## cr17132 — IMF FSAP excerpt for Bulgaria

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### Executive Board assessment and system‑wide findings
- Executive Directors agreed with the main findings and recommendations of the Financial System Stability Assessment.
- Directors commended authorities for steps taken to rebuild credibility after the 2014 collapse of the then fourth-largest bank.
- Directors encouraged continued efforts to strengthen financial sector resilience and address weaknesses identified by the 2016 Asset Quality Review (AQR) and stress test.
- While the banking system overall shows resilience (confirmed by the FSAP stress test), the exercise revealed capital weaknesses in some domestically owned banks.
- Directors urged prioritization of restructuring and capitalization plans for banks with capital weaknesses and emphasized strengthening supervision, governance, related-party exposure monitoring, and concentration risk management.
- Directors called for extending the Bulgarian National Bank’s (BNB) macro‑prudential mandate to address the high level of nonperforming loans (NPLs).

### Nonperforming loans (NPLs) — scale, drivers, and implications
- Measures and comparisons:
  - EBA-based measure: 13.7 percent of total loans as of June 2016.
  - BNB definition: NPLs level stood at nearly 20 percent in June 2016.
  - EU-weighted average NPLs: 5.5 percent.
- Coverage and provisioning:
  - Loan-loss reserve to NPL ratio (coverage ratio): 51.7 percent as of June 2016 (BNB measure); from just over 100 percent in 2008.
  - IFRS 9 effective date for EU banks: Beginning January 1, 2018.
  - Estimated European increase in loan loss allowances under IFRS 9: 18-33 percent.
- Contributing practices and effects:
  - Certain accounting, collateral valuation, and risk management practices contributed to disincentives for NPL reduction.
  - High NPLs negatively impact financial intermediation and the real economy, potentially limiting investment and consumption and constraining asset-price recovery.
  - Banks may be reluctant to lend, especially to sectors burdened by high indebtedness.

### Stress testing, capital needs, and supervisory implications
- AQR/stress test outcomes:
  - The 2016 AQR/stress test identified capital needs in three banks; the rest of the system showed substantial capital buffers.
  - Capital shortfall for the three banks amounted to about 0.3 percent of GDP (AQR/stress test).
  - Three banks represented 12 percent of total banking system assets.
  - Reclassification of EUR1.9 billion of exposure as nonperforming loans and adjustments to loan-loss provisions resulted from the AQR.
  - Systemically important bank needed to build capital of around EUR105 million; two smaller domestic banks had shortfalls of EUR19 million.
- FSAP top-down stress test (coverage and scenarios):
  - Coverage: 17 largest banks accounting for 95 percent of industry assets.
  - Baseline and adverse scenarios: adverse spans three years (2016Q2–2019Q2) with a V-shaped GDP profile; simulated GDP growth rates represent a cumulative deviation of approximately 12 percentage points over two years from the baseline.
  - Bulgaria-specific severe stress scenario GDP path: 2017: -6 percent; 2018: -6.4 percent; 2019: -3.4 percent.
- Solvency results:
  - Aggregate CET1 ratio falls to around 15 percent by June 2019 in the adverse scenario (regulatory minimum CET1: 4.5 percent).
  - System-wide leverage ratio falls from 11 percent to 8 percent (remains above 3 percent).
  - Five banks fall below the regulatory minimum CET1 ratio of 4.5 percent and below the referenced 3 percent leverage ratio by end of simulation; capital shortfall in the third year would amount to 1.8 percent of the annualized GDP.
  - Of the five banks falling below the regulatory minimum, three become technically insolvent.
- Drivers and sensitivities:
  - Largest driver of capital decline in the adverse scenario is loan-loss provisions; stress scenario assumes an increase in the provisioning ratio of 20 percentage points.
  - IFRS 9 sensitivity: increasing provisions by 20 percentage points for the existing stock of NPLs leads to two banks falling below the regulatory minimum threshold and an aggregate CET1 ratio decline of approximately 6 percentage points.
- Liquidity stress test outcomes:
  - LCR: system LCR remained above the 100 percent threshold even in the extreme scenario; resulting liquidity shortfall was less than BGN 740 million or 0.85 percent of 2015 GDP.
  - NSFR: system-level NSFR drops to 125.2 percent (above 100 percent standard); three banks perform below standard with shortfall amounting to BGN 1 billion or 1.2 percent of GDP under extreme scenario.
  - Cashflow analysis: three banks vulnerable in seven-day horizon with combined shortfall of 0.7 percent of GDP; one bank vulnerable in ninety-day horizon with shortfall of 0.5 percent of GDP; no bank vulnerable within one-year horizon.

### Financial safety net, crisis management, and liquidity considerations
- Toolkit and readiness:
  - Authorities introduced a comprehensive resolution toolkit, designated the BNB as resolution authority, and established funding mechanisms for resolution measures, but components are not fully developed.
  - Early intervention framework (EIF) lacks quantitative escalation policies and procedures and does not ensure a smooth transition into resolution.
  - For practical purposes, there is no emergency liquidity assistance (ELA) facility due to lack of funds and policy constraints.
  - Deposit insurance fund is insufficient to cover payouts to depositors of the smallest mid-sized bank unless the BDIF takes on a sizeable loan or collects extraordinary premiums.
  - Bank resolution fund recently started collecting premiums and is not operational; no recovery and resolution plan (RRP) has been finalized for any of the 13 majority domestically owned banks.
- Currency Board Arrangement (CBA) implications:
  - CBA contributed to macroeconomic stability but constrains BNB’s ability to provide lender‑of‑last‑resort liquidity in times of financial stress.
  - Directors saw merit in developing a framework to provide for lender-of-last-resort liquidity assistance to address constraints stemming from the CBA and EU state aid procedures.

### Financial structure, market composition, and sectoral indicators
- System size and composition:
  - Financial system assets: 115 percent of GDP.
  - Banking sector assets: 101 percent of GDP.
  - Number of banks: 27 (13 subsidiaries and 5 branches of foreign banks).
  - Foreign-bank presence accounts for 77 percent of total bank assets as of June 2016.
  - Nine domestically owned banks with combined bank asset share of 23.3 percent (including the third largest bank).
  - Top five banks represent 59 percent of total bank assets.
  - Banking system liabilities: deposit funded (83 percent of liabilities).
  - About half of loans denominated in foreign currency (predominantly in euros).
- Key macrofinancial indicators:
  - GDP growth: 3.6 percent in 2015 and 3.4 percent in 2016.
  - NPLs (EBA measure): 13.7 percent of total loans as of June 2016.
  - NPLs (BNB measure): nearly 20 percent in June 2016.
  - Capital shortfall from 2016 AQR/stress test for three banks: about 0.3 percent of GDP.
  - Number of majority domestically owned banks without finalized RRPs: 13.

### Bank soundness, AQR adjustments, and liquidity framework
- Soundness indicators (June 2016 / Q2 2016):
  - Tier 1 capital adequacy ratio: 21.2 percent as of June 2016.
  - Total capital adequacy ratio: 22.7 percent as of June 2016.
  - Liquid asset ratio: 31 percent at June 2016 (from 26 percent in 2014) in terms of assets.
  - Return on Assets (RoA): 1.8 percent in Q2 2016.
- AQR adjustments (August 2016 AQR/stress test):
  - Reclassification of EUR1.9 billion of exposure as NPLs.
  - Systemically important bank capital need: around EUR105 million.
  - Two smaller domestic banks capital shortfalls: EUR19 million.
  - One of the three banks already raised capital via debt-to-equity conversion.
  - Authorities aimed for banks to meet capital targets by mid-2017.
- BNB liquidity assistance and requirements (Box 1 summary):
  - BNB may extend liquidity assistance only to solvent banks, in lev, with maturity no longer than three months; and up to the amount of the BNB’s excess international reserves.
  - Assistance must be fully collateralized by highly liquid assets (e.g., gold, certain foreign currency, domestic and prime-rated government securities).
  - Required minimum reserve requirement (differentiated RR): 10 percent of funds attracted in lev; 5 percent for funds in foreign currency.
  - BNB adopted Basel liquidity requirement (LCR) of 70 percent for 2016, 80 percent for 2017, and 100 percent for 2018.
  - Liquid asset ratio: 31 percent at June 2016 (higher than current required ratio of 20 percent); 50 percent in terms of short-term liabilities.

### Macroprudential framework, tools, and data needs
- BNB designated macroprudential authority for banks; FSC for nonbanks.
- Implemented tools and measures (selection and dates):
  - Credit ceilings (additional reserves when credit expands >6 percent per quarter) — Adoption Date: Feb 2005.
  - Higher risk weight on mortgages (70% LTV threshold) — Adoption Date: 2005 Q3.
  - Stricter consumer lending standards (no credit to household with less than 100 BGN per member per month) — Adoption Date: 2006.
  - Extended credit register coverage (include nonbank borrowers) — Adoption Date: July 2009.
  - Counter-cyclical buffer set at 0 percent and reviewed quarterly — Adoption Date: Jan 1, 2016; Notified to the ESRB: Dec 21, 2015.
  - Higher liquidity coverage requirements and liquidity reporting enhancements — Adoption Date: 2009; Ordinance No. 11 amendments Adoption Date: Oct 2010.
  - Systemic risk buffer (SRB) of 3 percent applied to domestic exposures — Adoption Date: Dec 31, 2014; Notified to the ESRB: Nov 11, 2014.
  - Higher capital requirements for O-SIBs (phase-in starting 2017) — Effective from: January 1, 2017; Notified to the ESRB: Nov 10, 2016.
  - Capital conservation buffer early introduction at 2.5 percent — Adoption Date: May 13, 2014; Notified to the ESRB: Nov 11, 2014.
- Capacity and data needs:
  - Additional resources needed to close data gaps and develop techniques for monitoring systemic risk.
  - BNB should collect more detailed data on NPLs, real estate market condition, corporate sector indebtedness (including collateral values, NPL data by sectors, and corporate debt at firm level).
  - Enhance analytical capacity for full-fledged top-down stress tests and scenario analysis covering credit and liquidity risks.

### Microprudential oversight, governance, and supervisory strengthening
- BNB governance and BSD effectiveness:
  - New BNB governance model in place to enhance supervision; GC receives quarterly banking risk reports; BSD subject to annual internal audit.
  - DGS remains by law the sole authority responsible for supervision, except GC authority on licenses and special measures.
- BSD organization and processes:
  - New Offsite Directorate segregated from Onsite Inspection; inspection teams increased to six.
  - New Analysis of Market Behavior and Risk Division created to focus on AML/CFT.
  - New staff recruited but desired levels not yet reached; external assessment launched for adequacy of IT systems for supervision and resolution.
- Supervisory methodology and SREP:
  - Need to recalibrate risk-assessment methodology (CAEL and CAMELOS), coordinate offsite and onsite assessments, and formalize SREP to set explicit Pillar 2 capital requirements.
  - BNB Act empowers BNB to impose Pillar 2 requirements.
  - BSD 2017 supervisory plan to follow up on 2016 AQR outcomes; BNB targeting 2017 adoption of new supervision process and inspection manuals.
- Corporate governance:
  - EU directives transposed to strengthen Supervisory Board function and internal controls; implementation uneven with domestic private banks showing concentrated ownership and blurred roles between shareholders, SB, and MB.
  - Recommendations include evolving SBs into oversight bodies, reinforcing independence of internal control functions, elevating CROs, and establishing SB-level Risk Committees.
- AML/CFT:
  - Amendments passed on confiscation and targeted financial sanctions; deficiencies remain on criminalization of terrorist financing.
  - Suspicious transaction reporting from designated non-financial sectors remains very low as of mid-2016.
  - Finalizing AML/CFT law to transpose EU’s Fourth AML Directive is underway.
  - Recommendations: clarify beneficial ownership in law and adopt risk-based AML/CFT approaches consistent with FATF guidance.

### NPL reduction strategy — findings, recommendations, and actions
- Key statistics:
  - NPL level at end-June 2016: 19.7 percent of loans (BNB measure).
  - EBA NPL measure: 13.7 percent as of June 2016.
  - Loan-loss reserve to NPL ratio: 51.7 percent as of June 2016.
  - Estimated IFRS 9 impact on loan loss allowances: 18-33 percent increase.
- Immediate / short-term supervisory actions (selected):
  - Implement a comprehensive NPL reduction strategy including supervisory review tools to:
    - (i) enforce robust provisioning in 2017 (under IAS 39) and in 2018 (under IFRS 9);
    - (ii) oblige write-offs of NPLs where collection is unlikely;
    - (iii) issue supervisory guidance on minimum collateral valuation practices;
    - (iv) enhance supervisory reporting and disclosure (BNB ¶41 to ¶45).
  - Extend the BNB’s macroprudential mandate to introduce supervisory review approaches to exhort more robust provisioning, NPL accounting write-offs, and improved collateral valuation practices.
  - Work with national authorities, the banking industry, and investors to improve the market for NPLs and collateral enforcement.
- Bank recapitalization and resolution:
  - Ensure the three banks with identified capital needs undertake credible recapitalization plans, prioritize recovery and resolution planning, and source equity from bona fide investors.
  - BNB should act promptly if banks do not meet commitments under BNB orders; prioritize RRP for banks with AQR-identified shortfalls and majority domestically owned D-SIBs.
- Supervisory strengthening (Near-term / NT and Immediate / I actions):
  - Ensure adequate staffing and resources of all financial oversight authorities and arrange training and capacity building (MoF, BNB, BDIF, FSC).
  - Adopt a multi-year Action Plan with detailed activities to continue strengthening BSD.
  - Implement a comprehensive supervisory strategy for target banks under the AQR.
  - Introduce regulation on related parties setting criteria to typify circumvention.
  - Enforce remedies to concentration and related-party risks based on 2017 inspections.
  - Implement a risk-based approach to AML/CFT supervision in line with FATF standards.
- Financial safety net and crisis management (Immediate / I and Near-term / NT):
  - Ensure smooth and decisive transition from early intervention into resolution; define joint BNB‑MoF strategies for liquidity assistance consistent with the CBA, supported by a comprehensive toolkit.
  - Under the oversight of an expanded FSAC mandate and membership, strengthen the crisis management framework.
- Disclosure and NPL market infrastructure:
  - BNB should promote adoption of the FSB EDTF recommendations for enhanced bank risk disclosures.
  - Strengthen bank systems for timely collection and sharing of internal loan and collateral data to support credit risk management and make NPLs more transparent to potential investors.
  - Work with banks and stakeholders to improve infrastructure for the NPL market, including standardization of information about NPLs and related collateral and removal of legal impediments to collateral enforcement and insolvency resolution.

### Annex II: FSAP and BNB stress test key methodological differences (selected)
- Interest income on NPLs:
  - FSAP excluded interest income from nonperforming exposures in both baseline and adverse scenarios.
  - BNB (in line with EBA methodology) excluded interest income only in the adverse scenario.
- Adverse scenario horizon:
  - FSAP simulated three years of GDP decline in its adverse scenario.
  - BNB’s adverse scenario simulated two years of GDP decline and a return to growth in the third year.
- FSAP top-down methodology highlights:
  - Institutions included: 17 banks covering 95 percent of assets.
  - Baseline date: end-June 2016.
  - Models: satellite models for macro-financial linkages; no accrued income on NPL loans in FSAP approach.

### Annex VI: Implementation status of 2008 FSAP — crisis management, supervision, and reforms
- Crisis management and fiscal support:
  - Directive 2014/59/EU (BRRD) transposed into Bulgarian legislation (LRRCIIF); Chapter XIV contains rules for government stabilization tools; MoF indicates government debt ceiling (BGN 5.3 billion) could be used to finance stabilization under LRRCIIF.
- Banking supervision and stress testing:
  - BNB reports multiple stress tests since 2009 and a bottom-up macro-scenario stress test in 2016.
  - BNB updated Banking Supervisory Process Manual to better reflect Basel recommendations on Pillar 2 and EBA standards.
- Pension and insurance sector actions:
  - FSC increased staff and engaged in capacity building and disclosure improvements for pension funds; some proposed reforms not supported by MoF.
- Authorities’ statement (May 22, 2017):
  - BNB gross international reserves increased by 17.8 percent and reached 23.9 billion euro.
  - 2016 fiscal consolidation went ahead of schedule to a surplus.
  - New coalition government aims for a structurally balanced budget by 2020 and supports financial stability reforms.
  - AQR confirmed comfortable position of banks’ balance sheets as of end-2015; 2016 RoA and RoE increased to 1.4 and 10.4 percent respectively; capital adequacy ratio remained high at 22.2 percent.
  - Banking system leverage ratio: 10.9 percent.
  - Total liquid assets of the banking system increased by 9.6 percent and liquidity ratio reached 38.2 percent at end-2016.
- Conclusions and priorities:
  - Progress since 2014 is acknowledged, but authorities emphasize no room for complacency.
  - Priorities: further enhance bank capital buffers; strengthen compliance and supervision; strengthen financial safety net, crisis management and bank resolution.
  - Authorities open to systematic NPL reduction approaches and continue work with domestic and international counterparts.

_Italic: Source: IMF Financial System Stability Assessment (FSAP) — Bulgaria (May 5, 2017). Canonical URL: https://www.imf.org/-/media/files/publications/cr/2017/cr17132.pdf_

### 13.7 percent of total loans as of June 2016

### 13.7 percent of total loans as of June 2016

### Executive Board Assessment and system-wide findings
- Executive Directors agreed with the main findings and recommendations of the Financial System Stability Assessment.
- Directors commended authorities for steps taken to rebuild credibility after the 2014 collapse of the then fourth-largest bank, which revealed weaknesses in supervision and crisis management.
- Directors encouraged continued efforts to strengthen financial sector resilience and to address weaknesses identified by the 2016 Asset Quality Review (AQR) and stress test.
- While the banking system overall shows resilience—as confirmed by the Financial Sector Assessment Program’s stress test—the exercise revealed capital weaknesses in some domestically owned banks.
- Directors urged prioritization of restructuring and capitalization plans for banks with capital weaknesses and emphasized strengthening supervision, governance, related-party exposure monitoring, and concentration risk management.
- Directors commended improvements in banking oversight since the 2015 Basel Core Principles assessment but noted remaining shortcomings and called for extending the Bulgarian National Bank’s (BNB) macro-prudential mandate to address the high level of nonperforming loans (NPLs).

### Nonperforming loans (NPLs) — scale, drivers, and implications
- NPL measures and comparisons:
  - EBA-based measure: 13.7 percent of total loans as of June 2016 — against an EU-weighted average of 5.5 percent.
  - BNB definition: NPLs level stood at nearly 20 percent in June 2016.
- Contributing practices:
  - Certain accounting, collateral valuation, and risk management practices have contributed to disincentives for NPL reduction.
- IFRS 9 / provisioning implications:
  - Beginning January 1, 2018, EU banks will be subject to IFRS 9 for determining loan loss provisions.
  - Across Europe, estimates of the impact from IFRS 9 are that loan loss allowances may need to increase by 18-33 percent from current levels.
  - Banks will need to build provisions in preparation for the implementation of expected credit loss provisioning standards.
- Economic and financial effects:
  - High NPLs have a negative impact on financial intermediation and the real economy, potentially limiting investment and consumption and constraining asset-price recovery.
  - Banks may be reluctant to lend, especially to sectors burdened by high indebtedness.

### Stress testing, capital needs, and supervisory implications
- AQR/stress test outcomes:
  - The authorities’ AQR/stress test in 2016 identified capital needs in three banks; the rest of the system showed substantial capital buffers.
  - From the AQR/stress test, the capital shortfall for the three banks amounted to about 0.3 percent of GDP.
- Methodological differences between FSAP and BNB stress tests:
  - The FSAP excluded interest income from nonperforming exposures in both the baseline and adverse scenarios; the BNB (in line with EBA methodology) excluded interest income only in the adverse scenario.
  - The FSAP simulated three years of GDP decline in its adverse scenario; the BNB’s adverse scenario simulated two years of GDP decline and a return to growth in the third year.
- Supervisory capacity and reforms:
  - Some progress since the 2015 BCP assessment, but BSD needs staffing, systems, and recalibration of rating schemes (CAEL and CAMELOS).
  - The BNB should formalize the Supervisory Review and Evaluation Process (SREP) to set explicit Pillar 2 capital requirements.
  - The BNB is targeting 2017 for adoption of new banking supervision process and inspection manuals.

### Financial safety net, crisis management, and liquidity considerations
- Status and challenges:
  - Authorities introduced a comprehensive resolution toolkit, designated the BNB as resolution authority, and established funding mechanisms for resolution measures, but components are not fully developed.
  - Early intervention framework (EIF) lacks quantitative escalation policies and procedures and does not ensure a smooth transition into resolution.
  - For practical purposes, there is no emergency liquidity assistance (ELA) facility due to lack of funds and policy constraints.
  - The deposit insurance fund is insufficient to cover payouts to depositors of the smallest mid-sized bank unless the BDIF takes on a sizeable loan or collects extraordinary premiums.
  - The bank resolution fund recently started collecting premiums and is not operational; no recovery and resolution plan (RRP) has been finalized for any of the 13 majority domestically owned banks.
- Currency Board Arrangement (CBA) implications:
  - The CBA has contributed to macroeconomic stability but constrains the BNB’s ability to provide lender-of-last-resort liquidity in times of financial stress.
  - Directors saw merit in developing a framework to provide for lender-of-last-resort liquidity assistance to address constraints stemming from the CBA and EU state aid procedures.

### Policy recommendations and priority actions (selected)
- NPL reduction strategy (Immediate / I):
  - Implement a comprehensive strategy for NPL reduction, including supervisory review tools to: (i) enforce robust provisioning in 2017 (under IAS 39) and in 2018 (under IFRS 9); (ii) oblige write-offs of NPLs where collection is unlikely; (iii) issue supervisory guidance on minimum collateral valuation practices; and (iv) enhance supervisory reporting and disclosure (BNB ¶41 to ¶45).
  - Extend the BNB’s macroprudential mandate to introduce supervisory review approaches to exhort more robust provisioning, NPL accounting write-offs, and improved collateral valuation practices.
  - Work with national authorities, the banking industry, and investors to improve the market for NPLs and collateral enforcement.
- Bank recapitalization and resolution (Immediate / I):
  - Ensure the three banks with identified capital needs undertake credible recapitalization plans, prioritize recovery and resolution planning, and source equity from bona fide investors to improve credibility and governance.
  - BNB should act promptly if banks do not meet commitments under BNB orders; prioritize RRP for banks with AQR-identified shortfalls and majority domestically owned D-SIBs.
- Supervisory strengthening (Near-term / NT and Immediate / I actions):
  - Ensure adequate staffing and resources of all financial oversight authorities and arrange training and capacity building (MoF, BNB, BDIF, FSC).
  - Adopt a multi-year Action Plan with detailed activities to continue strengthening BSD (BNB).
  - Implement a comprehensive supervisory strategy for target banks under the AQR (BNB).
  - Introduce regulation on related parties setting criteria to typify circumvention (BNB).
  - Enforce remedies to concentration and related-party risks based on 2017 inspections (BNB).
  - Implement a risk-based approach to AML/CFT supervision in line with FATF standards.
- Financial safety net and crisis management (Immediate / I and Near-term / NT):
  - Ensure smooth and decisive transition from early intervention into resolution; define joint BNB-MoF strategies for liquidity assistance consistent with the CBA, supported by a comprehensive toolkit.
  - Under the oversight of an expanded FSAC mandate and membership, strengthen the crisis management framework.

### Key macrofinancial and sector indicators referenced
- GDP growth: 3.6 percent in 2015 and 3.4 percent in 2016.
- NPLs:
  - EBA measure: 13.7 percent of total loans as of June 2016.
  - BNB definition: nearly 20 percent in June 2016.
- EU-weighted average NPLs: 5.5 percent.
- Capital shortfall from 2016 AQR/stress test for three banks: about 0.3 percent of GDP.
- Estimated European increase in loan loss allowances under IFRS 9: 18-33 percent.
- IFRS 9 effective date for EU banks: Beginning January 1, 2018.
- Number of majority domestically owned banks without finalized RRPs: 13.

*Source: IMF Financial System Stability Assessment (FSAP) — Bulgaria (May 5, 2017). Canonical URL: https://www.imf.org/-/media/files/publications/cr/2017/cr17132.pdf*

### 4.      Bulgaria’s financial system is bank dominated, with an important presence of

### 4.      Bulgaria’s financial system is bank dominated, with an important presence of 

### Financial structure and market composition
- Financial system assets amount to 115 percent of GDP and the banking sector assets amount to 101 percent of GDP.
- There are 27 banks, of which 13 are subsidiaries and 5 are branches of foreign banks.
- Foreign-bank presence accounts for 77 percent of total bank assets as of June 2016.
- There are nine domestically owned banks, with a combined bank asset share of 23.3 percent (including the third largest bank).
- Among the nine domestically owned banks are one state-owned bank and one municipality-owned bank that together represent just 3 percent of total bank assets.
- The top five banks represent 59 percent of total bank assets.
- The banking system is deposit funded (83 percent of liabilities).
- Assets are dominated by lending, with about half of loans denominated in foreign currency (predominantly in euros).

### Recent events, liquidity support, and deposit insurance
- Some banks experienced liquidity outflows following the 2014 collapse of a systemic bank, which was taken into conservatorship and later closed by the BNB.
- Liquidity assistance was provided by the government with the EC’s approval, as the BNB’s capacity to provide lender-of-last-resort liquidity was constrained by the CBA.
- The liquidity program was available to all banks; the only user was the largest domestically-owned bank (at the time, the third largest in the system), which lost 10 percent of its deposits in a single day.
- For the bank that failed in November 2014, depositors were subsequently reimbursed by the Bulgaria Deposit Insurance Fund (BDIF), which needed to draw on official support.

### Banking sector soundness indicators (June 2016 and Q2 2016)
- Tier 1 capital adequacy ratio: 21.2 percent as of June 2016.
- Total capital adequacy ratio: 22.7 percent as of June 2016.
- Liquid asset ratio: 31 percent at June 2016 (from 26 percent in 2014) in terms of assets.
- Return on Assets (RoA): 1.8 percent in Q2 2016.
- Profitability increase in H1 2016 driven by reduced operational and provisioning expenses and an increase in non-recurring items.
- The banking sector is heterogeneous with some banks performing worse than average; AQRs point to pockets of vulnerabilities, particularly in related-party and connected lending of some (mainly domestically owned) banks.

### AQR and capital adjustments (August 2016 AQR/stress test)
- Three banks had capital shortfalls; the three banks represented 12 percent of total banking system assets.
- Reclassification of EUR1.9 billion of exposure as nonperforming loans and adjustments to loan-loss provisions resulted from the AQR.
- The systemically important bank needed to build capital of around EUR105 million.
- Capital shortfalls for two smaller domestic banks amounted to EUR19 million.
- The smallest of the three banks has already raised capital through the conversion of debt into equity.
- Authorities aimed to have the banks achieve the capital targets by mid-2017.

### BNB liquidity framework and measures (Box 1 summary)
- The BNB may extend liquidity assistance only to solvent banks, in lev, with a maturity of no longer than three months; and up to the amount of the BNB’s excess international reserves.
- Assistance must be fully collateralized by highly liquid assets (e.g., gold, certain foreign currency, domestic and prime-rated government securities).
- Required minimum reserve requirement (differentiated RR): 10 percent of the funds attracted in lev; 5 percent for funds in foreign currency.
- The BNB has adopted Basel liquidity requirement (LCR) of 70 percent for 2016, 80 percent for 2017, and 100 percent for 2018.
- The liquid asset ratio increased to 31 percent at June 2016, higher than the current required ratio of 20 percent; and to 50 percent in terms of short-term liabilities.
- The level of foreign deposits held at the BNB reached high levels given limited domestic investment opportunities and lower returns abroad.

### Nonbank financial institutions context
- The Nonbank Financial Institution sector is relatively small.
- The insurance industry is small and dominated by subsidiaries of foreign firms.
- Market capitalization of the Bulgarian Stock Exchange was around 10 percent of GDP at end-2015.
- Pension system assets amounted to 9.4 percent of GDP at end-2015.
- The Financial Supervision Commission (FSC) undertook a balance sheet review and stress test exercise for the insurance and pension sectors in 2016; results published February 3, 2017 noted capital needs for 13 insurance entities that would not meet minimum capital requirements at end-June 2016.
- For insurance entities, the aggregate deficiencies were not large compared with the total capital of the insurers.

### Key risks and vulnerabilities
- Main banking sector vulnerabilities: high NPLs, concentrated exposures in several banks, and relatively high corporate sector indebtedness.
- NPL ratio remains persistently high with most NPLs consisting of loans over one year past due.
- Loan portfolio concentration, including to related parties in some domestic banks, could pose larger risks than estimated during the AQR and stress tests; a few large loan defaults in some banks could lead to significant credit losses.
- Several economy-wide risks that could significantly impact the banking system include:
  - protracted slowdown of European growth;
  - change of investor sentiment toward emerging markets resulting in financial stress;
  - increasing geopolitical tensions related to countries in the region;
  - asset price uncertainty over NPLs.

### Stability analysis — solvency stress tests (top-down)
- Coverage: 17 largest banks accounting for 95 percent of industry assets.
- Data: supervisory balance sheets as of June 2016.
- Scenarios: “baseline” (based on October 2016 WEO projections) and a severe but plausible “adverse” scenario spanning three years (June 2016 to June 2019).
- Adverse scenario: simulates a V-shaped GDP profile with declining external demand and investor confidence, and asset price uncertainty over NPLs.
- Calibration result: simulated GDP growth rates represent a cumulative deviation of approximately 12 percentage points over two years from the baseline scenario (approximately 2 times the standard deviation of the two-year cumulative growth rates observed during 2006–2015).
- Under the adverse scenario, the banking system’s average NPL ratio increases by approximately 8 percentage points between 2016Q2 and 2019Q2, with corporate and mortgage loans experiencing the highest increases.

### Stress test solvency results
- Aggregate CET1 ratio falls to around 15 percent by June 2019 in the adverse scenario (compared with regulatory minimum of 4.5 percent).
- System-wide leverage ratio falls from 11 percent to 8 percent and remains above the 3 percent level.
- Five banks fall below the regulatory minimum CET1 ratio of 4.5 percent and below the referenced 3 percent leverage ratio by the end of the simulation; the capital shortfall in the third year would amount to 1.8 percent of the annualized GDP.
- Of the five banks falling below the regulatory minimum at the end of the simulation period, three become technically insolvent.

### Drivers of capital deterioration and accounting standard sensitivity
- The largest driver of capital decline in the adverse scenario is loan-loss provisions.
- The stress scenario assumes an increase in the provisioning ratio of 20 percentage points.
- For domestic banks, interest rate-related losses (from sizeable funding shocks) are the second largest driver of capital decline.
- IFRS 9 sensitivity test: increasing provisions by 20 percentage points for the existing stock of NPLs (as part of sensitivity analysis) leads to:
  - Two banks falling below the regulatory minimum threshold for capital.
  - Aggregate CET1 ratio in the system declines by approximately 6 percentage points.

### Liquidity stress tests and outcomes
- Three methods used: LCR, NSFR, and cashflow-based liquidity stress test.
- Liquidity Coverage Ratio (LCR): system LCR remained above the 100 percent threshold even in the extreme scenario with only one bank performing below standard; resulting liquidity shortfall was less than BGN 740 million or 0.85 percent of 2015 GDP.
- Net Stable Funding Ratio (NSFR): system-level NSFR drops to 125.2 percent (above 100 percent standard); however, three banks perform below standard with shortfall amounting to BGN 1 billion or 1.2 percent of GDP at the extreme scenario of 50 percent or less stable deposits outflow.
- Cashflow analysis:
  - Three banks could be vulnerable to cash outflows in the very short term (seven-day horizon), with a combined shortfall of 0.7 percent of GDP.
  - Only one bank may be vulnerable in the ninety-day horizon with a shortfall of 0.5 percent of GDP.
  - No bank would be vulnerable within a one-year time horizon.

*Source: IMF staff analysis (from the provided chapter text).*

### 20.      Spillover risks from banking system exposures are minimal. Local banks are funded

### 20.      Spillover risks from banking system exposures are minimal. Local banks are funded

### Spillover risks and funding structure
- Local banks are funded mostly by domestic deposits and do not depend on significant foreign or wholesale funding.
- Foreign-owned banks’ reliance on parents for funding is minimal; they are predominantly funded by domestic deposits.
- Interbank borrowing activity is limited.
- The Bulgarian banking system displays little vulnerability to direct (balance sheet-based) spillovers.
- Indirect channels (loss of confidence and deposit withdrawals) remain a risk, as experienced during the 2014 bank collapse.

### Microprudential oversight — banking
Findings:
- The BNB has endorsed and is implementing a multi-year plan to address issues identified by the 2015 Basel Core Principles (BCP) Assessment.
- Prioritization of the 2016 AQR and stress test placed heavy pressure on limited supervisory resources and delayed some planned BCP recommendations.
- A set of new policies, manuals, and ordinances are expected later in 2017-early 2018.
- Room remains to enhance the governance model of supervision, risk-assessment practices, and response to risk accumulation, notably regarding local risks.

Policy recommendations and planned actions:
- Assess needs and allocate reasonable incremental supervisory resources, including tools to support and manage the risk-assessment process.
- Complete manuals, SREP and pillar 2 capital approaches, and response procedures to ensure early remediation of risk.
- Adopt by the Governing Council (GC) an explicit framework and procedures to assess delivery on selected policy objectives.
- Adopt formal policies specifying conditions under which the GC and the Deputy Governor in charge of Supervision (DGS) will escalate response and intervention measures, including severity of enforcement actions.

### BNB governance and BSD effectiveness
Findings:
- A new BNB governance model is in place to enhance the effectiveness of supervision, including formal policies for the Banking Supervision Department (BSD) based on EBA/GL/2014/13.
- The GC receives a new quarterly report on banking risks; BSD is subject to an annual internal audit.
- Decision-making for supervision is streamlined with a more active role for the Advisory Council (AC), which provides a collective opinion to the DGS.
- The DGS remains by law the sole authority responsible for supervision, except the GC’s authority on licenses and special supervision measures.

Recommendations:
- Reinforce accountability to ensure prompt and effective risk response.
- Adopt a strategic tool to align GC risk tolerance with BSD response and escalation stance (e.g., combine risk profile and systemic impact per institution to guide supervisory responses).
- Assess ex post effectiveness of GC and BSD responses by their success in containing/resolving assessed risks.

### BSD organization, resources, and processes
Findings:
- New Offsite Directorate segregated from Onsite Inspection; inspection teams increased to six.
- New Analysis of Market Behavior and Risk Division created to focus on AML/CFT.
- Cooperation improved via three new Memoranda of Understanding.
- New staff recruited, but desired levels not yet reached.
- External assessment launched for adequacy of IT systems for supervision and resolution.
- Key ordinances await drafting to adopt forthcoming EBA standards (e.g., LCI Article 45 on related-party transactions).

Recommendations:
- Review BSD annual operational objectives and engagement model to estimate workload and staffing needs.
- Implement curriculum and training program and adopt attractive remuneration system.
- Provide modern software tools to support integrated, efficient, and auditable risk assessment and response aligned with GC risk tolerance.

### Supervisory methodology and SREP
Findings:
- Onsite inspection processes being reviewed to become a handbook for supervision by risk, aligned to EBA standards.
- Current risk-assessment methodology needs recalibration with key benchmark risk indicators, more granular criteria, and control points for assessing central functions.
- Need to coordinate offsite and onsite assessments (CAEL and CAMELOS) for a combined rating leading to explicit response and escalation policy.
- Need to formalize a comprehensive Supervisory and Review and Evaluation Process (SREP) including a detailed supervisory Pillar 2 capital requirement; BNB Act empowers BNB to impose Pillar 2 requirements.

Actions underway:
- BSD 2017 supervisory plan to follow up on 2016 AQR outcomes and banks’ compliance progress.
- Onsite Inspection Directorate adopted an inspection plan with targets; Offsite Inspection Directorate monitoring via more frequent ad hoc reporting.
- Policy Directorate strengthening tools to profile interconnections and relationships.

Key enforcement levers for banks with capital shortfalls:
- (i) higher loan loss provisions and NPL write-offs (implementation of the NPL strategy);
- (ii) a well-calibrated Pillar 2 capital add-on requirement, potentially more demanding than forthcoming EBA standards.

### Bank corporate governance
Findings:
- EU directives and regulations transposed into domestic framework to: (i) strengthen Supervisory Board (SB) function; (ii) enhance independence and effectiveness of internal control functions (audit, risk, compliance); (iii) improve quality and disclosure of financial information (IFRS).
- Implementation is uneven: foreign bank subsidiaries show more developed practices; domestic private banks have highly concentrated ownership structures.
- In many domestic banks, the distinction between shareholders, SB members, and Management Board (MB) members is blurred, leaving real management influenced by controlling shareholders.

Recommendations:
- SBs should evolve from a “policy approving body” to an “oversight body.”
- Review independence of internal control functions to ensure SB remains at arm’s length from controlling owners.
- Continue BNB commitment to improving risk management practices across banks, including recruiting and elevating CROs and establishing SB-level Risk Committees.
- Enhance supervision and effective enforcement to harmonize corporate governance practices.

### Nonbank sector
Findings and recommendations:
- Financial Supervision Commission (FSC) Act needs amendment to provide FSC with financial and operational independence, adequate powers, and statutory indemnity for the FSC and its staff.
- Main FSC funding source is the state budget, which may compromise effective supervision; supervised entities should fund FSC operations via levies, requiring statutory powers to raise levies.
- FSC should review all Acts that give it supervisory powers and ensure supervisory actions are executory.

### Macroprudential policy framework
Findings:
- In absence of independent monetary policy, the BNB actively applies macroprudential tools to address systemic risk (Annex V).
- BNB is the designated macroprudential authority for banks; FSC for nonbanks.
- During 2001–2008, BNB used higher reserve requirements and measures to curb rapid credit growth (e.g., lower loan-to-value ratios, stricter lending requirements, limiting dividends if capital/provisioning buffers are insufficient).
- Macroprudential measures helped contain spillovers from Greece caused by Greek bank subsidiaries.
- Financial Stability Advisory Council (FSAC) includes BNB, FSC, and Ministry of Finance; Minister of Finance chairs FSAC. FSAC analyzes systemic risk, but setting macroprudential instruments remains responsibility of BNB and FSC.

Capacity and data needs:
- BNB has adequate powers and access to information, and can designate systemically important institutions.
- Additional resources needed to close data gaps and develop techniques for monitoring systemic risk.
- BNB should collect regularly more detailed data on NPLs, real estate market condition, and corporate sector indebtedness (including value of various types of collateral for NPLs, NPL data by sectors, and corporate debt at firm level).
- Enhance analytical capacity to conduct full-fledged, top-down stress tests, including scenario analysis covering credit and liquidity risks and focusing on systemic risks.

Transparency and communication:
- BNB is accountable to the national parliament; Board decisions are published on BNB’s website.
- Improve communication of macroprudential policy by explaining: (i) overall objectives; (ii) reasoning for decisions and expected mechanism of measures; (iii) ex-post assessment of effectiveness.

### Anti‑Money Laundering and Combating the Financing of Terrorism (AML/CFT)
Findings:
- Authorities have taken steps to strengthen AML/CFT framework; amendments passed on confiscation and targeted financial sanctions.
- Deficiencies remain regarding criminalization of terrorist financing.
- As of mid-2016, suspicious transaction reporting from designated non-financial sectors remains very low.
- Finalizing AML/CFT law to transpose EU’s Fourth AML Directive is underway.
- Efforts to enhance AML/CFT supervision of the banking sector include increasing resources and signing an MoU between the BNB and the Financial Intelligence Unit.
Recommendations:
- Address in law aspects on definition of beneficial ownership.
- BNB to adopt risk-based AML/CFT approaches consistent with Financial Action Task Force guidance.

### Nonperforming loans (NPL) reduction strategy — findings and recommendations
Key statistics:
- NPL level at end-June 2016 was 19.7 percent of loans (BNB’s own measure), with most NPLs over one year past due.
- Using the EBA’s NPL measure, Bulgaria’s banks had NPLs of 13.7 percent against the EU weighted average 5.5 percent as of June 2016.
- Loan-loss reserve to NPL ratio (coverage ratio) declined to 51.7 percent as of June 2016, from just over 100 percent in 2008 (BNB’s own NPL measure).
- Estimates of the impact from IFRS 9 are that loan-loss allowances may increase by 18-33 percent from current levels.

Findings:
- BNB actions include the 2016 AQR, limits on dividend payments based on high NPL ratios, and continual monitoring of forbearance and NPL exposures.
- Banks generally have high capital and liquidity buffers, confirmed by AQR/stress test, but loan-loss provisioning coverage shows weaknesses.
- Provisions lagged higher NPL flows since the global financial crisis.

Recommendations — comprehensive NPL reduction strategy (three- to five-year horizon):
- Focus supervisory actions on three main areas:
  - (i) loan-loss provisioning (LLP);
  - (ii) loan write-offs of NPLs, in whole or in part, where collection is unlikely;
  - (iii) collateral valuation.
- Support the strategy with enhanced supervisory guidance, supervisory reporting, and risk disclosure.
- Improve banks’ early warning systems (EWS) and develop the NPL market.
- Strengthen supervisory review: expect banks to follow IFRS but specify supervisory expectations using BNB measurement metrics; apply additional supervisory scrutiny if reported allowances are insufficient relative to BNB supervisory metrics.
- Prepare for IFRS 9 adoption with supervisory guidance, ensuring banks adapt provisioning practices to recognize loan deterioration using forecasts and enhance EWS.
- Issue supervisory guidance setting forth robust collateral valuation practices, including use of internal and external valuation experts; adopt uniform, conservative valuation rules to reduce NPL pricing gap and support NPL market development.

*From IMF staff report excerpt (cr17132).*

### 46.      The BNB should promote improved risk information for investors and risk disclosure

### 46.      The BNB should promote improved risk information for investors and risk disclosure

### Role of improved risk information and disclosure
- Improve credit risk management by strengthening bank systems for the timely collection of internal loan and collateral data; this data could be useful to potential investors in NPLs.
- The global financial crisis highlighted the importance to market confidence of reliable valuations and useful risk disclosures.
- The Financial Stability Board’s (FSB) Enhanced Disclosure Task Force (EDTF) recommendations provide improved bank risk disclosures and extensive examples of leading disclosure practices designed to provide timely information useful to investors and other users.
- Over time, improved disclosures could contribute to improved market confidence in financial institutions and foster better NPL markets by supplying information needed for potential investors.

### Recommendations to the BNB on disclosure and infrastructure for NPL markets
- Promote adoption of the FSB EDTF recommendations for enhanced bank risk disclosures.
- Strengthen bank systems for timely collection and sharing of internal loan and collateral data to support credit risk management and make NPLs more transparent to potential investors.
- Work with banks, other national authorities, and other stakeholders to improve infrastructure for the NPL market, recognizing the Bulgarian NPL market is developing but remains shallow.
- Potential improvements identified:
  - (i) Standardization of information about NPLs and related collateral (in effect, an extension of the AQR exercise).
  - (ii) Removal of certain legal impediments in the areas of collateral enforcement, insolvency regimes, and out-of-court settlement, as indicated in the World Bank Insolvency and Credit/Debtor Regimes ROSC in 2016.

### Empirical context from Figure 7 and text (selected indicators)
- LLR coverage is 52% of NPLs based on local BNB measure.
- Most NPLs are over 1 year past due.
- NPL ratios are highest in construction and real estate (Figure 7 sectoral NPL ratios, June 2016).
- Provision expense to total loans series shown (annualized) with time path from 2007 to Jun-16 (source BNB).
- EBA measures indicate Bulgaria’s NPL stock and coverage imply higher risk than many peers (EBA Risk Dashboard comparisons).

*Source: IMF staff report (cr17132) — “46. The BNB should promote improved risk information for investors and risk disclosure”*

### Annex II. FSAP and BNB Stress Test Key Differences

### Annex II. FSAP and BNB Stress Test Key Differences

### Risk Assessment Matrix — Key Risks, Likelihood, Impact, and Modeling Notes
- 1. Protracted period of slower European growth.
  - Relative Likelihood: High
  - Impact if Realized: High
  - Notes: "Bulgaria’s exports are highly dependent on Euro-area markets. There would be direct negative influence through trade and investment channels."
  - Transmission and outcomes: "Low potential growth, high structural unemployment and low FDI, continued fiscal pressures. External shocks will lead to lower income for corporate sector as well as households. Fixed exchange rate will be maintained, thus external shocks will materialize in lower public spending, corporate sector income, and household wages."
  - Stress-test modeling: "modeled through lower GDP growth and higher unemployment shocks, which lead to higher NPLs."

- 2. Financial stress in emerging markets
  - Relative Likelihood: Medium
  - Impact if Realized: Medium
  - Notes: "Adverse effects on banks and corporates due to increased investor risk aversion, which leads to higher risk premiums."
  - Transmission and outcomes: "Increased country risk premium, leading to wider spreads for the sovereign, funding pressures for banks, higher borrowing costs for nonfinancial corporates, and lower FDI."
  - Stress-test modeling: "modeled through wider spreads for the sovereign (losses on domestic mark-to-market securities) and higher funding costs for banks."

- 3. Intensification of geo-political tensions related to Russia, Ukraine, and Turkey.
  - Relative Likelihood: High/Medium
  - Impact if Realized: High/Medium
  - Notes: "Negative spillovers from trade and investment channels increase in country risk, sovereign rating downgrade."
  - Transmission and outcomes: "Adverse effect on economic activity and social tensions leading to the higher country risk premiums and potential sovereign rating downgrade by one to three notches."
  - Stress-test modeling: "modeled through a stand-alone sensitivity shock (sovereign downgrade)."

- 4. Asset price uncertainty over NPLs.
  - Relative Likelihood: High
  - Impact if Realized: Medium
  - Notes: "Delayed recognition of NPLs, and loan foreclosures. Impediments to releasing collateral associated with NPLs, including judicial bottlenecks and administrative costs."
  - Transmission and outcomes: "Collateral prices decline. The need for higher provisions lowers bank profits and capital; investment and growth prospects are in turn weakened."
  - Stress-test modeling: "modeled through higher provisioning rates for banks."

### Top-down Stress Test (STeM) — Banking Sector Solvency: Institutional Perimeter and Data
- Institutions included: 17 banks
- Market share covered: 95 percent of the banking system assets
- Data and baseline date: "Source: Supervisory and publicly-available data. Baseline date: End-June 2016"
- Scope of Consolidation: "Consolidated level data for banks which have their headquarters in Bulgaria and subsidiary level data for the subsidiaries of foreign banks"
- Stress test horizon: "3 years (2016 Q2– 2019 Q2)"

### Top-down Stress Test — Methodology and Channels of Risk Propagation
- Methodology: "Satellite models developed by the FSAP team"
- Approach: "Balance sheet-based approach"
- Models and items included:
  - "Satellite models for macro-financial linkages"
  - "Models for credit losses, pre-impairment income, credit growth, expert judgment"
  - "Models to integrate solvency-funding interactions"
  - "Methodology to calculate sovereign risk"
  - "Methodology to calculate losses from bonds and money market instruments (sovereign and other issuers)"
  - "Net fee income and commission income projected based on nominal GDP growth and expert judgment"
  - "No accrued income on NPL loans"

### Tail Scenarios and Sensitivities (Solvency)
- Scenario analysis specifics:
  - "Scenario-based tests ... assess the impacts on the entire portfolio including the loans and, if applicable, the trading book"
  - Scenario variables: "domestic macro-financial variables (e.g., GDP and inflation), and GDP for key trading partners (EU, Russia, neighboring non-EU countries)"
- Bulgaria-specific severe stress scenario GDP path:
  - 2017: -6 percent
  - 2018: -6.4 percent
  - 2019: -3.4 percent
- External sector shocks: "calibrated to magnitudes like those observed in countries with currency board system during 2008–2009"
- Sensitivity analyses will evaluate:
  - "sovereign rating downgrade and a decline in the prices of sovereign bonds"
  - "Default of large corporate borrowers."
  - "Decline in real estate prices."
  - "Increase in interest rates (risk premiums)."

### Risks, Behavioral Assumptions, and Reporting (Solvency)
- Risks/factors assessed:
  - "Credit losses."
  - "Losses from bonds and money market instruments (sovereign and other issuers) in the banking and trading books."
  - "Funding costs."
- Behavioral adjustments:
  - "Balance sheet grows in line with nominal GDP."
  - "Dividends are paid out by banks that remain adequately capitalized throughout the stress period. Dividend payout ratio is determined by using historical data."
- Calibration of risk parameters: "Through-the-cycle and point-in-time for credit risk parameters or proxies."
- Regulatory/accounting and market-based standards: "European and national regulation. Basel II/III STA approach."
- Reporting format for results:
  - "System-wide capital shortfall."
  - "Number of banks and percentage of banking assets in the system that that fall below microprudential hurdle rates (Basel minimum: 4.5 percent and 8 percent for common equity tier 1 and total capital ratios, and 3 percent leverage ratio)."

### Top-down Stress Test — Banking Sector Liquidity: Perimeter, Methods, and Outputs
- Institutional perimeter:
  - Institutions included: 17 largest banks in the system
  - Market share: 95 percent of the banking system assets
  - Data and baseline date: "Source: Supervisory data. Baseline date: End-June 2016."
  - Scope of Consolidation: "Consolidated level data for banks that have their headquarters in Bulgaria, and subsidiary level data for the subsidiaries of foreign banks."
- Methodology and channels:
  - "Basel III-LCR and NSFR type proxies, based on European Commission Delegated Act."
  - "Cash-flow based liquidity stress test using maturity buckets by banks."
- Risks and buffers:
  - Risks: "Funding liquidity (liquidity outflows)." and "Market liquidity (price shocks and haircuts)."
  - Buffers: "Counterbalancing capacity (HQLA)." and "Central bank facilities."
- Tail shocks and shock sizing:
  - "Runoff rates calculated based on historical events and LCR/NSFR rates."
  - "Bank run and dry up of wholesale funding markets, considering haircuts to liquid assets."
- Regulatory and market-based references:
  - "European Commission Delegated Regulation (EU) 2015/61; and Basel Committee on Banking Supervision (2014), “Basel III: The Net Stable funding ratio” Basel, October."
- Reporting format for results:
  - "Bank-level and aggregate banking-level liquidity gaps."
  - "Survival period in days by bank, number of banks that can still meet their obligations."

### Top-down Stress Test — Interconnectedness
- Institutional perimeter:
  - Institutions included: 17 largest banks in the system
- Modeling approach:
  - "Simple balance sheet contagion model."

### Macroprudential Tools and Instruments Implemented by the BNB — Overview and Key Measures
- Credit risk tools
  - Introduction of credit ceilings
    - Objective: "To mitigate and prevent excessive credit growth and leverage"
    - Description: "Additional required reserves were imposed on banks whose credit portfolio expands by more than 6 percent per quarter."
    - Adoption Date: Feb 2005
  - Introduced higher risk weight on mortgages
    - Objective: "To slow excessive mortgage lending."
    - Description: "Amendments to Regulation 8 introduced that for mortgage credit to have a 50% risk weight, the loan amount must be less than 70% of the home value (70% loan-to-value ratio), otherwise the risk-weight is 100%."
    - Adoption Date: 2005 Q3
  - Stricter consumer lending standards
    - Objective: "To mitigate and prevent excessive credit growth and leverage"
    - Description: "To prevent excessive credit growth, restrictions on credit standards were introduced, such as not extending credit to household with less than 100 BGN per member per month."
    - Adoption Date: 2006
  - Increase/decrease reserve requirement ratio (RRR)
    - Objective: "To mitigate and prevent excessive credit growth and leverage"
    - Description: "Influence credit growth in a countercyclical manner by increasing RRR from 8 percent to 12 percent during the cycle’s upturn and decrease them from 12 percent to 10 percent in the downturn. As of January 1, 2009, minimum RRR on funds attracted by the banks from abroad were decreased from 10 percent to 5 percent. As of January 1, 2009, no minimum required reserves were allocated on funds attracted from the state and local government budgets"
    - Adoption Date: 2007/2008 Q4
  - Extended coverage of the information in the credit register
    - Objective: "To strengthen the resilience of the banking sector"
    - Description: "The scope of data collected in the credit register was extended to include also nonbank borrowers."
    - Adoption Date: July 2009
  - Counter-cyclical buffer
    - Objective: To mitigate and prevent excessive credit growth and leverage
    - Description: "To protect the banking sector from periods of excess aggregate credit growth ... Set at 0 percent and reviewed on a quarterly basis."
    - Adoption Date: Jan 1, 2016
    - Notified to the ESRB: Dec 21, 2015

- Liquidity risk tools
  - Higher liquidity coverage requirements
    - Objective: "To prevent the materialization of risks to the liquidity and provide for sustainable sources of funding"
    - Description: "All banks were recommended to considerably enhance the timeliness and granularity of information on liquidity, and to strengthen precautionary measures ... Since 2009, banks were explicitly required to maintain a minimum liquidity coverage requirement. The measure was applied in a countercyclical manner, as the level of the requirement varied between 15 percent and 25 percent."
    - Adoption Date: 2009
  - Ordinance No. 11 amendments
    - Objective: "To prevent the materialization of risks to the liquidity and provide for sustainable sources of funding"
    - Description: "Ordinance No. 11 addressed bank liquidity management ... Since mid-2014, banks have prepared liquidity reporting on a more frequent (even daily) basis."
    - Adoption Date: Oct 2010
  - Higher liquidity measures for Greek banks
    - Objective: "To prevent the materialization of risks to the liquidity and provide for sustainable sources of funding"
    - Description: "Measures also included the requirement to maintain cash and total liquidity levels above those required for other credit institutions."
    - Adoption Date: March 15, 2010; and 2012

- Funding risk tools
  - Funding and liquidity management independence
    - Objective: "To limit the risks stemming from banking system interlinkages and the materialization of external risks to the banking system (contagion)"
    - Description: "To mitigate potential contagion from the Greek crisis, the Greek banks were further required to implement plans for reducing their dependency on funds attracted from the parent or other group entities. In 2012 requirements for banks with Greek equity in Bulgaria to achieve operational independence in their activities in the territory of Bulgaria and to ensure their own liquidity management. In January 2015, the banks with Greek equity were required to stop operations at group level, which may jeopardize the control over liquid resources in case of further financial distress in Greece."
    - Adoption Date: March 15, 2010; 2012; and January 2015

- Structural measures to lower systemic risks
  - Dividend distribution restrictions
    - Objective: "To strengthen the resilience of the banking sector"
    - Description: "Banks can distribute profits based on quantitative and qualitative criteria such as: minimum level of capital adequacy (CAR and Tier I), liquidity coverage ratio (the share of liquid assets to attracted funds from nonbanks/core funding), asset quality indicators (including level of NPLs), supervisory ratings, and other elements specific for the respective year. The dividend distribution restrictions are confirmed on an annual basis since 2009, and implemented via recommendations. For 2015 year-end, the decision for dividend distribution is conditional on individual AQR and Stress test results."
    - Adoption Date: January 6, 2009
  - Systemic risk buffer (SRB)
    - Objective: "To strengthen the resilience of the banking sector"
    - Description: "With the aim to prevent and mitigate long-term non-cyclical systemic or macroprudential risks, the SRB of 3 percent was introduced. Applied to domestic exposures. Applied on individual, consolidated, and sub-consolidated basis."
    - Adoption Date: Dec 31, 2014
    - Notified to the ESRB: Nov 11, 2014
  - Macroprudential reporting
    - Objective: "To strengthen the resilience of the banking sector"
    - Description: "The BNB developed a new reporting template for monthly loan-level data from early 2015 onward ... The quarterly template covers credit activity in the banking sector (LTV, LTI, PTI, DTEBITDA, and flow of newly granted/renegotiated loans. The annual template contains data on credit migration between the categories of past-due status."
    - Adoption Date: January 2015
  - Higher capital requirements for O-SIBs
    - Objective: "To limit the risk stemming from the activity of systemically important institutions"
    - Description: "Introduce a capital surcharge based on size, interconnectedness, complexity, and substitutability. The surcharge was gradually applied for 3 groups of banks. The buffer was initially set at 0 percent in 2017 and will increase in increments each year within a period of four years until 2020."
    - Effective from: January 1, 2017
    - Notified to the ESRB: Nov 10, 2016
  - Limit investment in Greek government securities
    - Objective: "To limit the risks stemming from banking system interlinkages and the materialization of external risks to the banking system (contagion)"
    - Description: "Measures to prevent uncertainty and transfer of vulnerabilities through contagion channels. Banks with Greek equity in Bulgaria were required to implement a more conservative policy on group placements to reduce exposures and discontinue investing in Greek government securities."
    - Adoption Date: March 2010 and January 2015
  - Capital conservation buffer
    - CRD Objective: "To strengthen the resilience of the banking sector"
    - Description: "Early introduction at 2.5 percent level."
    - Adoption Date: May 13, 2014
    - Notified to the ESRB: Nov 11, 2014

_Italic: Source: cr17132 - Annex II. FSAP and BNB Stress Test Key Differences (cr17132 - Annex II. FSAP and BNB Stress Test Key Differences)_

### Annex VI. Implementation Status of 2008 FSAP

### Annex VI. Implementation Status of 2008 FSAP

### Crisis management
- Recommendation: Establish clear principles and objectives in allowing discretion over the use of a part of the Fiscal Reserve Account for emergency bank liquidity assistance.
- Recommendation: Create fiscal buffers in the fiscal reserve account for potential solvency support, in case of systemic problems.
- MoF response:
  - Notes that the 2008 FSAP recommendations were made in the absence of a framework for recovery and resolution of credit institutions.
  - Directive 2014/59/EU of the European Parliament and of the Council establishing a framework for the recovery and resolution of credit institutions and investment firms (BRRD) sets clear rules for the provision of public liquidity and capital assistance to banks (Article 32, para 4 (d), items i to iii). These provisions were transposed into the Bulgarian legislation in Article 51, (3) and (4) of the Law on recovery and resolution of credit institutions and investment firms (LRRCIIF).
  - With a view to the asset quality review and stress test of the whole banking system in Bulgaria, the 2016 Law on the State Budget of the Republic of Bulgaria: if within the limit set out for new government debt (BGN 5.3 billion), the new government debt could be assumed to finance programmes and instruments for financial stabilisation and provision of extraordinary public financial support under the LRRCIIF.
  - Chapter XIV of the LRRCIIF contains clear and detailed rules and conditions for the application of government stabilization tools—government equity support and temporary government ownership tool; these tools can only be applied in the event of a systemic crisis as a last resort and under strict conditions. Considering the above, along with other related aspects of the Public Finance Law, the Ministry of Finance does not support the recommendations made with respect to creating fiscal buffers in the fiscal reserve account.

### Banking Supervision and Regulation — governance
- Recommendation: In line with EU practice, consider moving to a governance structure for BNB to discharge its bank supervisory responsibilities with the BNB Board taking key decisions and limiting discretionary powers of the Deputy-Governor in charge of the Banking Supervision Department.
- BNB response:
  - The concentration of power for supervisory action in a single individual, the deputy governor for supervision, was a conscious decision designed to ensure responsibility and accountability.
  - Checks and balances: not all powers are reserved by the deputy governor.
    - Decisions such as licensing, revocation, conservatorship must be made by the full Governing Council based on a joint motion by the governor and deputy governor.
    - The Governing Council has responsibility for issuing the regulations of the BNB, including those regulations pertaining to supervision.
    - Since the fourth quarter 2015, a quarterly report is submitted to the BNB Governing Council containing information on the current supervisory monitoring of banks and the identified problems.

### Banking Supervision and Regulation — stress testing and risk analysis
- Recommendation: Enhance BNB’s capacity to carry out macro-scenario stress testing at the system level and bank level, with special emphasis on credit, foreign exchange and liquidity risks.
- BNB response:
  - After 2009, several different types of stress tests (in 2011, 2014, and 2016), covering credit, market, and interest rate risk, have been implemented.
  - Liquidity risk top-down simulations are performed on a regular basis, and credit risk is tested each year.
  - As part of the 2016 comprehensive assessment of the Bulgarian banking system, a bottom-up macro-scenario stress test was carried out (details available on the BNB website).

### Securities and Capital Markets
- Recommendation: Strengthen capacity of FSC to monitor and enforce the securities laws by increasing FSC staff numbers and enhancing their skills through training and secondments with other regulators.
- FSC implementation and capacity-building:
  - Since its participation by law in the EU authorities ESMA/EIOPA, the FSC has participated in training programs of ESMA/EIOPA, Institute of Public Administration and Joint Vienna Institute.
  - The FSC has two secondments in the EC and the ESMA.
  - From January 1, 2008 until August 29, 2016, the FSC has increased its staff by 17 experts.
- Recommendation: Build an effective on-going FSC oversight program of the stock exchange and securities clearing and settlement.
  - Implementation:
    - Coordinated activities between the Bulgarian Stock Exchange and the FSC grant access to the new settlement system to an extra observer for oversight of trade on the stock exchange.
    - Following consultations with the Bulgarian Stock Exchange, the FSC published an action plan in October 2010 identifying priorities for coordinated supervisory activities and for capital markets development.
    - Onsite inspections have been conducted on the Bulgarian Stock Exchange and on the Central Depositary, focusing on the clearing and settlement systems.
- Recommendation: Upgrade the securities clearing and settlement system for the private debt markets to meet international standards.
  - Implementation:
    - The Central Depositary JSC and the BNB realize the clearing of transactions in securities jointly.
    - The depositary institution has taken organizational measures for its alignment with the European requirements and the future issuance of license to the institution in accordance with Regulation (EU) ȶ 909/2014.
    - Current legislation provides for the separation of the two services. CDAD establishes and operates a system for the settlement of transactions in financial instruments in accordance with Art. 109a of the LPOS. CDAD is responsible for registration of financial instruments in accordance with Art. 127 of LPOS.

### Pension Fund and Insurance Sectors
- Recommendation: Redesign the regulatory framework for the pay-out phase for retirement products.
  - FSC actions 2012–2016:
    - Prepared a conceptual framework concerning improvement of the regulation on the private pension funds, including the pay-out phase, and a new draft law proposing necessary amendments in the Social Insurance Code.
    - Following public consultation on the draft law, the Ministry of Finance decided to put this group of amendments for more detailed discussion with the Ministry of Labor and Social Policy.
- Recommendation: Increase scope for price competition by increasing disclosure of net risk-adjusted performance, reviewing the rules related to switching and the automatic assignation rule.
  - Implementation and disclosures:
    - Pension insurance companies are required to disclose annually on their websites information on the investment results of the pension funds they manage, including Sharpe’s ratio.
    - The FSC publishes on its webpage statistics on pension insurance companies and the funds managed by them, including data on amounts of fees and deductions, investment performance and benefits paid.
    - Pension insurance companies started to disclose the real rate of return (adjusted for changes in prices due to inflation) achieved in the course of management of the pension funds and to disclose more frequently (on a quarterly basis instead of annually).
    - Newly introduced rights of the members of the universal pension funds stimulate competition in the sector.
    - A gradual decrease was introduced of both the deduction from each contribution and the investment fee. The fee for switching participation from one mandatory pension fund to another was repealed.
    - The draft law amending the Social Insurance Code proposes that members of the mandatory pension funds can switch their participation to another pension fund of the same type more frequently after the conclusion of the first social insurance contract and the fee for switching participation from one voluntary pension fund to another is repealed.
- Recommendation: Introduce investment options in the mandatory funds through life style or life cycle funds.
  - Outcome: The FSC prepared amendments in this respect in the period 2012–2016, but they were not supported by the Ministry of Finance, and were subsequently removed from the draft law.

### Statement by Mr. Doornbosch and Mr. Manchev (May 22, 2017)
- Authorities’ engagement and objectives:
  - Bulgarian authorities have had constructive dialogues with the joint IMF/WB Financial Sector Assessment Program (FSAP) mission since July 2016.
  - Authorities remain committed to prudent macroeconomic and financial policies and thank staff for the Financial Sector Stability Assessment (FSSA) report.
  - New government (took office on May 4, 2017) aims to increase public confidence in the reform process, improve the business environment and strengthen utilization of EU funds to attract more private investment.
  - Authorities agree with staff that policies aimed at increasing financial sector resilience should continue.
- Macroeconomic anchors and recent developments:
  - The Currency Board Arrangement (CBA) continues to be the cornerstone for domestic policymaking together with the government’s strong underlying fiscal position.
  - BNB gross international reserves increased by 17.8 percent and reached the historically record level of 23.9 billion euro.
  - The 2016 fiscal consolidation went ahead of schedule to a surplus, mainly thanks to higher-than-initially expected growth and comprehensive administrative revenue measures.
  - The new coalition government will support financial stability and sustainability through a conservative medium-term fiscal consolidation strategy, aimed towards a structurally balanced budget by 2020.
  - Strategy objectives: allow automatic stabilizers to work, build up liquidity buffers in good times, and contain further debt accumulation.
- Financial sector reforms and safety nets:
  - Since the 2014 domestic bank failure and global crisis response, Bulgaria progressed in strengthening prudential supervision, financial safety net, crisis management and resolution frameworks.
  - Following the 2015 IMF/WB Assessment of compliance with the 2012 Basle Core Principles, the BNB adopted a detailed Plan on Reforms and Development of Banking Supervision to support a shift toward a more effective governance model and to promote risk-based supervision, including risk-based AML/CTF approaches.
  - The plan has been evaluated and regularly updated to accommodate developments like outcomes of the 2016 comprehensive asset quality review (AQR) and stress-tests.
  - The Bank Recovery and Resolution Directive (BRRD) was fully transposed into Bulgarian law in mid-August 2015.
  - BNB developed its macroprudential framework and capacity to analyse and address systemic risk.
  - In 2016, the Bulgarian Deposit Insurance Fund (BDIF) took two government-guaranteed loans from the WB and the EBRD to replenish resources; under the Resolution Act, with BNB guidance and technical assistance from the WB, the BDIF has started building capacity to manage either an asset separation vehicle or a bridge bank.
  - BNB updated the Banking Supervisory Process Manual to better reflect Basel Committee Recommendations on supervision of the Pillar 2 capital requirements and related EBA standards.
  - Financial Supervision Commission completed an AQR of the pension funds and insurance companies, and a stress test of the insurance and re-insurance industry earlier in the year.
- Banking system performance and resilience (end-2016 and related outcomes):
  - AQR confirmed comfortable position of banks’ balance sheets as of end-2015.
  - In 2016 returns on bank assets and capital increased respectively by 0.4 and 3 percentage points and reached 1.4 and 10.4 percent.
  - Capital adequacy ratio remained high at 22.2 percent.
  - All banks observed regulatory standards for accumulating various capital buffers; following the AQR some banks implemented recovery plans to achieve supervisory targets above the minimum regulatory capital.
  - Banking system leverage ratio: 10.9 percent; noted as among the lowest in the EU.
  - Commercial banks’ reserves with the BNB increased by 0.4 billion euro despite the central bank discouraging excess reserve policy.
  - Total liquid assets of the banking system increased by 9.6 percent, and the liquidity ratio reached 38.2 percent in the end of 2016.
- Stress testing and vulnerabilities:
  - Authorities welcome the FSAP “top-down” solvency stress test and liquidity stress-tests as helpful additions to authorities’ own “bottom-up” stress-test results based on the EBA methodology.
  - Both approaches demonstrated resilience of system-wide bank capital and revealed some vulnerabilities.
  - Main driver of change in capital position under the adverse stress-test scenario remains loan-loss provisions.
  - For a small open economy, main transmission channels of external shocks are linked to external demand and investor confidence.
  - Spillover risks from the Bulgarian banking system remain minimal due to stable domestic deposit funding and low reliance on both domestic and international wholesale financial markets.
- Market-driven changes and supervisory actions:
  - In early 2017 a large euro-area banking group operating in Bulgaria acquired Bulgarian subsidiaries (bank, insurance and leasing) of a Greek bank; in 2018 plans are to accomplish a merger of the respective businesses.
  - Based on AQR results, banking supervision initiated a comprehensive review of banks’ credit rules and procedures to strengthen risk-based assessment and asset classification and to reinforce collateral evaluation and provisioning in line with best recommended international practices.

### Conclusions
- The FSSA report shows progress Bulgaria has made since 2014.
- Authorities emphasize no room for complacency; further steps required over coming years to bolster Bulgaria’s financial stability.
- Priorities:
  - Further enhance bank capital buffers.
  - Strengthen compliance and supervision.
  - Strengthen the financial safety net, crisis management and bank resolution.
- BNB readiness:
  - BNB stands ready to sustain and further develop capacity of the banking system and individual credit institutions to withstand shocks.
- Non-performing loans (NPLs):
  - Authorities are open to recommendations and will consider a more systematic approach toward the NPLs reduction; they closely work with the domestic banking community and various counterparties at domestic and international level to sustainably address the NPLs.
- Continued focus: Bringing about these improvements will continue to be the focus of the authorities’ efforts.

*IMF staff summary based on Annex VI. Implementation Status of 2008 FSAP.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17132.pdf_