Credit conditions: The banking system is supporting the economy to a limited extent Owing to the low willingness to lend, the banking system is strongly procyclical in corporate lending. Resilience: The resilience of the Hungarian financial system has improved markedly LIQUIDITY: Despite the dynamic outflow of external funds, liquidity risks have abated due to the appreciation of the forint, the drop in CDS spreads, decrease in net FX swap exposure, and the longer maturities of swaps. CAPITAL: Capital injections by parent banks, steady deleveraging and the apprecation of the forint resulted in higher capital adequacy ratio, despite persistently high risk costs and fiscal burdens on the banking sector. Summary I. – Credit contraction may persist longer than anticipated 3
Risks: Several external and domestic perils 1.The protracted sovereign debt crisis in the euro-area remains a key risk, despite the improvement in investor sentiment. 2.The economic outlook of Hungary is deteriorating further. 3.Outflows of external funds may accelerate, while the reliance of the banking sector on the FX swap market remains high. 4.The ratio of non-performing loans is high in the domestic banking sector and the risk of insufficient loan loss coverage is rising. 5.Given the deteriorating portfolio quality and high tax burdens, banks’ profitability may remain subdued, which may translate into further deterioration in already low willingness to lend. 6.Banks partially offset rising loan losses by increasing interest rate margins, this, however, is not a sustainable income structure over the longer term. Summary II. – Credit contraction may persist longer than anticipated 4
6 The banking sector is not supporting economic growth 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. If the sign of the FCI is identical to that of the output gap, then the banking sector behaves procyclically. Financial Conditions Index (FCI), real GDP growth and the output gap
7 Tight credit conditions, particularly in corporate lending, have been causing credit contraction for a long time Source: MNB. Net quarterly changes in corporate loans outstanding
8 Credit supply constraints are driven primarily by low willingness to lend Source: MNB. Changes in credit conditions of corporate loans and factors contributing to changes
9 Despite tighter credit conditions, banks lend to corporations with higher default risk as a result of deteriorating economic conditions Source: CCIS, MNB estimate. Distribution of new loans according to probability of default in the given years
10 Banks adjusted in terms of quantities and maturities against the deteriorating corporate credit quality Source: CCIS, MNB estimate. Maturity structure of newly issued corporate loans
11 In contrast to corporate lending, household lending is driven predominantly by demand factors Source: MNB. Net quarterly changes in household loans outstanding
12 The state interest rate subsidy scheme reduces the initial interest costs markedly (to 8-9 per cent), which may boost credit demand Source: MNB. New disbursements of credit institutions in the household segment
14 System-wide Financial stress Index (SWFSI) is on low level Source: MNB. Note: Higher levels denote higher stress. The System-wide Financial stress Index
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) has improved markedly Source: MNB. Note: The ratio is the liquidity need to 10 percent of balance sheet total weighted by balance sheet total. Higher ratio is mean higher liquidity risk along baseline scenario. Liquidity Stess Index, liqudity surplus of banks above the regulatory limit, and need along baseline scenario
17 The scenarios of the solvency stress test Over the 8 quarter forecast horizon beginning 2012 H2, the shock hits in 2012 Q4. Our baseline scenario is the forecast of the Report on Inflation 2012 Q2. 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 significantly deteriorating economic environment their recovery rate falls. As regards the exchange rate cap scheme, we assumed 70 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 Main components of the losses of the banking sector in the stress test over a two-year horizon Source: MNB.
19 The Solvency Stress Index (SSI) shows one of the lowest value since the onset of the crisis 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
20 Foreign-owned banks have injected EUR 2.4 billion capital since 2009 Source: MNB. Profit after tax, dividend and capital raise of existing foreign owned banks
Protracted sovereign debt crisis in the euro area. Several periphery countries are compelled to implement stricter fiscal austerity measures. In some of the core countries, major fiscal consolidation measures will be implemented as well. Significant deterioration in the economic outlook of the euro area, while investor sentiment might remain volatile. Weak earning capacity of European banks due to the high funding costs and deteriorating portfolio quality. Worsening economic outlook weigh on banks’ balance-sheet. In several peripheral countries banking systems need substantial capital injections. Steady, or even accelerating deleveraging by parent banks. Risks in the external environment of the financial intermediary system 22
23 Deteriorating domestic economic outlook Source: Eurostat. Economic growth in international comparison
24 The recently benign investor sentiment and expectations over the EU/IMF negotiations reduced markedly the Hungarian CDS premia Source: MNB. Decomposition of the Hungarian 5–year CDS spread
25 The outflow of external funds continues to be strong, significant drop in loan-to-deposit ratio Source: MNB. Estimated and actual change of foreign funds and loan-to- deposit ratio
26 Given the still large FX swap exposure (open on- balance-sheet position), cap is necessary Source: MNB. On-balance-sheet open position of the banking system and the total assets based market share of banks exceeding the 15 per cent limit
27 The greatest challenge of the domestic financial intermediary system is managing the deteriorating portfolio quality Ratio of non-performing loans and the cost of provisioning Source: MNB. Corporate Household
28 High NPL ratio may persist amid sluggish portfolio cleaning Source: MNB. Cleaning of non performing loans
Flow problem: new defaults weigh on profitability through loan loss provisioning. (moderate risk) Stock problem: 1. High NPL ratio freeze banks’ balance-sheet (moderate risk) Reduces itself willingness to lend, particularly in the corporate segment. Refinance of non-performing loans erodes profitability. Deteriorates liquidity, increases maturity mismatch, diverts funds from lending. 2. Not just the NPL ratio, but also loan loss coverage matters (high risk) The higher the NPL ratio, the higher the risk of collateral misvaluation. 3. Despite its flaws in terms of international comparability, analysts pay particular attention to it in their risk perception over the banking sector in the CEE region. (high risk) In evaluating portfolio quality, in addition to the dynamics, the level is also crucial 29
30 Reducing NPL ratio is key Reduction of NPL ratio: 1. Through nominator: Portfolio cleaning and debtor rescue packages (by reviving loans from defaults) reduce the nominator. 2. Through denominator: Rebound in lending increases the denominator. If the NPL ratio cannot be reduced, then the loan loss coverage should be raised: a.Higher loan loss coverage may boost portfolio cleaning or b.Otherwise would make the banking sector safer, though portfolio cleaning would be more sluggish.
31 Loan loss coverage is low in regional comparison Source: EBCI, MNB. Note: (1)= 2011Q4, (2)= 2012Q1, (3)= 2012Q2. NPL ratio and loan loss coverage in international comparison
32 In the case of project loans and restructured foreign currency denominated, insufficient coverage is plausible Coverage of non-performing loans - corporate Coverage of non-performing loans - household Source: MNB.
33 Banks are attempting to offset higher costs by increasing interest margin Banking sector ROE in international comparison Net interest income to total assets (Dec 2011 – consolidated data) Source: IMF GFSR, EKB CBD database, MNB.
34 The interest margin remained high on the performing portfolio Source: MNB. Interest margin (based on aggregated individual, non-consolidated data)
The resilience of the banking sector and thus its lending capacity is strong. Given the deteriorating portfolio quality and high tax burdens, banks’ earnings may remain subdued, which may translate into further deterioration in low willingness to lend. The procyclical behaviour of banks concerns both new lending and loans outstanding. No turnaround is expected in new lending, leading to further contraction in loans outstanding. Banks are attempting to offset rising losses by widening interest margin (pass-through of costs to customers). Financial intermediation is becoming more expensive, leading to unsustainable state, as feedback loop may emerge: loan losses interest margin debt servicing burden consumption and investment non-performing loans interest margin …. Credit contraction may persist longer than anticipated 35