Bulgaria's central bank on November 5 rejected the conclusions of a report by the country's National Audit Office (NAO) that it failed to adequately supervise the banking system and ignored warnings about the health of Corporate Commercial Bank, which collapsed in June 2014, costing the Bulgarian taxpayer over €2bn and plunging the country into political and economic crisis.

Although the Bulgarian National Bank has already been heavily criticised by the International Monetary Fund (IMF), the World Bank and international rating agencies, NAO is the first local institution to officially blame it for failing to perform adequate supervision and allowing the collapse of the country's fourth largest lender. “If we had had efficient banking supervision, the Corpbank crisis would not have happened,” NAO’s head, Tzvetan Tzvetkov, said in an interview on the BNT1 evening TV show on November 4.

However, the BNB strongly disagreed with the damning report, with the current deputy governor in charge of banking supervision, Dimitar Kostov, telling BNR radio on November 5 that the conclusions arrived at by the audit office showed an obvious lack of understanding about the banking business and the supervisory operations.

“Implementation of some of the recommendations would prevent the supervisory authorities from following internationally recognised principles like Basel’s,” Kostov said in a November 5 speech at a conference on financial stability as quoted by The Banker, adding that this would create rather than solve the problems.

In the 108-page report published on November 3, which has 49 recommendations for bringing banking supervision practices up to acceptable levels, NAO claims that a timely reaction by the central bank could have contained the hole in Corpbank’s balance sheet that caused the equivalent of 4.5% of national output to disappear.

Worryingly, the budgetary agency also warned in the report that there could be other Corpbanks out there, with speculation rising about the identity of the other unnamed bank (the first assumed to be Corpbank) that the BNB had excluded from its automated validation system for financial reporting.

NAO states that the banking supervisory department was aware that during the month before Corpbank’s collapse, the bank “extended loans of considerable size”. Moreover, the central bank knew that in the first quarter of 2014, Corpbank:

• was the most vulnerable to liquidity shock (among all banks) and this vulnerability had worsened from the preceding year;
• had the lowest capital adequacy levels in the banking system;
• had the biggest nominal credit growth;
• experienced large declines in return on assets;
• was the only bank offering deposit interest rates many times higher than the average for the sector, and these were still rising.

Those records are included in the first-quarter 2014 report about the condition of Bulgaria's banking system, adopted by the BNB’s managing board on June 19, 2014 – a day before Corpbank was put into receivership at its own request. However, NAO notes that no information is available about when exactly the report was completed and the date when it was filed for approval by the BNB board.

Regulatory flaws

NAO’s report reveals a wide variety of regulatory flaws in BNB’s supervision practices, including insufficient inspections, lack of control over received data, inadequate (too mild) reactions to obvious breaches of regulations, as well as protectionism.

BNB uses the CAEL rating system (capital adequacy, asset quality, profitability, and liquidity) at its so-called remote inspections, when it compiles data submitted by the banks to evaluate their financial solvency. As the data submitted was not verified, some banks could have filed incorrect numbers, the audit report warns. Moreover, it underlines that BNB had excluded two banks from its automated validation system for financial reporting. Assuming Corpbank was one of them, speculation is rising about which bank is the other one.

The term “two banks” is mentioned once again in the NAO report in the context of the first-quarter 2014 banking system report. It is written that two credit institutions recorded a significant increase in lending as compared to the average for the system during the period. No action was taken. If one of these banks was Corpbank, which bank is the other unnamed one, analysts are asking?

These questions are relevant in terms of the run on deposits that hit First Investment Bank (FIBank), the country’s third biggest lender, just a week after Corpbank’s collapse. This time the government stepped in and rescued FIBank, pouring in €600mn of liquidity support.

Asked by the BNR reporter whether BNB really knew that two banks had problematic credit portfolios in the first quarter of 2014, Kostov, who has served as deputy governor (with responsibilities other than banking supervision) since 2005, replied: “It is written that BNB knew of credit portfolios, growing more than the average... I want to remind you that six-seven years ago, the lending portfolios of the whole banking system grew at [annual] rates of 50, 60, 70%. If the very fact of loan book growth raises concerns, then we should have closed [all] banks back then.”

Although FIBank is still implementing a restructuring plan supervised by the European Commission, because it must return the state aid, Fitch Ratings said in May that borrower concentrations in the bank’s loan book remain high, at several times the bank's FCC (Fitch core capital) ratio. The rating agency pointed also at weaknesses in FIBank's corporate governance, deteriorating asset quality, weak recurring profitability and moderate capitalisation. It admitted that the ongoing restructuring effort could have a moderate positive impact, but predicted that risks related to the bank’s legacy loan portfolio will at best unwind only gradually and will weigh on its risk profile over the medium term.

As the NAO report doesn't mention any banks by name, it can be only speculated that unorthodox practices by FIBank were also uncovered by the central bank, while there are a few other domestically-owned lenders that could also fit the description.

In his brief appearance on the BNT1 TV show, NAO chief Tzvetkov noted that there are cases when the central bank found indications of a deteriorating health at several lenders, but did not change their CAEL ratings. “Over the last decade there have been large investments in establishing a contemporary banking supervision, and this erosion in the activities of banking supervision that has happened is inexplicable to me,” Tzvetkov said.

"The banking supervision cannot guarantee that there will be no bank bankruptcies and it must not be assigned such a task," Kostov said.

Who killed Corpbank?

While the audit report accuses the BNB of neglecting its banking regulatory functions, it also highlights that the process of banking supervision was controlled solely by the deputy governor in charge of the banking supervision department, while the BNB board and the governor were not engaged in that process amidst inadequate coordination and reporting.

In June 2014, Tsvetan Gunev, the deputy governor in charge of the supervision of lenders and their loan books, was suspended amid a probe for failing to perform his duties after only a year in the post. Actually, his suspension, coupled with media reports, prompted Corpbank depositors to form long queues in front of branches in an attempt to withdraw their savings.

However, it is believed that Corpbank actually ran out of liquidity after several state-owned firms withdrew millions of euros in deposits. This cannot be verified with the data available, but a list that was published on the website of the Bulgarian Deposit Insurance Fund (BDIF) on November 3 confirms that almost all large state-controlled firms had Corpbank accounts, containing millions of levs, euros, and dollars, bearing a preferentially high interest rate. The list states only the maximum amount that has been available at each preferential Corpbank account with no time reference.

While speculation about an oligarch war that weakened significantly Bulgaria’s financial system are still circling, it is widely expected that none of the money lost will ever be recovered. An audit made by Deloitte, Ernst & Young and AFA recognised 63% of Corpbank's €3.4bn assets as impaired last October and the BDIF has already paid out some €1.9bn to guaranteed depositors.

This, coupled with the €600mn state support to FIBank, inflated Bulgaria’s budget gap to 5.8% of GDP last year. Thus the country, which has long been praised for its macroeconomic stability, racked up the fourth largest deficit in the EU after Cyprus (8.9%), Portugal (7.2%) and Spain (5.9%). Moreover, Bulgaria’s government debt/GDP ratio soared to 28.3% at end-June, recording the biggest annual jump of 8.1 percentage points in the 28-nation bloc.

Claiming that this was a one-off event and discarding the possibility of another fiscal slippage, the government led by populist centre-right GERB raised its 2015 budget deficit target by 0.4pp to 3.3% to accommodate for extra expenditures, but vowed to cut it to 2% next year.