The conversion of foreign currency-denominated mortgage loans came into effect with the fixing of the exchange rate for instalments de facto as of January 2015 (de jure February 2015). The MNB provided the required foreign exchange amount of EUR 9 billion to the counterparty institutions in a timely manner, in order to enable them to close the otherwise widening open FX position stemming from the conversion and debt settlement. As a result, 500,000 contracts with a HUF 3,300 billion outstanding amount were relieved from significant exchange rate risk. Due to the settlement and the resetting of lending rates, the debt servicing burden of households decreased by 20-25 per cent on average, but with significant heterogeneity. In the absence of forint conversion, their debt servicing burden could have jumped markedly, even by more than 50 per cent, as, in addition to the lifting of the CHF cap, the forint would have depreciated markedly as a result of a damaged banking sector and real economic costs. By contrast, the conversion has had a positive impact on the economy, households consumption and hence on the performance of the banking sector, including on its ability to support economic growth. However, smaller but relevant financial stability risks have remained. One part of risks identified in our report is associated with subdued lending activity, as well as with profitability and portfolio quality problems. While the FGS and its expansion directly supports lending, the management of the non-performing portfolio and the remaining households' foreign currency loans indirectly helps to ease on the constraints on the credit supply, by reducing uncertainty, improving profitability, and stimulating the real estate market. In addition, acceleration of the consolidation process is needed to improve the banking system's structural profitability. Another part of the risks relates to the vulnerability still remaining in banks’ balance sheets after the conversion of foreign currency loans. While the conversion closed the foreign currency position of the banking sector in the balance sheet and the repayment of a portion of short-term foreign currency funds is expected, regulatory measures are needed to permanently reduce the risks stemming from the dependence on short-term foreign liabilities, as well as foreign exchange swap markets. These risks can be mitigated by tightening the required level of, and amending the Foreign Exchange Funding Adequacy Ratio (DMM), and constraining the banks’ on balance sheet currency mismatch by the introduction of the Foreign Currency Equilibrium Ratio (DEM). With the conversion of foreign currency mortgage loans the maturity mismatch between forint denominated assets and liabilities increased and this may be addressed with incentive regulation (JMM), in which banks are encouraged to issue long-term mortgage-backed securities.
1. Although the Funding for Growth Scheme (FGS) achieved considerable results in avoiding credit crunch, no permanent turnaround has occurred yet in lending, and the growth of the corporate credit portfolio – which is essential for long-term, sustainable economic growth – has not yet commenced. The risk appetite of the banks has not changed significantly and lending outside the FGS is characterised by extreme caution; in this segment the credit portfolio has continued to decrease similarly to the trends seen in previous years. The Monetary Council decided on the launch of FGS+ with a limit of HUF 500 billion in order to manage credit supply frictions. With the new scheme, the central bank provides the banks with incentives to grant fixed-interest, long-term financing – as a result of the decreasing central bank costs – also to riskier, but creditworthy clients.
2. In the banking sector, the ratio of non-performing household loans remains high, with low rates of mortgage portfolio cleaning, and consequently the ratio has not changed significantly despite the numerous relief measures. However, it has not been possible to resolve the non-performing mortgages for lack of an adequate market, social consensus, institutional framework and appropriate legislation. A complex debt settlement procedure is needed which limits the moral hazard and does not impair repayment propensity going forward, while at the same time solves the problem of property owners who are still in distress. The foreign currency settlement reduces the number of distressed mortgage contracts, and some of the borrowers in difficulty (approximately 10,000 debtors) may find a solution due to the expansion of the purchases of Hungarian National Asset Management Inc., while another group (up to 25,000 debtors) may find a solution via the new institution of personal bankruptcy. Resolution of the remaining portfolio is still a high-priority problem, since there may be over one hundred thousand such contracts. The MNB is about to create database for the identification of debtor types, which may help in developing appropriate, customized debt settlement packages. Some international examples should be considered, one of which appears to be effective is the scenario in Ireland, where a planned quota system encouraged banks to clean up the portfolio of household in the scope of a complete debt settlement package. Another high-priority risk in the retail portfolio continues to be the remaining is that of the foreign currency denominated loans, primarily consisting of automobile and personal loans. This exposure has to be addressed as soon as possible because of its volume (HUF 300 Bn), the number of contracts (more than 250 thousand at the end of 2014), and the cross-default risk.
3. The quality of the corporate loan portfolio poses a persistently high risk. Although the work-out rate has risen, the combined ratio of non-performing and restructured project loans is still stagnating at a high level; the central bank's asset management company (MARK) may offer an effective market-based solution in this regard. Depending on the size of the portfolio which is taken over, the ratio of non-performing corporate loans can be reduced by up to four or five percentage points within one and a half to two years.
4. In recent years, the banking sector’s profitability has been low in international comparison, with the deterioration of portfolio quality, the government policies related to households’ foreign currency loan problems and the fiscal burdens playing a determinant role in this regard. In the years to come, most of these effects will not impact or will impair only to lesser extent the sector's profitability, but new income-reducing factors may arise. The decline in the previous foreign currency mortgage lending rates on the converted mortgage loan portfolio, the persistent narrowing of the net interest margin reduces the profit of the banking sector by HUF 90 billion annually. While the specific cases of abuse known as the “broker scandals” have no systemic importance and only represent one per cent of the capital market, the payments to the National Deposit Insurance Fund (NDIF) and the Investor Protection Fund (IPF) in the coming years indirectly mean a substantial burden (an additional HUF 15-20 billion annually) for the banks. The persistently low interest rate environment also negatively affects net interest income. However, the profitability prospects of banking sector are changing for better thanks to the robust improvement in economic growth, the planned reduction of the bank levy (by 60 billion in 2016 and by HUF 83 billion in 2017) and the abolishment of exchange rate cap scheme (HUF 13-15 billion annually), while the elimination of exchange rate risk also reduces uncertainty surrounding future prospects. Overall, the profitability outlook is gradually improving; however the revenue-generating capacity of the sector is still below regional standards, due to structural problems and problems of economies of scale, which makes further consolidation necessary.
5. In 2015, after the conversion of household mortgages denominated in foreign currency, the maturity mismatch between the forint denominated assets and liabilities on the banking sector's balance sheet has increased significantly. The resulting risks can be effectively reduced by the mortgage financing adequacy regulation, which encourages the institutions involved to reduce the maturity mismatch. The planned regulation for the Mortgage Financing Adequacy Ratio (JMM) introduces a minimum proportion of long-term forint liabilities compared to the stock of HUF retail mortgages with a maturity of over one year, and covered by the residential mortgages. In addition to containing liquidity risks, the new regulation promotes the development of the market of securities covered by mortgages, such as mortgage bonds.
6. Although as a consequence of FX-loan conversion, the importance of foreign currency external funding is decreasing, and due to settlement the asset side is contracting, regulatory intervention is needed for a sufficient reduction of the banking system’s short-term foreign currency debt and for a sustained reduction in the associated liquidity and rollover risks. One the one hand, this can be achieved by tightening the required level of, and amending the Foreign Exchange Funding Adequacy Ratio (DMM) so that long-term swap holdings cease to be eligible as long-term foreign currency financing (thus approximating the rules with the Basel NSFR regulation). On the other hand, as a preventive measure, the banking sector's excessive reliance on off-balance sheet instruments (such as FX-swaps) should also be reduced, which justifies the introduction of the Foreign Currency Equilibrium Ratio (DEM) aimed at limiting banks’ on-balance sheet currency mismatch.