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Our study examines developments in the profitability, profit sources and success strategies of Estonian banks. Despite the unstable economic and legal environment, banking in transition country has been much more profitable than in developed countries. But at the same time effectiveness of banking in a transition economy is volatile and bank failures risk is high. We also prove that new electronical channels provide to banks more cost saving than traditional channels and explain what is the difference in the cost structure. In the first part of our article we study changes in profit sources and strategies in several periods of transition in Estonian banking industry. In the transition economies, introduction of the market economy takes place simultaneously with structural and legal reforms. Therefore in the period of reforms, the economy undergoes one or more periods of crisis (economic recession, instability of monetary system) in which development rates and volatility are high. For this reason, a bank's shareholders' profit expectations are significantly more short-term than in countries with stable market economies. At the first stage in transition the hyperinflation period Estonian banks look for profit opportunities in speculation with currency. After currency reform they had ambitions growth strategies introducing new services and establishing the affiliated undertakings. Besides financial undertakings banks had holdings in many other fields of business. Major banks also try to enter to the neighboring less developed market areas, where interest margins are higher than in domestic market. Hansabank, who has in Estonia over 50% market share acquired other banks in Latvia and Lithuania and its market share in Baltics is overall ca 30%. In the period of stable economic development banks try to increase their market share in domestic market via introducing new products and taking some social responsibility. In the recent years electronic banking services has become extremely popular in Estonia, but are all of these services profitable for banks as well? In the second part of the article we study the profitability of e-banking services based on the example of one Estonian bank. In the article we explore the implementation techniques of activity-based-costing (ABC) in banking sector on example of an Estonian bank in order to analyze the cost structure differences for traditional and electronic channel transactions. The hardest part of calculating the e-banking services profitability is understanding the nature of IT costs, as they benefit mostly to the cost structure of e-channels transactions. Through ABC methodology it is possible to allocate IT expenses to bank products, as well as to define actual cost elements of an e-channel transaction. Also it is possible to understand which of these cost components can be influenced and which are fixed. In the research we find that electronic channels provide cost saving for banks and for bank clients. In the case of Hansabank, online bank payments are 12,5 times cheaper and offline bank payments are 30 times cheaper than traditional transactions concluded in branch network. But the rapid decrease in total costs related to the transactions cannot be achieved, as already existing channels cannot be closed in a speed as new distribution channels are introduced and funds invested in their development and maintenance.
