COVID-19 and the Bulgarian National Bank
In the recent week the COVID-19 pandemic led to financial market distress not seen for over a decade. While for the time being the real economy bears the main blow, central bank and government throughout the world are engaged with adopting urgent measures to guarantee liquidity in their national economies, ensure small and medium sized business‘ access to funding and prevent “infection” of the financial sector.
In this context, on 19.03.2020 the Bulgarian National Bank (BNB) announced a package of measures with a total amount of BGN 9.3 bn (EUR 1 = BGN 1,95583) aimed at ensuring the stability of the banking system and improving the system’s resilience in order to limit the negative effect of the pandemic related restrictions imposed on businesses and individuals. These measures include a restriction on the distribution of the profit accumulated in the banking system; retaining the current level of the countercyclical capital buffer for credit exposures in Bulgaria (0,5% of the total amount of such exposures) through cancellation of the scheduled increases of this buffer for 2020 (to 1%) and 2021 (to 1,5%); requirement for Bulgarian banks to decrease their foreign exposures.
Following prolonged discussions, presidential veto and last minute amendment, on 24.03.2020 the first package with measures against the COVID-19 pandemic, adopted by the Bulgarian parliament, was enacted – the Act on the Measures and Action against the COVID-19 Pandemic during the State of Emergency, declared with decision of the National Assembly dated 13.03.2020 (the State of Emergency Act).
While awaiting the next national measures for the handling of the current humanitarian and economic situation this material seeks to provide additional information on the measures, which the Bulgarian National Bank hat at its disposal in order to prepare and protect the banking sector from the times of economic distress which are likely to come for the Bulgarian and the world economies.
Measures aimed at Bulgarian banks
One type of measures which the BNB might undertake is aimed at the banks themselves – through actions aimed at reducing the administrative burden on their own funds and liquidity. This category includes also the measures declared by the central bank on 19.03.2020.
Through the announced capitalization of the banks’ profits and the decrease of their foreign exposures, the BNB aims to create addition liquidity to be used by banks in the context of reduced cash inflows resulting e.g. from an increase in the percentage of non-performing loans following the anti-epidemiological measures introduced in the country or due to the enacted stay on the sanctions for debtors defaulting on their credit obligations. On the other hand the cancellation of the increases in the level of the countercyclical buffer for credit exposures in Bulgaria, initially scheduled for 2020 and 2021, seeks to ease the burden on the banks’ capital base created by the combination of increase in the buffer level and a potential increase in the risk weight of exposures, included in its calculation.
As a next step the BNB could reduce the current level of other capital buffers applying to Bulgarian banks. Under Ordinance No. 8 of the BNB, the most relevant buffers include:
- Capital conservation buffer (2,5% of the total risk exposure amount);
- Countercyclical capital buffer (0,5% of the total amount of credit exposures in Bulgaria);
- Buffer for other systemically important institutions (between 0,5% and 1% of the total risk exposure amount of the 9 largest banks in Bulgaria);
- Systemic risk buffer (3% of the total risk exposures in Bulgaria).
With view of the outlining change in the economic cycle it is not unlikely that the countercyclical capital buffer level would be reduced to 0% in order to facilitate increased borrowing to the real economy. A reduction of the buffer levels in general could further help to prevent a market-wide breach of the combined buffer requirements following a sudden surge in the risk weights of bank exposure to clients and counterparties, suffering under the effects of the state of emergency. This in turn would reduce the stress on banks to improve their capital base by providing them with additional time to prepare and organize next steps beyond the short deadlines of the capital preservation procedure envisaged in Article 17 of Ordinance No. 8.
In addition, while entire sectors of the economy are barely functioning it can be expected that depositors withdraw their savings at an increased rate. This would increase the amount of cash outflows from Bulgarian banks and is likely to cause them to use assets included in their liquidity reserves. These reserves include most notably the minimum required reserves, kept by the banks with BNB in accordance with Ordinance No. 21 and the so-called liquidity coverage under Delegated Regulation (EU) 2015/61, which is comprised of liquid assets and is aimed at ensuring the liquidity necessary for a bank to meet its obligations in a 30-day period of stress. In such a situation BNB could make use of its supervisory powers to soften the initial stress on the banking system, e.g. by waiving interest rates due as a result of excessive use of the minimum required reserves, or by exercising its powers to relieve banks of administrative obligations related to a reduction of their liquidity coverage.
Reduction of ongoing obligations
The imposition of various restrictions on free movement in connection with the state of emergency, the introduction of additional sanitary and hygiene measures, changes in working hours, as well as the entry of many bank employees in home office mode, lead to the accumulation of additional stress on the organization of the work process and the maintenance of critical functions in the banking sector. These factors, coupled with the potential pressure on bank liquidity resulting from reduced inflows and increased cash outflows, can deprive a number of banks of the resources needed to meet their ongoing administrative obligations, e.g. collecting and reporting various data on their and their clients’ transactions and operations. The reorganization of the workflow could also hinder the ongoing supervision by the BNB, due to challenges in the carrying out of on-the-spot checks or the granting of access to certain types of information.
In view of such challenges, the BNB may (if not already done so) postpone or extend in an appropriate manner deadlines for providing certain types of reporting that are not critical for the functioning of the banking system, such as remuneration reporting under Regulation (EU) No 575/2013 or the provision of statistical data under Ordinances No. 27 and No 17 of the BNB. Alternatively, the central bank could signal that non-compliance with regulatory deadlines for such obligations would not be sanctioned. Given the current situation, it is also possible to suspend ongoing and postpone scheduled inspections part of BNB’s ongoing supervision. All of the above would correspond with the supervisory approach, recommended by the European Banking Authority (EBA) in a press release dated 12.03.2020. Due to the COVID-19 pandemic EBA already announced that it postpones to 2021 the comprehensive EU-wide stress test of 51 banks scheduled for this year. Among the bank included in the stress test were also the parent institutions of the three largest Bulgarian banks – the Italian UniCredit S.p.A., the Hungarian OTP Bank Nyrt. and the Belgian KBC Groupe.
Granting liquidity to the market
Whether BNB has the mandate to provide liquidity to the Bulgarian economy represents further interest. A number of central banks, most notably the European Central Bank and the US Federal Reserve, already announced their multi-billion debt purchase programs.
To this end, it should be noted that under applicable law the ability of the Bulgarian National Bank to act as a lender of last resort for Bulgarian banks in times of a liquidity crisis is only very limited. In particular, under the Bulgarian National Bank Act (BNBA), the BNB can only grant loans to solvent banks in the event of liquidity risk affecting the stability of the banking system. Such loans should be in BGN, for a term not exceeding 3 months and be fully secured by a pledge of gold, foreign currency (EUR, USD or CHF) or other very liquid assets as defined in Ordinance No. 6 of the BNB, such as government securities issued by one of several leading economies. Further to these legal restrictions, there is also a limit to the total amount of loans extended to the banking system. Ordinance No. 6 ties this amount to the funds available under the deposit of BNB’s Banking Department with Issue Department, which amounts to BGN 6.45 as of 28.02.2020. All these restrictions are probably also the reason why no such loans were ever granted since the entry into force of the BNBA in 1997.
Outside the context of crisis financing, the applicable law leaves substantial legal uncertainty as to whether BNB may take up an active role on the local financial market and inject money in the economy, e.g. by entering into repo transactions with Bulgarian banks or subscribing to debt instruments, issued by domestic issuers. By way of example, Article 31, para. 2 of the BNBA restricts the types of securities in which the BNB may invest its international foreign exchange reserves to top-rated liquid debt instruments issued by foreign countries, central banks, other foreign financial institutions or international financial organizations. At the same time there are good arguments that the general ban imposed on lending to Bulgarian banks by Article 33, para.1 of the BNBA should be extended to cover also other forms of financing such as repos and the subscription of debt, issue by a Bulgarian bank.
Therefore, the current legislation does not set the necessary preconditions for the provision of direct liquidity support by the BNB through an extensive investment program similar to those announced by other central banks.
Declaring a moratorium on the payment of principal or interest
Finally, it should be discussed whether the BNB has the power to impose a moratorium on the repayment of loans or interest rates on loan (in Bulgaria referred to as a “bank” or an “interest rate holiday”), similar to other central banks and governments throughout Europe. This controversial measure, which was recently unofficially rejected by the Bulgarian Government, aims to relieve debtors (primarily individuals and small and medium-sized businesses) whose ability to generate revenue and service their debts has been severely curtailed by the anti-epidemic measures introduced in Bulgaria.
In the absence of explicit powers granted to the BNB by the applicable law, the answer to this question should be sought in the general mandate of the central bank to regulate and supervise the activities of banks in Bulgaria for the purpose of ensuring the stability of the banking system and protecting depositors’ interests. (Article 2, para. 6 of the BNBA). Although, borrowers often maintain deposits with their financing bank, their interests as debtors under a loan are not aligned with their interests as depositors. While in its capacity as debtor a borrower has an interest not to pay its obligations in a time of crisis, as depositor it is dependent of the liquidity of its account holding bank in order to have access to its savings. The imposition of a payment moratorium, whether general or only with regard to interest rates, would deprive banks from one their main income sources which is why this measure undermines the stability of the banking system and creates a disbalance which, if combined with a mass withdrawal of deposits, could result in serious liquidity shortfalls for any banks concerned. Therefore, the power to decide on the imposition of such a moratorium should lie with the legislator and not the banking regulator.
Probably that is why, while the public discussion on the imposition of a “bank holiday” was ongoing, the BNB announced its package of urgent measures and called for “abstaining from proposals for administrative and legislative decisions that could have a devastating impact on the country’s financial system”.
Interestingly enough, in a press release dated 25.03.2020 the central bank hinted that in the coming day it shall decide on whether a payment moratorium on loans should be imposed and how its implications on the bank should be treated from a prudential point of view. This announcement of the BNB appears to have been part of a wider initiative, led by the EBA and aimed at producing a coordinated EU-wide response to the crisis caused by COVID-19. In the course of this initiative EBA would provide concrete guidance on certain questions, related with the imposition of payment moratoria in EU member states, as well as with the prudential and accounting treatment of the exposures, which are delayed in payment as a result of such moratoria, and the methods to account in the banks’ balance for any obligation, which have been rescheduled or otherwise restructured due to the current situation.
With adoption of Article 6 of the State of Emergency Act the focus on the discussion for the imposition of a moratorium over the payment of interests and principals was shifted. This provision grants borrowers with the option not to make payments on their loans without having to worry about the negative consequences of delay, such as the charging of penalty interest or the possibility to accelerate the loan, and has thus created a problem of its own.
Namely, the provision creates a stimulus for all borrowers – whether solvent or in financial difficulties – to cease making regular payments on their loans, which in turn creates conditions for an increase in overdue loans on the books of commercial bank in the coming months. If this delay continues for more than 90 days, the question arises as to whether the exposure to such borrowers should be qualified as non-performing for the purposes of Art. 178 of Regulation (EU) 575/2013 resulting in an additional risk weight on the capital base of the lending bank and accelerated absorption of the reserves provided by the bank’s capital buffers.
On the one hand, it is recognized that where the repayment of an obligation is suspended because of a law allowing this option (as an outright “bank holiday”), the counting of days past due should also be suspended during that period, i.e. such loan should not be considered non-performing solely on the grounds of it being overdue. At the same time, Article 6 of the State of Emergency Act does not suspend the repayment of a credit obligation, but simply creates the opportunity for a borrower – acting in good or in bad faith – to stop making payments without bearing contractual or legal penalties for its behaviour. Nonetheless, although different in its legal technique from an outright moratorium, Article 6 of the State of Emergency Act creates a similar legal result to that achieved by the moratorium. This is a strong argument in favour of the view that overdue credit obligations resulting from the application of this provision should not be treated as “non-performing” for the purposes of prudential supervision.
With view of the above and with the goal of preventing a widespread change of qualification of overdue credit exposures as a result of the application of the emergency legislation, BNB within its supervisory powers could clarify the prudential treatment of bank loans past due. By doing so the central bank would facilitate the creation of additional stability in the Bulgarian banking system and would support the handling of the longer-term consequences of the present humanitarian and economic distress. Given the most recent signals sent by the BNB and EBA, the banking sector could receive the necessary clarity within the coming days.
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