The rapid growth in lending to households in Bulgaria and other EU aspiring countries poses a serious threat to Europe’s overall financial stability.

This warning was given by the European Central Bank (ECB) in an overview of acceding and candidate countries.

Encouraged by low interest rates, for instance on loans in euro, individuals and companies in countries such as Romania and Bulgaria have increased foreign currency borrowings significantly in recent years.

But a sharp depreciation in local currencies could force a wave of bankruptcies, according to the report, published on the ECB’s web site.

“A vicious circle of this kind was a key factor behind the severity of the Asian financial crisis of 1997-98,” the report said.

The Financial Times noted in an article on the report that while the ECB paper made no judgment on the likelihood of such a scenario, its tone suggested that the ECB saw the threat as real.

The ECB’s main concern regarding private credit in Bulgaria is the increased foreign currency exposure of households and corporations. Against this background, some serious currency rate fluctuations could weigh on credit repayments and the banks’ profits and thus aggravate a possible industry crisis.

Attempts by central banks to curb foreign currency borrowings – which account for roughly half of loans in Romania and Bulgaria to consumers and companies other than banks, are being circumvented, the report said. That is likely to ring true for many bankers, the Financial Times said.

At a recent conference in Bucharest, the heads of several of Romania’s biggest banks poked fun at attempts by the country’s central bank to limit loans, said the newspaper.

The financial stability risk for Bulgaria and the other acceding countries is further compounded by macroeconomic developments related to inflationary gains, rising current account deficits and poor enforcement of anti-money laundering legislation.

The current data on banking services and lending in Bulgaria paints a picture of stability.

The level of financial intermediation in Bulgaria is still low compared to international standards as indicated by the private credit to GDP ratio of only 45 per cent.

Household borrowings (for housing and consumption) have risen particularly quickly in recent years albeit from very low levels. Household debt amounts to around 16 per cent of GDP which does not constitute a heavy debt service burden, noted the ECB.

The report on financial stability in Romania, Bulgaria, Croatia and Turkey is the latest to warn about the dangers posed by credit booms across the continent and comes as emerging market economies in Eastern Europe have been hit by a wave of financial turmoil.

In Turkey, the report noted significant improvements in the health of the financial sector but says faster private sector credit growth presents a “major challenge” for the authorities not least because of its stimulating effect on domestic demand and the consequent widening of the current account deficit.

“Experience shows that a substantial proportion of credit booms end in a banking crisis,” the report said. The ECB also pointed to a downside of the dominance of foreign-owned banks in many existing and future EU countries.

“Foreign bank presence may have also contributed to the very fast rates of credit growth, as foreign-owned banks compete for market share,” the report said.

In Romania, the central bank has had more success in trying to persuade banks to restrict foreign exchange lending voluntarily than in thinking up new rules.

In Bulgaria, the credit portfolio of commercial banks reached 19 billion leva (9.7 billion euro) at the end of May, up 16.9 per cent from a year earlier, Bulgarian National Bank said in late June.

Bulgarian banks’ deposits portfolio totalled 27 billion leva at the end of May, up 24.7 per cent from a year earlier.

The biggest Bulgarian bank by assets at the end of May was DSK Bank, owned by Hungary’s banking group OTP. Second came Bulbank, one of the three Bulgarian-based banks of Italian banking group UniCredit, and the National Bank of Greece’s United Bulgarian Bank was third.

The loan portfolio of Bulgarian banks rose by 33 per cent in 2005, slower than the 50 per cent growth recorded in the previous year. Urged by the International Monetary Fund (IMF), BNB has moved to slow growth in lending, blamed for the country’s widening current account deficit.

The IMF expects a lending growth rate of 17.5 per cent in Bulgaria this year, while the central bank has said credit growth will not exceed 20 per cent.