Bulgaria: Selected Issues
Author: International Monetary Fund
Publication Date:
02 Jun 2010
eISBN:
9781455207466
ISBN:
9781455207466
Language:
English
Keywords:
ISCR; CR; Bulgaria; exchange rate appreciation; exchange rate; output gap estimate; parent bank; expansion strategy; FX loan; resolute loan restructuring; banks' loan portfolio; Credit; Commercial banks; Capital adequacy requirements; Nonperforming loans
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Bulgaria’s potential output growth in future could be markedly lower, and it may take considerable time for the excess labor and resources to be absorbed by other sectors, in particular by the export sector. This suggests that the natural level of rate of unemployment will rise and remain higher, and the full employment level is likely to decline. There is a requirement of significant improvements in labor productivity and competitiveness, as well as reforms to further improve labor mobility and participation.

Abstract

Bulgaria’s potential output growth in future could be markedly lower, and it may take considerable time for the excess labor and resources to be absorbed by other sectors, in particular by the export sector. This suggests that the natural level of rate of unemployment will rise and remain higher, and the full employment level is likely to decline. There is a requirement of significant improvements in labor productivity and competitiveness, as well as reforms to further improve labor mobility and participation.

III. Recent Evolution and Soundness of The Bulgarian Banking Sector1

1. This chapter provides a broad overview of the Bulgarian banking sector and the short-run challenges it currently faces as the economy starts to emerge from recession. Section I discusses the sector’s market structure. Section II documents the evolution of credit during the boom years of 2002–08 while Section III analyzes developments during the 2009 recession and its impact on the soundness of the banking sector. Section IV reviews how some of the policies implemented during the boom have been reversed during the crisis. Section V concludes by presenting an analysis of risks at the current juncture.

A. Market Structure

2. The Bulgarian banking sector consists of 30 banks and is dominated by subsidiaries of large foreign banks. Only seven banks are domestically-owned institutions while six foreign banks operate as branches. The largest five banks have a market share of 58 percent for both loans and assets as of end-Q4, 2009 (Table 1). This structure is the outcome of the restructuring and gradual liberalization of the banking sector that followed the country’s financial crisis of 1996–97 (see Herderschee and Ong, 2006).

3. Major foreign banks are all from other EU countries, most notably Greece, Italy, Austria and Hungary. The five Greek banks together represent 30 percent of the market. Some of these banks entered the Bulgarian market relatively recently and have relied little on domestic deposits to fund their activity, as witnessed by their high loan-to-deposit ratios (see Table 1). The five private domestic institutions are typically controlled by a small number of individuals but four are listed on the Sofia stock exchange.

Table 1.

Bulgaria: Banking Sector Overview

(as of end-Q4 2009)

article image
Sources: BNB; and IMF staff calculations.

Controlling shareholder is OTP.

Controlling shareholder is National Bank of Greece.

Branch (not subsidiary).

Excludes deposits of financial corporations.

4. The size of domestic nonbank credit institutions is still relatively small but cross-border loans are significant (Table 2). The leasing sector’s credit to corporations represents only 15 percent of the banking sector’s while other credit institutions serve mostly households and have a 10 percent market share. These two types of institutions grew rapidly during the boom years, partly in response to constraints imposed by the BNB on banks to slow credit growth down, as discussed in Section IV below.2 Thirty percent of loans to corporations are provided by foreign institutions.3 External cross-border loans by BIS-reporting banks to the non-bank sector have grown a lot and are the highest in the region, behind Croatia (Figure 1).

Table 2.

Bulgaria: Distribution of Loans to Nonfinancial Domestic Corporations and Households by Type of Credit Institution

(As of end-Q3, 2009)

article image
Sources: BNB; and IMF staff calculations.

Data collected from 18 institutions, representing 97 percent of the total assets of that category.

Figure 1.
Figure 1.

Ratio of Cross-Border Loans to the Non-Bank Sector to GDP, 2001–2008 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BIS; IFS1/ Loans to non-banks by BIS reporting banks

B. The Credit Boom of 2002–08

5. Bulgaria’s banking sector grew very rapidly since the turn of the century. This is the result of fast growth of credit to the non-government sector (Figure 2). Growth of real credit has been among the strongest in the region during that period. Only Romania has had a consistently superior growth performance (Figure 3).

Figure 2.
Figure 2.

Credit to GDP ratio, 2001–2008 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: IFS and IMF staff calculations1/ excludes claims on central governmentand claims on central bank
Figure 3.
Figure 3.

Annual Real Credit Growth, 2002–2008 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source:IFS1/ excludes credit to central government and claims on central bank

6. Credit growth has to a large extent been financed from abroad, resulting in a notable rise of the loan-to-deposit ratio (Figure 4). In terms of levels, the loan-to deposit ratio is now close to the average of the region, behind the Baltic countries and Hungary, but well above 100. Loan-to-deposit ratios for individual banks vary between 100 percent and 315 percent, reflecting the diverse availability of funding from parent banks and the aggressiveness of each bank’s expansion strategy during the boom years (see Table 1).

Figure 4.
Figure 4.

Loan-to-Deposit ratio, 2005–2008 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: IFS, MFS1/ Loans exclude credit to central government and claims on central bank; Deposits exclude those by financial institutions

7. Total banking sector assets represent more than 100 percent of GDP.

This is not as high as in Estonia and Latvia, but well above Romania and Turkey (Figure 5). In fact, the development of the Bulgarian banking sector is quite advanced in relation to the country’s level of GDP per capita.

Figure 5.
Figure 5.

Total banking sector assets to GDP, 2008

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: IFS; MFS

8. Banks’ loan portfolio is dominated by loans to corporations (Figure 6). Banks diversified away from corporations in the first half of the past decade, but the share of loans to households (overdrafts, consumer loans and mortgages) has stabilized between 40 and 45 percent since 2005. This is modest relative to other countries in the region.

Figure 6.
Figure 6.

Share of Household and Corporate Credit in Total Credit to the Economy, 2009 Q3 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: Haver analytics1/ excludes credit to the financial sector and the government.

9. The evolution of the sectoral allocation of credit within the corporate sector reflects a gradual shift towards construction as well as real estate and other services during the boom years. This is true both for loans extended by the domestic banking system and cross-border loans (Figures 7 and 8). Available statistics do not provide a breakdown between real estate activities and other professional services (such as computer services) before 2009, but one can reasonably assume that loan growth in the real estate sector was extremely strong, mirroring its growth rate in value added.

Figure 7.
Figure 7.

Bulgaria: Domestic Loans to Nonfinancial corporations

(percent of GDP)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BNB; and IMF staff calculations
Figure 8.
Figure 8.

Bulgaria: External Loans to Nonfinancial corporations

(percent of GDP)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BNB; IFS; and IMF Staff calculations

10. The share of loans denominated in foreign currency is in line with the regional average (Figure 9). Direct cross-country comparisons of loan currency denomination can be hazardous, as loans indexed on a foreign currency are often classified together with standard loans in domestic currency. This is the reason why Croatia and Turkey are excluded from Figure 9. Moreover, Haver data do not provide a breakdown by foreign currency (in Bulgaria, FX loans are more than 96 percent denominated in euros).4 Nevertheless, available data suggest that the degree of loan euroization and dollarization is significantly less than in the Baltic region but higher than in countries such as Poland or the Czech Republic. Lending in foreign currency has been on an upward trend in recent years as integration with the rest of the EU has deepened, and as the average maturity of banks’ portfolios has kept increasing—in part as a result of the development of the mortgage market—and there is a strong positive correlation between loan maturity and FX denomination.

Figure 9.
Figure 9.

Share of Domestic and Foreign Currency Credit in Total Credit to the Economy, 2009 Q3 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: Haver analytics and IMF staff estimates1/ excludes credit to the financial and government sectors

C. The 2009 Credit Slump and its Impact on Banking Sector Soundness

11. The credit slump of 2009 was as sharp as the latest surge during the credit boom. Credit flows suddenly came to a halt in the last quarter of 2008, which affected corporations and households equally (Figure 10a-b).5 In the aggregate, credit growth remained positive for the year 2009 as a whole, in part because of some repurchases of loans from parent banks. Within the corporate sector, the stagnation of credit was broad-based. Within the household sector, the mortgage sector managed to expand slightly while the flow of consumer loans turned negative.

Figure 10a.
Figure 10a.

Bulgaria: Credit flows, 2002-2009

(percent of GDP, 12-month rolling)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BNB; and IMF staff estimates
Figure 10b.
Figure 10b.

Bulgaria: Credit stock, 2002-09

(percent of GDP)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BNB; and IMF staff estimates

12. While money market rates have started to normalize, deposit rates remain high. Tension on money market rates became apparent since the beginning of the global financial crisis in the late summer of 2007, as witnessed by the increase in bid-ask spreads and in spreads over Euro area market rates (Figure 11). Spreads further increased following the collapse of Lehman Brothers and are still well above pre-crisis levels except for the overnight rate. At the same time, deposit rates (both corporate and household) crept up alongside market rates until late 2008 and stayed at a very high level during 2009 as the competition for local deposits intensified in a context where new funding from parent banks and international markets froze (Figure 12). Reflecting the gradual increase in deposit rates, the lending spread has been on a downward-sloping trend since early 2007, which the slump amplified somewhat (Figure 13).

Figure 11.
Figure 11.

Bulgaria: Interest Rate Spreads over Eonia and Euribor, 2007-2009

(in percentage points)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BNB; and IMF Staff calculations
Figure 12.
Figure 12.

Bulgaria: Interest Rates on Deposits in Leva with Agreed Maturity, 2007-2009

(in percent)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BNB; and IMF staff calculations
Figure 13.
Figure 13.

Bulgaria: Lending Spreads in Leva, 2007-2009

(in percentage points)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BNB and IMF Staff calculations

13. The evolution of Financial Soundness Indicators suggests that the banking sector remains well capitalized and profitable in spite of the downturn (Table 3). The capital adequacy ratio (CAR) remains strong after the banks followed the BNB’s guidance to include all of their 2008 profits in their capital, and the Tier I ratio has increased significantly in part as a result of the conversion of Tier II capital. Banks entered the recession with a strong momentum in profitability, which has enabled them to remain comfortably profitable in 2009 in spite of the rapid deterioration of asset quality, even if the relaxation of provisioning rules in March 2009 helped lower impairment expenses. Even with decreasing lending spreads, banks were able to maintain a stable net interest margin in 2009 because of the combination of a higher average loan volume and a loan-to-deposit ratio well above 100, as well as lower cost of funding from foreign credit institutions.

14. The Bulgarian banking system also has relatively stronger capital buffers than regional peers. The level and change in level since end-2008 of the CAR, NPL ratio, coverage ratio and ROA all compare favorably to other banking systems in the region. Liquid assets appear to be more abundant in other countries, although this is likely to reflect partially a stricter definition of liquid assets in Bulgaria than in other countries (Figures 14—18).

Figure 14.
Figure 14.

Capital Adequacy Ratio 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

1/ 2009 data are for June in Estonia and October in Latvia and the Slovak RepublicSource: April 2010 GFSR
Figure 15.
Figure 15.

Non-performing Loans Ratio 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

1/ 2009 data are for June in Estonia, October in Latvia, the Slovak Republic and Romania, November in Turkey, and December in LithuaniaSource:April2010 GFSR
Figure 16.
Figure 16.

Provisions to NPL ratio

(in percent) 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

1/ 2009 data are for June in Croatia, October in Latvia, the Slovak Republic and Romania, and November in TurkeySource:April2010 GFSR
Figure 17.
Figure 17.

Return on Assets

(in percent)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

1/2009 data are for June in Estonia, October in Latvia, and the Slovak Republic November in Romania and Turkey, and December in LithuaniaSource: April 2010 GFSR
Figure 18.
Figure 18.

Liquid assets to short-term liabilities

(in percent) 1/

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

1/ 2009 data are for June in Estonia, October in Latvia, and the Slovak Republic November in Romania, and December in LithuaniaSource:April2010 GFSR

15. Publicly available data point to a rather homogeneous increase in non-performing loans across sectors. The weakening of asset quality has followed the same pace in the corporate, consumer and mortgage sectors even if somewhat more pronounced in the latter two. Within the corporate sector, agriculture, mining, textile, manufacture of transport equipment, construction, real estate, hotels, recreation and health services appear to be deteriorating somewhat more severely.

Table 3.

Bulgaria: Financial Soundness Indicators, 2006–09

(In percent)

article image
Source: BNB.

Return on equity is calculated with Tier I as denominator

Capital to assets is based on Tier I capital

The net open foreign-exchange position regulation was ended in 2005

Table 4.

Measures Taken by the BNB During the Credit Boom and the Slump

article image
article image
Source: Bulgarian National Bank.

D. Policies to Mitigate the Boom-Bust Cycle

16. The BNB introduced in 2004–06 various policy measures to try to put limits on bank lending (see Table 4a). First, the BNB tried to enhance information flows between banks and their customers so as to increase risk awareness, strengthened prudential supervision and withdrew liquidity. These measures were insufficient as banks were able to freely borrow from abroad and banks were keen to fight for their market share. In early 2005, the BNB introduced credit ceilings whereby banks were allowed to expand credit by up to 6 percent per quarter or faced a penalty in the form of marginal reserve requirements.

17. The initial impact of the measures evaporated quickly. Some banks observed the limits while others circumvented the new constraints or preferred to continue lending and pay the penalty. A form of circumvention was the selling of part of the loan portfolio to foreign banks or to Bulgarian nonbank financial institutions. After the credit ceiling measures lapsed at the end of 2006, some loan sales were reverted.

18. However, the measures contributed to the building of capital and liquidity buffers. By toughening loan classification and provisioning rules, changing the minimum capital requirements calculation, increasing reserve requirements, the banking sector built buffers which enabled the banking sector to enter the global recession from a position of relative strength.

19. Since the onset of the global financial crisis, the BNB has relaxed or reversed policy measures taken during the boom. In October 2008, it first reversed a measure taken in December 2004 by allowing 50 percent of cash in vault to count towards the fulfillment of reserve requirements. It also introduced some flexibility in the fulfillment of the requirements. In December 2008, it substantially decreased reserve requirements, in particular for funds attracted from abroad. In February 2009, it then changed the loan classification and provisioning requirement rules (see Box 1). The reclassification to the standard category was allowed after three standard installments, as opposed to up to six installments in the previous regulation (passed in April 2005). The loan classification was relaxed by increasing the number of days a loan can be overdue before moving to a worse category, as shown in Table 4b. Finally, an extension of the loan maturity for up to 2 years was allowed without the exposure being considered restructured. No maturity extension without reclassification was previously possible. Table 5 shows the evolution of the distribution of classified loans between end-Q1 and end-Q4 2009 as well as the associated provisions.

Table 5.

Bulgaria: Distribution of Impaired Loans

(In thousand leva)

article image
Source: BNB.

20. Very recently, the Bulgarian authorities relaxed further their conservative regulatory standards on bank capital. A 2009 survey by the European Commission of Bulgaria’s fulfillment of its obligations under the EU’ s Capital Requirement Directive (CRD)6 found that the BNB’s regulation was more conservative that the CRD for two main reasons. The first was the application of additional regulatory provisions as discussed further in Box 1. The second was the application of higher risk-weights under the standardized approach for credit risk for retail exposures (100 percent instead of 75 percent) and for mortgages (50 percent instead of 35 percent). This second deviation from the CRD has been eliminated in February 2010 and implies that the March 2010 CAR will automatically be boosted by a little less than 1 percentage point. In addition, February 2010 amendments to the Bulgarian capital adequacy regulation provide for the possibility for banks to include the audited profit from the previous year in their own funds prior to a decision taken at the shareholders’ meeting.

Main aspects of Bulgaria’s loan classification and specific provisioning rules

The BNB’s Ordinance No 9 establishes the criteria for classifying risk exposures and the allocation of specific provisions for credit risk and applies to banks using Basel II’s standardized approach for credit risk (i.e. all banks in Bulgaria currently). Specific provisions for credit risk are deducted from banks’ own funds for the calculation of capital adequacy. This Ordinance was amended in February 2009.

Risk exposures are evaluated and classified based on the delay of amounts overdue, the assessment of debtors’ financial state and the sources for repayment of debtors’ obligations.

Specific provisions are calculated as the excess of the balance sheet value of an exposure over its risk value. The risk value is calculated by reducing contractually agreed cash flows by a percentage that depends on the classification group of the exposure and adding all or a fraction the value of recognized collaterals or guarantees (depending on the type of collateral). The classification was changed in February 2009 as described in Table 4a below.

Loan Classification as of March 31, 2009

article image

The percentage reduction to compute the risk value is 10 percent for watch exposures, 50 percent for non-performing exposures, and 100 percent for loss exposures.

Other changes made to the ordinance in February 2009 include:

  • -Less restrictive criteria for reclassification as “standard”

  • -Greater room to extend loan maturity without triggering reclassification

  • -Extension of the list of recognized collateral

E. Short-Term Risks

21. The main two risks currently are the continued weakening of asset quality and a reversal of parent funding to their Bulgarian subsidiaries. As discussed above, classified loans have increased significantly during 2009 and it is likely that this negative momentum will continue for several more quarters looking forward. During the first three quarters of 2009, many banks seem to have preferred rolling over and marginally restructuring loans until the economic prospects of their customers have become clearer. More resolute loan restructuring seems to have taken place during Q4 2009 and this trend could continue in the beginning of 2010. With many subsidiaries operating with a loan-to-deposit ratio well above 100, the banking system depends on parent funding for the extension of credit. Although all foreign-owned institutions appear adequately capitalized and sufficiently liquid at the current juncture, persistent financial tensions in a parent bank’s country of origin (which could result from market concerns about sovereign debt sustainability) could spill over to Bulgaria.

Credit Risk

22. This section presents a very simple top-down stress test, based on an estimated macro-credit risk equation. We first estimate how the quality of banks’ loan portfolio is likely to evolve over the next two years based on the historical relationship between classified loans and the macroeconomic environment. We then ask whether banks’ profitability would be strong enough to maintain capital above the required minimum while absorbing the losses associated with the new classified assets.

23. The macro-credit risk model is constructed and estimated as follows. The BNB publishes monthly data on “bad and restructured” loans for the three main categories of loans: corporate loans, consumer loans and mortgage loans. The NPL series is not available at a disaggregated level and we thus decided to use the data on “bad and restructured” loans, which are defined as the sum of restructured loans and loans in the worse two categories of the classification shown in Table 4b.7 We thus estimate the relationship between the change in the “bad and restructured” loan ratio and the change in the output gap8. No other macroeconomic variable is found to be econometrically significant once the effect of the output gap is accounted for, except for loan growth during 1998–2002 which mechanically reduced the classified loan ratio of corporations as the share of legacy NPLs in that sector gradually shrank. An autoregressive term is included as it is strongly suggested by the data and three dummy variables are included to account for a change in the definition of the series in the third quarter of 2006 (with an effect spread over two quarters)9 and the loosening of loan classification rules in the first quarter of 2009. The sample period is 1998Q3–2009Q4.

24. Results indicate that the “bad and restructured” loan ratio is forecast to increase by another 4–6.5 percentage points for all categories of loans in 2010 and 0-1 percentage point in 2011 (Figure 19) under staff’s baseline scenario. The peak of the “bad and restructured” loan ratio is expected to be reached in the third quarter of 2011. By matching end-2009 supervisory and monetary data, one can estimate the share of restructured loans in total classified loans at 30 percent. Assuming that the flow of new “bad and restructured” loans is made for 30 percent of restructured loans and 70 percent of NPLs across categories, we would thus expect a further increase by about 3.5 percent of the NPL ratio during 2010 under the baseline scenario.

Figure 19.
Figure 19.

Bulgaria: “Bad and restructured” loans ratio and NPLratio, Sept. 1998-Sept. 2011

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: BNB; and IMF staff estimates

25. Several caveats should be attached to these results. In particular, our dataset includes only net flows of “bad and restructured” loans as opposed to gross flows. We are thus unable to account for write-offs or sales of classified loans. Also, the published series of “bad and restructured” loans we use mixes restructured loans (which could be performing) with non-performing loans, and the dynamics of these two series are probably somewhat different depending on the state of the business cycle and calendar effects. There are also uncertainties associated with the estimation of the output gap series and its projection over the next two years. Furthermore, the point estimates are very sensitive to the inclusion of the last few observations in the sample and the sample does not include a full economic cycle. It is quite possible that the impact of macroeconomic conditions on the evolution of the quality of banks’ loan portfolio be asymmetric during recessions and recoveries. Moreover, it is possible that, as suspected in other countries of the region, some banks are ever-greening loans and under-reporting restructured loans. Thus, both the initial level of classified loans and the elasticity of the change of the classified loan ratio to the change in output gap could be underestimated. For all these reasons, our estimates are likely biased, our forecast of the classified loan ratio is subject to possibly significant margins of error, as is our forecast of associated impairment losses below.

26. Nevertheless our forecast is in line with results obtained by a common rule of thumb established through cross-country studies. The rule suggests that the NPL ratio increases by 0.7 times the difference between trend growth and actual growth during the two years following the onset of a downturn. This rule has recently been used in the context of the regional CESE stress-testing exercise. In the case of Bulgaria, assuming pre-recession trend growth of 5 percent, it suggests an increase in the NPL ratio of 7 percentage points during 2009 and 3.5 percentage points during 2010, which is a close match to the estimate based on our regression.

27. in the baseline scenario, aggregate banking sector profits should be able to generate enough capital to cover the increase in corresponding provisions in 2010. We focus our analysis of the impact of the increase in classified loans on the 24 banks which are not branches of foreign banks. The stock of “bad and restructured” loans is forecast to increase by 2.4 billion leva during 2010, assuming a constant stock and distribution of loans across the corporate, consumer and mortgages categories. Based on a number of assumptions on the distribution of these loans across the various loan categories and on loss given default parameters, we estimate that total impairment expenses in 2010 would then amount to 1.25 billion leva, or about 20 percent more than in 2009. The pre-tax pre-provisions profitability of the 24 banks has remained unchanged between 2008 and 2009 slightly below 1.9 billion leva and we expect this level of gross profitability to be maintained in the baseline. This means that banks should be able to generate enough profits to cover impairment charges in the aggregate during 2010. Impairment charges in 2011 are expected to be quite manageable as the classified loan ratio is not expected to increase significantly then.

28. The net impact on the end-2010 aggregate regulatory capital adequacy ratio should be close to zero or slightly positive. As explained above in Box 1, the BNB requires banks to set aside “specific” provisions in addition to IFRS provisions, which provides the banking sector with an additional buffer. These are not treated as an accounting expense in the profit and loss statement but are taken into account in the computation of regulatory capital. The flow of these “specific” provisions amounted to 439 million leva in 2009. A flow of 1.68 billion leva of new “loss” loans and the transition of 500 million leva of loans from “non-performing” to “loss” during 2010 would likely generate the need for an additional 430 million leva of specific provisions, assuming the same provisioning ratio as at end-2009 shown in Table 5. As this is a little smaller than our baseline forecast pre-tax IFRS profit, we would expect aggregate regulatory capital to remain about flat or to increase slightly at a high and comfortable level.10

29. Still, the situation of some individual banks may be less comfortable. Profitability in 2009 was negative overall for two medium-sized banks (including one branch) and on a downward quarter-on-quarter trend for several others. Moreover, the rate of provisioning was close to zero or even negative in several medium-sized banks and one large bank, which may suggest under-provisioning. In the absence of publicly available data on individual banks’ capital adequacy ratio, one can nevertheless speculate that credit losses would require recapitalization in a small number of institutions under the current regulatory requirements.

30. The Bulgarian authorities still have room to relax their conservative regulatory standards on bank capital in case of need. The rules for the calculation of additional regulatory provisions discussed in Box 1 were amended in February 2009 and could be loosened again. Also, the minimum regulatory capital is set at 12 percent in Bulgaria, compared to 8 percent at the EU level. Therefore the BNB still has several instruments to implement further a counter-cyclical macro-prudential policy within the confines of EU regulation.

Funding and Liquidity Risk

31. Another source of risk is a stagnation of reversal of parent bank funding to their Bulgarian subsidiaries. As discussed above, the banking system crucially depends on parent funding for the extension of credit. A particular source of concern in this respect are Greek banks who have recently come under market pressure (Figure 20) as all major Greek banks were downgraded by rating agencies in December 2009. The action was prompted by a weakening of the banks’ stand-alone financial strength, combined with the rating agencies’ reassessment of Greece’s ability to support its banking system, following the lowering of the national government debt rating amidst concern over Greek public debt sustainability. Moreover, Greek banks have relied a lot on the ECB to obtain liquidity and the withdrawal of the ECB’s exceptional liquidity supply operations by the end of 2010, including the tightening of collateral requirements, could signify that Greek banks would have to scale back their funding to their SEE subsidiaries over the course of 2010 and 2011.

Figure 20.
Figure 20.

Bulgaria: Bankstock prices

(Jan. 5, 2009 = 100)

Citation: IMF Staff Country Reports 2010, 159; 10.5089/9781455207466.002.A003

Source: Bloomberg

32. Should severe liquidity tensions emerge in a small or medium-size institution, the Bulgarian authorities’ emergency liquidity assistance framework should be able to provide the necessary support. The BNB is restricted by law to provide LOLR assistance only to solvent banks experiencing an acute need of liquidity that cannot be satisfied from other sources, and for a maximum of three months, in cases of a liquidity risk that may jeopardize the stability of the banking system (LBNB Article 33 and BNB Ordinance No. 6). Eligible collateral is limited to monetary gold, some foreign currencies (euro, US dollar and Swiss franc) and liquid securities issued or guaranteed by the Bulgarian government or by some foreign governments and central banks. In addition, the government could also act as a lender of last resort by drawing on the fiscal reserve (i.e. the large central government deposits at the BNB). The Treasury mainly uses the BNB as its bank, but it can also place deposits with commercial banks provided they have eligible collateral, which comprises cash, domestic government securities and some foreign government securities.

References

  • Herderschee, J. and L. Ong (2006), “Bulgaria—The Implications of Bank Behavior and Credit Measures for Solvency Risk”, IMF Country Report No. 6/ 299 (Washington D.C.: IMF). Bulgaria: Selected Issues Paper, IMF.

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    • Export Citation

  • Herdershee, J. (2007), “Post Mortem on Bulgaria’s Credit Limits”, IMF Country Report No. 7/ 390 (Washington D.C.: IMF). Bulgaria: Selected Issues Paper, IMF.

    • Search Google Scholar
    • Export Citation

  • IMF (2010), Global Financial Stability Report, April.

1

Prepared by Jérôme Vandenbussche.

2

Two leasing companies and one other credit institution have assets above 1 bn Leva as of end-2009. March 2009 amendments to the Law on Credit Institutions and BNB Ordinance No. 26 issued in April 2009 require that nonbank credit institutions be registered at the BNB and have a minimum capital of 250,000 Leva, and subject them to regular reporting to the BNB and its credit registry.

3

This includes international organizations, foreign private financial institutions but also foreign private non-financial institutions that provide inter-company loans to local affiliates.

4

Bulgarian regulators make a distinction between euro- and lev-denominated loans, and loans denominated in other foreign currencies. Given the currency board arrangement, regulators see euro-denominated and lev-denominated loans as equally risky, and treat them in the same way. Loans in other currencies are seen as potentially more risky and over the period 2004–2009, the BNB’s regulatory and supervisory policy has successfully discouraged banks to introduce credit products in foreign currencies different from the euro.

5

The spike in 2005 and corresponding fall in 2006 are the result of credit growth restrictions imposed by the BNB discussed in the next Section (see Herderschee (2007) for a thorough analysis.

6

Surveys for all member states can be found at http://ec.europa.eu/internal market/bank/studies/index en.htm

7

As shown in Table 4b, the worse two categories are “substandard” and “non-performing” until February 2009 and “nonperforming” and “loss” afterwards.

8

The output gap series is constructed using the methodology used in Section I of this paper. The choice of lag for the output gap variable is determined based on the Akaike information criterion.

9

Until Q2 2006, the data include only the overdue principal. Since then, the total amount of exposure (principal and interest) is included.

10

Of course, this is excluding the one-time positive impact of the reduction in risk-weights on the CAR described in paragraph 20 and the inclusion of 2009 profits into the capital base, both of which are expected to take effect at end-Q1 2010. The combined effect of these measures should be to raise the aggregate CAR by about 2 percentage points.

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Cover IMF Staff Country Reports
Bulgaria: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2010: Issue 159
Publisher:
International Monetary Fund
ISBN:
9781455207466
ISSN:
1934-7685
Pages:
78
DOI:
https://doi.org/10.5089/9781455207466.002

Ratio of Cross-Border Loans to the Non-Bank Sector to GDP, 2001–2008 1/

Credit to GDP ratio, 2001–2008 1/

Annual Real Credit Growth, 2002–2008 1/

Loan-to-Deposit ratio, 2005–2008 1/

Total banking sector assets to GDP, 2008

Share of Household and Corporate Credit in Total Credit to the Economy, 2009 Q3 1/

Bulgaria: Domestic Loans to Nonfinancial corporations

(percent of GDP)

Bulgaria: External Loans to Nonfinancial corporations

(percent of GDP)

Share of Domestic and Foreign Currency Credit in Total Credit to the Economy, 2009 Q3 1/

Bulgaria: Credit flows, 2002-2009

(percent of GDP, 12-month rolling)

Bulgaria: Credit stock, 2002-09

(percent of GDP)

Bulgaria: Interest Rate Spreads over Eonia and Euribor, 2007-2009

(in percentage points)

Bulgaria: Interest Rates on Deposits in Leva with Agreed Maturity, 2007-2009

(in percent)

Bulgaria: Lending Spreads in Leva, 2007-2009

(in percentage points)

Capital Adequacy Ratio 1/

Non-performing Loans Ratio 1/

Provisions to NPL ratio

(in percent) 1/

Return on Assets

(in percent)

Liquid assets to short-term liabilities

(in percent) 1/

Bulgaria: “Bad and restructured” loans ratio and NPLratio, Sept. 1998-Sept. 2011

Bulgaria: Bankstock prices

(Jan. 5, 2009 = 100)