Does a Credit Boom Increase Bank Fragility?

Abstract

Based on a panel data analysis of thirty Bulgarian banks over the period 1999-2006, I identify the determinants of Bulgaria's rapid credit growth and evaluate whether the credit boom has increased bank fragility. I employ fixed effects and generalized method of moments approaches to explore the link between credit and capital base in a partial adjustment framework and find evidence of growing risks of credit expansion, which raise the probability of banking distress in the event of a downturn in global financial flows, as occurred in 2008. The credit boom has come at the expense of increased banking fragility, as banks reduced their capital base and registered an increase in nonperforming loans. Amid a quickly unfolding global financial crisis, conservative supervision of the banking sector by the Bulgarian National Bank and a stable currency board regime was a bulwark against potential banking distress and ensured financial and macroeconomic stability without resorting to International Monetary Fund funding.