STOCKHOLM (Reuters) - The three Baltic states of Estonia, Latvia and Lithuania will create a pan-Baltic capital market to boost liquidity and investment, they said on Monday.

The small economies are all part of the euro zone but lack the size for a well-functioning capital market on their own. In a bid to overcome this, their finance ministers have signed a memorandum of understanding to harmonize capital market regulations, dismantle investment barriers and create new market infrastructure.

“Our common efforts will ensure significant economic benefits, for instance, pan-Baltic asset class in covered bonds have a much better potential to be attractive for international investors thus improving the available funding options for the local capital market,” Latvia’s minister of finance, Dana Reizniece-Ozola, said in a joint press release.

The initiative is supported by the European Commission and The European Bank for Reconstruction and Development (EBRD) and the first instrument is likely to be a Baltic covered bond. The EBRD is hopeful that laws for a covered bond can be adopted in 2018.

According to the EBRD the combined outstanding residential mortgages for the three states total about 17 billion euros, which would put it between Hungary’s 14.8 billion and Slovakia’s 19.7 billion, currently the two smallest mortgage markets with covered bonds in Europe.

“The second point, what we want to help and support is small and medium sized enterprises’ access to capital markets,” said Jacek Kubas, Principal in Local Currency and Capital Markets team at the EBRD.

The Baltic economies are heavily tilted toward small and medium sized enterprises, which constitute 99.8 percent of all enterprises and employ 78 percent of all job-holders.