20 April 2011

The domestic financial intermediary system is considered stable, its ability to absorb adverse shocks is adequate. From a financial stability perspective, the most important challenge is to remove credit supply constraints to boost lending, and to improve the maturity structure of banks’ balance sheets.

The Hungarian financial intermediaries’ lending activity, mainly in the corporate segment, remains weak in international comparison, making the economic recovery vulnerable. Banks’ lending capacity can be strengthened if they manage their non-performing loans more efficiently and the bank levy, which is very high by international standards, is reduced.

Domestic banks are facing two important challenges in terms of portfolio quality developments: managing the existing non-performing loans and preventing its further increase. The ensuing moratorium on foreclosures and evictions leads to further accumulation of non-performing loans in banks’ balance sheets. Removing the moratorium, i.e. allowing banks to clean their portfolios efficiently, could be an important step towards strengthening balance sheets and improving borrowers’ access to credit. However, the removal of the moratorium could lead to unwelcome disturbances in the housing market, due to the large number of repossessed residential properties. Consequently, after full withdrawal of the moratorium market players should engage in coordinated behaviour which allows them to clean their portfolios as fast as possible without causing market turbulence through the sale of residential properties backing non-performing loans.

Banks are proactive in preventing further credit defaults. Loan restructuring, a method whereby banks and customers agree on lower monthly instalments for a temporary period, is aimed at restoring the ability of debtors to service their obligations to lenders. However, the current practice of loan-loss provisioning may encourage banks to restructure loans, expected to become non-performing, over and over again before the grace period expires. Through multiple restructurings, i.e. by continually extending grace periods, banks have a regulatory arbitrage for lower loan-loss provisioning, resulting in an artificial improvement in profitability. Although the magnitude appears to be limited at this moment, all this generates latent risks. Therefore, the existing regulation for loan-loss provisioning should be reviewed.

In 2010, the profitability of the Hungarian banking sector was one of the lowest in Central and Eastern Europe. Low profitability reduces the financial system’s ability to accumulate capital internally and, thereby bank’s capacity to lend, and eventually curbs economic recovery.

The inefficient management of deteriorating credit quality, coupled with the uncertain regulatory environment, may lead to a decline in the activity of the financial intermediary system, which is funded on shortening maturities. The maturity of external funding has been shortening at the fastest pace in the region. This process has adverse feedback effect on banks’ activity and, ultimately, on financial stability. The authorities responsible for financial stability should consider remedial regulatory steps to reduce the size of the maturity mismatch and to mitigate the related macroprudential risks.

The Magyar Nemzeti Bank summarised its warnings and recommendations aimed at reducing credit supply constraints to corporations and mitigating the rollover risk of external funding in the April 2011, Report on Financial Stability.

Magyar Nemzeti Bank

Monetary Council