Credit conditions: The banking system is still barely supporting the economy. Owing to the low willingness to lend, the banking system is strongly pro-cyclical in corporate lending, which impedes access to credit particularly for SMEs reliant on bank funding. Resilience to shocks: The increase in capital need under stress is manageable due to the proven commitment of parent banks. LIQUIDITY: Liquidity risks remain low, based on stress test results as well. At the same time, most of the liquidity reserves denominated in HUF; therefore, in a protracted stress situation the smooth functioning of the FX swap market is indispensable. CAPITAL: Capital position has improved on aggregate level. However, given the worse initial capital position at some banks, the solvency stress test indicates higher capital need. Taking into account the parent bank commitment this amount can be considered manageable. Overall assessment I. – Banking sector remains strongly pro-cyclical 3
4 Overall assessment II. – Key risk and mitigation measures Key risks: Risk mitigation measures: 1.Protracted euro-area sovereign debt crisis 1. Maintaining prudent fiscal policy and supporting sustainable economic growth in Hungary remain a priority to mitigate the impact of potential adverse shocks from the euro area. 2. Vulnerabilities of the domestic economy 2.1.Credit supply constraints on companies, particularly on SMEs 2.1. The first pillar of the Funding for Growth Scheme (FGS) may improve access to credit with favourable interest conditions for SMEs. 2.2.Exchange rate exposure of companies without natural hedging 2.2. The second pillar of the Funding for Growth Scheme is aimed at converting foreign currency loans of SMEs into forint loans. 2.3.Reliance on external funding, of which a high share is short-term financing 2.3. The third pillar of the Funding for Growth Scheme will reduce the countrys external debt and extend its maturity. 3.Deterioration in portfolio quality 3.1.High share of non-performing loans in the domestic banking sector 3.1. The planned introduction of the personal bankruptcy process could help the management of non- performing loans, while at the same time allowing over-indebted customers to start with a clean sheet. 3.2.Risk of surge in new defaults 3.2.1. Increasing participation in the exchange rate cap scheme could slow the deterioration in household portfolio quality. 3.2.2. The first and second pillars of the FGS may contribute to an improvement in SME loan portfolio quality. 4. Lack of competition among banks in mortgage lending 4.1. Expedient to cut the regulatory maximum of the early repayment fee to 1–1.5 per cent in the case of refinancing from another bank. 4.2. In agreement with the proposal of the Hungarian Competition Authority, the possibility of bank switching in the case of government subsidies should be examined. 4.3. It may be justified to reduce the maximum amount of notary fees, which are charged not by competing and not even by public bodies, as such fees represent a significant disincentive in the case of refinancing. 4.4. Most mortgage loans are tied to other products (predominantly current accounts); therefore, the switching of current accounts should be facilitated. 4.5. The entry of participants should be promoted which would help households to seek the most favourable offers.
6 The banking sector does not support the real economy Source: MNB. Note: The annual growth in the FCI shows the contribution of the financial intermediary system (banking sector) to the annual growth rate of real GDP. Financial Conditions Index (FCI) and real GDP growth
7 Domestic corporate lending has been steadily contracting since the onset of the crisis Source: MNB. Net quarterly change in domestic loans to corporate sector
8 Both demand and supply factors contributed to the contraction in corporate lending Source: MNB. Decomposition of the cumulative decline in corporate lending into supply and demand effects (relative to 2008 Q3)
9 The monetary easing cycle has a positive impact on price conditions in corporate lending… Source: MNB. Interest rate of corporate loans and the MNB policy rate
10 …hence corporate credit forecast was modified upwards Source: MNB estimation. Credit forecast to NFCs along different scenarios
11 As opposed to corporate lending, demand factors remain the key driver in household lending Source: MNB. Net quarterly change in domestic loans to household sector
12 The trend of plummeting new lending continued last year Source: MNB. New loan volumes of credit institutions to household sector
14 In the low level of the System-Wide Financial Stress Index (SWFSI), benign market conditions are reflected Source: MNB. Note: Higher level denotes higher stress. System-Wide Financial Stress Index (SWFSI)
15 The stress scenario of liquidity stress test Source: MNB. Note: The liquidity stress test is 30-day forward looking.
16 The Liquidity Stress Index (LSI) indicates low level of liquidity risk Source: MNB. Note: The ratio is the liquidity need to 10 percent of balance sheet total weighted by balance sheet total. Higher ratio denotes higher liquidity risk along the stress scenario. Liquidity Stess Index, liquidity surplus and need of banks relative to the regulatory minimum
17 The scenarios of the solvency stress test Over the 8 quarter forecast horizon beginning end-2012, the shock hits in 2013 Q2. Our baseline scenario is the forecast of the Report on Inflation 2013 Q1. Our stress scenario relative to our baseline scenario: 4.3 percentage points lower GDP growth; 15 per cent deprecation of HUF; 300 basis points risk premium shock; 10 per cent drop in house prices. Along the stress scenario we accounted for additional loan loss provisioning on outstanding non-performing loans as in a markedly deteriorating economic environment their recovery rate falls. As regards the exchange rate cap scheme, we assumed 50 per cent participation ratio both along the baseline and the stress scenario. The postponement of halving the bank levy and the pass-through of the entire financial transaction tax are taken into account.
18 The impact of key risks on the banking sector profitability in the stress test on 2-year forecast horizon Source: MNB.
19 In the baseline scenario no additional capital is needed, however along the stress scenario several banks need capital injection Source: MNB.
20 The Solvency Stress Index (SSI) shows an increasing, but still manageable capital need Source: MNB. Note: The indicator is the sum of normalised capital shortages relative to the 8 per cent level, weighted by the capital requirement. The higher the value of the index, the higher the solvency risk in the stress scenario. Stress test index, capital buffer and need in stress scenario at the end of 8 quarter horizon
1.Protracted euro-area sovereign debt crisis. 2.Despite the recovery from the technical recession the vulnerabilities of the domestic economy are still present. Credit supply constraints on companies, particularly on SMEs Exchange rate exposure of companies without natural hedging Reliance on external funding, of which a high share is short-term financing 3.The banking sector is heavily burdened by the high share of non-performing, which will rise further based on our forecasts. 4.Lack of competition among banks is causing welfare losses and real economic costs. 22 Key risks
Protracted euro-area sovereign debt crisis. Several peripheral countries are compelled to implement stricter fiscal consolidation. In some of the core countries, meaningful austerity measures will be implemented as well. Significant deterioration in the economic outlook of the euro area, while investor sentiment might remain volatile. Owing to high funding costs and deteriorating portfolio quality the profitability outlook of European banks is weak. Worsening economic outlook weighs on banks balance-sheet. In several peripheral countries banking systems need substantial capital injections. Risks in the external environment 23
24 Credit supply constraints hit the SME sector more severely Change in new lending to corporations and its decomposition by corporate size Source: CCIS, MNB estimation.
25 Exchange rate exposure of SMEs without natural hedge poses a significant risk Source: CCIS, MNB estimation. Distribution of exchange rate depreciation of individual contracts (by end-2012)
26 The first two pillars of the MNB Funding for Growth Scheme (FGS) are aimed at reversing contraction in lending and reducing exchange rate exposure of SMEs Source: MNB. Growth rate of domestic loans to corporate sector Corporate sector totalSME segment
27 The third pillar of the FGS accelerates the decrease in short-term external funds without any deleveraging Foreign funds of the banking system and the loan-to-deposit ratio Source: MNB.
28 The third pillar of the FGS is aimed at rationalising the debt structure and reducing the costs of MNB The reduction of short term external funds translates into lower level of foreign exchange reserves and MNB bills outstanding Without higher vulnerability The effects of MNB swaps on the banking system balance sheet: Changes in the consolidated balance sheet of the general government, in case the reduction of short term external funds is achieved with the cooperation of the Debt Management Agency
29 Banks remain reliant on external funding even in the case of loan-to-deposit ratio decreasing under 100 per cent Source: MNB. Schematic balance sheet of the banking sector at a 100 per cent loan-to-deposit ratio
30 Managing deteriorating portfolio quaility remains a key challenge Ratio of non-performing loans and cost of provisioning Source: MNB. Corporate sectorHousehold sector
31 In the corporate segment the I. and II. pillars of the FGS, while in the household portfolio the planned introduction of personal bankruptcy may improve portfolio quality Source: MNB. The planned personal bankruptcy procedure
32 Increasing participation in the exchange rate cap scheme would have a benign effect on household portfolio quaility Source: MNB. Participation in the exchange rate cap
33 Banks are striving for offsetting high costs through raising net interest income Net interest income to interest bearing assets Net interest income to total assets (June 2012 – consolidated data) Source: ECB CBD, MNB.
34 Market failures in pricing should be managed by enhancing competition Expedient to cut the regulatory maximum of the early repayment fee to 1–1.5 per cent in the case of refinancing from another bank. In agreement with the proposal of the Hungarian Competition Authority, the possibility of bank switching in the case of government subsidies should be examined. It may be justified to reduce the maximum amount of notary fees, which are charged not by competing and not even by public bodies, as such fees represent a significant disincentive in the case of refinancing. Most mortgage loans are tied to other products (predominantly current accounts); therefore, the switching of current accounts should be facilitated. The entry of participants should be promoted which would help households to seek the most favourable offers.