Hungary early FX repayment scheme can weaken bank system stability, says ECB

The European Central Bank (ECB) on Tuesday said the Hungarian government’s early repayment scheme for borrowers with foreign currency-denominated mortgages can weaken the banking system’s stability and have adverse effects on the economy.

The ECB made the statement in an opinion on recently approved legislation that allows full early repayment of foreign-currency denominated mortgages at fixed exchange rates under market rates.

"The ECB considers that, in allowing borrowers to repay their debt at fixed exchange rates substantially below current market rates, the law creates a situation that can substantially weaken the banking system’s stability and is likely to also have adverse spillover effects on the economy," according to the opinion.

The ECB said the losses the scheme means for lenders could adversely affect banks’ capital position and result in a reallocation of resources by foreign parents to units elsewhere, causing Hungarian banks’ lending capacity to deteriorate in the long term.

In addition to the immediate adverse financial impact on the banking system, the scheme could result in depreciation pressure on the exchange rate, higher country risk premiums, upward pressure on domestic interest rates, weaker growth due to a further fall in lending activity and tighter credit conditions, and deteriorating foreign investor sentiment as a result of an increase in legal uncertainty and perceived country risk, it added.

The scheme could also have a negative impact on public finances because of an increase in Hungary’s risk premium, the ECB said.

The ECB said the scheme "may raise issues of compliance" with the EU tenet of free movement of capital and payments.