Mathew Youkee, Editorial manager for Bulgaria, Oxford Business Group

As access to credit becomes more difficult across Europe and the European Central Bank is forced into drastic action to stave off the threat of recession, the Bulgarian credit market has remained remarkably strong. The question remains, however, whether the credit crunch will exert a delayed effect on Bulgaria or whether the country could actually benefit from Western Europe's economic problems.

In 2007 the volume of loans grew 58 per cent on the previous year. Even when Bulgarian National Bank (BNB), concerned by the runaway growth, increased the minimum reserve requirement from eight per cent to 12 per cent in September 2007, the number of loans being offered remained steady. Even though the cost of credit increased, Bulgarian banks - more than 85 per cent of which are foreign-owned - elected to absorb these costs themselves in order to maintain competitive interest rates on loans.

Bulgaria was not directly affected when news of the US sub-prime mortgage crisis broke and the effects spread to Western Europe on the back of securitised debt, bought up by mostly French and German banks. The country's predominantly Austrian- and Greek-owned banks had not bought up the faulty securitised bonds.

"In a sense, the less sophisticated nature of the banking system helped insulate Bulgaria from the worst of the credit crunch," Kalin Hristov, adviser to the governor of BNB, told OBG. "Banking is done in the old-fashioned way and incentives are not distorted by selling on risk."

In the first weeks of January, a number of analysts predicted that Bulgarian credit growth will continue unabated by the global financial crisis, citing strong demand for loans from both consumers and corporations, as well as a low level of financial intermediation. The rate of growth is expected to fall, however.

Many in the banking sector believe that a drop in credit exposure is needed to prevent the economy from over heating. The BNB is anxious to slow growth and has not ruled out increasing the mandatory reserve requirement to 15 per cent. With so many foreign-owned banks booking loans in their mother countries, many doubt whether this will have much of an effect.

Ullrich Schubert, CEO of BNP Paribas Bulgaria, told OBG, "A slowing down of lending growth could be beneficial for Bulgaria, but it will be achieved not from government regulations but from market imposed self-discipline."

According to Desislava Nickolova, an analyst with Raiffeisen Bank, conditions in Western European financial markets still have the power to affect Bulgarian banks.

"The Bulgarian economy is a small, open economy and it cannot remain isolated from global market swings," she said to OBG. "The direct effect is that refinancing costs for Bulgarian banks have increased. If the global credit crunch does not die out in four months or so, and if banks are unable to pass on increased costs to their clients, then the banks' profitability will be hurt."

In recent years banking penetration has increased rapidly in Bulgaria, where total banking assets are equal to 97 per cent of gross domestic product (GDP). Competition among banks for future business has, according to many in the industry, led to a narrowing of the interest spread and return on equity. Many may now choose to spend more on screening loan applicants.

Hristov, however, suggested that conditions in Europe might exert a very different effect. Instead of withdrawing their money from peripheral countries, European banks may in fact step up their activities in areas where economic growth remains strong.

"As business slows in the Eurozone they could continue to funnel money to countries such as Bulgaria, where the returns remain high. This is not an unrealistic prospect. Banks could continue to do business here in order to offset the losses they are sustaining elsewhere," Hristov said.

According to Hristov, corporate loans and mortgages were areas of particular potential growth. Mortgage growth is fuelled by the increasing willingness of internal migrants to Sofia to purchase their property and accumulate equity. Indeed, mortgages are one of the most important lending categories that set Bulgaria apart from the rest of Europe, with the overall volume of mortgages in GDP still significantly low. In addition, real estate loans have mainly been given to those who can afford them, so there has not been any mis-pricing of loan risk.

On the corporate side, many local companies need large investments in order to comply with European Union regulations. Nikolova also said she believed that the anticipated influx of around 6.8 billion euro in EU funds in 2008 will offer great potential for local banks to act as mediators in the funding process.

The future looks positive for banks, with most analysts in agreement that the Bulgarian economy is set to continue in rude health in 2008, with anticipated GDP growth of over six per cent and increasing levels of foreign direct investment. Even if financial conditions in Europe become worse and the end cost is passed on to the Bulgarian consumer, the opportunity for high returns should mean that greater interest rates can be tolerated by the majority.