Transitioning from Blanket Guarantees: The Case of Bulgaria


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IADI First Annual Conference - Basel, Switzerland, 7 - 8 May 2002.

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Transitioning from Blanket Guarantees: The Case of Bulgaria

  1. 1. INTERNATIONAL ASSOCIATION OF DEPOSIT INSURERS First Annual Conference Transitioning Issues for Deposit Insurers Practitioners Basel, May 7 – 8, 2002 Transitioning from Blanket Guarantees: The Case of Bulgaria Presented by Mileti Mladenov Chairman of the Management Board Deposit Insurance Fund Bulgaria
  2. 2. 2 Transitioning from Blanket Guarantees: The Case of Bulgaria Deposit Insurance in Bulgaria Prior to 1999Not much attention was paid to deposit insurance at the start of post-1989 politicaland economic reforms in Bulgaria. This reflected a shared public and governmentbelief that bank failures were atypical of the centrally-planned political andeconomic system. The only legally set government guarantee (of 100%) wasprovided for deposits at the State Savings Bank (SSB) by the Law on the StateSavings Bank of 1967. However, the majority of the public were convinced that allbank deposits during transition to a market economy were under governmentguarantee, irrespective of the lack of a deposit insurance legal framework. Inperiods of turbulent financial market fluctuations, that conviction was furtherboosted by the government and Bulgarian National Bank (BNB) - the Central Bankof Bulgaria. For a long time after the start of reform depositors had chosen theirbanks according to the financial conditions offered, absolutely disregarding thebank’s financial performance. This environment created conditions for “moralhazard”.During the transition period there have been three stages in developing depositinsurance scheme in Bulgaria. The first one involves Regulation No. 1 on BankDeposit Insurance (late 1995), the second one – Law on State Protection of Deposits(late 1996) and the third one – Law on Bank Deposit Guaranty (1998).In 1992 the National Assembly adopted the Law on Banks and Credit Activityregulating bank activity during transition to a market economy. Pursuant to thisLaw banks had to participate in the system developed by the Central Bank forinsuring deposits up to a specified amount. However, the importance of depositinsurance was undervalued. The BNB designed and adopted Regulation No. 1 onBank Deposit Insurance only at the end of 1995. This regulation determined theestablishment and operation of a system for insurance of bank deposits up to aspecified amount. The system established a deposit insurance fund that compliedwith most of the requirements of the best international practices.IADI First Annual Conference Basel, May 7 - 8, 2002
  3. 3. 3Major aspects of BNB Regulation No. 1 include: 1. Deposit guarantee covered only bank deposits of individuals (sole proprietors were excluded). 2. Repayment of guaranteed amounts was required to begin within three months after the date of license revocation. 3. The maximum amount of guaranteed reimbursement on covered deposit funds was the equivalent of approximately DEM 5,000. 4. The Deposit Insurance Fund established under BNB Regulation No. 1 was administratively subordinated to the BNB. The five-member Management Board was dominated by BNB representatives. The Chairman of the Fund and two Management Board members were nominated by the Governor of the Central Bank. 5. The annual premium contribution from banks was 0.4% of the total amount of individuals’ deposits as of 31 December previous year. 6. The Fund’s Management Board, acting on proposal from the Management Board of the Bulgarian National Bank, was allowed to raise the amount of annual premium contributions by banks exposed to higher risks to 1% of the total amount of individuals’ deposits.The poor timing of Bulgaria’s deposit insurance scheme launch proved to be itsmajor weakness. The deposit insurance scheme failed to start normal operations dueto the outbreak of the dire 1996 financial crisis. The extent of that financial crisiscalled for significantly more money than was available at the time for repayment ofguaranteed deposits.Immediately after enforcement of BNB Regulation No. 1 in the second half of May1996, the Central Bank petitioned for institution of bankruptcy proceedings againsttwo banks1 with significant deposit bases. These two banks were experiencing largescale runs by depositors, and practically ceased repayment of deposits. The BNBpetition for institution of bankruptcy proceedings against these banks increasedpressure on other banks as depositors withdraw their funds. Progressively eroding1 In September 1996 the BNB petitioned the institution of bankruptcy proceedings against nine more bankswhich it had established insolvent.IADI First Annual Conference Basel, May 7 - 8, 2002
  4. 4. 4depositor confidence in banks combined with galloping inflation, devaluation of thelocal currency (lev) against major convertible currencies, and national currencysubstitution could have destroyed Bulgaria’s financial system. This threat dictatedthe adoption at the end of May 1996 by the National Assembly of the Law on StateProtection of Deposits and Accounts with Commercial Banks.This new Law provided for a 100% repayment of the deposits of individuals(physical persons) and for a 50% repayment of the deposits of nonfinancial sectorcompanies (legal entities). No guarantee was provided on deposit accounts offinancial institutions or Management Board members and shareholders owning over1% of the equity of closed banks. Repayment of guaranteed deposits of bankruptbanks was complicated which impeded its realization within the term set by theLaw. Therefore, by the end of September 1996 the Law on State Protection ofDeposits and Accounts with Commercial Banks was amended, the term forrepayment of guaranteed deposits being extended.Despite some weaknesses this Law helped overcome the social consequences of thefinancial crisis. A special Fund for state protection of deposits and accounts ofphysical persons and legal entities was established. The Fund was managed by theMinistry of Finance and its monies were raised through the issue of governmentsecurities, the sale of assets of banks with revoked licenses, and privatization ofstate-owned enterprises. Through the BNB the Fund provided resources forrepayment of guaranteed deposits.Under its Transitional and Final Provisions, this Law was effective until theadoption of a Law on Bank Deposit Guaranty. The latter Law was adopted in April1998 and repealed the Law on State Protection of Deposits and Accounts withCommercial Banks. The Law on Bank Deposit Guaranty removed the stateprotection of deposits with regard to all licensed banks except the State SavingsBank (SSB). In accordance with the Law on Transformation of the State SavingsBank the state guarantee on deposits of its successor, DSK Bank, were retained untilMay 2000.IADI First Annual Conference Basel, May 7 - 8, 2002
  5. 5. 5 Legal Aspects of Deposit Insurance Since 1999The current deposit insurance scheme operating in Bulgaria is managed by theDeposit Insurance Fund (DIF) which was established in January 1999 pursuant tothe April 1998 Law on Bank Deposit Guaranty.According to international classifications of deposit insurance schemes, Bulgaria’scurrent deposit insurance scheme is a typical explicit deposit insurance scheme withlimited coverage and ex-ante guarantee fund.The DIF is an independent institution managed by a five-member ManagementBoard with a four-year term of office. Procedure for appointment of ManagementBoard members complies with best international practices. This procedure togetherwith the requirements to be met by Board’s members help reduce any possibleconflict of interest and agency problems. Under the Law on Bank Deposit Guarantymembers of the Fund’s Management Board may not work for banks or nonbankfinancial institutions.The major functions of the Fund involve: setting and collecting initial and annualpremiums from banks, managing raised funds, and repaying the guaranteed depositamount upon the failure of an insured bank. Amendments to the Law on Banks inJune 1999 provided the DIF a very limited oversight role over certain aspects of themanagement of a banks property by the assignees in bankruptcy.Sources of Fund monies include initial and annual premiums from banksparticipating in the deposit insurance scheme. Funds raised by the BNB from initialand annual premium contributions between 1996 and 1998 were transferred formanagement to the Deposit Insurance Fund established in early 1999. The DIFadditionally generates funds from investing contributions in assets as provided bythe Law, as well as from interest accrued due to delayed payment of contributionsby banks. The initial contribution is a single payment to be deposited by each banklicensed by the BNB. This amounts to 1% of the minimum capital required for abank but not less than BGL 100,000 (USD 45,450). Annual premium contributionsto be paid by each bank amount to 0.5% of the total amount of the deposit base.Premium contributions due have to be paid by 31 March of each year. In the eventIADI First Annual Conference Basel, May 7 - 8, 2002
  6. 6. 6of failure to pay the premium contributions within the term set, penalty interestaccrues. The Fund does not set risk-weighted premium contributions for individualbanks.Pursuant to the Law on Bank Deposit Guaranty if Fund monies are insufficient, theDIF Management Board may: (i) require banks to pay annual premium contributionsin advance; (ii) increase the annual premiums of banks but not more than 1.5% ofthe deposit base; (iii) borrow funds from the market or from the Budget after adecision by the National Assembly. The Fund may decide on reducing the amountof annual premium contributions provided that funds raised have made up 5% of thedeposit base.The Fund is exempt from paying national or local taxes and fees only on depositinsurance operations. The DIF may be transformed, cease its activities or beliquidated by a law. The Council of Ministers, the BNB and the National AuditOffice are authorized to exercise control over Fund activities. The Law on BankDeposit Guaranty regulates relationships between the BNB and the DIF regardingbank information in a clear manner and provides for Fund access to necessaryinformation through the Central Bank.The Fund guarantees full payment of monies held in a depositor’s account with abank regardless of the number of accounts and type of currency up to BGL 10,000(approximately USD 4,540). The ratio between maximum payable guaranteedamount and Gross Domestic Product per capita in Bulgaria in 2000 was 3.03.2 Thisratio is close to the 1998 average international ratio (3.0).The Fund pays the guaranteed amount of depositors funds when the Governor of theBulgarian National Bank has withdrawn the banking license granted to thecommercial bank. The Law on Bank Deposit Guaranty provides for a relativelyshort term3 within which the Fund should start payment of amounts on guaranteeddeposits.2 Using USD/BGL exchange rate USD 1 = BGL 2.203 Within 45 days of the date of the resolution of the BNB to revoke the bank’s license.IADI First Annual Conference Basel, May 7 - 8, 2002
  7. 7. 7 Scope of the Deposit Insurance SchemeThe deposit insurance scheme in Bulgaria encompasses all banks authorized by theBNB to accept deposits. Therefore, this scheme contains a very important feature ofmodern deposit insurance schemes with similar functions: compulsory participationfor all banks. The only exception to this mandatory participation is when the homecountry of the head office of a foreign bank operating a branch in Bulgaria providesdeposit insurance to local depositors in an amount greater than that provided by theBulgarian DIF. Currently there are three branches of Greek banks located inBulgaria that meet this exception.The Law on Bank Deposit Guaranty does not limit the guarantee by type of depositsand provides for a guarantee up to the amount set by the Law of all lev and foreigncurrency deposits of nonfinancial institutions and individuals (physical persons) nomatter whether they are residents or not. The deposit insurance scheme does notprovide for a guarantee on deposits of: government municipalities; banks andnonbank financial institutions (regardless of the nature of their activities);individuals (and members of their families) holding equity entitling them over 5% ofthe votes in the bank’s general shareholder meeting or who are involved in bankmanagement or auditing; or, depositors granted preferential interest rates. Depositsarising out of or related to transactions or actions constituting ‘money laundering’are excluded from the guarantee as well. The State Savings Bank CaseTill May 2000 deposits with the former State Savings Bank (SSB) were 100%guaranteed by the state. With the expiration of the two-year transition period(starting May 1998) the SSB was transformed into a commercial bank (DSK Bank)and the full government guarantee on deposits was removed. The bank now paysannual premiums to the DIF. The removal of the full guarantee was a very smoothprocess due to the fact that in the past the bank accepted only deposits in nationalcurrency and the average size of deposits with it was much lower than the insuredamount at that time.IADI First Annual Conference Basel, May 7 - 8, 2002
  8. 8. 8 Public Relations (PR) Activity During TransitioningThe DIF places a high priority on active and effective public relations activities.The DIF International and PR Department conducts these responsibilities largelyin-house.The PR activity focuses on educating and informing the public about the nature ofdeposit insurance and the policies and operations of the DIF. Internal ‘PublicRelations Rules’ have been developed. An underlying principle of these ‘rules’ istransparency of information and compliance with the requirements of the Law.Official position papers and press releases, including those providing information onfailed banks, are distributed through the mass media. Press conferences, interviewswith the Chairman for the TV, radio, and print media are also organized.In April 2000 a Q&A Brochure on Deposit Insurance was published and widelydistributed with the assistance of the Association of Commercial Banks in Bulgaria.This brochure is designed to inform the public, in a clear and understandablemanner, about deposit insurance coverage. A telephone hot-line was opened fordepositors. The brochure and the hot-line have proved to be very effective. InSeptember 2001 the DIF launched its institutional web site – both in Bulgarian andin English. The Q & A Brochure is published both in Bulgarian and in English onthe web site. The website contains a ‘test’ where depositors can check theirknowledge about deposit insurance in Bulgaria and also contains an electroniccalculator they can use to check the exact insured amount of their deposits.The project ‘A Survey on Public Information and Awareness of Deposit Insurance inBulgaria’, which started in March 2002, will provide the DIF with the necessaryinformation for further improvement of its PR activity. In this case, a PR firm washired to conduct the survey – a quantitative (a questionnaire of different groups ofquestions) and qualitative (focus groups) assessment.The DIF is also trying to promote the exchange of information with governmentinstitutions, banks, business and academic circles on issues related to its activities.In November 1999 the DIF and the BNB signed a Memorandum of Understandingsetting the details of information exchange regarding deposit insurance and bankIADI First Annual Conference Basel, May 7 - 8, 2002
  9. 9. 9regulation. A letter of Cooperation was signed with the Association of CommercialBanks in August 2001.Annual reports, which are distributed free of charge both in Bulgaria and abroad,contain a special section on Public Relations. ***In conclusion, the case of Bulgaria’s transitioning from blanket guarantees to limitedcoverage has been an example of a smooth process that did not result in anyturbulence for the banking system. This transitioning passed tree stages: 1. Transitioning from a full implicit guarantee under planned economy to a partial coverage, completed in early 1996. 2. Transitioning from a full coverage of physical persons’ deposits and a 50% coverage of deposits of nonfinancial sector companies (legal entities) under the Law on State Protection of Deposits of 1996 to a modern deposit insurance scheme with a partial coverage pursuant to the Law on Bank Deposit Guaranty of 1998. 3. The case of the State Savings Bank – one of the biggest Bulgarian banks, where the full government guarantee on deposits was removed with the bank’s transformation into a commercial bank in mid-2000.Transitioning to a partial coverage did not cause the turbulence to the Bulgarianbanks that occur during the 1996 financial crisis. That crisis was characterized bysevere erosion of public confidence in the banking system, decrease in savings anddeposits, lack of confidence in the national currency and preferences of keepingfunds in foreign currency as a substitute to the lev, mainly in cash and ‘under themattresses’. In contrast, no banking system disruption was experienced after 1998,when a modern deposit insurance scheme, that provided only partial depositguarantees, was established. This legislation created the existing ex-ante fund andrequires transparency of DIF activities. Furthermore, the DIF’s successful handlingof two bank failures, in early 1999 and the second in 2000, combined with efficientPR activities contributed to mitigating adverse public reaction.IADI First Annual Conference Basel, May 7 - 8, 2002
  10. 10. 10It is also worth mentioning that despite the existence of a higher coverage providedby a couple of foreign banks’ branches operating in Bulgaria, there is no trend ofshifting deposits to these banks (deposit coverage provided by these banks amountsto EUR 20,000 and even higher).Finally, each country has its specific features and the smooth transitioning fromblanket guarantees is not ensured due to the peculiarities of their variouscircumstances. This process depends also on the public confidence in the nationalcurrency, the local monetary authorities, the reputation of government institutions,and of course on the general political situation.IADI First Annual Conference Basel, May 7 - 8, 2002