Banks Building Confidence

Economic News

22 Jul 2010
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Bulgaria's banks are being cautious in their response to government calls to increase the flow of loans, wary of potential problems that could arise in the new year, while awaiting more positive signs from the economy before turning on the lending taps again.

As part of its efforts to get the economy, and more particularly liquidity, moving again, the Bulgarian National Bank (BNB) cut its basic interest rate for the fifth month in a row on December 1, reducing its key lending rate to 0.55%, down 0.06 percentage points compared to November. At the beginning of the year, the bank's basic rate was 5.17%, with the latest cut taking the BNB's rates to their lowest level since free market banking was introduced in the wake of the fall of communism in 1991.

Both the government and the central bank have been pushing commercial lenders to come to the party, citing the BNB's cuts to its rates and the relatively solid position of most private banks.

According to BNB governor Ivan Iskrov, the country's banking system retained high capital adequacy levels and was stable. This stability helped them post combined profits of more than $465m for the first nine months of the year, Iskrov said in early November.

Bulgaria's banks have worked to boost capital adequacy levels, offering higher interest rates to depositors to attract more funds and shore up their own position, paying out as much as 10% on deposit accounts.

In mid November, the finance minister, Simeon Djankov, called on the country's banks to reduce their interest rates by 3% or more on deposit accounts to give spending and investing greater appeal, while also saying the banks should step up loan activity.

While keen to see an increase in lending, Violina Marinova, the chairperson of the Association of Banks in Bulgaria (ABB) and the chief executive director of DSK Bank, recently said that a reduction of interest rates is not just reliant on the banks themselves and their good will but on the wider economic climate.

Once the economy began to pick up and run smoothly, companies will increase production and hire more staff, Marinova said in an interview with local press in mid-November. This in turn would result in the need for more finance for their activities and would spark competition among banks, thus pushing down interest rates, she said.

The economic spring may not bloom any time soon though, with the government predicting that the economy will contract further in 2010. Addressing the parliament in mid-November during the debate over next year's budget, Prime Minister Boyko Borisov said the economy would fall back by 2% in 2010, before returning to positive growth in 2011.

One of the requirements for a turnaround was a stable banking system, which the prime minister said would help "create the most adequate conditions for economic recovery".

While many banks have built up their capital levels, there are still causes for caution. One of these is the rising number of non-performing loans (NPLs) on banks' books, with the BNB predicting that bad loans will hit 16.5% of the total by the end of 2009.

Though other studies do not put the ratio of non-performing loans as highly as the BNB report, suggesting that the figure will be around 10% next year, even this level is a concern. On November 27, credit ratings agency Moody's issued a review of four Bulgarian banks, First Investment Bank AD, DSK Bank, Raiffeisenbank (Bulgaria) EAD and MKB Unionbank AD. All four were given a negative outlook, while the agency also downgraded FIB's financial strength rating and its long-term local and foreign currency deposit ratings and DSK Bank's local currency deposit ratings.

Moody's said the ratings action reflected the vulnerability of the bank's earnings and capital position to increased credit losses arising from the deepening recession in Bulgaria. In particular, the agency cited higher corporate defaults as a matter of concern.

"The corporate sector's financial performance in the country has weakened significantly, mostly due to lower demand for Bulgaria's exports from its main export partners and from the declining foreign direct investment," the agency said in a statement.

It also warned that, although the banking sector remained profitable, was strongly capitalised and had good liquidity levels, the recession was resulting in increased credit losses in the system, with the rates of NPLs more than doubling since the end of 2008.

According to Elena Panayiotou, lead analyst at Moody's for the Bulgarian banking sector, the latest assessment reflected the potential for weakened activity in the coming year as much as the present situation.

"Given that asset quality metrics lag behind macroeconomic indicators by several months, it is crucial that the banks' current ratings incorporate Moody's expectations of their future losses," Panayiotou said.

In some ways, there appears to be something of a standoff between the government and the banks, with the former needing the lenders to free up liquidity to help kick start the economy, while the banks are waiting for the economy to gain momentum before increasing loan activity.

With Borisov's government limited in the steps it can take to prime the economic pump, given the fixed exchange-rate regime and focus on fiscal policy, despite plans to issue $920m worth of euro-denominated bonds next year, it may be up to Bulgaria's banks to blink first.

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