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Hungary financial system stable, but lending activity remains weak

The Hungarian financial system is stable and its ability to absorb adverse shocks is adequate, however, the lending activity of Hungarian banks remains weak, the National Bank of Hungary said in its fresh Stability Report.

From a financial stability perspective, the most important challenge is to remove credit supply constraints to boost lending and to improve the maturity structure of banks' balance sheets, according to the Monetary Council's statement on financial stability.

The Council said weak lending curbs economic recovery and makes it vulnerable.

Lending capacity can be strengthened if banks manage their non-performing loans more efficiently and if the bank levy, which is high by international standards, is reduced.

Hungarian banks are facing two key challenges: managing the existing non-performing loans and preserving their further increase.

The current practice of loan-loss provisioning may encourage banks to restructure loans expected to become non-performing over and over again before the grace period expires. Through multiple restructurings, i.e. by continually extending grace periods, banks have a regulatory arbitrage for lower loan-loss provisioning, resulting in an artificial improvement in profitability, which generates latent risks, the Council warned. Therefore, the existing regulation for loan-loss provisioning should be reviewed.

In 2010, the profitability of the Hungarian banking sector was one of the lowest in central and Eastern Europe, which reduces the capacity of banks to lend and eventually curbs economic recovery, the Council said.

The activity of the Hungarian financial system is funded by liabilities of shortening maturities. The maturity of external funding has been shortening at the fastest pace in the region. The process has adverse feedback effect on banks' activity and ultimately, on financial stability. The authorities responsible for financial stability should consider remedial regulatory steps to reduce the size of the maturity mismatch and to mitigate the related risks, the Monetary Council said.