Every day, hundreds of companies worldwide suspend their activities and hundreds of others open new business. Every day, thousands of employment contracts are terminated, however, thousands of new jobs open at the same time. This is how the market works – unfit entrepreneurs, due to accumulated losses, lose their invested capital and become insolvent. This leads to the devaluation of assets they use, which creates conditions for their profitable use by other capitalists, willing to risk their resources under these depressed prices. Productive assets are transferred from one entrepreneur to another, and in the process, thousands of people need to review their own life plans. Some get rich, others become poorer. It is precisely thanks to corporate bankruptcies that market economy ensures the profitable use of scarce resources in the economy, which in turn is an indication that these resources are used according to consumer preferences. Aside from the followers of Karl Marx, today there are no other economists who disagree with this description of the market economy.
However, there is one business where the slightest jolt is met with great fear by almost all economists, and the general public – the activities of modern banks. While easily explained, it seems paradoxical, because in fact, in their work, modern banks are not limited by the available economic resources. They do not fund their loans only with borrowed capital, nor fully cover all deposits with liquidity. Precisely from this derives their ability to grant bank loans that are practically unlimited by economic factors. Bankers know that this great privilege is a double-edged sword. On one hand, more lending leads to more benefits. On the other hand, however, excessive lending creates excessive optimism among entrepreneurs, who are losing the grip on the real success of business projects, and mistakenly consider that the economy has more resources than they actually are. Due to this poor judgment, a time comes when not every business project can be completed, or they end up being insufficiently profitable to repay their loans in full. Then, banks realize that there are bad loans that undermine the quality of their financial assets; their capital decreases; doubts that they have sufficient capital emerge and that undermines their credibility. This is followed by withdrawal of saving accounts deposits by concerned companies and individuals, which eventually leads to depletion of available liquidity. Banks close their doors, and must somehow be restructured in order to pay their debts.
That’s what happened with Corporate Commercial Bank (KTB). In conditions of general economic stagnation, the assets of this bank increased four times in the last six years. The average annual growth of the Bank was more than four times faster compared to the average in the sector, and over two times more active than the one of other banks with Bulgarian capital. From an insignificant institution, KTB became a systemic bank that was providing over 13% of all loans to enterprises in Bulgaria. To fund the liquidity outflow, which is associated with each new loan, KTB was attracting an equally significant part of the investments of the population through interest rates higher than the market average. Higher interest rates are the result of higher risk, generated by the exponential growth of the bank. The more corporate loans were granted by the bank, the more deposits of the population it attracted. To some extent, we can say that the investments of the population in KTB “funded” the loans it was granting.
Of course, this business model cannot survive for a long time. Part of frenetically-granted credit has financed economically-unjustified i.e. hollow business projects that continued to exist not because they generated income, but because they were refinanced with new loans. High interest on deposits started to eat away the profits of the Bank. Indicators of lending quality remained good temporarily because the total amount of loans was growing too fast, but reduced profit as percentage of total assets should have alerted the Bank that there was a problem. And here came the tragic moment because the good standing of those indebted to it was based on additional loans! Loan narrowing was a “death sentence” for the indebted. For the Bank, however, this was the only life-saving solution. So, naturally, from business partners, the Bank and the indebted have ended, over irrefutable economic necessity, in an unresolved conflict. If the Bank delays narrowing lending, then the accumulated hollow projects would become too many, threatening it and its reputation. The time comes when attracting deposits is not enough, and the Bank goes insolvent.
This is exactly how we can explain what happened to KTB. The total return of its assets fell from 4.5% in early 2010 to less than 1% at the end of 2012. The Bank first tried to recover profits by speeding up lending. Without visible results in the next six months, from March 2013 it has started to accelerate its growth. A year later, in March 2014, the annual growth in assets was commensurate with that of other banks with Bulgarian capital. But it was already too late; precisely these attempts to rescue the general state of affairs of the Bank revealed that the granted loans were really bad ones. This, after all, has contributed to its liquidity problems. Conflicts between the bank and the indebted, along with mass withdrawal of deposits, are just a symptomatic manifestation of the specific business model of the Bank, namely fast lending for hollow projects and attracting liquidity through higher interest rates.
KTB has not been declared bankrupt yet. However, from an economic point of view it is obviously bankrupt. Otherwise it would not stay closed. But let’s get back to the basics of this article. Should what happened to KTB cause fear? Should KTB’s bankruptcy be repaired somehow, namely by paying all deposits in their full size? There are several reasons why every person concerned about their personal freedom has to welcome the collapse of KTB.
First, this bankruptcy actually stems from the collapse of the hollow business projects that the Bank has financed. Loans, which it provided, helped pseudo-entrepreneurs to attract assets, while the real ones have been “removed” from the economic stage. The collapse of KTB will trigger the failure of these pseudo-capitalists. The economic process, described at the beginning of this article, will force them to leave the market and to hand over the management of their assets to new, real entrepreneurs. The economic structure will be cleansed of hollow projects, and will respond more adequately to consumer preferences.
Second, the bankruptcy of KTB will be an admonition for all banks in Bulgaria, which will be far more cautious from now on. This means that funding of hollow projects will be narrowed naturally because hardly any other bank would like to end up being in KTB’s position. If no one is hurt financially by the collapse of KTB, this healing lesson will be forgotten very quickly.
Third, those who would lose from the collapse of KTB are owners of deposits of over 100,000 euro. The State does not guarantee deposits above this amount because it is believed that a person, who has acquired such sum of money as result of their contribution to society, is financially literate enough to take personal responsibility for their own choice of bank. If this is true for the richest countries of the European Union, it is much truer for the poorest! In fact, payment of deposit in full would mean that the poor are going to rescue the richer. What moral principle postulates this?
Fourth, full payment of deposits contradicts the basic principle of the Currency Board. According to this principle, the financial system is organized in such a way as to avoid deficits in public finances. The Board was completely successful – finances of the Bulgarian State are among the best in the European Union. Obviously, if it pays the unsecured deposits in KTB, the State would further increase its debt, and this increase can be significant. Precisely that is contrary to the basic meaning of the Currency Board. Any proposal for full payment of deposits, in fact, undermines this meaning.
Fifth, in the current economic conditions, there is no mechanism by which KTB’s bankruptcy can shake financial stability, and in particular the Currency Board. The Board has a real and constant coverage in euro of all levs in circulation – nearly 10.6 billion levs – and of all reserves of banks to the Central Bank (Bulgarian National Bank, BNB), of nearly 6.3 billion levs. The Board has additional reserves accumulated over the years, amounting to 5.2 billion levs. If we take into account some other State or State-regulated amounts, which could also be mobilized, the total sum of reserves is over 30 billion levs. Commercial banks also hold foreign assets of over 14 billion levs. In a nutshell, as much as someone is trying to shatter the Board, they cannot knock it down until the Bulgarian population exchanges at least 44 billion levs for euro. There is no other economic mechanism, on the inside or the outside, through which financial stability can be shaken. It is obvious that the failure of KTB, by itself, cannot cause an event of this magnitude.
Of even greater importance is the fact that there is no economic mechanism by which the bankruptcy of KTB can grow into such large event. Deposits in KTB amount to about 5.5 billion levs, of which 70% are guaranteed, and will not be lost. Part of unsecured deposits will be also repaid after it becomes clear what the real value of KTB assets is. There is no apparent cause for any another bank to fall into a liquidity crisis. Even if that happens, the government will secure liquidity support. The only way the bankruptcy of KTB can grow into a major banking crisis is loss of confidence in the banking system. The reason for this, at this point, can only be political. For a month now, since the closure of the Bank, rulers and politicians cannot answer one simple question – through which bank and when the guaranteed deposits will be paid, and what will happen to the Bank? The more a clear answer to this question is delayed, the more the suspicion of complete lack of competence and concern of Bulgarian rulers will grow. This, in turn, could lead to confidence collapse.
From the perspective of society, the bankruptcy of KTB, as of any other bank, is not a problem. Large investors in KTB, and pseudo-entrepreneurs, financed by it, will suffer losses. True capitalists and free people will win. This economic redistribution will take time; will require flexibility of those who will suffer losses, and will lead to further redistribution of resources and income. Some will get rich, others will become poorer, however, this happens every day in a market economy! As to how technically and legally KTB’s bankruptcy should develop – this is a matter for the current owners and the uninsured depositors. The faster they do this, the less will be lost. The State’s liability is limited to how quickly it will provide access to insured deposits.
Simeon Brutskus is the pseudonym of an author of academic research articles in the field of economic theory. The text is written exclusively for Bivol. Reproduction is not permitted without citing the source.
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