Mission - Bulgaria

Bulgaria’s financial system has been resilient to shocks in recent years, though it was shaken in 2014 by the collapse of the system’s fourth largest bank due to fraud and insider abuse. The failure raised questions about the viability of other banks, some of which experienced deposit outflows, and raised concerns about the supervision by the Bulgarian National Bank (BNB). To restore credibility, the authorities—in addition to requesting this Financial Sector Assessment (FSAP)—conducted an asset quality review (AQR) for banks and nonbanks, and initiated reforms to BNB supervision and introduced a new bank resolution function.

The financial system stabilized following the 2014 bank collapse, reflecting the initial reforms, and the overall significant capital and liquidity buffers. Nevertheless, risks remain, including for some banks that showed weakness in the authorities’ AQR and stress test, and for the system because of high nonperforming loans (NPLs). The Currency Board Arrangement has contributed to economic stability, though it constrains the BNB’s ability to provide liquidity support in times of financial stress.

Progress has been made to strengthen supervision since the 2015 Basel Core Principles (BCP) assessment, but more work and resources are needed. The AQR exercise provided a deep assessment of bank impairment practices, loan data quality, and collateral valuation processes.

While the financial safety net and crisis management arrangements are based on sound foundations, they face important challenges. The authorities have introduced a comprehensive resolution toolkit, designated by the BNB as the resolution authority for banks, and established mechanisms to fund resolution measures. However, the financial safety net components still are underdeveloped. Among the concerns are that resolution planning for larger domestically owned banks is incomplete, and, in the practical sense, an emergency liquidity assistance facility would not be available if needed.

A more targeted strategy is needed to address high NPLs, which in Bulgaria’s banks stood at 13.7 percent of total loans as of June 2016 [2] —against an EU-weighted average of 5.5 percent. Certain accounting, collateral valuation, and risk management practices have contributed to disincentives for NPL reduction. Banks will also need to build provisions in preparation for the implementation of the forthcoming expected credit loss provisioning standards beginning next year [3] .

Executive Board Assessment [4]

Executive Directors agreed with the main findings and recommendations of the Financial System Stability Assessment. They commended the authorities for the positive steps taken to rebuild credibility in the banking system after the collapse in 2014 of the then fourth-largest bank, which revealed weaknesses in supervision and crisis management tools. Directors encouraged the authorities to continue to press ahead with efforts aimed at strengthening financial sector resilience.

Directors welcomed the authorities’ plans to address weaknesses identified by the Asset Quality Review and stress test exercise completed in 2016. They noted that while the banking system overall shows resilience—as confirmed by the FSAP’s stress test—the exercise revealed capital weaknesses in some domestically owned banks. Directors encouraged the authorities to stay the course and prioritize the restructuring and capitalization plans for these banks. They also emphasized the importance of strengthening supervision and addressing governance concerns with particular attention to related-party exposures and credit concentration.

Directors commended the improvements in banking oversight since the 2015 BCP assessment, but noted that shortcomings remain. They called on the authorities to extend the BNB’s macro-prudential mandate to address the high level of NPLs in a comprehensive manner through a combination of measures, including strengthened loan-loss provisions, higher NPL write-offs, improved collateral valuations, enhanced disclosure practices, and strengthened data collection. Directors also underscored the need to strengthen supervision and address weaknesses in the non-bank sector.

Directors urged the authorities to fully develop all components of the financial safety net and crisis management arrangements. They saw merit in developing a framework to provide for lender of last resort liquidity assistance to address constraints stemming from the currency board arrangement and European Union state aid procedures.

Directors noted the progress in enhancing anti-money laundering (AML) supervision of the banking sector and encouraged the authorities to build on these efforts and implement a risk-based approach to AML supervision in line with the Financial Action Task Force standard.

[1] The Financial Sector Assessment Program (FSAP), established in 1999, is a comprehensive and in-depth assessment of a country’s financial sector. FSAPs assess the stability of the overall financial system and not that of individual institutions. They are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks and contagion. Certain categories of risk affecting financial institutions, such as operational or legal risk, or risk related to fraud, are not covered in the FSAPs.

[2] This number is based on the European Banking Authority’s measure.

[3] Beginning January 1, 2018, EU banks will be subject to the new International Financial Reporting Standard 9 (IFRS 9) for determining loan-loss provisions.

[4] At the conclusion of the discussion, the Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summing up can be found here: https://www.imf.org/external/np/sec/misc/qualifiers.htm l .