Bulgaria's Strange Bank Run

Includes: EWK, FXE, IYF
by: Acting Man

EU Approves Emergency Liquidity Injection

Over the past week, there has been a run on two of Bulgaria's biggest banks – late last week, the central bank ordered one of them closed, since it could not possibly pay all the deposits that were supposedly available “on demand” - as is always the case in fractionally reserved banking systems. On Monday the situation calmed down somewhat after the EU approved an emergency liquidity injection of 1.7 bn. Euro:

“Bulgaria’s banking system appeared to be stabilizing late on Monday after the EU approved a Lev3.3bn (€1.7bn) emergency credit line from the central bank, following runs on two of the country’s biggest lenders in a week.

The liquidity move followed assurances from political leaders over the weekend that Bulgarians’ savings were safe and the banking system was stable and well capitalized, in spite of a speculative attack involving anonymous text messages and emails.

Yes, well capitalized, but not well enough to actually withstand a bank run without emergency aid and a “bank holiday”. The story of how the run started is certainly a strange one:

The Bulgarian National Bank had warned on Friday of an “attempt to destabilize the state through an organized attack against Bulgarian banks”, as Bulgarians withdrew Lev 800m from branches of First Investment Bank, the country’s third-biggest lender.

Those withdrawals came just days after a run on Corporate Commercial Bank, the country’s fourth largest bank. Six people were arrested over the weekend, accused of sending electronic warnings that FIB was about to collapse; two were indicted on Monday for spreading false information on banks.

Rosen Plevneliev, Bulgaria’s president, also announced late on Sunday that after talks with party leaders he would dissolve parliament by July 25 and then name a caretaker administration, ahead of early elections called for October 5. That move helped ease political uncertainty that had fueled the crisis.

Bank shares recovered sharply on Monday after news of the central bank credit line. The European Commission also noted that the country’s bank sector was “well capitalized and has high levels of liquidity compared to its peers in other member states”.

“The situation has stabilised over the course of the day,” said Alex Bebov, managing director at Balkan Advisory Company, a Sofia-based brokerage.

“This was a very different style of banking crisis than, for example, in Slovenia, where you had a lot of fundamentals. Here it was much more an issue of cyber attacks, via SMS [text messages] and the internet.”(emphasis added)

So Bulgarian banks are actually in better shape than banks elsewhere in Europe? Does the EU commission mean to convey that the rest of Europe should panic while there's still time?

There was by the way media silence over what happened until the crisis was essentially over. The earliest mainstream reports we could find were dated June 29 – after the arrests alluded to above were already made. The perpetrators are accused of spreading “false information about the health of Bulgaria's banking system”. However, given that the banks concerned needed to be closed and rescued with an emergency loan once depositors wanted their money back, one could just as well argue that they were actually spreading the truth about the banking system rather than false information.

In Europe, only a very small percentage of “demand deposits” is actually backed by standard money (i.e., bank reserves or vault cash), and the percentage has been shrinking since the banks have begun to pay back LTROs to the ECB. So it is actually a bit cheeky to call these deposits “overnight” or “demand” deposits – as the money is most definitely not “there”. The system essentially works only as long as depositors leave deposit money inside the banking system. Although one only gets pieces of paper when actually withdrawing money, which in turn are backed by absolutely nothing (they used to be receipts for gold a long time ago), these are safer than deposit money is. Most deposit money consists just of numbers in an account – fiduciary media that have been literally created out of thin air in the process of inflationary lending. The term "fiduciary media" already indicates that the bank client is “trusting” that in extremis, he will have the dexterity to arrive in time and be at the start of the queue, instead of at its end.

The Sofia Stock Exchange Index has been hit hard by the bank run. This shows by the way that the crisis built up through the entire month of June.

A Battle Between Oligarchs?

But why have a handful of people suddenly thought it necessary to remind Bulgaria's citizens of the nature of the banking system over the internet? This hasn't really been fully explained anywhere just yet (although as you will see below, there are certain suspicions). Bulgaria's central bank stated that the bank runs were driven by “an outbreak of rumors and malicious public statements” .

A sudden “outbreak” of rumors and malicious statements? Sounds as though making malicious statements were a contagious illness. Is there a malicious statements virus on the loose in Bulgaria? An injurious falsehoods bug?

Apparently the reasons are more mundane. As one source reports with respect to the political backdrop, it appears as though the entire political elite is widely despised, regardless of ideological or party affiliation. By most accounts, Bulgaria is run by a thoroughly corrupt political/bureaucratic mafia.

Bulgaria continues to be beset by political instability, meanwhile, with the Socialist-backed government of technocrat Prime Minister Plamen Oresharski expected to resign in the coming weeks ahead of elections likely on October 5.

Oresharski's short-lived government has been the focus of almost constant protests, with voters angry about poverty, corruption and cronyism. The snap vote is expected to return the conservative GERB party to power, whose leader — ex-premier Boyko Borisov — was himself forced to resign in February 2013 after nationwide demonstrations.”

However, the bank run apparently directly involves two big Bulgarian businessmen, resp. part-time politicians, a.k.a. “oligarchs”. Here is one report regarding their likely motives:

As far as anyone can tell, the turmoil appears to stem from a spat between the businessman Tzvetan Vassilev, chairman of Corpbank, and the parliamentarian Delyan Peevski. The one-time business partners reportedly fell out over control of the country’s former tobacco monopoly, a variety of unpaid debts, and abrupt corporate account closures at Vassilev’s bank, which was the first to see a run on deposits. Oh, and each has also accused the other of plotting his assassination.

The theory goes that shadowy forces are taking advantage of the turmoil to destabilize the banking system and force officials to break the lev’s rigid peg to the euro, put in place after a brutal banking crisis in 1996-97 led to a bout of hyperinflation. Or, at least, that’s how Vassilev’s theory goes—as he told the Financial Times, “I suspect the involvement of political figures and businessmen with huge debts they want to melt away.”

The NYT has in the meantime also picked up on that story and provides additional color. It also explains why it was so easy to get a bank run going in Bulgaria – apparently, many Bulgarians have already lost everything once in a banking crash. That happened in 1996, so the memory is still fresh. The NYT incidentally mentions that the bank that was subject to the initial run – namely the one that is is linked to the above mentioned feud between tycoons with too much debt – remains “temporarily closed”. People who still have deposits at that particular bank evidently remain out of luck at this juncture.

“But questions remained about how a country could be plunged into crisis by what the authorities described as nothing more than a digital rumor-mongering campaign that may have been linked to animosity among rival business tycoons with political ties.


“While Bulgaria’s dominant banks are foreign-owned — and therefore less exposed to domestic political infighting — further bank runs cannot be ruled out if the crisis is mismanaged or miscommunicated by the government,” Otilia Dhand, vice president at Teneo Intelligence, a political consulting firm, wrote in a note to investors on Monday. “The Bulgarian population is prone to panic withdrawals due to memories of the disastrous banking crash of 1996.” During that financial crisis, caused by government mismanagement of the economy, more than a dozen Bulgarian banks went bankrupt.

On Sunday, Bulgaria’s national security agency said it had detained six people suspected of using text messages, emails and social media to urge people to pull their money out of First Investment Bank, or F.I.B., the country’s third-largest financial institution. One of those arrested was a manager at a brokerage firm in Sofia, according to local media reports.

A similar attack on another bank, Corporate Commercial Bank, known by its Bulgarian initials K.T.B., appeared to be linked to convoluted maneuvering and two prominent businessmen with ties to different political parties. The Bulgarian central bank assumed control over K.T.B. on June 20 after more than 20 percent of its deposits were withdrawn in a week. The bank has since been temporarily closed.

(emphasis added)

Since Bulgaria has a currency board so as to keep the Bulgarian lev tied to the euro at a fixed exchange rate, the country is forced to hold a large level of foreign reserves. However, as is the case with other currency board arrangements (Argentina had a particularly disastrous one), this is actually a bit of a sham, as the commercial banks evidently remain fractionally reserved and hence are able to expand the lev money supply domestically without first obtaining euro backing for the credit they create from thin air.

This fact, along with huge foreign debt amassed by the government, is what brought Argentina to its knees in 2001. At the time, depositors also lost a bundle, first via withdrawal restrictions, then a bank holiday, and then an overnight devaluation coupled with the forcible conversion of all dollar deposits into pesos. This means that they first lost the bulk of their deposits via confiscatory deflation, and thereafter the government lost no time to inflate what was left into oblivion.

We know too little about Bulgaria at this point to be able to tell if a similar threat exists there, but presumably not, as the country's EU membership at least forces the government to hew to fiscal discipline to some extent.

However, it is still not clear to us how the currency board can possibly avert domestic inflation of the money supply. In fact, there is probably a considerable danger that it promotes rather than averts it, given the ECB's ZIRP/NIRP policy.

Lastly, non-performing loans remain extremely high all over the Central and Eastern European region. While there has recently been a bit of an economic recovery that should eventually remedy the situation to some extent, it hasn't been remedied yet. Bulgaria's situation actually seems to serve as a good example for a major boom that has turned into an equally major bust, as a long term chart of the SOFIX suggests:

SOFIX monthly- boom and bust.

We suspect the boom was greatly enhanced by the currency board arrangement, which has theoretically removed exchange rate risk for foreign investors. Few people think about the risks posed by a fractionally reserved banking system under a currency board system, but that risk is actually substantial. This is especially the case when the foreign central bank issuing the currency which the board is tied to is suppressing interest rates as much as the ECB is currently doing.


Bulgaria is too small and unimportant to cause "contagion" elsewhere, but the bank run – regardless of the reasons for it – is a good reminder that the fractional reserves privilege actually violates property rights. Either overnight funds are available on demand or not – and obviously, they are not. It is also a reminder how vulnerable the entire European banking system remains, considering that the EU deems Bulgaria's banks to be in better shape capital and liquidity-wise than banks elsewhere in Europe.

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