In mid-1996 the Bulgarian banking system was on the point of collapse. Commercial banks had negative aggregate net worth and extremely low liquidity, while the government no longer had the resources to bail them out.
In practice, the Bulgarian government used the banks to provide implicit subsidies in the form of soft loans to loss-making state-owned enterprises. Themselves benefiting from soft refinancing, the managers of commercial banks also actively expanded credit to the new private sector, often in a context of corruption. Lending by commercial banks to the non-financial sector had reached a level unseen in any other European transition economy.
The measures adopted since then have addressed these problems. The National Bank changed strategy radically, considerably reduced bank refinancing and improved commercial banks' incentives. Prudential regulations and supervision were strengthened and made more severe. In the second half of 1997 and 1998, commercial banks seemed properly capitalised and solvent on aggregate, and the banking sector as a whole managed to show a profit. In February 1998, however, 74% of assets were still concentrated in 7 large banks, 5 of which were in State hands, the other two having been privatised.
One of the main current problems is that the weakness of the institutional framework prevents commercial banks from playing a profitable role in financial intermediation or the development of corporate governance. They are not sufficiently equipped to take action against firms that default on payments. Furthermore, institutions to handle bankruptcies and liquidations are still very underdeveloped, despite the fact that many firms still report losses and accumulate arrears. Unless these fundamental weaknesses are addressed, Bulgarian commercial banks will most likely be very limited in their abilities to expand their loan portfolios in a profitable way.
©OECD Observer No 217/218, Summer 1999