IADI First Annual Conference - Basel, Switzerland, 7 - 8 May 2002.

1. INTERNATIONAL ASSOCIATION OF DEPOSIT INSURERS
First Annual Conference
Transitioning Issues for Deposit Insurers Practitioners
Basel, May 7 – 8, 2002
Transitioning from Blanket Guarantees:
The Case of Bulgaria
Presented by
Mileti Mladenov
Chairman of the Management Board
Deposit Insurance Fund
Bulgaria

2. 2
Transitioning from Blanket Guarantees: The Case of Bulgaria
Deposit Insurance in Bulgaria Prior to 1999
Not much attention was paid to deposit insurance at the start of post-1989 political
and economic reforms in Bulgaria. This reflected a shared public and government
belief that bank failures were atypical of the centrally-planned political and
economic system. The only legally set government guarantee (of 100%) was
provided for deposits at the State Savings Bank (SSB) by the Law on the State
Savings Bank of 1967. However, the majority of the public were convinced that all
bank deposits during transition to a market economy were under government
guarantee, irrespective of the lack of a deposit insurance legal framework. In
periods of turbulent financial market fluctuations, that conviction was further
boosted by the government and Bulgarian National Bank (BNB) - the Central Bank
of Bulgaria. For a long time after the start of reform depositors had chosen their
banks according to the financial conditions offered, absolutely disregarding the
bank’s financial performance. This environment created conditions for “moral
hazard”.
During the transition period there have been three stages in developing deposit
insurance scheme in Bulgaria. The first one involves Regulation No. 1 on Bank
Deposit Insurance (late 1995), the second one – Law on State Protection of Deposits
(late 1996) and the third one – Law on Bank Deposit Guaranty (1998).
In 1992 the National Assembly adopted the Law on Banks and Credit Activity
regulating bank activity during transition to a market economy. Pursuant to this
Law banks had to participate in the system developed by the Central Bank for
insuring deposits up to a specified amount. However, the importance of deposit
insurance was undervalued. The BNB designed and adopted Regulation No. 1 on
Bank Deposit Insurance only at the end of 1995. This regulation determined the
establishment and operation of a system for insurance of bank deposits up to a
specified amount. The system established a deposit insurance fund that complied
with most of the requirements of the best international practices.
IADI First Annual Conference Basel, May 7 - 8, 2002

3. 3
Major aspects of BNB Regulation No. 1 include:
1. Deposit guarantee covered only bank deposits of individuals (sole
proprietors were excluded).
2. Repayment of guaranteed amounts was required to begin within three
months after the date of license revocation.
3. The maximum amount of guaranteed reimbursement on covered deposit
funds was the equivalent of approximately DEM 5,000.
4. The Deposit Insurance Fund established under BNB Regulation No. 1 was
administratively subordinated to the BNB. The five-member Management
Board was dominated by BNB representatives. The Chairman of the Fund
and two Management Board members were nominated by the Governor of
the Central Bank.
5. The annual premium contribution from banks was 0.4% of the total amount
of individuals’ deposits as of 31 December previous year.
6. The Fund’s Management Board, acting on proposal from the Management
Board of the Bulgarian National Bank, was allowed to raise the amount of
annual premium contributions by banks exposed to higher risks to 1% of the
total amount of individuals’ deposits.
The poor timing of Bulgaria’s deposit insurance scheme launch proved to be its
major weakness. The deposit insurance scheme failed to start normal operations due
to the outbreak of the dire 1996 financial crisis. The extent of that financial crisis
called for significantly more money than was available at the time for repayment of
guaranteed deposits.
Immediately after enforcement of BNB Regulation No. 1 in the second half of May
1996, the Central Bank petitioned for institution of bankruptcy proceedings against
two banks1 with significant deposit bases. These two banks were experiencing large
scale runs by depositors, and practically ceased repayment of deposits. The BNB
petition for institution of bankruptcy proceedings against these banks increased
pressure on other banks as depositors withdraw their funds. Progressively eroding
1
In September 1996 the BNB petitioned the institution of bankruptcy proceedings against nine more banks
which it had established insolvent.
IADI First Annual Conference Basel, May 7 - 8, 2002

4. 4
depositor confidence in banks combined with galloping inflation, devaluation of the
local currency (lev) against major convertible currencies, and national currency
substitution could have destroyed Bulgaria’s financial system. This threat dictated
the adoption at the end of May 1996 by the National Assembly of the Law on State
Protection of Deposits and Accounts with Commercial Banks.
This new Law provided for a 100% repayment of the deposits of individuals
(physical persons) and for a 50% repayment of the deposits of nonfinancial sector
companies (legal entities). No guarantee was provided on deposit accounts of
financial institutions or Management Board members and shareholders owning over
1% of the equity of closed banks. Repayment of guaranteed deposits of bankrupt
banks was complicated which impeded its realization within the term set by the
Law. Therefore, by the end of September 1996 the Law on State Protection of
Deposits and Accounts with Commercial Banks was amended, the term for
repayment of guaranteed deposits being extended.
Despite some weaknesses this Law helped overcome the social consequences of the
financial crisis. A special Fund for state protection of deposits and accounts of
physical persons and legal entities was established. The Fund was managed by the
Ministry of Finance and its monies were raised through the issue of government
securities, the sale of assets of banks with revoked licenses, and privatization of
state-owned enterprises. Through the BNB the Fund provided resources for
repayment of guaranteed deposits.
Under its Transitional and Final Provisions, this Law was effective until the
adoption of a Law on Bank Deposit Guaranty. The latter Law was adopted in April
1998 and repealed the Law on State Protection of Deposits and Accounts with
Commercial Banks. The Law on Bank Deposit Guaranty removed the state
protection of deposits with regard to all licensed banks except the State Savings
Bank (SSB). In accordance with the Law on Transformation of the State Savings
Bank the state guarantee on deposits of its successor, DSK Bank, were retained until
May 2000.
IADI First Annual Conference Basel, May 7 - 8, 2002

5. 5
Legal Aspects of Deposit Insurance Since 1999
The current deposit insurance scheme operating in Bulgaria is managed by the
Deposit Insurance Fund (DIF) which was established in January 1999 pursuant to
the April 1998 Law on Bank Deposit Guaranty.
According to international classifications of deposit insurance schemes, Bulgaria’s
current deposit insurance scheme is a typical explicit deposit insurance scheme with
limited coverage and ex-ante guarantee fund.
The DIF is an independent institution managed by a five-member Management
Board with a four-year term of office. Procedure for appointment of Management
Board members complies with best international practices. This procedure together
with the requirements to be met by Board’s members help reduce any possible
conflict of interest and agency problems. Under the Law on Bank Deposit Guaranty
members of the Fund’s Management Board may not work for banks or nonbank
financial institutions.
The major functions of the Fund involve: setting and collecting initial and annual
premiums from banks, managing raised funds, and repaying the guaranteed deposit
amount upon the failure of an insured bank. Amendments to the Law on Banks in
June 1999 provided the DIF a very limited oversight role over certain aspects of the
management of a bank's property by the assignees in bankruptcy.
Sources of Fund monies include initial and annual premiums from banks
participating in the deposit insurance scheme. Funds raised by the BNB from initial
and annual premium contributions between 1996 and 1998 were transferred for
management to the Deposit Insurance Fund established in early 1999. The DIF
additionally generates funds from investing contributions in assets as provided by
the Law, as well as from interest accrued due to delayed payment of contributions
by banks. The initial contribution is a single payment to be deposited by each bank
licensed by the BNB. This amounts to 1% of the minimum capital required for a
bank but not less than BGL 100,000 (USD 45,450). Annual premium contributions
to be paid by each bank amount to 0.5% of the total amount of the deposit base.
Premium contributions due have to be paid by 31 March of each year. In the event
IADI First Annual Conference Basel, May 7 - 8, 2002

6. 6
of failure to pay the premium contributions within the term set, penalty interest
accrues. The Fund does not set risk-weighted premium contributions for individual
banks.
Pursuant to the Law on Bank Deposit Guaranty if Fund monies are insufficient, the
DIF Management Board may: (i) require banks to pay annual premium contributions
in advance; (ii) increase the annual premiums of banks but not more than 1.5% of
the deposit base; (iii) borrow funds from the market or from the Budget after a
decision by the National Assembly. The Fund may decide on reducing the amount
of annual premium contributions provided that funds raised have made up 5% of the
deposit base.
The Fund is exempt from paying national or local taxes and fees only on deposit
insurance operations. The DIF may be transformed, cease its activities or be
liquidated by a law. The Council of Ministers, the BNB and the National Audit
Office are authorized to exercise control over Fund activities. The Law on Bank
Deposit Guaranty regulates relationships between the BNB and the DIF regarding
bank information in a clear manner and provides for Fund access to necessary
information through the Central Bank.
The Fund guarantees full payment of monies held in a depositor’s account with a
bank regardless of the number of accounts and type of currency up to BGL 10,000
(approximately USD 4,540). The ratio between maximum payable guaranteed
amount and Gross Domestic Product per capita in Bulgaria in 2000 was 3.03.2 This
ratio is close to the 1998 average international ratio (3.0).
The Fund pays the guaranteed amount of depositors funds when the Governor of the
Bulgarian National Bank has withdrawn the banking license granted to the
commercial bank. The Law on Bank Deposit Guaranty provides for a relatively
short term3 within which the Fund should start payment of amounts on guaranteed
deposits.
2
Using USD/BGL exchange rate USD 1 = BGL 2.20
3
Within 45 days of the date of the resolution of the BNB to revoke the bank’s license.
IADI First Annual Conference Basel, May 7 - 8, 2002

7. 7
Scope of the Deposit Insurance Scheme
The deposit insurance scheme in Bulgaria encompasses all banks authorized by the
BNB to accept deposits. Therefore, this scheme contains a very important feature of
modern deposit insurance schemes with similar functions: compulsory participation
for all banks. The only exception to this mandatory participation is when the home
country of the head office of a foreign bank operating a branch in Bulgaria provides
deposit insurance to local depositors in an amount greater than that provided by the
Bulgarian DIF. Currently there are three branches of Greek banks located in
Bulgaria that meet this exception.
The Law on Bank Deposit Guaranty does not limit the guarantee by type of deposits
and provides for a guarantee up to the amount set by the Law of all lev and foreign
currency deposits of nonfinancial institutions and individuals (physical persons) no
matter whether they are residents or not. The deposit insurance scheme does not
provide for a guarantee on deposits of: government municipalities; banks and
nonbank financial institutions (regardless of the nature of their activities);
individuals (and members of their families) holding equity entitling them over 5% of
the votes in the bank’s general shareholder meeting or who are involved in bank
management or auditing; or, depositors granted preferential interest rates. Deposits
arising out of or related to transactions or actions constituting ‘money laundering’
are excluded from the guarantee as well.
The State Savings Bank Case
Till May 2000 deposits with the former State Savings Bank (SSB) were 100%
guaranteed by the state. With the expiration of the two-year transition period
(starting May 1998) the SSB was transformed into a commercial bank (DSK Bank)
and the full government guarantee on deposits was removed. The bank now pays
annual premiums to the DIF. The removal of the full guarantee was a very smooth
process due to the fact that in the past the bank accepted only deposits in national
currency and the average size of deposits with it was much lower than the insured
amount at that time.
IADI First Annual Conference Basel, May 7 - 8, 2002

8. 8
Public Relations (PR) Activity During Transitioning
The DIF places a high priority on active and effective public relations activities.
The DIF International and PR Department conducts these responsibilities largely
in-house.
The PR activity focuses on educating and informing the public about the nature of
deposit insurance and the policies and operations of the DIF. Internal ‘Public
Relations Rules’ have been developed. An underlying principle of these ‘rules’ is
transparency of information and compliance with the requirements of the Law.
Official position papers and press releases, including those providing information on
failed banks, are distributed through the mass media. Press conferences, interviews
with the Chairman for the TV, radio, and print media are also organized.
In April 2000 a Q&A Brochure on Deposit Insurance was published and widely
distributed with the assistance of the Association of Commercial Banks in Bulgaria.
This brochure is designed to inform the public, in a clear and understandable
manner, about deposit insurance coverage. A telephone hot-line was opened for
depositors. The brochure and the hot-line have proved to be very effective. In
September 2001 the DIF launched its institutional web site – both in Bulgarian and
in English. The Q & A Brochure is published both in Bulgarian and in English on
the web site. The website contains a ‘test’ where depositors can check their
knowledge about deposit insurance in Bulgaria and also contains an electronic
calculator they can use to check the exact insured amount of their deposits.
The project ‘A Survey on Public Information and Awareness of Deposit Insurance in
Bulgaria’, which started in March 2002, will provide the DIF with the necessary
information for further improvement of its PR activity. In this case, a PR firm was
hired to conduct the survey – a quantitative (a questionnaire of different groups of
questions) and qualitative (focus groups) assessment.
The DIF is also trying to promote the exchange of information with government
institutions, banks, business and academic circles on issues related to its activities.
In November 1999 the DIF and the BNB signed a Memorandum of Understanding
setting the details of information exchange regarding deposit insurance and bank
IADI First Annual Conference Basel, May 7 - 8, 2002

9. 9
regulation. A letter of Cooperation was signed with the Association of Commercial
Banks in August 2001.
Annual reports, which are distributed free of charge both in Bulgaria and abroad,
contain a special section on Public Relations.
***
In conclusion, the case of Bulgaria’s transitioning from blanket guarantees to limited
coverage has been an example of a smooth process that did not result in any
turbulence for the banking system. This transitioning passed tree stages:
1. Transitioning from a full implicit guarantee under planned economy to a
partial coverage, completed in early 1996.
2. Transitioning from a full coverage of physical persons’ deposits and a 50%
coverage of deposits of nonfinancial sector companies (legal entities) under
the Law on State Protection of Deposits of 1996 to a modern deposit
insurance scheme with a partial coverage pursuant to the Law on Bank
Deposit Guaranty of 1998.
3. The case of the State Savings Bank – one of the biggest Bulgarian banks,
where the full government guarantee on deposits was removed with the
bank’s transformation into a commercial bank in mid-2000.
Transitioning to a partial coverage did not cause the turbulence to the Bulgarian
banks that occur during the 1996 financial crisis. That crisis was characterized by
severe erosion of public confidence in the banking system, decrease in savings and
deposits, lack of confidence in the national currency and preferences of keeping
funds in foreign currency as a substitute to the lev, mainly in cash and ‘under the
mattresses’. In contrast, no banking system disruption was experienced after 1998,
when a modern deposit insurance scheme, that provided only partial deposit
guarantees, was established. This legislation created the existing ex-ante fund and
requires transparency of DIF activities. Furthermore, the DIF’s successful handling
of two bank failures, in early 1999 and the second in 2000, combined with efficient
PR activities contributed to mitigating adverse public reaction.
IADI First Annual Conference Basel, May 7 - 8, 2002

10. 10
It is also worth mentioning that despite the existence of a higher coverage provided
by a couple of foreign banks’ branches operating in Bulgaria, there is no trend of
shifting deposits to these banks (deposit coverage provided by these banks amounts
to EUR 20,000 and even higher).
Finally, each country has its specific features and the smooth transitioning from
blanket guarantees is not ensured due to the peculiarities of their various
circumstances. This process depends also on the public confidence in the national
currency, the local monetary authorities, the reputation of government institutions,
and of course on the general political situation.
IADI First Annual Conference Basel, May 7 - 8, 2002