THE CURRENT FINANCIAL CRISISTHE CURRENT FINANCIAL CRISIS: :

THEORYTHEORY, , PRACTICE AND LESSONSPRACTICE AND LESSONS

TSVETAN MANCHEV, Ph.D.TSVETAN MANCHEV, Ph.D.

DEPUTY GOVERNOR OF THEDEPUTY GOVERNOR OF THE

BULGARIAN NATIONAL BANKBULGARIAN NATIONAL BANK

CONFERENCECONFERENCE

““THE FINANCIAL SECTOR IN THE CONDITIONS OF A THE FINANCIAL SECTOR IN THE CONDITIONS OF A GLOBAL FINANCIAL AND ECONOMIC CRISISGLOBAL FINANCIAL AND ECONOMIC CRISIS””

PlovdivPlovdiv, 4 , 4 MarchMarch 2009 2009

What are the principal theoretical and practical results What are the principal theoretical and practical results and conclusions from the recent developments and how and conclusions from the recent developments and how does the macroeconomic policy respond to them?does the macroeconomic policy respond to them?

What are the possible scenarios for the development of What are the possible scenarios for the development of the processthe process??

What are the conclusions to be drawn for small and open What are the conclusions to be drawn for small and open economieseconomies??

Where do we fallWhere do we fall?? What should (not) be doneWhat should (not) be done??

MAJOR ISSUESMAJOR ISSUES

Factors known to theory, inferred from previous crises: „The bubble burst” – the priсe bubble that burst on the US real estate market.

Its effect was exacerbated by the practice of subprime lending and loan securitization (the originate-to-distribute model) by financial institutions, instrumental to keeping liquidity high and hence interest rates at historically low levels;

«Inconsistent and incomplete regulation» of the US financial sector that allowed investment banks, hedge funds, etc. to earn profits significantly higher than the average market levels;

«Lack of incentives» mortgage loans were taken out of commercial banks’ balance sheets, which LEAVES NO INCENTIVES for the lending banks to monitor the condition of these loans and the borrowers’ creditworthiness;

«Errors» made by credit rating agencies which increase the «asymmetry of information».

Factors that turned the crisis global: «Imbalances» in the world economy; The role of the US dollar as a global currency.

FACTORS FOR THE GLOBAL CRISISFACTORS FOR THE GLOBAL CRISIS 2008-2009 2008-2009

What underlies the crisis is the interaction between the

global macroeconomic imbalances building up in the

last 10 years, and the trends in the major international

financial markets evidenced for almost 30 years now but

which gained particular momentum under the impact of

the above imbalances.

THEORETICAL AND PRACTICAL CONCLUSIONS THEORETICAL AND PRACTICAL CONCLUSIONS FROM THE DEVELOPMENTS IN THE FROM THE DEVELOPMENTS IN THE 15 15 MONTHS MONTHS

SINCE SEPTEMBERSINCE SEPTEMBER 2007 2007

Practically unlimited provision of liquidity not only by central banks but also by GOVERNMENTS

Guarantees to protect depositors and creditors, even in the extreme form of the so-called „UNSECURED GUARANTEES”

Structuring of programs for direct government lending to non-financial corporations (the automotive industry)

Structuring of programs for large-scale purchases by governments of considerable share participation in banks and financial institutions, not excluding the possibility for these programs to cover also non-financial corporations

Structuring of government programs for support of small and medium-sized enterprises and protection against unemployment, and of borrower protection programs.

INITIAL MEASURES TO COPE WITH THE CRISISINITIAL MEASURES TO COPE WITH THE CRISIS

Bringing the process to a s stop by means of a new social agreement between the

agents to:

Restrict the unfavourable impact of the crisis on the main macroeconomic

indicators;

Restructure the institutions that have lost public credibility so that they

can pursue an adequate macroeconomic, and particularly monetary,

policy.

This means intensifying of various elements of the economic policy and of the

regulations on micro, mezo, and macro level to reduce the uncertainty and clearly set

the rules on the markets, including:

Active, but transparent, central banking policy to maintain high bank liquidity;

Bringing the regulatory capital adequacy of debtors in line with market requirements;

THE SUCCESSFUL CRISIS RESOLUTION THE SUCCESSFUL CRISIS RESOLUTION POLICY (1POLICY (1))

Strengthening banking supervision and enhancing transparency of

creditors and borrowers;

Legal guarantees in case of bankruptcy as a principal means for debt

problem resolution, besides within time limits needed by the market;

Establishing and maintaining long-term relations between credit

institutions and borrowers and supporting detailed information by means

of accessible credit registers for real time exchange of information

between credit institutions for risk management purposes;

Enforcing, where necessary, additional legal restrictions and regulation of

banks and other financial intermediaries in these sectors approaching the

rate of profit in the other sectors.

THE SUCCESSFUL CRISIS RESOLUTION THE SUCCESSFUL CRISIS RESOLUTION POLICY POLICY (2)(2)

The main conclusion is that the initial response for handling the crisis globally was not efficient, as it was not well coordinated worldwide, not well targeted at (focused on) eliminating the factors behind it, and not fully taking into account past experience.

This has already multiplied the cost of accommodation and the time needed for it compared to preliminary expectations, and has further increased uncertainty and mistrust.

CURRENT RESULTSCURRENT RESULTS

1. Continuing downfall and disintegration of global economy

2. Quick recovery

3. “State” capitalism”

4. “Liberal regionalism” (Restricting liberalisation at the global

level while preserving it within the respective economic and

monetary unions)

POSSIBLE SCENARIOS FOR WORLD ECONOMY POSSIBLE SCENARIOS FOR WORLD ECONOMY DEVELOPMENT IN THE MID-TERM DEVELOPMENT IN THE MID-TERM (3-5 (3-5 yearsyears))

IS CAPITALISM “DYING”? IS CAPITALISM “DYING”?

FirstFirst,, the politicians’ acting too hastily to prevent the crisis with the state being the politicians’ acting too hastily to prevent the crisis with the state being overly and fully involved from the very beginning, which has already made overly and fully involved from the very beginning, which has already made apparent the sizeable long-term costs, should not be regarded as a long-term policyapparent the sizeable long-term costs, should not be regarded as a long-term policy ..

Second, the so far failed attempts of politicians and civil servants to act as bankers the so far failed attempts of politicians and civil servants to act as bankers have in many countries already drained the public credit of trust in them, which too have in many countries already drained the public credit of trust in them, which too makes them reconsider their strategies and return to the sound theoretical principles makes them reconsider their strategies and return to the sound theoretical principles of market economy.of market economy.

ThirdThird,, it has become clear that neither the expansionist, however opaque, it has become clear that neither the expansionist, however opaque, monetary policy of the major central banks, nor any of the forms of capital control monetary policy of the major central banks, nor any of the forms of capital control introduced by individual developing countries can substitute a framework of introduced by individual developing countries can substitute a framework of supervisory regulations adequate to market requirements and globally observed by supervisory regulations adequate to market requirements and globally observed by all participantsall participants. .

CONCLUSIONS FOR SMALL OPEN ECONOMIESCONCLUSIONS FOR SMALL OPEN ECONOMIES (1) (1)

Countries with small open economies in the global crisis environment are not unaffected and need to adjust.

The tools of competitiveness of these countries are even more limited in times of crisis, i.e. they need the crisis to end soonest more than the others.

Small open economies which are part of economic and monetary unions are in a better competitive position than the others as they enjoy, at least at a minimum, the generally higher market confidence in the major participants in these unions and in the unions in general.

The individual starting point and the level of affectedness by the crisis of each small open economy, either participating or not in a monetary union, are of GREAT importance where national adjustment strategies and actions need to be developed.

CONCLUSIONS FOR SMALL OPEN ECONOMIESCONCLUSIONS FOR SMALL OPEN ECONOMIES (2) (2)

A small open economy with a sustainable and transparent long-term macroeconomic and monetary policy, supported by political consensus, which has not undergone fundamental changes over the recent months enjoys a better understanding, public and investors’ trust and will adjust relatively much easier with no need for the country to become “indebted”.

In the above case the main strategy should aim at further cutting down government expenditure and enhancing labour market flexibility, which is regarded higher by markets than are «blank» guarantees or other forms of state intervention that only disrupt markets’ long-term functioning leaving imbalances unrestricted. This is also the EU position.

It has to be carefully watched to which of the above scenarios the global economy will evolve in the mid-term so that an adequate adjustment strategy and a range of actions be looked for and found on a timely basis.

WHERE ARE WE? (1)WHERE ARE WE? (1)

There is a clear political consensus on key long-term policies – currency board in place till the adoption of the Euro; at least a balanced budget after taking account of cyclical factors; low taxes as the main tool for better competitiveness; keeping the current high degree of freedom of movement of people, capitals, goods and services;

The monetary policy has been based on clear rules for a long time and in times of crisis liquidity is provided in a transparent for the market way, observing the rules of the currency board arrangement;

Strong public finances and low debt burden of the public sector; Lack of a direct channel for “infecting” banks owing to the long-standing,

closely related to traditional banking markets, evaluation of financial instruments;

WHERE ARE WE? (2)WHERE ARE WE? (2)

Stable, though decreasing, funding from parent banks which are also in good financial shape, are among the relatively less affected by the crisis, and so far have not taken unexpected actions towards their subsidiaries;

Well-diversified domestic financial market in terms of institutions by countries, instruments, currencies, counterparties;

Quick change in banks’ behaviour (adaptation) in the new situation – change in the risk appetite; improving the methods and models for its management; trying to ensure symmetry of information through an active dialogue with regulators, markets and customers;

Current profits are not affected by “impairment losses” resultant from worsened quality of loans;

WHERE ARE WE? (3)WHERE ARE WE? (3)

Transparent and clearly-defined “anti-cyclical” regulatory framework:– Conservative approach in provisioning, generating capital cushions;– Additional provisions when capital charges are required (other than

those for impairment losses under IFRS);– High level of MRR (currently 10%, but effectively over 7%);

Pro-active and clearly-defined “anti-cyclical” monetary policy of the BNB in recent years. A number of measures have been taken in a transparent and timely manner to slow down credit growth, which provided a basis for a sound increase in banking intermediation. In a consistent, transparent and timely manner we also take measures to normalise liquidity after the shocks in the past months;

Yet there are some sporadic “cases” of, and “markets” with, unequal legal or regulatory treatment of participants during the crisis.

CURRENT CONDITION OF THE BANKING SYSTEMCURRENT CONDITION OF THE BANKING SYSTEM

All indicators are in % 2007 June 2008

December 2008

Return on assets (ROA) 2.37 2.40 2,14

Return on equity (ROE) 23.9 24.25 22.74

Capital adequacy 13.9 14.55 14.86

Non-performing loans (overdue by more than 90 days)

2.05 1.91 2.41

Cost of resource 2.92 3.42 3,75

Liquidity 28.00 24.01 21.71

Annual credit growth rate 62.5 51.9 32.3

CURRENT CONDITION OF THE BANKING SYSTEMCURRENT CONDITION OF THE BANKING SYSTEM – – latest datalatest data

Data at JanuaryData at January 2009 2009:: BGN BGN 72 72 million monthly profit million monthly profit ((one of the few banking one of the few banking

systems in Europe that generate profits even in systems in Europe that generate profits even in 2009)2009) The foundation is being reinforcedThe foundation is being reinforced::

• Audited profits for 2008 will be included in banks’ Audited profits for 2008 will be included in banks’ capitalcapital

• Quality of assets is still high and stableQuality of assets is still high and stable

• Liquidity ratio is above Liquidity ratio is above 20%20%

• Stable financing for banks in the coming periodsStable financing for banks in the coming periods

THE RESULTS SO FARTHE RESULTS SO FAR

All markets function normally; we did not allow any «failure» on the major markets – money, banking, credit, debt, labour, investment.

The major conclusion is that Bulgaria is getting adapted smoothly and consistently, in a market way, to the new global balance. There is economic growth, even though decreasing. There is also positive, though relatively low, growth of credit to the non-financial sector which corresponds to the changes in agents’ risk appetite.

Market participants’ increasing uncertainty and distrust as to borrowers’ abilities to repay their debts given the decelarating economic growth in Bulgaria in 2009 – 2010..

WHAT SHOULDWHAT SHOULD ( (NOTNOT) ) BE DONEBE DONE??

AS MARKETS FUNCTION EVEN DURING THE CRISIS, WE NEED MORE THAN EVER PREDICTABILITY AND CONSISTENCY OF THE MACROECONOMIC POLICY AND UNCONDITIONAL OBSERVANCE OF MARKET PRINCIPLES!!!

Keeping and strengthening the political consensus on key long-term policies; keeping the current crises response framework – a currency board accompanied by a strong transparent anti-cyclical fiscal policy, supported with a pro-active transparent monetary policy and an anti-cyclical transparent regulatory policyGiving up any inconsistent (ad hoc) legal and regulatory intervention in the functioning marketsThe public dialogue about “the Bulgarian strategy”and individuals’ behaviour during the crisis should not take heed of the interests of “fear sellers” and those who were making profits well above market levels in the period before the crisis; Implementing a package of measures aimed to increase the administrative capacity in accordance with the European Commission latest report on the performance of Lisbon Strategy objectivesContinuous participation in the search for and quick finding of a generally accepted strategy for restructuring after the crisis within the EU, actively supporting any proposal for consistent liberalisation of markets and equal treatment of participants.

THANK YOU FOR YOUR THANK YOU FOR YOUR ATTENTIONATTENTION!!