A turbulent period for the Bulgarian banking sector had another chapter last Friday. Starting from the fateful early summer days of 2014 when the fourth-largest bank, Corporate Commercial Bank failed and was subsequently put into insolvency procedures, followed by the run on the then third-largest, First Investment Bank (“Fibank”). Calm was restored after a government intervention, but the trust of depositors and investors was damaged. The following three years saw a comprehensive asset quality review (“AQR”) review over the whole banking sector, development of a non-performing loan (“NPL”) market and more importantly, the most significant consolidation in the banking sector in the last 15 years, which saw big players exiting the market, including the Greek NBG and Piraeus as well as the French Societe Generale.

Already in that summer of 2014 the Bulgarian political and business establishment came to the common understanding that the long-term security and viability of the Bulgarian financial sector was intertwined with its further integration into the Eurozone and the European Banking Union. The political and economic process culminated in the Action Plan on the measures, deadlines and responsible institutions in relation to the country's intentions of joining the European Exchange Rate Mechanism (“ERM II”) and participation in the EU's Single Supervisory Mechanism ("SSM") through close cooperation with ECB. Importantly, the government’s plans view that participation in the SSM and the joining of the Eurozone as a simultaneous process.

As part of the process for establishing a close cooperation a fresh round of AQR was initiated followed by stress tests (baseline scenario and an adverse scenario). Both exercises were based on the methodologies applied by ECB Banking Supervision in its regular comprehensive assessments of banks that have recently been classified as significant or could potentially become significant, the most recent example being Nordea Bank from this month. The stress tests was conducted using the methodology applied in the European Banking Authority’s 2018 stress test. Notably, the AQR and the stress testing methodologies included IFRS 9 forward-looking approach to provisioning, which has implications with respect to impairments of bank assets and classifying financial instruments.

The six banks, subject to the assessment were independently chosen by the European Central Bank (ECB) with the process being directly supervised by central bank.

The results of the AQR and the stress tests came out on Friday and while the biggest three banks (UniCredit, DSK (OTP) and UBB (KBC)) performed well and did not incur any significant impairments or capital shortfalls under the two scenarios the two worst performers from the 2016 AQR tests, Fibank and Investbank, experienced capital shortfalls, including negative equity under both the baseline and adverse scenario. More importantly, Fibank fell below the 8% CET1 ratio threshold under the AQR, experiencing non-performing exposure (a technically broader concept than NPL under EBA guidance) increase by more than 20 % to 44, 1 % with large impairments stemming exclusively from the corporate segment of the bank.

The Bulgarian National Bank issued a statement endorsing the resilience of the Bulgarian Banking system and consistency of the present AQR results with the 2015 results “taking into consideration the time lag and the changes in the methodology to incorporate the effect of the accounting standard IFRS 9”. Both Fibank and Investbank issued statements on the results underlying their capital resilience, commitment to the strengthening of their balance sheet and credit portfolio with Fibank stating that it had already covered more than half of the projected capital shortfalls under the stress tests at the beginning of this year.