The Banking and Currency Crises in Bulgaria: 1996 - 1997

Abstract

The paper examines the nature of the Bulgarian banking and currency crises in 1996-1997 and evaluates the causal link between them. The analysis shows that the banking crisis has resulted from slow structural reforms, inefficient prudential regulation and prolonged unsound lending practices. The probit model estimates illustrate that excessive credit, augmented interest rate spread and overvalued exchange rate exacerbated the banks' liquidity position. The currency crisis was a consequence of expansionary monetary policy, which led to irreversible depletion of international reserves and caused eventual collapse of the exchange rate. The probit estimations found real exchange rate, money multiplier, interest rate, current account balance, ratio of broad money to reserves and credit expansion to be the most relevant indicators of the balance-of-payment crisis. The causal link between the twin crises is  explained through expansionary monetary policy that comes as a response to the banking crisis. It focuses on the inability of the central bank to sustain the exchange rate when it faces a run on its reserves.