed of the ECB and the national competent authorities, including the Estonian Financial Supervisory Authority (FSA), the ECB is, in accordance with all relevant Union law (and Estonian legislation transposing Directives), exclusively competent to carry out, for prudential supervisory

purposes, the tasks of authorising credit institutions and withdrawing authorisations of credit institutions .

3. Specific observations on the draft law’s provisions lowering the initial capital requirements for association banks

3.1 Under the CRD, Member States may grant authorisation to particular categories of credit institutions with initial capital of less than EUR 5 million, subject to the condition, inter alia, that the initial capital is no less than EUR 1 million . The CRD does not authorise Member States to introduce a lower initial capital requirement than EUR 5 million for all credit institutions, but only for particular categories of credit institutions. The draft law provides for a EUR 1 million initial capital requirement only for association banks. The ECB understands that association banks are a particular category of credit institution as they can exist only in the specific legal from of a commercial association , must be established by at least 50 persons , and irrespective of the amount of capital contributed by any member to the share or initial capital of an association bank, each member of an association bank has one vote at the general meeting of an association bank . However, the ECB understands that Estonian law does not limit the range of services that an association bank may provide, and that association banks may provide the same range of services as credit institutions established as public limited companies (aktsiaselts). 3.2 While, from a legal perspective, the provisions of the draft law enabling association banks to be established with a minimum initial capital of EUR 1 million may not contravene the CRD, the ECB cautions that a combination of a potentially large number of new entrants to the banking market of a rather limited size and relatively low capital levels could lead to increased risks. Therefore, the ECB encourages the Estonian legislator to thoroughly consider whether lowering the initial capital requirement for association banks to EUR 1 million is a good legislative choice in terms of policy for the banking market. 3.3 If the lower initial capital requirement is implemented, the ECB would, upon assessing the licencing applications of such association banks, consider it prudent to require applicants to always prepare an exit plan, which should be a prerequisite for the granting of authorisation. Furthermore, given that the initial capital requirement is aimed at various risks primarily related to the provision of various types of banking and investment services which licenced credit institutions are permitted to provide, the ECB suggests to consider whether it would be advisable to limit the range of services that association banks with lower initial capital may provide in order to better manage the risks in the banking sector. 3.4 Furthermore, a credit institution must comply with the own funds requirements as set by the relevant applicable EU and national law, including Regulation (EU) No 575/2013 of the European Parliament

and of the Council (the ‘CRR’) . The amount of own funds required at authorisation is determined on the basis of an entity's business plan and the risks that it intends to undertake during the first years of operations . Hence, the ECB considers that, in most cases concerning specific credit institutions, own funds in addition to the minimum initial capital of EUR 1 million will be necessary to establish the business of a credit institution and obtain authorisation .

4. Specific observations on the transitional period provided for in the draft law

The ECB welcomes the establishment of a transitional framework for the gradual phase out of savings and loan associations and to direct them towards applying for a credit institution licence or ceasing to provide regulated banking services . Providing sufficient time for existing savings and loan associations to apply for a credit institution licence is vital to give the ECB, sufficient time to conduct, in cooperation with the FSA , a thorough analysis and scrutiny of any credit institution licence applications received. In this respect, the ECB understands that it would be required to decide on the credit institution licence application within six months following the receipt of all the necessary documents and information which meet the requirements of the law, and no later than within twelve months following the receipt of the licence application .

This opinion will be published on EUR-Lex.

Done at Frankfurt am Main, 2 February 2023.

[signed]

The President of the ECB

Christine LAGARDE