This Selected Issues paper for Bulgaria highlights that the rapid credit expansion has not raised significant financial stability issues, but has been a key factor in the sharp weakening of the external current account. Although the deficit has been mostly financed by foreign direct investment (FDI) inflows, deficits of this magnitude cannot be sustained as privatization inflows will dry up with the completion of the government’s privatization program. Concurrent with the surge in bank credit, the external current account has weakened, reaching a deficit of 8½ percent of GDP in 2003.


This Selected Issues paper for Bulgaria highlights that the rapid credit expansion has not raised significant financial stability issues, but has been a key factor in the sharp weakening of the external current account. Although the deficit has been mostly financed by foreign direct investment (FDI) inflows, deficits of this magnitude cannot be sustained as privatization inflows will dry up with the completion of the government’s privatization program. Concurrent with the surge in bank credit, the external current account has weakened, reaching a deficit of 8½ percent of GDP in 2003.

IV. Bulgaria—FSAP Follow–Up40

88. For financial surveillance purposes, a follow-up of the 2001/02 FSAP was conducted during the 2004 Article IV consultation mission. The main purpose of this work was to assess the vulnerability of the financial sector in light of recent developments, in particular fast credit growth, and examine how these developments may alter the risk profile of Bulgaria’s financial sector in the near future. In addition, the FSAP follow-up presents a factual description of the main measures that the authorities have taken in response to FSAP recommendations in the banking and nonbanking sectors. A summary table that lists the main FSAP recommendations (see IMF Country Report No. 02/188) and steps taken by the authorities to implement the recommendations is presented in Appendix I.

A. Financial Sector Vulnerability Assessment

Recent developments in the banking sector

89. Overall, the banking sector, which represents over 90 percent of total financial sector assets, continues to operate in an environment of high capital, profitability and liquidity levels. The stability of Bulgaria’s banking system is further supported by four main contributing factors: (i) a strong supervisory and regulatory framework; (ii) the dominance of a core group of large, highly liquid and capitalized, and mostly foreign-owned banks, which perform their activities under close scrutiny from their parent company; (iii) a fully privatized banking system, with the exception of two small banks which, together, represent less than 3 percent of total banking sector assets; and (iv) relatively traditional scope of banking activities, where most of the risk continues to be concentrated in credit risk and related areas. The structure of the financial sector is presented in Table 1.

Table 1.

Bulgaria. Financial Sector Structure, 1999-2003

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Sources: BNB and FSC.

Under the Bulgarian legislation the CIS are open-end investment companies and closed-end investment companies.

Under the Bulgarian legislation each pension company manages up to 3 pension funds, one fund for mandatory pension insurance, one fund for occupational pension insurance and one fund for voluntary pension insurance. The data refers to the number of pension companies.

The first pension companies in Bulgaria were licensed in 2000.

The Financial Supervision Commission (FSC) has no consolidated data on securities firms for 1999-2002.

The data about the insurance companies for 2003 is as of end-Q3

90. To assess the soundness of individual financial institutions, the BNB Banking Supervision Department (BSD) divides the banks into three groups: Group I, comprising of the 10 biggest banks; Group II, composed of the other 19 medium and small banks; and Group III, including the six branches of foreign banks. The BSD no longer differentiates between its now ten local and 25 foreign-owned banks, as was the case at the time of the FSAP. According to the BSD, this differentiation is no longer relevant for analytical purposes, as asset size seems to represent a better proxy for characterizing a bank’s risk management or investment strategy than its ownership structure.

91. Group I dominates the banking system, with a market share of approximately 75 percent of total assets, total deposits, total loans, and total capital (Table 2). Although the market position of the large banks has been increasing slightly, it has remained relatively stable over the last few years. Competition among the three largest banks, at least in the lending market, appears to have increased, with their market share falling from 39 percent to 33 percent between 2000 and 2003. However, this may also suggest that the largest banks have adopted a more prudent lending strategy than some of the smaller banks eager to gain market share.

Table 2.

Bulgaria. Bank Market Structure, 1999-2003

(number, in millions of leva)

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Source: BNB

Financial soundness indicators

92. Financial soundness indicators suggest that the banking sector remains sound and does not show particular signs of financial stability concerns (Table 3). In particular:

  • Banks continue to be highly capitalized, with an overall capital adequacy ratio of 22 percent at end-2003. This strong capital position is shared by both the largest banks (Group I) and the medium and small banks (Group II).

  • The quality of assets remains good. Classified loans (i.e., loans past due over 31 days) as a share of total loans continued to fall, reaching 7.3 percent at end-2003, or almost seven percentage points lower than two years earlier.

  • Banks’ profitability remains strong, largely due to the expansion of profitable lending activities, which have translated into high net interest income and higher fee and commission income. In 2003, the return on assets reached 2.4 percent, while the return on equity was 21.7 percent.

  • Banks’ liquidity remains sufficient, although there are signs that the sharp credit growth may have absorbed banks’ excess liquidity and that a further credit expansion would require banks to adjust their liquidity management and find new funding sources.

  • Although higher than in 2001, foreign currency substitution has remained stable in 2003. The ratio of foreign currency loans (deposits) to total loans (deposits) was 43.6 percent (51.7 percent) at end-2003.

Table 3.

Bulgaria. Financial Soundness Indicators, 1999–2003

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Sources: BNB Banking Supervision Department and Credit Registry.

Only fee and commission income until end 2002.

Marketable assets to total assets, where marketable assets include cash, interbank demand deposits, interbank time deposits with less than 30 days maturity, trading assets, repos and exclude pledged assets and classified bank claims.

Marketable assets to attracted fund, where attracted funds are total liabilities minus trading liabilities, hedging derivatives, off-balance sheets provisions and “other” liabilities).

No capital for branches.

Risk analysis and monitoring

Credit risk

93. The speed of credit growth, exceeding 50 percent on a twelve-month basis in early 2004, remains the highest concern. So far, asset quality remains adequate, with nonperforming loans (i.e., past 90 days) continuing their decline and currently standing at 3 percent of total loans, in contrast to 6 percent at end-2001 (Table 4). The loan portfolio quality is significantly worse in the medium and small banks (where 12 percent of loans are classified) than in the Group I banks and three largest banks, where classified loans represent, respectively, 6 percent and less than 1 percent of their loan portfolio. Large exposures remain well below the prudential limits and the BSD monitors their development closely, with a particular focus on the quality of loans above BGN 1 million and BGN 20 million. At the system’s level, there does not seem to be excessive overexposure to particular economic sectors or foreign currency. The sectoral composition of loans appears to be well diversified and the currency composition of bank lending is shifting slowly toward the domestic currency (Tables 5a and 5b).41

Table 4.

Bulgaria. Quality of Banks’ Loan Portfolio, 1999-2003

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Source: BNB.

Past due 31-60 days.

Past due 61-90 days.

Past due 91-120 days.

Past due over 120 days.

General provision - on a portfolio basis, as well as for country risk according IAS since 2003

Specific provisions - as a result of impairment

Definition of large exposures - see T7.

Table 5a.

Bulgaria. Sectoral Distribution of Commercial Banks’ Loans Registered in the Credit Registry. 1/

(in millions of leva)

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Source: BNB Credit Registry.
Table 5b.

Bulgaria. Currency Breakdown of Commercial Banks’ Loans Registered in the Credit Registry 1/

(in millions of leva)

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Source: BNB Credit Registry.

All loans above 10,000 leva are to be registered in the Credit Registry.

Information from banks on consumer loans (less than 10,000 leva).

94. This relatively favorable risk assessment reflects partly banks’ sound credit screening and risk management practices and the BSD’s strict and efficient supervisory framework. As was noted in the FSAP report, in some areas the regulatory framework applies relatively stricter standards than those of many other countries, as in the case of provisioning and loan classification. Furthermore, the BSD has recently strengthened its monitoring, with more frequent full and targeted on-site inspections, new reporting requirements for the most aggressive lenders, and in-depth monthly off-site analysis of the risk profiles of these higher-risk banks.

95. Nevertheless, credit developments need to be monitored closely. Asset quality is a backward-looking indicator that does not provide early warning signals for the emergence of potential problems. The transmission mechanism between loan growth and loan quality tends to be particularly slow when credit expands rapidly, as is the case in Bulgaria, often creating a false sense of optimism regarding the soundness of banks’ loan portfolio. Furthermore, credit expansion was strongest in new markets, such as consumer and mortgage lending (Table 6). If sustained, these developments could give rise to new sources of vulnerabilities.

Table 6.

Bulgaria. Commercial Banks’ Credit Structure, 1999-2003. 1/

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Source: BNB.

Data obtained from banks’ analytical accounts including loans to non-bank financial corporations, nonfinancial corporations and households.

Includes all long-term credits which are overdue.

For 1999-2002 repurchase agreements are part of credits. Starting January 2003, repos reported in separate ‘Repurchase agreements’ item.

For 1999-2002, NPISHs were included in households.

Includes all loans to nonfinancial corporations and nonbank financial corporations.

Includes loans to general government, commercial banks, nonfinancial corporations, nonbank financial corporations, households and NPISHs.

Foreign exchange risk

96. The foreign exchange risk remains low but could rise if the envisaged liquidityreducing measures were to induce capital inflows. The total net open currency position of the banking system is short (6 percent), at a level which remains well within the limits of sound prudential requirements (Table 7). The prudential limit on net open foreign currency positions, however, excludes euro positions.42 This exclusion may have seemed reasonable so far, given that the system has been enjoying a comfortable long position in euros. But if banks are to sustain further credit growth, as they are planning to do, they will need to attract new resources, including from abroad. With the exclusion of euro positions from the prudential open foreign currency position limit, it is possible that they will try to fulfill their liquidity demand disproportionately with euro-denominated borrowing. It is important that the BSD monitors these developments closely.

Table 7.

Bulgaria. Prudential Ratio Requirements, December 2003

(In percent unless specified otherwise)

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Source: BNB

Regulation 4 of BNB. In percent of capital base. Excluding foreign exchange position in euros.

Regulation 7 of BNB. In percent of capital base.

Regulation 8 of BNB. In percent of capital base.

Article 30 of Banking Law. In percent of equity base. Reporting requirement included in Reg. 7.

Article 47 of Banking Law. In percent of capital base. Reporting requirement included in Reg. 7.

Regulation 11 of BNB. No required liquid assets to total assets ratio. Only detailed reporting requirements.

As share of deposits. These indicators are part of government securities primary dealer selection mechanism (23 out of 35 banks as of March 2004).

Cash / total attracted funds, where total attracted funds include total liabilities minus trading liabilities, hedging derivatives and off-balance sheet provisions.

Liquid assets / total attracted funds, where liquid assets include cash, interbank demand deposits, interbank time deposits with maturity less than 30 days, trading assets, repos and exclude pledged assets and classified bank claims.

Interest rate risk

97. Interest rate risk remains moderate, although it is likely to increase somewhat with the observed maturity lengthening of banks’ balance sheets and limited shift to fixed interest rate contracts. These developments are largely related to banks’ increasing desire to provide longer-term mortgage lending to households. At present, however, the risks are well contained as these developments remain limited in magnitude.

Liquidity risk

98. The system’s exposure to liquidity risk remains low but could rise slightly with the introduction of new credit products, which may change the maturity structure of banks’ balance sheets. Currently, the BSD does not require banks to satisfy a particular liquid asset ratio, although it monitors closely banks’ liquidity positions through a detailed reporting system. This may have been satisfactory practice so far, given that banks enjoyed ample liquidity and were able to fund their short-term lending activities with their short-term (but stable) deposit base. But as banks are increasingly extending longer-term credit, their balance sheets are likely to exhibit a widening maturity mismatch, which will need to be monitored closely and, if necessary, regulated.

99. Some liquidity indicators suggest that the recent credit boom has been reducing slowly banks’ excess loanable funds (Table 8). The credit to deposit ratio, for example, rose by almost 30 percentage points in three years, reaching 83 percent at end-2003. Similarly, banks’ net foreign asset position fell from 31 percent of total assets at end-2001 to 8 percent at end-2003, where it seems to have stabilized in early 2004, suggesting that banks have little room to further fund their planned credit expansion by drawing down their deposits held abroad. As domestic deposit growth is not likely to expand much beyond the current 20 percent as of end-2003 (Table 9), banks will need to adopt new funding strategies, including borrowing from abroad. One possible strategy, especially for longer-term credit, is to issue mortgage bonds.43 So far, only a few such mortgage bond issuances has taken place and for an insignificant amount. According to the BSD, six banks have organized a total of 11 such issues, for an amount equivalent to BGN 118 million, or 7 percent of banks’ total investment portfolio. The typical maturity of these bonds is three years and over half of the amount issued was denominated in euros. The authorities will need to monitor closely these developments, including the structure of banks’ balance sheets.

Table 8.

Bulgaria. Loanable Resources of Commercial Banks, 1999–2003

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Source: BNB.

Excluding interbank credits.

Excluding interbank deposits.

Table 9.

Bulgaria. Deposit Structure, 1999–2003 1/

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Source: BNB.

Data are obtained from commercial banks’ analytical accounts.

For 1999-2002 NPISHs are included in households.

Includes time deposits, restricted deposits (deposits, withdrawals of which are restricted on the basis of legal, regulatory, commercial or other requirements) and credits received.