The rate-setting Monetary Council of the National Bank of Hungary said the country's banking system is stable and resilient, but noted its ability to support growth had weakened in an assessment of the central bank's regular Stability Report published on Thursday.
"In the Council's judgment, the Hungarian financial intermediary system continues to be stable and has strong resilience to shocks; however, its ability to support economic growth has been weakening," the Council said.
The Council noted several risks as well as mitigating measures in its assessment of the report.
It said strong deleveraging in the eurozone banking sector and the weak ability of domestic banks to draw capital had resulted in a continued or accelerated outflow of external funds in regional comparison.
It warned that the high reliance of the banking sector on the FX swap market created "significant vulnerability" as liquidity buffers could shrink because of a weaker forint, growing maturity mismatches could result from the substitution of external funds for short-term FX swap exposure, and central bank intervention against FX swap market turbulence could lower foreign exchange reserves. The Council said it would explore the possibility of introducing a new macroprudential regulatory instruments to deal with the matter.
The Council said a further deterioration in the quality of banks' corporate lending portfolios could significantly weaken the banking sector's lending capacity. The non-performing loan portfolio diverts funds for new lending and does not create income, it explained. The Council said such loans should be recovered or their removal from the portfolio should be accelerated.
The Council said a reduced willingness to lend still contributed to credit supply constraints, but added that deteriorating lending capacity, particularly from the considerations it noted, raises the risk of a credit crunch, mainly in the corporate sector.
The Council said it was important to restore the profitability of the domestic banking sector, adding that a reduction in the bank levy, "the absence of one-off profitability shocks" and lower risk costs could offset a fall in performing loans resulting from an early repayment scheme for foreign currency-denominated mortgages.
Under the early repayment scheme, which ran from the end of last September until the end of February, borrowers could repay their forex mortgages in full with an exchange rate discount provided at lenders' expense.
The Council said reaching an agreement on precautionary financial assistance Hungary is seeking from the International Monetary Fund and the European Union as soon as possible was "crucial". Such an agreement would cause Hungary's risk premium to fall, lowering funding costs for the state and the banking sector, it said.
"[An agreement] would also facilitate orderly deleveraging in the banking sector, and, as a result, a decline in net external debt, at lower real economic costs. The latter could be underpinned by parent bank commitments associated with the agreement between the Government and the EU and IMF," the Council said.
MNB director Márton Nagy said that the go-ahead for the start of official talks with the IMF and the EU this week changed the market environment for the better, but the main findings of the report, closed on April 10, still hold.
The problem is not on the capital but rather on the liquidity front, Nagy said. He called the current situation a "credit squeeze", which prevents part of replacement of capacity-amortization or additional investments from materializing, thus moderately reducing potential GDP.
But there is a growing danger of a credit crunch, especially in which even viable companies go bankrupt because of a lack of financing, thus severely reducing available capacities and thus potential GDP, he warned.
Parent banks injected a combined €1.2 billion capital into their Hungarian units between the end of 2011 and the beginning of 2012, Nagy said. This raised the capital adequacy ratio of banks, he added.
The banking system as a whole would need only HUF 27 billion in additional capital this year and HUF 83 billion in 2013 in case of a severe shock, the latest stress test carried out by the MNB showed. The HUF 83 billion figure is well under the HUF 196 billion in the previous test carried out last November and the HUF 300 billion calculated in April 2009.
Still, external funding of the Hungarian banking system have fallen at a rapid, accelerating rate since June 2010, contracting by one-third or €12 billion over one and a half years. The rapid outflow is not merely a consequence but more and more a cause of banks’ deteriorating capacity to lend, Nagy said.
An agreement with the IMF/EU is not just a safety net, but could confirm foreign parent banks’ commitment via their units here, he said. He noted that parent banks promised late in 2008 as part of the Vienna Initiative to keep their funding to Hungarian units at 95% of levels in September 2008 levels as long as Hungary’s previous agreement with the IMF/EU remained in effect.
Another main risk in the banking sector is the rapidly growing FX swap stock. Any decision on a new regulatory instrument to limit the possibility of a sudden jump in the stock of FX swaps will be made after exploring the likely effects. Nagy noted that the MNB can introduce a measure because amended legislation gave it the right to issue decrees related to macroprudential regulation in four areas from January. It can issue decrees to halt excessive lending, to mitigate system-wide liquidity risk, to create anticyclic capital buffers and to require additional capital requirement of banks deemed of systemic importance. The Monetary Council takes decisions on these decrees.