The Magyar Nemzeti Bank has today published the Report on Financial Stability. One of the main findings of the Report is that the current financial and economic crisis has led to a contraction in domestic economic activity, due in part to the Hungarian economy’s high degree of openness. The downturn in the economy has been inevitably aggravated by the necessary adjustment aimed at reducing the country’s vulnerability. Efforts to reduce the high levels of public and private debt will inevitably imply a sacrifice over the short term, but may contribute to a sustainable improvement in Hungary’s long-term growth prospects. The Hungarian banking sector is able to meet the challenges posed by the new economic environment. There has been a significant improvement in banks’ liquidity position, and the deterioration in the quality of credit portfolios has been broadly in line with expectations.

The Report states that the domestic financial system has become more stable since the publication of the April 2009 Report. Although the reduction in the vulnerability of the Hungarian economy is likely to lead to a significant output loss over the short term, it may improve the country’s long-term sustainable growth prospects. The economic adjustment has been rapid and substantial; it is both desirable and necessary to rapidly reduce and decrease the high levels of public and private debt, thereby eliminating the most important source of Hungary’s vulnerability.

The domestic banking sector has adjusted rapidly to the changed financial and macroeconomic environment. Banks’ reliance on foreign funding has been moderating through a swift reduction in the loan-to-deposit ratio. Although their liquidity position has been steadily improving, they are likely to experience a deterioration in portfolio quality and an increase in loan losses in the recessionary environment this year and the next. The banking sector may realise higher-than-expected profits this year, albeit this is likely to be driven by one-off factors. Consequently, profitability is expected to fall in the future. Meanwhile, banks’ capital buffer has strengthened, with the capital adequacy ratio expected to remain above 11 per cent along the projected baseline macroeconomic path next year.

The Magyar Nemzeti Bank’s experts regularly examine the domestic banking sector’s resilience to shocks by conducting stress tests. Recent results suggest that even if underlying economic conditions were to deteriorate much more sharply than assumed in the baseline macroeconomic scenario, additional bank recapitalisation needs would remain at manageable levels. Based on past experience and commitments, parent banks would remain committed to supporting their subsidiaries under adverse conditions.

The primary goal of the central bank is to strengthten the financial stability and to reduce risks endangering the functioning of the financial system. The Magyar Nemzeti Bank considers it necessary to use regulatory instruments to prevent an excessive build-up of household debt and to reduce the risks associated with foreign currency lending, and ultimately to promote responsible lending practices and reduce the country’s vulnerability. In addition, the Magyar Nemzeti Bank also considers it important to develop a new, a more efficient regulatory and supervisory framework. To this end, the Magyar Nemzeti Bank, jointly with other institutions responsible for maintaining price stability, i.e. with the Ministry of Finance and the Hungarian Financial Superviosry Authority, had elaborated a proposal for a new supervisory structure, which the Government submitted to Parliament.