Budapest, 29 November 2018 – The shock-absorbing capacity of the Hungarian banking sector is strong, both in terms of liquidity and capital adequacy. Profitability is outstanding by international standards as well, which strengthens the banks' capital position, but the unsustainable profit structure foreshadows a decline in banks' profit. The sector's balance sheet growth and the supportive economic environment facilitate an organic, sustainable improvement in banks' profitability, via further expansion in lending and progress in efficiency.

In the favourable economic environment, domestic banks have clearly embarked on a path of growth, which is reflected by the expansion of the balance sheet total and by growth in both corporate and household lending. The growth in assets keeps helping the banking sector to gradually outgrow the problems which may be regarded as the legacy of the period after the outbreak of the 2008 crisis. The rising balance sheet total, increasing lending and improving economic fundamentals have a benign effect on the non-performing loan ratio, loan loss provisioning, and the cost-to-assets ratio as well.

However, in addition to these favourable developments, the few problems inherited from the crisis are still not settled entirely, while new risks have also surfaced. In this report, we identify the following key risks.

Risks stemming from the external macroeconomic environment. Global economic trends are characterised by an anticipated deceleration in growth and a moderate rise in stability risks. The rise in inflation points to normalisation of monetary policy, which suggests a rise in the interest environment even in the case of the central banks that have not yet reached their inflation targets. Capital outflows due to the normalisation of monetary policy in developed countries and the change in investors' risk appetite, as well as the resurgence of political risks in the past half-year, have resulted in wide-ranging tensions in the emerging region, to varying degrees in different countries. The tensions of the past half-year affected the countries of the CEE region to a lesser extent due to the more favourable macroeconomic fundamentals. Developed countries have also been impacted by the rising yields: high indebtedness represents a risk via rising debt servicing, while structurally weak banks and bank-sovereign loops generate risks through depreciation of the government bond portfolio in the banks' balance sheet.

Risks observed on the Hungarian housing market. The rise in Hungarian house prices continued in the past period, moreover at an accelerating rate in Budapest. In view of this, the risk of overvaluation on the housing market has increased substantially. On the other hand, the risks arising from this factor are mitigated by the fact that the rise in prices was not accompanied by a wide-ranging spread in risky lending, and thus the impact of a potential price correction would be moderate on banks' stability. In addition to overseeing prudent lending, the Magyar Nemzeti Bank (MNB) also regularly consults property market participants and closely monitors property market trends.

Structural risks in corporate and household lending. Since the end of phase three of the Funding for Growth Scheme, dynamic growth in corporate lending has not taken place in the desired structure, since only few companies in the SME credit market have access to predictable, long-term financing. With a view to reducing the interest rate risk, starting from January 2019 the MNB will launch the Funding for Growth Scheme Fix (FGS Fix) facility in the amount of HUF 1,000 billion. According to our expectations, the scheme will exert an effect primarily on the structure of the contracts, while the degree of additional credit expansion will remain limited. In case of the reviving commercial real estate financing, the high share of FX lending may pose a risk: it is important, when lending in foreign currency, that the financed projects shall have sufficient income in the given currency to ensure a proper natural hedge. In household lending, within new contracts, the ratio of loans with interest rates fixed for a longer term has increased substantially, with major contributions from Certified Consumer-friendly Housing Loans gaining more ground. Maintaining the favourable interest rate structure of new loans is supported by the amendment of the debt cap rules effective since 1 October 2018, which – in the case of variable-rate loans – prescribes higher income for borrowers. However, it represents a risk that the majority of outstanding lending is still characterised by interest rates with a short-term initial fixation.

Profitability risks. The profit realised by banks in 2018 H1 remains outstanding by international standards, but falls moderately short of the year-on-year profit, primarily due to the decline in the reversal of provisions. With the exhaustion of the release of the provisions recognised earlier, a further decline in the profitability of the banking sector can be expected. A reduction in operating expenses together with improving efficiency could permanently improve banks' profit. One way to achieve this – according to international experience – is the widescale application of digital solutions, which can be fostered by a supportive regulatory environment.