Bulgaria's anti-money laundering gray-listing could hike costs for local banks

Bulgarian banks could face greater scrutiny and higher costs after the global money-laundering and terrorist financing watchdog gray-listed the country in October.

The Financial Action Task Force on Oct. 27 added Bulgaria to its gray list of countries subject to increased monitoring due to strategic deficiencies in the country's regime's ability to counter money laundering and terrorist financing.

Bulgaria is the second EU country to be placed on the list, after Croatia in June. The gray list includes 21 other countries, including South Africa, Turkey and the United Arab Emirates.

"As with Croatia, gray-listing threatens greater difficulties in maintaining corresponding banking relationships and accessing external finance, while damaging liquidity by reducing near-term inflows of foreign funds," Natasha McSwiggan, senior economist, banking risk, at S&P Global Market Intelligence, said in an Oct. 31 note. The overall impact on liquidity risk in Bulgaria's banking sector will, however, be limited, McSwiggan added.

Bulgaria's big banks

The Bulgarian subsidiaries of large EU banking groups held roughly 70% of the sector's assets as of 2022-end, Market Intelligence data shows. The country's largest banks include UniCredit Bulbank AD and DSK Bank EAD, which are owned by UniCredit SpA and Hungary-based OTP Bank Nyrt., respectively. Those are followed by the local units of KBC Group NV and Eurobank Ergasias Services and Holdings SA. Bulgaria's fifth-biggest lender, First Investment Bank AD, is controlled by local investors.

The average liquidity coverage ratio at Bulgaria's top five banks was above 200% in 2022, although this fell year over year at UniCredit Bulbank and KBC Group's United Bulgarian Bank AD unit. The aggregate liquidity coverage ratio for the country's banking sector was 225.6% after the second quarter of 2023, according to Bulgaria's banking association.

The liquidity coverage ratio for banks participating in the Single Supervisory Mechanism was 163.7% at the end of the first quarter, the association said, citing ECB data.

United Bulgarian Bank had the highest cost-to-income ratio as of 2022 among the country's largest lenders, amounting to 51.9%. Overall, the Bulgarian banking sector was one of the most cost-efficient in central and southeast Europe, with an aggregate cost-to-income ratio below 46%.

The sector's dominance by banks owned by EU-based financial institutions will limit the gray-listing fallout for local lenders, Gunter Deuber, managing director, chief economist and head of Raiffeisen Research, told Market Intelligence. Still, local banks may have to communicate more actively with their foreign counterparts about their anti-money laundering frameworks.

"We do not expect cut and run behavior, but Western banks will be more selective and will require more information and process documentation," Deuber said.

More intense communication with correspondent banks and foreign counterparts will increase compliance and regulatory costs for local lenders, Deuber said. "We would not expect a liquidity crunch. However, foreign banks will be possibly more restrictive with overall limits and cross-border transactions," Deuber said.

In response to the gray-listing, Bulgarian authorities are likely to introduce anti-money laundering regulatory enhancements in the near term, which means local financial institutions would face increased scrutiny and more comprehensive reporting requirements as a result, McSwiggan noted.

The Bulgarian banking sector is stable, with solid capital levels and improving asset quality, according to Fitch Ratings. The sector's total net profit stood at roughly 1.8 billion leva in 2022, the highest level in the last five years, while the core Tier 1 capital ratio was at 20.1%, Market Intelligence data showed.

Euro entry

There is a chance that the gray-listing could further delay Bulgaria's entry into the eurozone, although the main stumbling block in this process is "the lack of political consensus in the country to embark on a serious euro entry path," Deuber noted.

Bulgaria originally planned to adopt the euro in January 2024 but delayed the entry by one year after failing to meet the entry criteria on inflation and implement necessary legislative reforms amid political instability in the country.

Financial Action Task Force (FATF) decisions can influence investors' perceptions of a country's risk, negatively impacting foreign investment. Capital inflows to such a country can decline on average by 7.6% of GDP when added to the FATF gray list, according to a 2021 IMF report.

Parts of the Bulgarian economy will feel the increased investor skepticism following the gray-listing, Deuber noted. "However ... Bulgaria was already perceived as a more oligarch economy in certain economic sectors, hence the FATF gray-listing is possibly more a confirmation of this already existing perception," the analyst said.

– Access Bulgarian banking sector aggregates on CapIQ Pro. – Access economic and demographic data for Bulgaria on CapIQ Pro.

Bulgaria's real GDP growth is projected to fall to 1.75% from 3.75% in 2022, Market Intelligence data showed, while inflation is estimated to fall to 8.45 from the year-ago 13.02%.

According to a 2022 assessment by the Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism, or Moneyval, Bulgaria was largely compliant or compliant with 17 of 40 FATF recommendations, and only partially compliant with the remaining recommendations. The assessment also found that Bulgaria had the highest proportion of the shadow economy to GDP among EU jurisdictions, standing at 29.6%.

As of Nov. 3, US$1 was equivalent to 1.82 Bulgarian leva.