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Statement by the Monetary Council regarding the publication titled ‘Report on Financial Stability’

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The operation of Hungary’s financial system is characterised by stability. However, processes carrying potential risks are gradually strengthening. Risks deriving from still existing macroeconomic imbalances have so far been mitigated by favourable developments in international money markets. Consequently, an eventual sudden change in the international investment environment may become a source of risk. The operation of the financial intermediary system is characterised by the gradual appearance and calculated taking of new types of risks. At the same time, profitability of the banking sector is outstanding and its capital position is stable.

Uncertainties related to global economic prospects have remained broadly unchanged since the publication of the previous report. The persistence of global imbalance may be considered as one of the most significant macroeconomic stability risks. There has been no adequate improvement in underlying economic developments in Hungary. Although the balance of trade in goods and services improved, the current level of the external borrowing requirement of the economy cannot be maintained in the long run. The greatest risk is constituted by the government deficit, which is the most critical point of the macroeconomic situation. The fulfilment of the deficit reduction plan outlined in the convergence programme is required to make investor confidence strengthen.

Until now the favourable international investment environment has made it easier for Hungary to handle imbalances. This is attributable to the fact that developed economies have been operating at low inflation and interest rate levels for years, and partly due to this, emerging markets are also characterised by historically low risk premiums. One of the most significant risks is the quicker than expected increase in the low interest rate level of developed markets. Consequently, an eventual rise in risk premiums may have a negative impact on the financing and on growth prospects of the Hungarian economy as well.  

The financial intermediary system is characterised by a dynamic building of credit risks due to both demand and supply factors. Should companies adapt themselves too slowly to the economic environment, which is less favourable than before, banks’ loan portfolio quality may deteriorate due to downward profitability risks. In the household segment, as a result of considerable increase in debt burdens the greatest risk is constituted by the uncertainty deriving from the developments in real wages.

Parallelly with financial deepening, banks turn to new, higher-risk groups of clients with no credit history, and at the same time, as a consequence of their market acquisition strategies and of increasing competition they are compelled to relax their lending conditions. It is also especially risky that of the newly extended loans foreign currency lending has an increasing share in case of households and corporations which do not have natural hedge. Strengthening of foreign currency lending also represents a risk because even those clients with liquidity constraints may receive funds that otherwise would be excluded from forint financing. Stepping out to new markets and foreign currency lending result in an increasing probability that banks may not be able to precisely assess relevant additional risks and to take them into account when pricing.

Even in international comparison the Hungarian banking sector has been operating with high profitability and stable capital position for years. However, this benign picture is shaded by the fact that one-off factors also contributed to high profitability. A decline in the growth of housing loans and the lower interest rate level project a more moderate increase in income already in the short run. Should profitability expectations vis-a-vis banks stabilise at a high level, it may encourage them to take increasing risks. However, banks may temper this tension by a calculated improvement in cost efficiency, thus counterbalancing negative impacts on profitability.

Budapest, 25 April 2005

                                                                                    Magyar Nemzeti Bank

                                                                                       Monetary  Council