“Our clients are dear to us.”

An ad by Corporate Commercial Bank (CCB)

on Bulgarian National Radio (BNR), July 7, 2014

“While credit growth remains low, the system is stable and liquid, with banks’ non-performing loans buffered by provisions and significant capital, as well as a positive net foreign asset position.“

IMF Concludes Staff Visit to Bulgaria,

Press Release No. 14/278, June 12, 2014ⁱⁱ

Surprise, Surprise

This advertisement by the bankthat caused the crisis, CCB, still runs regularly on BNR, but the bank itself is closed, and put under special supervision by the Bulgarian National Bank (BNB) since June 20, 2014. Nine days earlier the IMF finalized its above-quoted staff assessment of the Bulgaria’s economy.

The CCB was the fourth largest bank in the country, and is locally owned. On June 26, panicked depositors at the third largest First Investment Bank (FIB) withdrew reportedly BGN 800 mln. (approx. EUR 400 mln.), causing a liquidity problem and forcing FIB to close doors next day at 2 p.m., Friday, June 27. FIB is another locally owned bank, with a large depositor base and a relatively limited volume of non-performing loans.

It seemed that domestic and international observers alike, plus BNB had been taken by surprise.

It should be noted that BNB operates as a currency board, meaning that it has no right to act as lender of last resort for the government of Bulgaria (GOB) and/or the banks, but supervises the banking industry. There is a legal limit to BNB’s function as special supervisor/receiver of problematic banks up to three months, by then it is obliged to restructure the ailing bank, sell it and retreat from its position in the bank in question.

On June 21, BNB announced that it will fulfill its mission at CCB within a month, by July 21. By then it promises that CCB will have either a new ownership structure or a strategic investor, or else be taken by the only state-owned Bulgarian Development Bank (BDB, with about 1% market share).

By June 28, the GOB remained totally silent on the matter, hoping that BNB would be able to digest it. Facing the problem with FIB, BNB drafted an alternative strategy to impose a classic bank holiday and ask for an IMF facility to support the liquidity crisis in these two banks. The situation with FIB forced President Rosen Plevneliev to call a meeting of the National Security Council (in which major political factions and the GOB take part), to work out a solution to the problem. Other banks opposed the prospect of a bank holiday (since it would mean a stalemate of the payment system with unforeseeable impacts). For political reasons, the Bulgarian Socialist Party (BSP), a sponsor of the incumbent cabinet opposed the holiday option as well: BSP governed the country in 1995-1997 when 50% of the banks bankrupted, now it wanted to avoid a similar blow on its image.ⁱⁱⁱ

Since FIB seemed to have only a limited liquidity problem, the GOB needed to show a gesticulation of commitment to calm the FIB depositors and the public. Such a gesture would not have been lawful without a European Commission’s weaver on the ban of state aid.^iv It was negotiated during the weekend of June 28-29, and EC granted it Monday noon; by then the FIB was functioning as usual, paying all deposits upon request.

Some statistics¹

If one looks at the banking system statistics for 2013, the conditions of the sector could hardly cast a shadow of anxiety.

As of 31 Dec 2013, the assets of Bulgarian banks were up 4% on year-to-year basis, totaling BGN 85.7 bln.; 2013 GDP in current prices was 78.1 bln. (or assets equaled 109.9% of GDP).

Banking System Structure by Type of Ownership

*Note: FIB acquired 100% of MKB Union Bank (December 2013)

Structure of Bank Assets

The situation with attracted funds looked healthy as well. As of the end of December they amounted to BGN 73.9 bln. (94.6% of 2013 GDP): up BGN 1.1 billion compared to September2013. Those from residents went up BGN 1.6 bln.on an year-on-year basis as a result of growth in individuals’ deposits; non-residents savings decreased by BGN 0.547 bln to 16.4% of all attracted funds.

Structure of Attracted Funds

The share of net non-performing loans at the end of December 2013 was 10.3% of net loans, down by 0.5 p.p. in the last quarter of the year.

Liquid assets of the banking system in total at the end of 2013 were BGN 20.052 bln.; the total assets inflow – BGN 72.928 bln., and total liabilities – BGN 74.084 bln. The coefficient of liquid assets was 27.07%.

In summary, six and a half months ago net non-performing were going down, liquidity in the banking system was going up and the balance of the system looked more than healthy. At the end of 2013 the capital adequacy (solvency) ratio of the banking system was 16.08%, and in the end of June 2014 the reserves of BNB’s Banking Department were BGN 5.1 bln.^v

What actually happened: reputation and micro-issues

There is no reason not to trust the above statistics and to suspect that the system could deteriorate in less than a year. What matters, however, are the reputation and micro-management issues that cannot appear in the overall statistics.

The story is a very useful experience that was grossly misunderstood by local and international media, by Bulgarian politicians and institutions, besides perhaps BNB.

It is the following.

CCB, originally a boutique-agent in settling debt between Bulgaria and the Russian Federation, was capitalized and grew three times for a period of three-four years (2008-2013) by political, personal-political means.

The utilization of political connections in banking rested upon a 10-year old institutional arrangement: in 2004 the coalition government of monarchists (NDSV^vi party) and the political party DPS^vii, which Bulgarian Muslims vote for, decided to stop privatization of state owned enterprises (SOE): electricity, gas and tobacco monopolies along with the railways and a couple of military SOEs were suddenly believed so “important” that they were listed as enterprises that could only be privatized by an act of Parliament.

The rise of CCB began with the next coalition of the Bulgaria Socialist Party (BSP)^viii, NDSV and DPS that governed Bulgaria between 2005 and 2009; and then it continued under the new government of GERB^ix. The engine of this growth was a series of GOB decisions, as principal of the above-mentioned SOEs, to transfer their accounts to CCB. In fact two socialist and center-left (that of GERB) GOBs had driven this engine. The incumbent GOB is sponsored by the ex-BSP PM of 2005-2009 and their sister coalition partner DPS.

The owner of CCB – it should be noted that the bank is almost a sole proprietorship – had a hobby of financing individual politicians and political parties, and due to old ties, he had invited as minority shareholder the Russian Vnesh-Torg Bank. VTB was the agent of the other side of the debt-settlement deal with the Russian Federation. The bank obtained a heavy political weight which helpedbothin attracting private depositors (announcing, at times, above 8% interest on deposits, while the average was hovering around 3%) and in outrunning everyone else as a custodian of future large government sponsored projects, mostly in the power sector and sponsored by Russian SOEs like GASPROM or ROSATOM. Or at least, CCB hoped it will be servicing such projects and companies.

The primeCCB political helper in these efforts, and coordinator of the above efforts to rechannel SOEs’ accounts to the bank, was and still is the DPS MP who in 2008 served as senior GOB executive in an insignificant ministry and whose nomination in June 2013 triggered the protest against the incumbent government. ^x

This political clout that helped CCB grow from one of the smallest to the fourth largest bank of the country had recently entered into aninternal conflict between the owner and the political helper in April – early-May this year: the conflict was over the credits of the helper, and the control over some former SOE, privatized and partially owned by VTB (the ex-tobacco and telecommunications monopolies). The bleak prospect for prompt construction of the South Steam pipeline by GAZPROM could have also been a factor – GAZPROM’s construction arm is owned by one of the sanctioned Russian subjects in relation to the annexation of Crimea. The design of the contracts and the pipeline construction procurement contradicts to the EU law, and has triggered penalties from the Commission in Brussels. The project seems to have been put on hold, while Bulgarian subcontractors of GAZPROM were hoped to bring in more cash into the CCB.

The risks associated with these projects and the mentioned conflict forced the GOB to withdraw some of the SOE accounts from CCB. The conflict and spitting between the two CCB gentlemen hit the media fan, private depositors panicked, claimed their savings and caused a liquidity problem.

It is now a matter of guess how deep is the hole: CCB’s political connection does not necessarily mean its projects and credits were allocated to competitive ventures, rather than the opposite.

Besides CCB’s size, the situation seemed manageable but after the panic spilled over to FIB the GOB and BNB hastened into thinking of a Bank Holiday “solution” that could have turned the situation into a monumental disaster.

FIB, which, as mentioned above, could have hardly had any liquidity problems but is also a Bulgarian owned bank, was perceived as a political bank as well. The GOB says the panic was engineered (via artificial lines of depositors, organized SMS and e-mal messages, etc.). There could have been such attempts but they are not the likeliest reason for the run.

A more probable reason is the image of FIB as a “political bank“. This image has stacked with FIB since 2008 when it was bailed out by the incumbent PM, then a finance minister. In the eyes of the public CCB was, if we use this Communist era archetype, a POLITBUREAU Bank. The CCB growth and the privileges were allowed to emerge, exist and expand due to this structure of political decision-making. The difference from the Communist era is that, in a representative democracy, the Politbureau membership changes in a somewhat unpredictable manner.

In both CCB and FIB cases the reason for the public distrust is the fact that the incumbent POLITBUREAU is falling apart. As it is known, this non-typical “banking crisis” evolved amidst political protests which have been everyday reality since 14 of June 2013, when the CCB political helper was appointed head of the Bulgarian analogue of FBI with no credentials and against any normal political logic.

The problem with these banks is still manageable even if CCB were insolvent, although this may not be the case — in a matter of a week or so we would know for sure. The currency board (BNB’s emission department) foreign reserves cover more than 100% of the money in circulation.^xi Due to the conjecture, the GOB could borrow at a historically low rate (on June 25 it raised EUR 1.5 bln. at 3.05%); goverment debt to GDP is about 22%.

Put together the BNB’s Bank Department reserves (BGN 5.1 bln.), the EC state aid allowance (BGN 3.3 bln.), the resources of the Deposit Guarantee Fund (BGN 2.2 bln.) and BDB assets (app. BGN 0.5 bln.) would more than suffice to heal both CCB and FIB (if needed at all).

Lessons?

The story shows that foreign banks, as conservatively managed as they are in Bulgaria, are more stable for one very simple reason: politicians and central bankers cannot go fishing with owners of CitiCorp., UniCreditGroup, Raiffeisen or HSBC while they can do so with domestic banks’ sole proprietors every weekend. The POLITBUREAU type of decision-making is based on personal connections. In principle it makes no difference whether this personal trust uses private or state-owned institutions. The GOB-owned BDB may substitute CCB: one of the most probable outcomes in the near future is that BDb assets grow very fast as the only institutional conduit at hand.

Even with very few political connections (there are four such “political” banks – the other two being very small ones), the banking system in such a small open economy like Bulgaria, with retained SOEs – however limited their number – may surrender to temptations and be put at serious risk.If the economy was totally privatized or at least depoliticized, such a bank run would have never happened.

In the meantime, themismanagement of the power sector by a combination of wrong ideas and influence from Russian SOEs’ juicy projects and personal connections has added more dangers and uncertainty in the public governance.

At the end of the day, political trust and mistrust are prone to creating problems in the banking industry with fractional reserves, irrespective of the limited monetary power of the central bank.