Bulgarian Banking: Looking for Sustainability

In this work, we trace and analyze the emergence of the crisis in the Bulgarian banking system as well as the behavior of the central bank and other macroeconomic institutions. The average annual rate of growth in the net profits of the commercial banks for the period 2002-2008 amounted to 31.6%, which encouraged and accounted for the increase in credits. After 2008, the pendulum began to swing back as the difficulties in collecting loan repayments increased, the strain in financial balances tightened and assistance and support from the regulators were requested. The level of the financial and operating income was maintained primarily because of the high interest rates on the loans, but the structure of their distribution shifted substantially. Administrative costs and depreciation were nearly frozen up, and impairment and provisions grew at the expense of profit. This work shows that macroeconomic policies allowed the expansion of the lending boom and encouraged its irrational development. Poor operation and poor quality of the institutions not only allowed but also enabled direction of investments to financing of inefficient production structures. Underestimating the negative consequences shoring up a dysfunctional institutional environment is deemed a form of irrationality; however, not one of the immediate economic players acted to override the economic and political environment. The financial and economic crisis currently affecting the country has its roots in the deficiencies of the domestic macroeconomic policies, and therefore, the efforts toward overcoming these failures should be directed at improved domestic macroeconomic management.


Resource provision and lending policies
Immediately following the 1996-1997, years of crisis, the CBs were exceptionally careful and restrained in formulating their lending policies. Confidence between lenders and debtors was at a notably low level.
Because the CBs were reluctant to lend, their financial resources were not used to the fullest. During this period, the CBs preferred to export their resources and retain them as deposits with first-class foreign CBs (Figure 2). Therefore, only a quarter of the CBs' assets were realized as loans ( Figure 4). Lending grew over time, however, and by 2005, it accounted for approxmately 60% of assets. Koetter & Wedow (2010) proved that under the given circumstances, expanding the amount of bank credit has no significant effect on growth and that the quality of banking is more important. During the same year, the BNB undertook selected regulatory measures to cool the rate of lending: regulations were aimed at the operation of thecommercial banks' reserves held with the BNB. The lending market reacted positively to the regulatory measures, and the share of the loans in the CBs' assets fell gradually to near 52%.
This share was close to the average for the EU member  The gradual reduction in corporate tax, from 35% (2000) to 10% (2008), made a significant contribution to this intensive dynamics as well. The flat rate in Bulgaria has remained at the lowest level in the EU, but the future harmonization of the tax system within the EC is considered unavoidable (Wołowiec & Soboń, 2011). The growth in the CBs' net profit provided a foundation and accounted for the unbalanced drive towards making the most of the opportunities for increasing lending.
The foreign owners of the resident CBs supported this lending. The deposits of non-residents, held with the resident CBs, rose gradually ( Figure 2). These deposits represented foreign financial resources (most likely that of the owners) provided to the resident CBs to raise their potential for intensified lending. With the country's accession to the EU, this process became particularly active. The process of foreign capital penetration in the newly accessed member-countries of the EU is a typical feature of the period under consideration and has been noted in specialist literature (Krugman, 2008;Wilczyński, 2011 A lack of possibilities for sterilizing the money supply due to the CBA in operation should raise an alert by the regulatory authority, which did not prove sufficiently alert under the conditions of Bulgaria.

Bulgarian banking: looking for sustainability
The credit risk linked with the sectoral structure of credits remained unappreciated as well. Granting credits to sectors such as "Real estate, renting and business activities", and "Construction" and "Transport, storage and communications" became more prevalent ( Figure   5). However, lending to the production sector lagged behind. The sectors of "Manufacturing", "Mining and quarrying", "Electricity, gas and water supply", and "Agriculture, hunting, forestry and fishing" barely accounted for 16.5% of the overall credits in 2008 (4.7 percentage points less compared with 2005), and 37.4% were directed to "Households and NPISHs". The major portion of the credits went to construction and the service sector (46.1% in 2008, 5.7 percentage points greater than three years ago). Such a sectoral lending structure was typical of the EU and not only of the EU. In fact, the mania for investing in real estate, renting and business activities seemed universal (DG Enterprise and Industry, 2012;European Commission, 2011). The prevailing public opinion was that real estate prices would never collapse (Roubini & Mihm, 2010). This sector composition of credits cannot be deemed sustainable or promising for the future. Regulation of the lending sector composition lies outside the authority of the BNB. This type of activity requires and presumes a much better coordination between the BNB and the government. It is a public secret that real estate transactions during this period were officially effected at artificially low prices (roughly ten times lower than the real price paid), which encouraged profiteering in real estate. Control of licenses for new construction was a formality that enabled accelerated investment on a large scale, and construction sites were quickly designed without care for the future, using easy money. All these activities became possible because the various institutions functioned poorly.
In parallel with this process, the formal grounds for charges of illegal (criminal) deeds were eliminated because the huge amount of real estate acquired was officially accounted at unnaturally low prices. For experienced defenders of the law, it is not difficult to find a seemingly satisfactory explanation of how large buildings were acquired at artificially lower official prices and thus escape legal prosecution.
The government is the authority that should install order in this type of speculation. If the government had not allowed cheating in the sales and trading prices of real estate, then the incentives for profiteering in this field would have been eliminated. Roubini & Mihm (2010) found that banking security is transient and erratic. After 2008, the banking pen-  The events at the end of 2008 had an influence on concern in the BNB sector over the soundness of the commercial banks, as reflected in the growth of the CB equity ( Figure 6). Immediately after in the following year, the total CB equity grew by almost a fifth (given an asset growth of 1.9%), allocated primarily to "...the  However, the responsibility for their liquidity condition was to be borne by their foreign head offices.

Sobering
Indirect indicators (at least four) show that the CBs suffered from liquidity problems after 2008, which reflected on their lending policies.  Until the beginning of 2009, the weekly fluctuations observed might be considered normal. Later, however, a certain regularity of fluctuations with expanding amplitude was outlined. By the end of each month, the CBs deposited the funds needed to ensure that the required aggregate monthly size of MRR was available, and this moment corresponds to the peaks observed in Figure 9.
Immediately afterwards, the CBs would withdraw up to a fourth ormore from the MRR. By 2012, this amplitude had clearly shrunk but has remained quite large.
A logical explanation for the process observed is that the CBs need liquidity, and thus they resort to using their own reserves maintained with the BNB.   Third, we examine the composition of the CBs' assets.
In Figure 4, we can trace the change in the share of the CBs' loans via their assets (the data are given for the    "We should look for the prerequisites for growth rather than the prerequisites for crisis" is a statement made by Mises (2006). The consequences from resorting to regulation (or the lack of regulation), if the situation were not properly assessed in time, would reflect by undesirable developments. (not with the CBs), which was ripe for realization.
In the primary GS market for the period under consideration, the non-banking institutions, i.e. insurance companies, pension funds, non-banking financial in-   stitutions, companies and individuals, became much more active (Table 3). For the sake of thoroughness, we should add foreign investors as holders as well, but their participation was limited to one percent of the overall quantity of GS issued on the internal money market). These products were legal entities that accumulated free financial resources and were searching for opportunities for investment with a view towards rational management of the money funds and provision for a return. The preferences included to investing in GS because these products enjoyed higher security and a much longer maturity, which was of considerable importance as well. The one-year GS, issued in 2010, accounted for a tenth of the overall issue of GS, and more than half had a 10-year maturity. At the same time, the predominant promotion of CBs was for de-posits of 3-6 month maturity, which obviously differed from what investors sought.
In addition, the cross-border flow of financial resources from residents included in the financial account of the balance of payments (Table 4) was also predominantly sourced from non-banking investors.
The information quoted implies that the various institutional funds in the country enjoyed liquidity that remained underused. Simultaneously, the CBs showed signs of liquidity difficulties. The two sides did not meet, mostly due to structural imbalances. Institutional investors were interested in long-term lucrative investments, whereas the CBs would have rather attracted short-term funds with the expectation of lowering their interest rates costs and receiving improved return on the loans made. Table 5 illustrates the currency composition of the funds attracted by the CBs (by the end of the year), and Table 6 displays the currency composition of the loans granted from the resident CBs in the country. (In Table 6, the sum by years is less than 100% because there is one additional component that is not presented, namely "Impairment"). Table 5 shows that a shift in the CBs' behavior was The changes in the currency composition of the loans followed a strict logic of contraction of the BGLloan share at the expense of the EUR-loan share.  There are no chance phenomena with bankers; as a rule, their behaviors are well-thought out and calculated. Therefore, the question that remains is why did the model of banking behavior change?
The party that gains under a substantial depreciation (devaluation, crisis) of the local currency is the borrower, and the party that loses is the lender. If the local currency (the Bulgarian lev) crashed, the bankers who had granted BGL-loans would have lost. As a consequence, the depositors that maintained BGN deposits would have also lost.
The process described is highly inertial (structural sta-

Income and Expenses Composition
The crisis of 2008 revealed many problems connected with the assessment and adoption of various types of risks in commercial banking. One of these problems is the way in which the remuneration of employees in the banking sector was worked out (Attali, 2008). It is logical for remunerations to follow the dynamics of the final financial results from the banking operations, but global experience has shown that this is not always so, especially with CBs of dubious success.  The gross pay of bankers' labor outstripped the average labor pay in the country but not by much, i.е., there are no grounds to claim that bankers abused the possibility of raising their income. The level of pay in the country was rather low compared with European standards, and it is therefore natural to record relatively higher rates of growth under these circumstances.
The internal structure of pay by individual labor categories in the banking system is no doubt essential, but this information remains confidential. The narrow circle of top management of the CBs enjoyed an income several times higher than that of the average employee, but this is the usual practice.   After four years the normalization sought in the income statement structures of the banking system had drifted substantiually. The structure of Figure 12 would have been much more unfavorable for the CBs, if the old criteria for classification of risk exposure in the individual risk groups of "watch exposures", "nonperforming exposures" and "loss" had been maintained (had they not been extended to twice as long in time instead). A hidden revolving door of bad debts was observed (which statistics are unable to capture) in the hope that borrowers would manage to recover their business profitability in time. The CBs did not demonstrate a desire to begin cashing the collateral pledged.
Obviously, there were no acceptable conditions for that outcome.
For the overbuilt areas that consumed a notably large amount of credit resources, the process runs slowly and sluggishly: investors are not prone to lower prices, and their expectations match the traditional beliefs that the market will not only pick up again but that it must pick up. The process extends in time together with the normalization of lending. Certain institutional changes have now restrained the speculation in real estate, and moreover, the real estate market appears saturated at the moment. The other type of business that acts as a debtor to the CBs (and lies in the service sector primarily) suffers from the present crisis in consumer psychology. The latter can be stated somewhat in terms of "better be prepared for a poor tomorrow than to loosen one's purse hoping for higher income in the future".
Developments in the structure of the financial and operating income were also frozen ( Figure 13). After 2008, the CBs tried to maintain the level of interest income attained primarily through operation with the agreed floating interest rates on credits. An analogical effort to maintain the level of interest expenses was observed; in 2009, increased efforts were launched to attract deposits (Figure 10), but the effort put towards maintaining them outweighed them, however.
Contradictory opinions exist with thespect to the CBs' fee and commission income. According to the data, their size is also relatively stable, remaining within a fifth of the financial and operating income.
An entirely different matter is that, given the situation, the fees and commissions have provided for the CBs' profit ( Figure 14), and they have become vital for the operation of the banking system.

Policy lessons
There is an opinion in certain professional economic circles that the financial and economic crisis of 2007-2008 arose because of excessive faith in the rationality of the market and that of the participants in the markets (Attali, 2008;Stiglitz, 2010b). Regulations shrank steadily to allow for the free operation of market initiative and this initiative managed to create and spin a broad web of speculative threads, which were wound round and sucked out the economic forces -in the interest of the "irrational" market masters. These actions had their own redistribution effects, which went beyond the direct financial and economic operations.   most rapidly and significantly on the cross-border movement of capital, but it is also true that money does not shy away from an opportunity described by foresight, transparency, safety and profit.
It is indicative that according to Transparency International, Bulgaria has firmly held the position of the most corrupt country in the EU, and moreover, this situation has continued to worsen (Minassian, 2011).
At its essence, corruption is a political not an economic problem, i.e., it exists because the political class cannot (or does not want to) eradicate it. The black market has not been cornered and also has been steadily as-  (Sariyski, 2008;Taseva, 2012).
Central bankers claim that the Bulgarian taxpayer has not spent money to save the Bulgarian CBs, but this is a surface observation. The highly restricted lending due to the excessively high interest rates is connected with the consistent and tangible shrinking of all investment activities in the country, which sounds ominous in the long run given the exceptional technological backwardness of the Bulgarian economy.
In addition, the highly restricted lending forced economic players at the microeconomic level to activate commercial lending, which is a type of time bomb. Additionally, it is not possible to speak of domestic financial sustainability when residents prefer to export their resources abroad.
What determines the health of an economy is the availability of economic sustainability, and the latter in turn determines social and economic prosperity.
If there is no economic sustainability, everything else (including the so-called sustainability of government finances) is merely rhetorics.

Conclusion
The banking system is a component of the financial and economic institutional structure of society, which is of crucial importance for the normal development of economic processes. Formally, the responsibility for keeping the banking system sustainable lies with the central bank, but as a matter of fact, the banking system becomes the meeting point for almost all elements of macroeconomic management. An adequate assessment of the banking system situation and its regulation presumes taking a view that is higher than banking coordinates, from the position of the national (and the supranational) economy. The sustainability of the banking system is functionally linked to and correlates with the sustainability of economic development. Problems in the banking system might arise from inadequate regulatory measures undertaken by the central bank, but in a prevailing number of cases, they are the outcome of deficiencies in macroeconomic management as a whole.
The soundness of the banking system is linked to the value of transaction costs in the economy.
The financial and economic crisis that Bulgaria has experienced is the outcome of the domestic macroeconomic management of poor quality. Havrylchyk & Bulgarian banking: looking for sustainability Jurzyk (2011) found that direct evidence did not exist for the transfer of negative financial impacts from the parent bank to its subsidiary banks from Central and Eastern Europe, and Acharya &-Schnabl (2010) came to the conclusion that reducing global imbalances was not a panacea for preventing banking crises under the conditions of inefficient regulation. Investment banking was not developed in Bulgaria, and it cannot be blamed for the crisis. Even the shrinking external demand cannot be named as an exogenous reason for the difficulties that the country has experienced. In 2011, for example, the export of goods and services exceeded its pre-crisis level of 2008 by a quarter, whereas the imports of goods and services were almost a tenth lower, i.e., there are grounds to claim that in the critical situation, Bulgaria caused difficulties for its trade partners rather than the opposite.
However, the globalization of developments, and of economic thinking most of all, reflects on the way in which domestic economic processes take place, and their manifestations follow the usual process of "contamination" (Baur, 2012;Ismailescu & Kazemi, 2011;Wilczyński, 2011). It is a fact that the sharp withdrawal of foreign capital from Bulgaria coincided with the global recession and had a significant impact on the shrinking of national output, but such a reflection of financial and economic perturbations has occurred all over the world. If we trace the quotations of the Bulgarian Brady bonds of the 90s in the last century as a barometer of investment interest towards the country, it becomes clear that they were influenced by global conjuncture, although Bulgaria did not participate in this specific process of crisis. A fall in investment interest in Bulgaria was witnessed during the Mexican debt crisis of 1994 (tequila effect), after the financial crisis in South-east Asia in 1997 and also (especially so) during the Russian financial crisis a year later. The effect of "contamination" in terms of the ebb in investment interest was impulsive, but the length of the recovery of the pre-crisis levels correlated positively with the efficiency of macroeconomic policy.
Financial and banking sustainability is an element of overall economic sustainability, which results primarily from endogenous management policies. Economic history has persistently confirmed that in the end "nothing is really exogenous" (Ray, 2004). The explanation of the financial and economic processes observed and the search for sustainability cannot take place except within the context of an integrated theory of finance and macroeconomics (Mehrling, 2004).