Reports on Observance of Standards and Codes
1. The following considers the financial policy transparency practices of Bulgaria in the area of deposit insurance policy. The first two sections cover the broad principles underlying the IMF Code of Good Practices on Transparency in Monetary and Financial Policies (available on the IMF web site at http://www.imf.org/external/np/mae/mft/code/index.htm). The Code identifies desirable transparency practices for financial agents in their conduct of financial policy. In this instance, transparency practices in the Code focus on: clarity of the roles, responsibilities, and objectives of the Deposit Insurance Fund (DIF) implementing the deposit guaranty; the processes for formulating and reporting policies for the guaranty; public availability of information on such policies; and the accountability and assurances of integrity by the DIF. The last section ventures beyond transparency and provides a summary assessment of the extent to which Bulgaria’s deposit insurance system is consistent with guidelines developed in an IMF working paper.2
2. Transparency by DIF, particularly in clarifying its objectives, should contribute to policy effectiveness by enabling financial market participants to assess better the context of deposit insurance, thereby reducing uncertainty in the decision making of market participants. Moreover, by enabling market participants and the general public to understand and evaluate DIF 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 DIF provides an additional mechanism for enhancing the credibility of its actions. There may also be circumstances when public accountability of decisions by DIF can reduce the potential for moral hazard.
Clarity of roles, responsibilities, and objectives
3. The system of deposit protection is provided by the Deposit Insurance Fund, an independent financial agency created under the Law on Bank Deposit Guarantee, which was adopted in April 1998. This Act, together with Regulation 23 on the Terms and Procedures for Payment of Amounts on Deposits with Banks with Revoked Licenses up to the Insured Amount, which was adopted in February 1999, and the DIF Management Board’s Rules of Procedure, define the legal framework of the agency.
4. The DIF’s broad objectives—to promote financial stability, protect depositors’ interests, and enhance public confidence and trust in the banking system—are not directly defined in the LBDG or in Regulation 23. The Chairperson of DIF considers that they have been disclosed in written reports submitted to the Legislature, in official government publications (such as the State Gazette), and by press releases to the media. The objectives have not been prioritized.
5. The procedures for appointment, term of office, and any general criteria for removing the heads and members of the governing body of the DIF have been publicly disclosed. As specified in the LBDG, the Board comprises a Chairperson, appointed by the Council of Ministers, Deputy Chairperson, appointed by the BNB, and three other members (one appointed by commercial banks and the other two by the Chairperson and Deputy Chairperson). The Chairperson is not permitted to accept employment elsewhere (except in research or teaching). Board members are appointed for a four-year term, but may be re-appointed. They may be removed from office for serious conflicts of interest, serious misconduct, prolonged incapacity, impairing the DIF’s interests, or absence from three consecutive meetings of the DIF Board. In addition, since they are not regarded as civil servants, management and staff are not legally protected in exercising their duties under the LBDG. The terms of appointment and dismissal have been publicly disclosed in the LBDG, official government publications (such as the State Gazette), and through the media. It is not clear who holds the responsibility for initiating removal.
6. The DIF’s relationships with the other financial agencies (the BNB, MOF, COM, and National Audit Chamber) have been publicly disclosed in the LBDG, and by publication in official organs. For example, the LBDG specifies that the “National Audit Chamber shall exercise control over the Fund’s activities.” In addition, it requires the BNB to provide data (although not sufficient data) to the DIF; the DIF to present its Annual Report to the COM, BNB, and National Audit Chamber; and the DIF to obtain approval from the BNB for its budget, proposed legislative amendments and new regulations.
Open process for formulating and reporting policy decisions
7. The regulatory framework of the DIF and its operating procedures are defined in legislation and regulations. Information is released on: annual premium contributions, the deposit base, and the size of insured amounts. Regulation 23 sets the terms and procedures for reimbursement of guaranteed deposits. In case the DIF resources are insufficient, additional funding from banks, the markets, and the government is allowed. The DIF is allowed to exercise certain control over the collection activities of a trustee. However, its role in controlling the effectiveness of the assignees is not clear. The DIF charges premiums to banks. The premium structure has been disclosed in the LBDG.
8. The DIF is dependent on the BNB for information essential to fulfilling its role and responsibilities. The agency has formal procedures for sharing information with other domestic financial agencies, especially the BNB. These have been established in the LBDG and Regulation 23, and have been disclosed in written reports to the legislature and the State Gazette, and to the media.
9. The LBDG permits the DIF to invest in short-term deposits with commercial banks that are authorized dealers of government securities. While the current Chairperson does not intend to use this provision to provide support to illiquid banks, it could be so used in principle.
Information on policies
10. The agency publicizes its objectives and operational performance through publications and public meetings. Its audited financial statements are to be published in the Annual Report. In addition, the texts of regulations and other generally applicable directives and guidelines are readily available to the public through the Gazette and the Annual Report when it is published. Written information is also available on the nature and form of the deposit protection, the operating procedures of the scheme, the financing of the guarantee, and the performance of the protection arrangement, but not internal governance procedures. To enhance transparency further, senior officials stand ready to explain the DIF’s objectives and performance to the public in speeches made at public and private meetings, and media interviews. The timing of statements by senior DIF officials depends on the frequency of changes and developments in the deposit guaranty environment. Thus statements are made on an irregular basis but at least once a month.
11. The modalities of the DIF’s accountability have been publicly defined in the LBDG, in DIF regulations, and the internal legal framework as defined in the Management Board’s Rules of Procedure. The DIF management is not required by law to appear before any designated public authority. However, under Article 76 of the 1991 Constitution of Bulgaria, officials of every state body, official or public organization and citizens are required to submit data and documents relating to their work to Parliamentary committees. Moreover, the LBDG requires the DIF to submit its independently audited annual report, which includes its financial statements, to the BNB, the Council of Ministers, and National Audit Chamber for approval.
12. The DIF’s internal governance procedures for ensuring the integrity of its operations, including internal audit procedures, are not publicly disclosed.
13. The DIF has been designed with regard to considerations that favor transparency. While it is too early to know whether the agency will take advantage of its good design to make its actions transparent, it did successfully handle the failure of a commercial bank and payment of its insured depositors soon after it went into operation. Public confidence was rapidly restored, whereas it could have deteriorated seriously.
14. The DIF can nevertheless further improve the transparency of its objectives and performance in the following ways:
15. The DIF in Bulgaria has a design that conforms in many respects to guidelines developed in an IMF working paper (Table 3). It has many provisions designed to help avoid the pitfalls of perverse incentives (moral hazard, adverse selection, and agency problems) that a poorly designed system could convey to the financial system.
16. The Bulgarian deposit insurance system is explicitly defined in law and regulation; is compulsory; provides low coverage; and should provide adequate funding from private sources in time after the fund has grown to approximate its target level of 5 percent of insured deposits. The granting to the DIF of priority over the assets of a failed bank as compared to uninsured depositors and other creditors will help the insurance fund to limit its losses should additional banks fail. However, the current legal provisions lead to severe delays in the liquidation of failed banks, and need to be amended if the DIF is to protect its financial viability. While premiums are not currently risk-adjusted, a flat premium structure is appropriate for a newly formulated system during its testing period.
17. The DIF is independent of political interference, but needs BNB’s approval for legislative amendments, new regulations, and its budget. It is largely, but not fully, accountable for its activities. The banking legislation gives supervisors an adequate system of sanctions to remedy weak institutions, and close failed ones. However, the requirement that failed institutions be dealt with quickly is not met. This deficiency may damage confidence in the DIF and the banking system, and can be costly for the DIF because it will diminish the amount recovered from failed banks’ assets. Ways to remedy this deficiency are currently under discussion.
18. The BNB is required under the LBDG to provide information at the DIF’s request on banks’ deposits to enable the DIF to calculate premiums. The BNB is also required to provide information at the DIF’s request on the financial status of banks so that the DIF can assess its exposure to risk. It would be preferable if the BNB were given the responsibility to provide this information to the DIF on a regular basis and to regularly inform, and consult with, the DIF of the condition of banks in the system. This information would allow the DIF to prepare for impending failures and not be taken by surprise when a bank’s license is revoked. The BNB should also have the responsibility to inform the DIF immediately when the condition of any bank deteriorates to a point that it imposes a risk to the DIF.
19. The BNB should also be responsible for informing the public of the condition of all individual banks. This would exert market discipline which would help protect the financial integrity of the DIF. The DIF itself is required to inform the public of its financial condition; however, the basis for the practice of obtaining an independent audit of financial statements should be clarified.
|Best Practice||Practices in Bulgaria||Comments|
|1. Avoid incentive problems.||Legislation addresses moral hazard, adverse selection and agency problems.||The design is modern.|
|2. Define the system explicitly in law and regulation.||Met.||However, some amendments are recommended.|
|3. Give the supervisor a system of prompt remedial actions.||Met.||A wide range of prudential sanctions exist, but they should be graduated.|
|4. Resolve failed depository institutions promptly.||Failed institutions are closed promptly, but are resolved only very slowly.||Improvements in resolution procedures are under discussion.|
|5. Provide low coverage.||Met (coinsurance 95% to BGN 2,000, 0.8 times per capita GDP, and 80% up to BGN 6,250, with a maximum paid amount of BGN 6,900).||Would be better to insure smallest deposits in full.|
|6. Make membership compulsory.||Met.|
|7. Pay (transfer) deposits quickly.||Article 23 of the LBDG provides that depositors be compensated within 45 days of revoking the bank’s license.||Faster payment would be preferable and could be achieved by permitting deposit transfer.|
|8. Ensure adequate sources of funding to avoid insolvency.||(1) Initial contribution is 1% of minimum capital; (2) annual premiums of 0.5% of deposits can be raised to 1.5%; (3) target of 5% of total deposits; can borrow in markets (without a government guarantee) or from government.||Fund currently stands at 30 million BGN, and will take 10 years to reach its target. Parliament is judged unlikely to provide aid. No provision for aid from BNB.|
|9. Risk-adjust premiums.||Not in operation.||System has only just started; risk adjusting needs more experience.|
|10. Invest DIF resources wisely.||Article 22 of the LBDG permits investments in government or government-guaranteed securities, and short-term deposits with primary dealer banks or the BNB.||Restricting investments to Bulgarian securities exposes the DIF to foreign exchange risk.|
|11. Organize good information.||Under Article 21 of the LBDG, the DIF is dependent on the BNB supervisor for data, without placing the onus on the BNB to keep the DIF informed.||Data availability is insufficient. Data are needed on the amount of insured deposits, and the distribution of deposits by size.|
|12. Make appropriate disclosure.||Annual report, data to legislature and press.||Web site might be useful.|
|13. Create an independent, but accountable DIF.||Politically independent, but is subordinated to the BNB under Article 12 of the LBDG.||Good, but not quite perfect provisions.|
|14. Have bankers on an advisory, not the main, board.||Met: no currently employed bankers allowed on the DIF’s Board.||Relations with bankers remain to be developed.|
|15. Ensure close relations with the lender of last resort and the supervisor.||The legislative arrangements in Article 21 are inadequate.||To be seen if arrangements will work in practice.|
|16. Start the system when the banking system is sound.||Not perfectly satisfied: one of 35 banks failed quickly.||Additional failures could strain the DIF.|
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 management and the staff of the Deposit Insurance Fund, representatives of five banks and of the Bankers’ Association, experts in two international accounting firms operating in Bulgaria, the Bulgarian National Bank, and the National Accountancy Department of the Ministry of Finance. The staff also consulted the Law on the Bulgarian National Bank, the Law on Banks, the Law on Bank Deposit Guaranty, and Regulation No. 23 on the Terms and Procedure for Payment of Insured Amounts of Deposits with Banks with Revoked Licenses. The chapter draws heavily on answers to a questionnaire on Good Transparency Practices for Financial Policies by Financial Agencies prepared by the Deposit Insurance Fund.
2 See Gillian Garcia, “Deposit Insurance: Actual and Best Practices,” IMF Working Paper No. 99/54, April 1999. It should be noted that these guidelines have not been considered by the IMF Executive Board and that there are no internationally agreed standards in this area.
3 This section compares actual practices with guidelines developed in Gillian Garcia, “Deposit Insurance: Actual and Best Practices,” IMF Working Paper No. 99/54, April 1999. These guidelines have not been considered by the IMF Executive Board, nor are there internationally agreed standards in this area.
4 Adapted from Table 1 of Gillian Garcia, “Deposit Insurance: Actual and Best Practices,” IMF Working Paper No. 99/54, April 1999. It should be noted that these guidelines have not been considered by the IMF Executive Board and that there are no internationally agreed standards in this area.