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MNB: bank sector still resilient to shock, but risks remain

The shock-absorbing capacity of Hungarian banks “continues to be robust,” but sustainable profitability is low, the National Bank of Hungary (MNB) says in its biannual Financial Stability Report released Thursday, identifying the still high ratio of variable-rate loans and overheating on the Budapest housing market among risks.

The MNB says that banksʼ capital adequacy ratios indicate strong solvency, while the sectorʼs liquidity coverage ratio is also well above the regulatory requirements. According to stress tests, the report adds, the sector could meet those requirements even in the case of a severely adverse macroeconomic scenario.

Banksʼ corporate loans outstanding rose by 14% and their retail loans rose by more than 7% last year. The MNBʼs report stresses that “the favourable economic environment and the wide range of regulatory instruments ensure that credit growth is occurring in a balanced and sustainable way.”

As to the risks involved in the high share of variable-rate loans, the report admits that in the retail segment “there is only limited room for maneuver in reducing the interest rate risk on a market basis on account of the high costs of refinancing, the inappropriate financial awareness of borrowers, and the large share of those debtors who are not creditworthy.”

This, MTI notes, explains an MNB recommendation to banks to make the most affected customers specific offers to convert their loans into fixed-rate ones.

In the corporate loan segment, the share of fixed-rate loans has increased again for longer maturities, thanks to the Funding for Growth Scheme Fix (FGS Fix), the report notes. Here, the central bank says it expects to make the sector more resilient to crises and diversify its funding via its recently announced Bond Funding for Growth Scheme (BGS).

Risk of overheating on housing market

Meanwhile, the risk of overheating on the Budapest housing market has increased, the report notes. Property prices in the capital rose 22.9% in the 12 months to the end of 2018, and were up 153% compared to the trough in the current housing market cycle at the end of 2013.

Nevertheless, the MNB says that “a potential housing market shock would be less likely to create a negative, self-reinforcing spiral between the banking system and the housing market” since price increases were not coupled with a considerable rise in the share of risky loans with a high loan-to-value ratio (LTV).

The proportion of mortgage loans with an LTV of over 70% relative to banks’ own funds is at a fraction of pre-crisis levels, both in terms of outstanding loans and new contracts, the report notes.

The MNB also notes that property prices have hardly recovered in parts of the country, where selling a property does not typically offer a way out of default for delinquent mortgage debtors. The extension of the governmentʼs CSOK home purchase subsidy system to villages could support the property market in such areas, the report adds.

The MNB notes that profits of the banking system have dropped from the extremes of the previous year, when, similar to recent years, the sector was boosted by the release of write-downs.

“The write-back of earlier reserves concealed the fact that banksʼ structural profits are considerably lower than in the past two years,” the report observes, adding that banks should further improve cost effectiveness, take cost-cutting measures, and expand credit to increase sustainable profitability.

Risk of euro area slowdown

The external macroeconomic environment has remained uncertain, the MNB notes. Although expectations for rising interest rates in developed countries have lessened - and so, too, the risk of capital flight from developing countries - the reports warns that “the risks entailed by the low interest rate environment (over-indebtedness, asset price bubbles, less room for central bank stimulus) have become more pronounced.”

The greatest external risk is the substantial slowdown of growth in the euro area, specifically Germany, the report says, though adding that “the Hungarian economy is more resilient to shocks than before due to its strengthening fundamentals.”

The full report can be read in English here, and in Hungarian here.