Lending to the private sector, and particularly to households, accelerated sharply in the years prior to the financial crisis. This was mainly reflected in the unsustainable increase in foreign currency mortgage loans, which typically have very long term to maturity, in some cases exceeding 20 years. However, the original maturity of foreign currency funds underlying such loans is significantly shorter, which has led to the development of a significant maturity mismatch in the banking sector’s balance sheet.
The financial crisis has highlighted the fact that Hungary’s external foreign currency exposure is an important contributing factor to the vulnerability of the economy. Another major factor has been the banking sector’s short-term foreign currency liabilities, which may pose a risk mainly on account of the rollover risk associated with banks' reliance on short-term funding. This development has been unfavourable not only because of the deterioration in the maturity mismatch of the banking sector’s foreign currency positions, but also because it has increased significantly the country’s need for foreign exchange reserves. The cost of holding higher foreign exchange reserves, in turn, has placed a burden on general government.
In Hungary, the foreign funding adequacy ratio (FFAR) was introduced on 1 July 2012, in order to mitigate liquidity risks. The ratio also takes into account the characteristic features of domestic liquidity risks, and therefore it is able to address issues arising from both currency mismatches and the problem of the maturity mismatch of on and off-balance sheet foreign currency positions.
Experience with the FFAR since its introduction has shown that the previous regulation was successful in reversing the deteriorating trends in terms of the shortening of the maturity of foreign funds. However, the regulation was not well suited to significantly and gradually improving the maturity mismatch of the banking sector’s foreign currency positions, due to the lower required level of the ratio.
Under the MNB Act becoming effective on 1 October 2013, the MNB, as a macroprudential authority, has been given a mandate to adopt a regulation with the aim of reducing systemic liquidity risk in an MNB Decree, which is as powerful as a Government Decree in the legal hierarchy. Accordingly, the MNB, taking into account past experiences and consulting the market participants affected, has revised the content of the FFAR, its required level and the range of financial institutions subjected to the regulation.
The revision has resulted in a change in the required minimum level of the FFAR and provided for its gradual increase. The adequacy ratio will be raised from the current 65% to 75% on 1 July 2014 and by 5 percentage points semi-annually to 100% by 1 January 2017. The announced level has been justified by methodological changes, while the gradual increase in the ratio will help participants adjust smoothly to international stable funding requirements. In addition to the revision of the required minimum level, the effect of the regulation has been extended to Hungarian branches of foreign credit institutions.
The revision and tightening of the regulation on the FFAR are likely to contribute to strengthening the resilience of the financial system, mitigating the banking sector’s liquidity risk and reducing the MNB’s foreign exchange reserve requirement. The macroprudential regulation is consistent with the MNB’s other objectives and actions and contributes to the success of the Funding for Growth Scheme.
Magyar Nemzeti Bank