Things move quickly in Bulgaria. Less than a month ago, the IMF gave Bulgaria’s banking system a clean bill of health, saying it was “stable and liquid, with banks’ non-performing loans buffered by provisions and significant capital, as well as a positive net foreign asset position.” But yesterday, the President of Bulgaria was forced to issue a statement reassuring people that their money was safe after a week of bank runs. And the EU has now granted Bulgaria an emergency line of credit to support its banking system.
It all started with news that a large depositor, thought to be businessman Delyan Peevski, was abruptly removing funds from Bulgaria’s Corporate Commercial Bank AD (CCB). This sparked a bank run which destroyed the bank’s liquidity and that of the local subsidiary (ACA) it recently acquired from Crédit Agricole SA, forcing them to suspend operations. Bulgaria’s central bank, the Bulgarian National Bank (BNB) took over both banks on June 20, and two days later announced plans to recapitalize them using funds from Bulgaria’s state-owned Bank for Development and Deposit Guarantee Fund.
It is obvious that banks subject to runs need central bank liquidity support: fractional reserve banks only keep a small proportion of their deposit base in liquid assets, the rest being transformed into illiquid assets in the process of lending. When there is a bank run, fractional reserve banks can literally run out of money. This is what happened to CCB and ACA. But it is perhaps less clear why they need recapitalizing. Bank runs destroy capital because banks are forced to sell assets at fire sale prices to maintain liquidity. CCB and ACA, previously sound, are now not just illiquid, they are possibly insolvent. It is a fine example of how a rumor-driven run can bring down a bank.
Editor’s Note: In banking your objective should be to put your money where it is treated best. Often you can find much sounder banks—better capitalized with better liquidity—outside of your home country. For more International Man intelligence on offshore banking, see here.