Problems of Bank Lending in Bulgaria: Information Asymmetry and Institutional Learning

Why are there such severe problems in lending in the transition countries? This research took a microeconomic and institutional look at part of the problem. We conducted interviews in Bulgaria and Hungary and sought answers to two questions. First, how do banks making "normal" loans insure that they were making "good" loans? Second, how do banks get their money back on loans that have turned bad? Clearly, weaknesses at either stage could explain both past loan failures and present reluctance to lend. The bankers we spoke to reported significant difficulties at both stages of the credit process. First, the bankers reported difficulties in accumulating the information to evaluate borrowers and their projects. The bankers also reported problems with encouraging borrowers to repay and difficulties with seizing collateral, and using legal action in collecting bad debts. Although many of the problems are universal problems of bank lending, many seemed specific to transition economies in general and Bulgaria in particular. We identified specific problems with obtaining and using the evidence about borrowers that might have been available. Bulgarian bankers were often less than fully effective in collecting all available information, or in considering later how they could improve their methods of evaluating clients. One method that more banks might usefully adopt is systematic review of loan losses and the incorporation of lessons learned into the training of new loan officers. In addition, there were serious difficulties in sharing information about borrowers among bankers and between bankers and other firms. Some relaxation of bank secrecy would be appropriate. We also identified policy areas where improvement appears appropriate. Reputation can be effective in ensuring that borrowers fulfill their contracts. However, there is a general lack of credit reporting institutions to share information about credit-worthiness; this need to be remedied. The heavy reliance on collateral imposes high costs on borrowers and lenders. For collateral to work properly, banks must be able to perfect the collateral and to dispose of it quickly. Finally, fraud against banks was common, but typically went unpunished; prosecutors were apparently not interested in such cases. Bankers and prosecutors must make the prosecution of bank fraud a priority. We base our findings on the 24 banking interviews we conducted in Bulgaria. We also conducted 12 interviews in Hungary. Bankers were surprisingly candid in describing most of their problems.