1. Lessons learned from the crisis and policies aimed at strengthening the resilience of the banking sector – the HFSA case Katalin Mero Hungarian Financial Supervisory Authority XXIII BSCEE Conference, 2010 June

2. 2 The Crisis and Hungary Pre- Lehman period - mild effect  no direct exposures to subprime mortgage market – decoupling theory  effects: increased funding costs (150- 200bp rise in CDS spreads) and shortening funding maturities Post-Lehman period- strong effect  no liquidity at any price  Dried up interbank markets, high and volatile CDS spreads (more than 600 bp at the peak), freezing of the swap markets  Currency depreciation (10 % in 4 days), more burden on FX loans, deteriorating portfolio  300 bp CB intrest rate increase in October 2008 (up to 11,5%), more burden on HUF loans, deteriorating portfolio

3. 3 5 year sovereign CDS spreads in some CEE countries

4. 4 Inmediate crisis responses by HFSA Asses the direct quantitative impacts - negligible Strengthen the supervision of liquidity management of the banks HFSA SREP Guidlines appendix on highly risky portfolio segments and extra capital requirements Recomendation and Dear CEO letter on responsible lending

5. 5 HFSA classification of highly risky portfolio segments Portfolio segments of banksRequired excess capital Japanese yen denominated loans 50-100 % of the capital requirement under Pillar I. Retail loans provided on loose conditions (e.g. lending without certification of income or own contribution, retail lending with LTV ratio above 80 %, etc) 50-100 % of the capital requirement under Pillar I. Lending to debtors resident in a country with lower sovereign credit rating than Hungary Capital calculated on the basis of specific method determined by the Supervisory Authority

6. 6 HFSA actions after the Lehman shock Case of property investment funds – suspension and change repurchase rules from T+3 to T+90 days Daily liquidity reporting requirement, daily supervisory evaluation of the liquidity and general situation of largest banks (two ad-hoc working group) Asking commitment declaration from the parent banks of largest Hungarian subsidiary bank Supervisory VaR model for FX risk calculation under the SREP risky portfolio Annex

7. 7 New metodology for forcasting and managing institution level crises – the decision-making model Identification of the critical risk factors by supervised sectors according to the risk menu of HFSA Five levels of evaluation (low, modest, significant, high,incurred) by risk categories General evaluation of the institution (weighted avarage) Supervisory measures linked to given levels

8. 8 EnvironmentCorporate governanceMarket presence Business processes and capital Sectors  Demand  Asset markets  Service provider market  Product and sales competition  Retail customers  Institutional customers  Legal and regulatory environment Ownership  Structure of ownership  Governance and control  Owners’ relations Products  The products and services of the institution Financial and operational risks *  Credit risk  Market risk  Operational risk  Liquidity risk  Insurance risk Strategy  Institutional strategy  Reputation  Market position Internal governance  Corporate structure, organisation  Structure of management system, management and supervision functions  Publicity and transparency Customers  Marketing, customer acquisition  Customer information  Complaint management Capital and earnings  Capital adequacy  Reserves  Earnings Internal control system  Risk management system  Compliance  Internal audit Fraud management  Detection of frauds committed against customers  Detection of money laundering  Insider trading, market influencing, violation of company acquisition rules, detection of unlicensed activities

9. 9 Example: Classification Levels of Liquidity Risk Low:  Determinant refinancing by owners;  High ratio of stable funds to the balance sheet total  Negligible mismatch between the maturity of assets and liabilities;  Planned and well predictable cash-flow;  Minimal differences in content between the composition of cash outflows and cash inflows; High volume of existing reserves;  High ratio of liquid assets.

10. 10 Moderate:  Significant refinancing by owners;  Comforting ratio of stable funds to the balance sheet total  Insignificant mismatch between the maturity of assets and liabilities;  Well predictable cash flow;  Limited differences in content between the composition of cash outflows and cash inflows;  The proportion of products with guaranteed returns is not significant;  Portfolio concentrations are not typical;  High volume of existing reserves;  Adequate ratio of liquid assets.

11. 11 Significant:  Significant refinancing by owners;  Ratio of stable funds to the balance sheet total is modest;  Significant mismatch between the maturity profiles of assets and liabilities;  Cash-flow difficult to predict;  Large differences in content between the composition of cash outflows and cash inflows;  Products with guaranteed returns are typical;  Portfolio concentrations;  Satisfactory volume of existing reserves;  Modest ratio of liquid assets.

12. 12 High:  Significant refinancing by owners;  Ratio of stable funds to the balance sheet total is low  Large mismatch between the maturity of assets and liabilities;  Cash-flow is not planned and difficult to estimate;  Significant transfers in maturities, short-term liabilities used to fund long-term assets;  Dominance of products with guaranteed returns;  Concentrated liabilities, large single deposits;  High volume of existing reserves;  Insignificant ratio of liquid assets.

13. 13 Supervisory measures linked to given levels Six levels of measures defined related to the previous classification of risk levels (low, moderate, significant, high, incurred) 0 simple access to information 1 intense obtain of information 2 encourage to find a solution 3 enforce the decreasing of given risk level, penalties, retaliative actions 4 direct intervention 5 crisis management

14. 14 2. level (moderate) – Encourage to find a solution Sending of Management/Supervisory letter, Obligation: deadline must be defined, Financial recovery plan, Prudential meeting, Prohibition of behaviour against national law

15. 15 5. Level (incurred)–Crisis management  Appointed supervisory commissionaire  Exercise of voting rights suspended  Transfer of assets required  Withdrawal of licence  Withdrawal of authorization  Liquidation procedure opened  Procedure of winding-up initiated

16. 16 Regulatory answers to the crisis 1. Act CIV. of 2008 on strengthening the financial stability: Two major tools: governmental guarantee, state capital increase Temporary It is renewed half-yearly on Commission’s approval Renewal is applicable only for state capital increase Stronger remedial powers have been granted to the HFSA in 2009: thresholds for the mandatory appointment of a supervisory commissioner have been defined, more precise responsibility rules for commissioners, restriction of carrying out whole institutions’ or sectors’ activities

17. 17 Regulatory answers to the crisis 2. Change the status of HFSA Establishment of Financial Stability Board

18. 18 Regulatory answers to the crisis 3. Draft of a comprihensive banking resolution framework: Preconditions are clearly stated by law (non- cooperative, sytematically important credit institutions) Tasks and responsibilities of authorities are also well defined Two main tools: P&A transaction and bridge bank solution Expropriation some of shareholders’ rights - compensation