Slowing Growth on Bank Lending

Economic News

22 Jul 2010
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On July 19, the Bulgarian National Bank (BNB) increased the minimum mandatory reserve requirement (MRR) in a move intended to slow lending growth.



The BNB governing council announced that, from September 1 this year, the MRR of banks in Bulgaria will be 12%, up from 8% at present. Banks' MMR is held in the central bank, tied up in non-interest-bearing deposits.



Bulgarian businesses and consumers have been enjoying the fruits of an economy registering growth of around 6% in recent years, and have been taking out more and more loans, helped also by the abolition of credit restrictions and the increasing penetration of banks in the country. The lending growth has been a leading contributor to the country's large and troubling current account deficit, which is expected to continue to grow this year.



Tightening the MRR is one of the tools available to the BNB to slow lending growth. Due to the lev's currency board, which fixes its rate against the euro, interest rate changes cannot be used as a tool of monetary policy. The currency board has now been in place for 10 years, a significant anniversary lost on neither the supporters of the BNB's decision, nor its detractors. The board has helped lock in economic stability and helped the banking system become one of the most trusted and respected sectors of the economy, a decade after a banking collapse destroyed confidence in it and set back Bulgaria's transitional economy. Inflation averaged 233% between 1991 and the introduction of the currency board, compared to 5.7% since.



On January 1, as Bulgaria joined the EU, the BNB scrapped credit limits which had previously helped restrain loan growth, but pledged to keep the annual rate of lending growth below 20%. Under IMF advice, the BNB moved to slow lending growth to tackle the current account deficit. The BNB said credit control served to decrease the risk rate in the banking sector.



The growth of lending has led the private sector's indebtedness to banks to rise to 57.5% in mid-2007 from 47.4% at the end of last year, according to the BNB. Banks' lending to non-financial corporations increased 49.1% in the year to the end of May, to reach a total of $11.695bn. Meanwhile, mortgage lending grew 77% to $2.955bn and loans to households and non-profit-making institutions 40% to $7.45bn in the same period.



While reassuring investors that the banking system remained robust, the BNB said it was taking steps to rein risk in a dog-eat-dog environment. The statement announcing the new reserve requirement said: "Although the indicators of quality of credit portfolios remain good, the fast pace of growth of bank lending leads to the accumulation of higher credit risk in the banking system. On the one hand, the risk rate in the banking system increases, on the other, the strong competition and struggle for market share lead to loosening of credit standards and decreasing of interest rates on loans."



The BNB said real interest rates on household and corporate lending comes close to or even below zero, and that while interest rates in Bulgaria had been following a downward trend due to disinflation and competition, the overall global trend on rates is upwards. The bank warned that this situation "creates unrealistic expectations with the borrower and results in underestimating the risks they take", particularly as Bulgaria does not have a practice of lending at fixed rates, and that therefore at some point, the higher global rates will feed into those in Bulgaria.



The BNB reminded commercial banks that the "highly conservative" supervisory framework allows it to impose restrictive measures on an individual basis, and that the tightening of the MRR could be followed by "additional measures to achieve a moderate bank credit growth and stable development of the banking system".



Levon Hampartzoumian, the chairperson of the Bulgarian Association of Commercial Banks, told local press the BNB's move would increase the interest rates on consumer debts.



Others were unimpressed with the central bank's decision, with one news agency carrying the headline "Does BNB know what it's doing?" The report criticised the decision to increase banks' non-interest bearing deposits as "a tax on deposit base" that could force banks to decrease interest on deposits, discouraging saving. It went on to say that elsewhere in Europe, the MRR is not used as a tool to slow banking growth. It stated that larger foreign-owned banks would be able to find other sources of liquidity, while smaller banks would suffer. Banks might even increase credit in order to compensate for the MRR, having the opposite effect to that which the BNB intended.



However, the BNB has proved an able and astute guardian of the banking sector, albeit on the foundations of the currency board, for the past 10 years. As Bulgaria moves steadily towards euro membership, slated for between 2010 and 2012, it is expected to be cautious. Should the MRR increase not have the desired effect, the governing council has shown every intention of acting again, down different avenues, to keep the system and the economy on track.

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