The rise in interest rates and the state of the credit market in Bulgaria - is there cause for concern?

By mid-2023, the credit market in Bulgaria is in a peculiar situation. While interest rates on loans across the eurozone are skyrocketing and lending is suffocating, the situation in our country, at least at first glance, is far calmer. What do the data from the Bulgarian National Bank (BNB) show about the situation on the credit market and what can we expect to happen to it in the foreseeable future?

The BNB began raising the key interest rate in October 2022, just a few months after the European Central Bank (ECB) began raising its interest rates (July 2022). From 0% in September 2022, as of 01.09.2023 the level of the key interest rate in our country is already 3.53%. This is a very serious increase in a relatively short period of time. However, the effect on commercial bank interest rates does not seem to be linear. BNB statistics show a significant increase in the interest rate on loans to non-financial enterprises, from 2.49% in July 2022 to 4.18% in July 2023. In consumer loans, there is a slight increase from 8.19% in July last year to 8.92% in July this year. The most insignificant increase is the increase in interest rates on housing loans, from 2.48% to 2.57% over the same period. At the same time, bank lending has slowed down, but continues to grow at a very strong pace in all categories. In July, corporate loans grew by 7.25% on an annual basis, and loans to households by as much as 14.05%!

Banks in Bulgaria still enjoy relatively abundant liquidity

What can account for this very slight increase in interest rates and still extremely strong growth in household loans? The contrast is particularly stark compared to other European countries that are member states of the eurozone – in many of them, housing loan interest rates have increased sharply over the past year, and lending is visibly slowing down. In neighboring Greece, for example, from 3% in July 2022, the average interest rate on housing loans is now 4.22%. Lending to households in the entire eurozone grew by only 1.3% in July. The most logical explanation for the unusual situation in our country is the better capitalization of Bulgarian banks compared to those in the eurozone. The capital adequacy ratio of banks in Bulgaria was 19.98% on average at the end of 2022, compared to 14.74% in the eurozone.

In addition, the profit of the banking sector in our country rose by 66% on an annual basis to 1.7 billion leva in the first half of 2023. All this indicates that liquidity is still relatively abundant in the Bulgarian banking sector. The key question, however, is how much longer can this continue? Inflation across Europe is proving to be more persistent than experts and institutions initially expected, respectively, the European Central Bank will have to continue raising interest rates, or keep them at higher levels for longer. This will inevitably affect Bulgarian banks as well - we should not think that we can get away with a more tangible increase in interest rates in our country. The more difficulties the ECB has in the fight against inflation, the more certain it is that high bank interest rates, including on housing loans, will come to us as well. This is inevitable, because the Bulgarian banking system is directly connected to the rest of Europe. In such a situation in the credit market, the role of non-bank credit institutions will be key to preventing a collapse in business activity and economic consumption.

Inflation turns out to be more persistent than expected, so monetary policy will be tightened for a longer period of time

Thanks to them, those affected by the scarcer bank credit are given the opportunity to continue financing their projects and their consumption. The presence of an alternative to which economic agents can turn (at least initially) in the event of scarce bank liquidity allows the economic shock caused by this scarcity to be smoothed out. The role of this type of financial institutions, classified by the BNB as “companies specialized in lending”, is too often overlooked, perhaps due to the association of this type of companies with the so-called “fast” loans. But they also play an important role in the financial system.

BNB statistics show that at the end of the second quarter of 2023, the total value of loans granted by non-bank credit institutions was BGN 4.93 billion, which is equivalent to nearly 6% of the total value of loans granted in Bulgaria at the end of June 2023. This value of BGN 4.93 billion is 19.6% higher than the value at the end of the second quarter of 2022. This is serious growth, although below the levels achieved in 2022 compared to 2021. A good signal is that the share of non-performing loans of the total value is only 6.78%, below the levels of 8% to 9% reported in 2021-2022. This shows that despite the slowed economic growth (in Bulgaria and the EU as a whole) and the growth in interest rates, the non-bank lending sector remains financially stable for now.

In the event of a crisis, the role of non-bank credit could prove key

The majority of loans granted by non-banking companies have a maturity of over 5 years, which does not at all correspond to the popular perception of these companies as companies for "fast" loans. As of the end of the second quarter of this year, of all loans granted, 45.2% have a maturity of over 5 years, and 21.7% have a maturity between 1 and 5 years. Statistics also show that the role of non-banking companies specializing in lending is the largest in the consumer credit market. Over 66% of loans granted by this type of company as of the end of the second quarter of 2023 are for consumer purposes. The share of loans to non-financial enterprises is also significant - 25.6%.

It is very likely that the role of non-bank companies specializing in lending will increase in the next year. Data shows that these companies are already being used by consumers and businesses as an alternative to bank lending. It is in these categories of loans (to enterprises and for consumer purposes) that the largest increase in interest rates has been observed so far. In a crisis situation, in which the growth of interest rates has accelerated further and bank liquidity has sharply decreased, companies specializing in lending can provide (at least temporarily) an alternative and thus cushion the economic shock.

The property market is vulnerable in the event of prolonged tight monetary policy

Where the shock could be much more serious is in the area of housing lending and, accordingly, the property market. Bank lending has almost no alternative in this area and, accordingly, if interest rates on housing loans granted by banks rise, this will have a direct and very rapid negative effect. The financial situation of households with housing loans will deteriorate due to increased payments, which will hit consumption. In addition, financing the purchase of a home will become much more difficult for households, which will lead to a decline in demand for property. This, in turn, will also cause a decline in property market prices. At this stage, this is still a hypothetical scenario, which, however, seems increasingly likely. Some increase in housing loan interest rates and, accordingly, some correction in the property market seems inevitable, given that inflation remains high and the ECB is forced to either raise interest rates further or keep them at the current elevated level for a longer period of time.

This article was originally published in Manager magazine.

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