Lending of First versus Lending of Last Resort: The Bulgarian Financial Crisis of 1996/19971

Michael Berlemann () and Nikolay Nenovsky ()

Comparative Economic Studies, 2004, vol. 46, issue 2, 245-271

Abstract: In 1996/1997 Bulgaria was hit by a severe financial crisis, spreading from a banking crisis to a currency crisis. We argue that the Bulgarian Financial Crisis might serve as an illustrative example of a twin crisis involving both a currency and a banking crisis. While the Bulgarian Crisis had some properties of the so-called fundamental crises, as explained by first-generation models of currency crises, the severity of the crisis was primarily (but not only) due to systematic and path-dependent moral hazard behaviour of the banking sector. Special attention is paid to the crucial role the Bulgarian National Bank played in the pre-crisis and crisis periods when acting more as a lender of first resort rather than a lender of last resort (LOLR). We also show how Bulgaria managed to overcome the crisis by introducing a second-generation currency board allowing the central bank to act strictly as a limited LOLR, thereby making the country less prone to a financial crisis in the future. Comparative Economic Studies (2004) 46, 245–271. doi:10.1057/palgrave.ces.8100028

Date: 2004
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