15 April 2008

In the Monetary Council’s assessment, the Hungarian financial system has been confronted with new risks since the publication of the autumn 2007 Report on Financial Stability, increasing its vulnerability to shocks. However, financially strong foreign ownership, coupled with declining but still adequate earnings, ensures that Hungarian institutions remain robust in the face of shocks.

The risks arising in the operational environment of the domestic financial system are mainly related to the spillover to global financial markets from the disruption in the US mortgage market in the summer of 2007. Due to the prolonged weakness in markets, there was a significant drop in investor risk appetite at the global level, which in turn led to a sharp increase in risk premia from the historically low levels seen in previous years. Financial market uncertainty may persist for some time, given that full information on the scale of losses and their distribution across the financial system is not yet available.

The wide-ranging effects of market turbulence have also been felt in Hungary, due to the high degree of integration of financial markets. The required premium on forint assets rose as a consequence of the fall in global willingness to take risks, and the liquidity of the domestic financial system deteriorated, as suggested by the ongoing turbulence in the government securities market, as well as by the shortening in the maturity and rises in the costs of foreign borrowing by the banking sector. All this underlines the need to further improve the operational efficiency of the government securities market and banks’ liquidity management techniques.

There has been a reduction in sustainability risks in Hungary recently in the wake of the fiscal adjustment measures; however, there is a risk that domestic economic growth will remain weak. The higher costs of credit and a decline in credit supply in response to financial contagion may cause a slowdown in the European economy. The related drop in demand in the major European export markets may have a negative impact on Hungarian economic performance. More recently, the potential growth rate of the economy has been adversely affected by weak corporate investment activity and deteriorating labour market conditions.

In the current unfavourable economic environment, domestic financial institutions are competing by introducing new products with higher risk profiles and easing lending standards for households. Meanwhile, the household debt service ratio is rising. The Magyar Nemzeti Bank and the Hungarian Financial Supervisory Authority have jointly issued a recommendation to draw attention to the additional risks of foreign currency lending in general, and those associated with more volatile Japanese yen-based loans in particular, as well as to the prudential instruments serving to manage them. Compliance with these recommendations is crucially important from the perspective of the entire financial system.

Monetary Council