Despite a slowdown in lending in September, Bulgarian banks have so far enjoyed a profitable year.
Data released by the Bulgarian National Bank (BNB) showed that the country's banks posted profits of $636m in the first nine months of 2007, a 60% increase on last year's figure. Bank assets in September 2007 totalled $38.4bn, a year-on-year increase of 34%. In addition, the bank's reserves have risen by almost 50% between July and September this year.
The direct cause of the dramatic increase in the bank's reserves was the decision taken this past July to increase the minimum mandatory reserve requirement (MRR) from 8% to 12% as of September 1.
Bulgaria's growing current account deficit, which is forecast to hit 20% of GDP by the end of the year, has led the government to seek ways to slow credit growth. Given that the country has a currency board, which effectively binds the base interest rate to that of the euro, increasing the MRR is one of the main methods of raising the cost of loans. Banks however, have taken the MRR hikes in stride.
There was indeed a drop in loans issued in September. BNB data shows that loans issued during the month totalled $723m compared to $981m in August. But this drop has been attributed to cautiousness among the public who, fearing the increase of interest rates predicted by media, put their loan plans on hold. As it turned out, the anticipated sector- wide rise in interest rates did not come.
Desislava Nickolova, an analyst at Raiffeisenbank EAD, Sofia, told OBG, "Only a few of the bigger banks raised interest rates on loans following the introduction of higher mandatory reserves and this increase was limited to 0.25 - 0.5 percentage points."
In fact, BNB statistics show that, on average, lending rates on loans to non-financial institutions actually decreased from August to September. Nickolova said, "This is due to fierce competition among local banks, most of which prefer to reduce their lending rates than lose market share."
Almost all of Bulgaria's major banks are foreign owned and can therefore find liquidity from outside the country. A series of mergers have taken place as many banks develop expansion strategies. On November 6 Greece's EFG Eurobank Erasias merged its two Bulgarian banks DZI and Postbank. The new bank, which will be renamed EFG Postbank in the first quarter of 2008, will be the fifth-largest bank by assets. Anthony Hassiotis, CEO of Postbank told OBG that DZI and Postbank complemented each other in terms of personnel and branch locations, facilitating plans to become one of the country's top three largest banks by 2011.
In April this year the Bulgarian subsidiaries of Italian Bank Unicredit, Bulbank, HVB Bank Biochim and Hebros Bank merged under the name of Unicredit to become Bulgaria's largest bank.
Competition among banks for market share resulting in lower interest loans may be good news for consumers but the long-term consequences of the continued credit boom could be problematic. Following the guidance of the International Monetary Fund, the government is keen to slow lending growth as a way of tackling the current account deficit. Upon EU accession at the beginning of this year, the BNB moved to scrap credit limits that had previously restricted loan growth and pledged to keep the annual rate of lending growth under 20%. That target now seems increasingly unrealistic. Even with the increase in MRR, lending growth is expected to be 50% more in 2007 than the previous year, according to Credit Centre, a Sofia-based consultancy.
An industry insider told OBG that the effectiveness of using MMR increases to curb monetary demand is reduced further by Bulgarian banks' habit of booking some loans outside the country or by using special purpose vehicles to bypass the MMR. Another member of the banking community told OBG that many in the sector believe the government could shortly raise the MMR again to 15%.
Equally, the likelihood that slowing lending growth will help reduce the current account deficit, the current area of most concern for economists, is also low.
While a reduction in credit could reduce imports of consumer items, current statistics show that 75% of imports into the country are investment goods. The current account deficit was funded by over $6.5bn in foreign direct investment over the last year and so attempts to curb consumer spending in the country would have a minimal effect on the overall current account.
Many believe a cut in lending growth can only be achieved through a hike in European Central Bank interest rates, a prospect that is looking increasingly likely. With the currency board in place and most banks operating under European parent organisations, the continuation of the credit crunch in Europe could affect Bulgaria.
Nickolova said, "The Bulgarian economy is a small open economy and it cannot remain isolated from global market swings. The direct effect is that refinancing costs for Bulgarian banks have increased. If the global credit crunch does not die out in around six months, and if banks cannot pass on the increased costs to their clients, then profitability will be hurt."
While the immediate future looks positive for those seeking loans in Bulgaria, the current stability of interest rates is dependent on events in Europe. With banks across the continent still unsure as to the extent and the longevity of the recent financial crisis, a rise in the cost of loans could soon be on the way.
