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Bulgaria extended special supervision of Corporate Commercial Bank (CCB) by two months on July 15, after politicians failed to reach agreement on a bailout plan for the troubled lender. That threatens to spread the crisis across the banking sector, and has Sofia seeking support from the EU and raising the public deficit target for the year due to the clean-up costs.

CCB and its subsidiary Credit Agricole Bulgaria will now remain closed until September 21, the Bulgarian National Bank (BNB) said in a statement. The central bank also announced it has started talks with the European Central Bank (ECB) and the European Banking Authority after President Rosen Plevneliev agreed on July 14 that Bulgaria should become the first country outside the Eurozone to join the Single Supervisory Mechanism. 

Following corruption allegations, a run on CCB saw the BNB put it under supervision and dismiss the management and supervisory boards on June 20. That was just a week after CCB had announced the purchase of Credit Agricole Bulgaria. The state then moved quickly to back Fibank after it was beseiged by panicked depositors.

The BNB has proposed closing CCB and diverting the "good" assets into Credit Agricole Bulgaria, which would then be nationalized. It has also suggested state guarantees on all deposits. Currently, Bulgaria's deposit insurance scheme covers only those up to BGN196,000 (€100,000). However, the central bank failed to secure support for the plan at a meeting with Plevneliev and representatives of Bulgaria's main political parties on July 15.

"Given no agreement exists on the legislative approach proposed by the central bank and the government, which was discussed beforehand with experts of the main political parties... the Bulgarian National Bank is continuing work under the special supervision procedure," the statement reads. The BNB has the power to keep banks under special supervision for up to six months.

Meanwhile, the BNB and politicians announced there would be an international audit of the lender, after a first report released on July 8 failed to give a clear answer on credit quality. Auditors said information is missing on BNG3.5bn in loans out of a total portfolio of BGN5.4bn.

The results of the wider audit risks further destabilizing the banking sector, worries Lyubomir Peshev at Elana Trading. "If the new audit shows that there is a large amount of bad loans... we expect BNB to guarantee only deposits up to BNG 196 000," he writes. A ceiling on state guarantees will see "a considerable increase in the uncertainty in the banking system," he adds, with other Bulgarian banks set to lose deposits. Meanwhile, with CCB holding BGN1.6bn in corporate deposits, "a number of companies will experience serious financial difficulties."

Complications

The threat to the country's banks is being complicated by the long-running political crisis in the country. Prime Minister Plamen Oresharski agreed last month to snap elections. The government is due to resign by July 26, with a caretaker administration to hold the reins until the vote on October 5.

Investors were already unnerved then even before the banking crisis jumped out at them. In the first five months of the year, foreign direct investment (FDI) dropped 33.8% compared with the same period of 2013. The BNB reports that FDI dwindled to just €8.6m in May, compared with €151.8m the previous year.

Sofia is clearly seeking to negate the additional stress by plugging its financial system more deeply into the EU. On top of the international audit it will run on CCB, the central bank said on July 15 that it has asked the European Banking Authority to review its supervisory practices. The ECB has also been asked "about starting a procedure for Bulgaria's application for membership in the EU's Single Supervisory Mechanism," the BNB statement added.

"There is full consensus for an immediate start of procedures for Bulgaria's entry into the Single Supervisory System of the European Union as a first step to joining the EU's 'banking union'," President  Plevneliev said on July 14, according to AFP. The new system of European banking oversight is expected to become operational in November, with the ECB charged with preventing problems at Eurozone banks. 

Yet before that, Sofia will need to put its hand in its pocket to prevent the banking sector sliding deeper into a hole. The meeting of the political leaders on July 15 agreed to raise the budget deficit target by 1.2 percentage points to 3% of GDP and to raise the debt ceiling. Government estimates suggest it would cost BGN2bn to cover all deposits at CCB.

Bulgaria is expected to a modest revival in GDP growth this year, with the International Monetary Fund forecasting 1.6% growth, driven by domestic demand and higher absorption of European Union funds. Political uncertainty remains the main risk, and will make it more difficult for political leaders to agree quickly on a plan to stop the CCB crisis spreading through the banking sector.