One of the most important external factors is the sovereign debt crisis of euro-area peripheral countries, which is increasing the risks of renewed financial market turmoil and a global economic recession. European banks hold tremendous amounts of government securities issued by euro-area periphery countries. Consequently, the contagion risk between sectors (the public and financial sectors) and countries (euro-area member states) is high. The performance of the Hungarian economy is severely affected by the euro-area sovereign debt crisis, given its high reliance on exports and external funding.

Rapidly deteriorating portfolio quality and the impact of the early repayment programme on the banking sector are the most important domestic factors. The non-performing portfolio has increased to 16 per cent in the corporate sector and to nearly 13 per cent in the household sector, increasing loan losses, due to the weak macroeconomic environment, the depreciation of the forint and the rising external funding costs. The high level of households’ foreign currency debt is an acute problem. Early repayment reduces the burden on mortgage debtors participating in the programme and eliminates their exchange rate risk, but at the same time it creates additional demand for foreign currency in the market, which in turn increases the debt and debt servicing burdens of customers unable to participate in the programme. The Magyar Nemzeti Bank is ready to make available for the domestic banking sector the amount necessary to repay existing foreign currency debt using its foreign exchange reserves, in order to reduce the effect of additional foreign currency demand on the forint exchange rate and mitigate the increase in the burdens of those unable to participate in the programme. Nevertheless, debt relief via the scheme is likely to cause significant losses to the domestic banking sector, depending on the number of participants in the scheme and the exchange rate prevailing at the time of conversion.

Hungarian banks’ capital buffers are falling sharply, reflecting the effects of external and domestic shocks. Along the baseline scenario outlined in the MNB’s September Quarterly Report on Inflation and assuming a 20 per cent early repayment ratio, the domestic banking sector would not need additional capital injection. However, assuming that the sovereign debt problems in Europe escalate and the early repayment ratio is higher at about 30 per cent (stress scenario), banks would need an additional capital injection of nearly HUF 200 billion.

Consequently, the Hungarian banking sector is unable to support economic growth in the absence of additional capital injection, despite the fact that its liquidity and funding position is adequate to expand its lending. In the current situation, therefore, there is a rising need for parent banks to show strong commitment towards their Hungarian subsidiaries. At the same time, the European sovereign debt crisis is increasing the likelihood that parent banks would not be able to inject additional capital into their Hungarian subsidiaries, thereby forcing them for stronger deleveraging.

Report on Financial Stability (November 2011)

Magyar Nemzeti Bank