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The Wind of Bank Reforms in Bulgaria


After a critical 2014 marked by political instability, one major bank’s unexpected collapse, and another being provided significant liquidity support by the Government, the main challenge for 2015 was to stabilize and restore confidence in the Bulgarian banking sector.

The unfavorable events of 2014 revealed major weaknesses on an institutional level and shortcomings in supervisory practices, and they hastened (at least temporarily) the outflow of deposits. The State provided a credit line of BGN 3.3 billion (approved by the European Commission under EU State Aid rules) to address the turmoil and to alleviate liquidity pressures. 

After dealing with short-term challenges arising from the failure of the Corporate Commercial Bank, the focus shifted to making significant long-term reforms in the banking sector. The Bulgarian authorities took a three-pronged approach in an attempt to restore confidence in the banking system: implementing the EU’s Bank Recovery and Resolution Directive (“BRRD”), strengthening banking supervision and carrying out Asset Quality Reviews (“AQR’s”), and conducting stress tests of Bulgarian banks.

In August 2015, the new Act for Recovery and Resolution of Credit Institutions and Investment Intermediaries (the “Act”) was adopted. The Act implements the BRRD provisions that seek to address bank instability at an earlier stage and to minimize negative consequences and control contagion, as well as to regulate the use of public funds to save troubled banks. The Bulgarian National Bank (“BNB”) was appointed as the resolution authority for banks in Bulgaria. 

The Act imposes a range of new obligations on banks, all of whom – including the BNB – are required to dedicate significant time and resources to ensure compliance. Recovery plans in accordance with the Act will have to be prepared in the first half of 2016, which, along with the pending AQR’s, is expected to put pressure on staff workloads and use up other available (already limited) resources. Interestingly, the two processes will run in parallel. Hence, any problems that might be exposed through the AQR’s would have to be handled within the new BRRD framework at a time when market participants are still adjusting, both institutionally and operationally. This said, the industry seems cautiously optimistic that the AQR’s are unlikely to reveal any major flaws. 

Scrutinizing and updating the supervisory practices of the BNB has been another major item on the 2015 agenda. The BNB emerged from the banking crisis with a new management team committed to reforming banking supervision. A “Plan for Reform and Enhancement of Banking Supervision in Bulgaria” was adopted in October 2015. There have been a number of structural changes within the BNB as well. A new Directorate of “Distance Supervision” has been established, and a department of “Risk Analysis Related to Market Behavior” will be created within the existing “Banking Supervision” Directorate, aimed at strengthening internal controls within the BNB. In addition, to comply with the BRRD provisions for operational independence and avoidance of conflict of interest, the BNB will create an independent “Resolution of Banks” Directorate. The BNB has publicly stated its desire to restore confidence in its own expert potential, as well as in the Bulgarian banking sector as a whole.

The BNB has prioritized both the update of supervisory practices and the achievement of full compliance with the Basel core principles for effective banking supervision. Bulgarian authorities have declared their intention to enter into close cooperation with the Single Supervisory Mechanism at the European Central Bank (“ECB”). Various other measures are directed at establishing proper and more robust oversight. 

Accordingly, AQRs will be performed on the entire banking system (which includes 22 Bulgarian incorporated banks but excludes the branches of foreign banks operating in Bulgaria), based on the methodologies applied by the ECB in its comprehensive assessment. Weak asset quality and collateral with overstated value have been recognized as major items that should be addressed. Banks will have to put efforts into cleaning their balance sheets and finding effective solutions for decreasing the rate of non-performing loans (NPLs). 

The AQRs and stress tests are to be completed within a tight timeframe, by mid-2016. As an immediate effect, they are expected to result in a somewhat reduced appetite by the banks and greater selectivity towards borrowers (but given the existing liquidity this is anticipated to be of short-term effect).

Operating conditions remain challenging, and corporate sector indebtedness, affecting banks via NPLs and risk of corporate bankruptcy, is still high compared to other EU member states. Nevertheless, the reform process has been set in motion. Although it may take some time for the full effect of the changes to be felt, the banking sector in Bulgaria has started to slowly recover from the 2014 crisis. BNB’s conservative approach in the past has led to the establishment of strong capital buffers, which support financial stability and will contribute to handling any further negative effects relating to unanticipated bank losses. In general, there was no significant outflow of deposits from the banking sector as a whole, as deposits appear to have been redistributed within the Bulgarian banking system. The reform agenda was implemented relatively quickly and robustly. It is now important to stay the course.

By Elitsa Ivanova, Head of Banking and International Finance, CMS Sofia

This Article was originally published in Issue 2.6. of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

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