Reports on Observance of Standards and Codes
1. The following reviews banking supervision practices in Bulgaria. The first two sections consider the financial policy transparency practices of Bulgaria in the area of banking supervision as they relate to the broad principles underlying the IMF’s Code of Good Practices on Transparency in Monetary and Financial Policies (available on the IMF web site under http://www.imf.org/external/np/mae/mft/code/index.htm). The Code identifies desirable transparency practices for central banks (or other regulatory bodies) in their supervision of banks. Following the Code, these sections focus on: clarity of roles, responsibilities and objectives of the BNB in the area of banking supervision; the processes for formulating and reporting supervisory decisions by the central bank; public availability of information on supervision policies; and accountability and assurances of integrity by the central bank. The last section provides a summary of the IMF staff’s views on the extent to which domestic practices are consistent with the Basle Core Principles of Effective Banking Supervision.
2. Transparency by bank supervisors, particularly in clarifying their objectives, should contribute to policy effectiveness by enabling financial market participants to assess better the context of bank supervision, thereby reducing uncertainty in the decision making of market participants. Moreover, by enabling market participants and the general public to understand and evaluate bank supervision policies, transparency is likely to be conducive to good policymaking. This can help to promote financial as well as systemic stability. Transparent descriptions of the policy formulation process provide the public with an understanding of the rules of the game. The release of adequate information to the public on the activities of bank supervisors provides an additional mechanism for enhancing the credibility of their actions. There may also be circumstances when public accountability of decisions by bank supervisors can reduce the potential for moral hazard.
3. The Basle Core Principles represent the basic elements of an effective supervisory system. They are comprehensive in their coverage, addressing the preconditions for effective banking supervision, licensing and structure, prudential regulations and requirements, methods of ongoing banking supervision, information requirements, formal powers of supervisors and cross-border banking.
Clarity of roles, responsibilities, and objectives
4. BNB is the sole supervisor of banks. Its role as supervisor is clearly stated in the LoBNB: “The Bulgarian National Bank shall regulate and supervise other banks’ activities in this country for the purpose of ensuring the stability of the banking system and protecting depositors’ interests.” The role, responsibilities, and powers of the BNB in performing its supervisory role are mainly provided for in the LoBNB, the LoB, and the regulations governing its implementation. Also the Law on Securities, Stock Exchanges and Investment Companies, the Bank Deposit Insurance Law, the Law on Measures against Money Laundering and the Law on Transactions in Foreign Exchange Valuables and Foreign Exchange Control (LoFX) are applicable to some extent. These laws and regulations are reproduced, in Bulgarian and English in Banking Laws and Regulations, Bulgarian National Bank, July 1999, and they are available on line. The BNB also monitors the transactions in foreign instruments of payment of finance houses and exchange bureaus.
5. As the LoBNB and the LoB make clear, the banking supervision function is performed by the Banking Supervision Department (BSD) which is a part of the BNB, an autonomous central bank. Hence, the basic provisions of autonomy and accountability of the BNB (discussed in Chapter IV) cover those of the BSD as well. Moreover, the BSD has a degree of autonomy within the BNB. The LoBNB states that the Deputy Governor responsible for banking supervision, in exercising his supervisory powers, “shall apply, separately and at his own discretion, the remedial actions and penalties as provided for by law. Granting and revoking a bank permit (license) shall require a decision by the Governor, taken on a motion by the said Deputy Governor.”
6. The relationships between the BNB and the following agencies on supervising financial institutions are regulated by law: The Committee on Securities and Stock Exchanges, the Bank Deposit Insurance Fund, and the Ministry of Finance. There is no explicit provision in the LoBNB regarding relations with the Insurance Supervision Directorate. However, the LoBNB includes a general provision about cooperation between government authorities, which is interpreted by the BNB to apply, e.g., to cooperation with the insurance supervisor. Moreover, the Regulation on the Structure and Operations of the Insurance Supervision Directorate covers such cooperation. The legislation on relationships between various supervisors and other agencies, inter alia, defines to what extent secret information may be exchanged between these agencies.
Open process for formulating and reporting policy decisions
7. The regulatory framework for banking supervision is spelled out in detail in the LoB and in the LoBNB. The BNB has issued a number of regulations, guidelines and instructions in order to transform the general framework into operative policies and procedures. The BNB also issues instructions to banks and nonbank financial institutions on BNB requirements, providing unified enforcement practices and interpreting disputable regulatory provisions. The BNB maintains an Internet web site, where information on all its normative acts is presented (www.bnb.bg).
8. The reporting requirements by banks for banking supervision purposes are based on the LoB. The rules and procedures for reporting are established by the BNB and presented in the general instruction circulars that are sent to the banks for preparing specific reports. Sample forms and guidelines are attached to the circulars. Banks must also comply with the Accountancy Law and with National Accounting Standards, for which the BNB issues interpretations. The BNB’s regulations for prudential reporting are publicized, including, e.g., the format for the reporting forms. Highly technical documents such as detailed instructions for filling in the reporting forms are not actively published, but are available upon request.
9. The BNB conducts on-site examinations and assigns CAMELS2 ratings to banks as an integral part of its supervision. For these purposes it has developed (and continues to refine) an examination manual. Neither the manual nor the results of on- and off-site examinations are publicly available.
10. The LoB states that the BNB may require banks to pay charges for administrative supervisory services. The charges are to be decided by the BNB´s Management Board. So far, the BNB only levies charges for granting banking permits and for issuing certificates ascertaining qualification and professional experience in banking. The exact amount of such charges is stated in the BNB regulations.
11. There are legal provisions for information sharing between domestic authorities. However, there are no formal arrangements, such as MoUs, governing these arrangements. The Law on Bank Deposit Guarantee provides a mechanism for the exchange of information between the BNB and the Deposit Insurance Fund and for performing inspections in relation to the deposit insurance law. The LoB and other laws set forth procedures for performing joint examinations such as are presently conducted between the BNB and the Securities and Stock Exchanges Commission (SSEC), exchange of information and consultations between the BNB and the MOF, and through the Financial Intelligence Office. The BNB and the MOF also have legal powers to jointly oversee compliance of the foreign exchange regime. The BNB, MOF and the Securities Commission work jointly on a committee that decides on the approval of primary dealers for government securities. The LoB provides the mandate for the BNB, in exercising its supervisory powers, to conclude agreements with other central banks or foreign supervisory bodies for the mutual exchange of information. So far, no such agreements have been concluded. Cooperation is reported, by the BNB, to function well on an informal basis.
12. The BNB informs the banks and the Bankers’ Association about proposed changes in prudential and other regulations, and the Bankers’ Association is invited to comment, through a consultative procedure, on such proposals. When relevant, discussions are also held with representatives of other financial agencies.
Public availability of information on supervision policies
13. The BNB publishes a number of reports on the condition of the banking sector. The LoBNB obliges the BNB to present to the National Assembly twice a year a detailed report on its activities as well as an Annual Report. Both reports are comprehensive and contain both statistical and qualitative information on the financial system and measures taken by the BNB. The reports are published. These reports contain a large number of data and indicators on financial market factors, and aggregate data for banks grouped into categories, such as on distribution of assets and liabilities, capital ratios, and on risk exposure ratios. The BNB also publishes a monthly Information Bulletin on the development of the financial system and of financial policy decisions taken by the BNB. Individual bank financial statements, together with information on management and shareholders, will be published in the Bulletin starting in the Fall of 1999. Data are published in the Bulletin with a time-lag of about 1½ months from the reporting date.
14. As banking supervision is conducted by the central bank, the provisions for publishing the BNB’s financial statements are discussed in the chapter on monetary policy.
15. All laws and regulations regarding banking are published in the State Gazette, annual reports, and on the BNB´s Internet web site. In the event of major changes, these are explained in press conferences held by BNB management. The BNB issues and regularly updates a compendium on all banking laws and regulations.
16. The BNB has no formal responsibility for consumer protection issues. However, the central bank receives and reacts to complaints from bank clients. There is no public announcement about the BNB´s procedures as to consumer complaints, or of the BNB´s actions based upon complaints. The LoB sets out rules on banks’ relations with their customers, such as that banks must publicize their conditions for receiving deposits and making loans.
Accountability and assurances of integrity by the BNB
17. When the National Assembly discusses issues related to the BNB´s competencies, the Governor and the relevant Deputy Governor take part in the discussion. Sessions of the National Assembly, and some meetings of its sub-committees are open to the public and reported in the media.
18. In addition to the accountability clauses applicable to the BNB in general (see the corresponding section in the monetary policy chapter), it follows indirectly from the LoB and the LoBNB that BNB staff may not have financial interests in the banks they supervise. Supervisory staff must report to the appropriate body in the BNB about their interests, such as equity holdings, in financial institutions. The LoBNB binds all employees of the BNB to sign declarations that they will observe the law, properly perform their functions, and keep bank and trade secrecy. The LoB imposes restrictions on loans granted by banks to persons who supervise the banking system.
19. Bulgaria’s transparency practices in the area of banking supervision is overall quite good and, with a few exceptions, in line with international best practices. Of the still remaining weaknesses which have been identified by IMF staff, the following are the most important ones:
20. Traditionally the Basle Core Principles are grouped into seven major categories: (i) objectives, autonomy, powers, and resources; (ii) licensing and structure; (iii) prudential regulations and requirements; (iv) methods on ongoing supervision; (v) information requirements; (vi) formal powers of supervisors; and (vii) cross-border banking. The results of the IMF staff assessment are grouped according to these categories (with a summary provided in Table 2), preceded by a review of preconditions for effective banking supervision in Bulgaria.
21. Preconditions for effective banking supervision. The general legal and accounting framework in which banking and banking supervision takes place is quite good. Contracts may be expected to be honored and collateral can be claimed, though sometimes rather slowly. Financial statements provide meaningful information and are in most material aspects in line with international accounting standards. The rule of law prevails. BNB regulations and guidelines are generally very comprehensive and detailed, and are supervised on a detailed level. The market environment in which the banks operate and which disciplines bank behavior is reasonably transparent and competitive. With the exception of the tax treatment of provisions for doubtful loans, there are no major distortionary factors, such as direct or indirect subsidies from the state. The earlier overall deposit guarantee has since January 1, 1999 been transformed into a limited deposit guarantee that is generally in line with guidelines developed in an IMF Working Paper regarding the configuration of a system of deposit insurance (see Chapter VI). The 16 illiquid and bankrupt banks which still have not been fully wound up (although their licenses have been revoked) do not act or interfere in the banking markets.
22. Objectives, autonomy, powers, and resources, Core Principle (CP) 1.The BNB is the sole supervisor of banks. There are laws and regulations setting forth the autonomous status of the BNB and of its supervisory functions. The BNB has the powers to issue normative acts in all areas of bank regulation and supervision. The BNB has created a Banking Supervision Department which is organized to conduct effective supervision. Through an explicit provision in the LoB, BNB management and staff are protected from liability when conducting their supervisory tasks, if in good faith. All sub-divisions of CP 1 are complied with, although some minor amendments of laws and regulations are recommended, e.g. to reduce the risk of having to resort to interpretations of the exact meaning of the rules.
23. Licensing and structure, CPs 2–5. These Principles focus on the definition of banking activities and the proper use of the name “bank” as well as supervisory means to protecting sound ownership and structure of banks. Bulgaria complies with these Principles, with minor exceptions. The required skills and expertise of bank managers are explicitly defined, and evaluated in the laws and regulations. However, it is recommended that in applying the laws and regulations the supervisor should focus more on assessing the appropriateness of a manager’s background in enabling the manager to control the bank and its business activities. Further, the BNB should have the powers, and use them, to prevent banks from starting certain activities if the managers and management bodies do not have the relevant expertise to manage and monitor these.
24. Prudential regulations and requirements, CPs 6–15. Bulgarian banks have to maintain a minimum capital, a (non-risk-weighted) leverage ratio, and a capital adequacy (risk-weighted) ratio (CP 6). The risk-weighted ratio is based on the model of the Basle Capital Accord, although it is less demanding in some aspects. It does not include market risks, with the exception of open positions in foreign currency and some off-balance sheet risks. The risk-weights for commercial real estate and maritime mortgages are only 50 percent, as opposed to the Basle rule of 100 percent. Finally, the capital ratios are not calculated on a consolidated basis, although this is still a minor problem in practice because it would only apply to very few banks. On the positive side, it should be noted that the BNB applies a 10 percent capital adequacy ratio requirement, to be raised to 12 percent by end-1999. There are comprehensive rules for granting credit and for the evaluation of loans and of loan-loss provisions (CPs 7 and 8). Moreover, a central credit registry will be made operational starting October 1, 1999, giving all banks and the BNB access to standard information on all bank credits with cumulative exposure exceeding 10,000 leva. However, in the present BNB regulations, some types of illiquid collateral, such as commercial property and movable properties, are treated too generously as a basis for calculating the need for provisioning. There is also a need for requiring banks’ higher management bodies to take decisions not only on loans for large amounts, but also on loans that are risky or uncommon to the bank.
25. On large exposures (CP 9), consolidated reporting should be implemented, and allowances for some types of illiquid collateral should be less generous. To facilitate its monitoring of connected lending (CP 10), the BNB should create a comprehensive database. The broad definition of connected parties, which by itself is commendable, makes such a systematized register important. The Principle on country risk (CP 11) is not met. The BNB should set out rules for country risk, including a requirement for banks to create and maintain adequate policies and procedures. The BNB should also formulate internal guidelines for the supervision of such risks. For market risks (CP 12), compliance is mixed. There are detailed regulations for foreign exchange risk, including a capital requirement and limits for open foreign currency positions. There also exist implicit rules for bank managers, within their overall management, to manage other market risks and adherence is verified during on-site and off-site supervision. However, there are no explicit rules—and no capital requirements—for important market risks such as interest rate risk in the trading book, and equity risk. Nor are there any rules or guidelines for an integrated management of market risks. It is recommended that the BNB address these deficiencies. A similar situation applies to “other risks” (CP 13). The BNB should adopt regulations and guidelines for banks to establish integrated policies and procedures, and for bank management/Board oversight over compliance.
26. On internal control systems (CP 14), the guidelines on corporate governance should be made more explicit, defining the roles and responsibilities of the different managerial bodies. The conduct of internal controls and the supervisory verification should gradually put more emphasis on strategic, structural, and organizational issues in addition to the validation of banks’ transactions and activities. As noted above, the fit and proper tests of management and Board members should focus more on the actual understanding of a bank’s activities, in addition to the formal criteria. Rules for the creation of audit committees in banks should be introduced. To make prevention of money laundering and fraud (CP 15) more effective, lowering the present threshold for reporting a large cash transaction—about US$15,000—could be considered. Banks should introduce policies that include the prevention of fraud (i.e., not only money laundering). Banks should adopt more stringent ethical and professional standards for their management and staff.
27. Methods of ongoing supervision, CPs 16–20. This group of principles relates to the supervisory methods that should be applied, both on-site and off-site, and the necessity to evaluate these methods qualitatively and on an ongoing basis. The group includes the necessity of supervising banks on a consolidated basis. CP 16 (the framework for on-site and off-site supervision) is complied with. On CP 17 (bank management contact), it is recommended that the list of events that the bank, immediately, has to notify the supervisor about be expanded to include breaches of prudential requirements other than those defined in present regulations, as well as major losses to the bank. On off-site supervision (CP 18), Bulgaria must implement consolidated reporting in order to comply. On validation of information (CP 19), the BNB is encouraged to start systematized “horizontal” examinations of various bank functions, e.g., to ensure equal interpretation of regulatory rules and prudential requirements. Bulgaria is materially non-compliant with the Principle on consolidated supervision (CP 20); such supervision should be implemented. Most of the legal basis is already in place, and the BNB has recently started to require banks to present their annual financial statements on a consolidated level.
28. Information requirements, CP 21. The existing legal requirement that banks’ external auditors must report to the BNB all major events that may be detrimental to the financial situation of the bank (this is internationally known as the “BCCI-requirement”), should be enforced in practice.
29. Remedial measures and exit, CP 22. The BNB complies with this Principle.
30. Cross-border banking, CP 23–25. These principles are all related to cross-border banking, such as cooperation between home and host country supervisors and exchange of information, consolidated supervision on a global basis, and equal treatment of foreign establishments. First, it should be noted that at present only one Bulgarian bank maintains (two) branches abroad. However, there is a significant number (at present 11) of foreign bank establishments in Bulgaria. So far, the BNB seems to have had no problems in conducting effective supervision on the branches abroad, and has had good and open relations both with host and home country supervisors. This has been achieved on informal grounds, without any written arrangements. A recent amendment to the Law on Banks provides the explicit legal basis for the exchange of supervisory information with supervisory authorities in other countries. It is recommended that the BNB enter into formal arrangements with other countries’ supervisors to facilitate future supervision. The BNB should also prepare for consolidated supervision on a global basis, although this is not needed at present (since the only case involves branches, which anyway are consolidated into the bank). For better control over overseas operations, the BNB should be provided with the explicit legal powers to refuse, or close, banking activities abroad if proper supervision, commensurate with the risk the establishment poses to the parent bank, cannot be granted.
31. If measured against the Essential Criteria only, Bulgaria is fully compliant with 15, largely compliant with 8, materially non-compliant with 1, and non-compliant with 1 of the 25 core principles. If measured against the Essential and Additional Criteria in combination, Bulgaria is fully compliant with 9, largely compliant with 14, materially non-compliant with 1, and non-compliant with 1.
32. Initiatives underway in the BNB, such as the introduction of consolidated reporting of certain prudential ratios, stricter rules for the valuation of some types of collateral applied when calculating prudential requirements, introduction of rules and capital charges for market risks, concluding agreements with foreign supervisors, and introduction of policies for country risk, should markedly improve compliance on several Principles, such as CPs 6, 8, 9, 11, 12, 18, 20, 23, and 25. A remaining group of “related” improvements refers to requiring banks to introduce and maintain comprehensive and integrated policies and practices for, e.g., corporate governance, overall risk management (including comprehensive internal controls, audit committees, and management information systems), loan granting and evaluation policies, market risk management, and management of “other risks.” After all these measures have been taken, only a number of relatively minor measures, not requiring changes in laws or regulations but rather simple changes in practices, remain before achieving full compliance with the Core Principles.
|Recommendations for Full Compliance|
|1. Objectives, autonomy, powers, and resources||X||X||Fully compliant.|
|2. Permissible activities||X||X||Fully compliant.|
|3. Licensing criteria||X||X||Focus more on actual skills of managers, structure of the bank, corporate governance, and the way the bank will be run.|
|4. Ownership transfer||X||X||Fully compliant.|
|5. Investment criteria||X||X||Fully compliant.|
|6. Capital adequacy||X||X||Apply capital adequacy requirement on a consolidated basis, charge capital for interest rate and equity risks, conform risk weights for mortgages to international standards.|
|7. Credit policies||X||X||Combine the definition of risk categories and criteria to classify loans in these categories. Require high management decisions on risky or unusual loans.|
|8. Loan evaluation||X||X||Ensure that banks have adequate systems for collecting past due loans. Clarify guidelines for write-offs. Tighten rules for valuation of collateral.|
|9. Large exposures||X||X||Implement consolidated supervision. Tighten acceptance rules of collateral for large exposures.|
|10. Connected lending||X||X||Fully compliant.|
|11. Country risk||X||X||Require banks to create policies and procedures for actively analyzing country and transfer risks. Verify adherence to these policies and procedures, and create a system for setting provisions for these risks.|
|12. Market risks||X||X||Implement regulations and capital charges on a consolidated bases for interest rate and equity risks. Require banks to have policies for measuring, controlling and managing such risks, and to perform stress tests, scenario analyses, and contingency planning.|
|13. Other risks||X||X||Implement regulations and policies for interest rate risks in the banking book, operational risk, and legal risk.|
|14. Internal control||X||X||Implement more explicit rules on the roles and responsibilities of the different management bodies. Establish rules for Audit Committees.|
|15. Money laundering||X||X||Fully compliant.|
|16. On-site and off-site supervision||X||X||Fully compliant.|
|17. Bank management||X||X||Focus on strategic and other general issues in discussions with banks. Broaden the list of events about which the banks must immediately notify the supervisor, including major losses.|
|18. Off-site supervision||X||X||Implement consolidated reporting on all quantitative prudential requirements.|
|19. Validation of info||X||X||Start programs for systematic, horizontal evaluation of the implementation of prudential requirements.|
|20. Consolidated sup.||X||X||Implement consolidated supervision.|
|21. Accounting||X||X||Enforce reporting by auditors of any significant event that is potentially damaging to a bank.|
|22. Remedial measures||X||X||Fully compliant.|
|23. Global consolidation||X||X||Introduce rules for consolidated global supervision. Acquire legal powers to refuse licensing of, or close banks’ foreign establishment.|
|24. Host country sup.||X||X||Fully compliant.|
|25. Sup./foreign establishments||X||X||Conclude arrangements with foreign supervisory authorities.|
|1 The columns marked 1-2-3-4 indicate the degree of compliance. 1= full compliance; 2= largely compliant; 3=materially non-compliant; 4=non-compliant. The first set of columns refer to the Essential Criteria, the next set to the Essential + Additional Criteria combined, that is an overall assessment of each Core Principle.|
1 Prepared by Mr. Kähkönen and Mr. Feyzioğlu (both European I Department) and a team from the Monetary and Exchange Affairs Department of the IMF led by Mr. Coats, in consultation with the Bulgarian authorities. In preparing this chapter, IMF staff held discussions with officials of the BNB, the Securities and Stock Exchange Commission, the Deposit Insurance Fund, the Ministry of Finance, and the Bankers’ Association, and with bankers and representatives of the accountancy and auditing firms. The staff reviewed the Law on the Bulgarian National Bank, the Law on Banks, the Law on Bank Deposit Guaranty (LBDG), the Law on Measures against Money Laundering (LMAML), and other laws and regulations published in Banking Laws and Regulations, Bulgarian National Bank, July 1999. This chapter also draws on the BNB’s answers to a questionnaire on Good Transparency Practices for Financial Policies by Financial Agencies and on an IMF assessment of the BNB’s observance of the Basle Core Principles for Effective Banking Supervision.
2 “S” in the Bulgarian framework stands for “systemic,” i.e., evaluating the impact of macroeconomic developments on banks.