BANKING CLIMATE IN BULGARIA - access to finance, corporate sector funding sources and loan conditions Kristofor Pavlov, Chief Economist Bulbank member of UniCredit Group Sofia, 08 th June 2005

2 BANKING MARKET – SIZE, DEPTH, PENETRATION AND ACTIVITIES ,73115,216,517,719,4 3827,9 7,8 25,4621,9252,1072,2642,504 n.a.41%45%50%66% 94%15%20%27%37% 72%30%32%36%43% n.a.0,03% 0,07%0,15% BULGARIA NE(12) EU (15) Size of the market GDP (in billion Euro)807 Population (million)179 Per capita GDP 4,499 Banking sector volumes Total Assets / GDPn.a. Total Loans / GDP29% Total Deposits / GDP 40% Total AUM / GDP n.a Banking activities Branches per mln inhabitant Number of employees (thousands) Share FX Deposits Share FX Loans n.a n.a *513** n.a  Strong growth drives intermediation levels quickly to approach NE standards  Still room for branch banking expansion  Large share of FX activities, due to openness of the economy and monetary arrangement chosen. Source: BNB, Bulbank & UCI database *Data for NE12 for ** Data for EU is and EU15 is for 2000.

3 SUCCESSFUL STRUCTURAL TRANSFORMATION Source: New Europe Research Network, based on Central Bank Statistics. (1) Data as of % State owned 82.9% Foreign owned 60.6% State owned 16.7% Other 32.3% Foreign owned 7.1% Other Foreign ownership in NE12 as % of total assets¹ Foreign ownership in NE12 as % of total assets¹  With privatization completion market structure in terms of key players is fixed.  Market liberalisation and restructuring achieved indirectly via foreign banks entry.  Foreign banks impact on local market:  Inflow of capital and new market behaviour;  New segment and product development;  Transfer of experience, new practices and competencies;  IT and Human Resources enhancement Bulgaria Total assets by ownership

4 * Bulbank’s estimate based on BNB data Bank ’ s importance for investment assets acquisition Bank ’ s share in financing the residential property market Bank ’ s funding of household consumption expenditure LOANS EXTENDED BY LOCAL BANKS – KEY DRIVER OF DOMESTUIC DEMAND

5 Average Interest Rate Retail Interest Rate Corporate Interest Rate INTEREST RATES – FAST REDUCTION IN COST OF BOOROWING General methodology note – applicable interest rates are on newly extended loans and newly contracted deposits

6 LENDING BOOM – MORE OR LESS STANDARD PHENOMENON FOR TRANSITION COUNTRIES; IN BULGARIA – OVERDUE CATCH UP Yearly change in Loans-to-GDP ratio ( ) Source: Data for Estonia, Lithuania, Hungary, and Slovenia is taken from EuroStat. Lending boom determinants:  strong capital inflow and access to international funding market;  cutback in borrowing costs;  local savings growth recovery;  risk reduction due to improving operating environment;  newly privatized bank’s owners search for profit maximization opportunities;  rising investment demand to close the technology and productivity gap with EU;  demand for consumer durables recovers from the depressed levels in 1997, households confident in their improved debt service capacity;  crowding-in effect, due to prudent fiscal policy and reduced borrowing needs of the pubic sector.

7 Lending growth impact on external accounts and inflation LENDING BOOM - MACROECONOMIC IMPLICATION & RISKS Source: National Statistics Office and Central Bank * Real estate prices refer to average selling price of apartments in Sofia town 6,2  Sharp rise in the availability of financing undergird economic expansion since  However, fast lending growth:  fuels internal demand which in turn exercise pressure on import causing CA deficit to widen - a standard phenomenon for a transition country.  no impact on prices inflation as CPI is rather driven by supply side determinants  no assets price bubbles so far. Rising real estate prices - another overdue catch up process.

8 LENDING BOOM – BANKING SECTOR STABILITY IMPLICATIONS AND RISKS Credit quality indicators (2001 – 2004) Source: BNB reported data NPLs Non-performing Loans * Substandard Loans Loss Loans Coverage Ratio NPLs ratio over gross loans7,9%7,9%5,0%3,9%3,9%3,5% Total Provisions / Total Gross Loans7,9%7,9%5,5%5,5%3,8%3,4% Total Provisions / NPLs101%112%97,5%97,5%95,3% Net provisions (flow) / Total Operating Income-10,5%-1,4%1,0%-8,8% * Before 2004 NPL also include doubtful loan classification category.  Credit quality is a relevant concern.  Some smaller banks seems to lack adequate:  risk management skills;  discipline;  experience and  financial strength.

9 Application for banking credit Major hurdles for real sector development ACCESS TO LENDING IS NOT A SETBACK FOR LARGE COMPANIES  Substantial loans concentration – 1100 companies control 60% of outstanding loans. Generally these are large companies with sales revenues above BGN 5mln.  Despite its rising significance for the economy SME sectors still remains relatively isolated from bank lending.  Looking forward SME’s will become increasingly a focus of attention of banks. * Data are from poll conducted by Alpha Research in early 2005 among 130 regular corporate bank borrowers

10 LOANS DEMAND ON THE RISE IN STILL LARGE RELEVANCE OF ALTERNATIVE FUNDING SOURCES STRUCTURE Although, all polled companies have already used 1 or more loans, only some one third has never used alternative funding sources * As percent of the number of companies in the poll. Alternative funding sources* In what way has the need for banking credit for your company changed in 2004?

11 Borrowers eligibility requirements changes in 2004 How have borrowers eligibility requirements applied by banks changed in 2004? BANKS HAVE LOOSENED BORROWERS ELLIGIBILITY REQUIREMENTS

12 EU AND EMU ACCESSION HIGHLIGHT THE NEED OF ADDITIONAL INVESTMENT, …  IMPROVING MACROECONOMIC FUNDAMENTALS  IMPROVING OPERATING ENVIRONMENT – enforcement of contracts, property rights, corporate governance - all driving risk level down  COMPETITIVENESS – low cost of inputs and especially labour  INTERNATIONAL SPECIALISATION – still large share of low value added exports  TECHNOLOGY TRANSFER – import of investment goods, FDI and imitation  STRUCTURAL RIGIDITIES REDUCTION – still fundamental prerequisite; ALL LEADING TO NEED OF STRONG INVESTMENT ACTIVITY AHEAD OF EU ACCESSION  SOPHISTICATION OF DOMESTIC DEMAND – requiring high quality in customer service and fast reaction to changes in the customers’ needs and preferences;  EU STRUCTURAL FUNDS – lead to rising incomes in some sectors as agriculture but could disguise loss maker and harm efficiency;  INCREASING COST OF LABOUR – requires to develop and sustain other competitive advantages  FOLLOWING EMU ENTRY – better access to external finnacing, no exchange rate risk and substatial bonus in terms of country risk reduction. Cope with monetary policy rather targeted at core EU countries; ALL SUGGESTING IMPROVEMENT IN OPERATING CONDITIONS IN ACCESS TO FINANCING AND RISK REDUCTION CURRENT MARKET TRENDS CHALLENGES AND OPPORTUNITIES

13 Thankyou! Thank you!