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Strengthened PSzÁF could help avert another crisis

Ádám Farkas, the former chairman of the Hungarian Financial Supervisory Authority (PSzÁF), resigned shortly after the parliamentary elections, in June 2010, after serving only one year of his six-year term. He is now taking a year off from work, as according to the conflict of interest provisions of the law on the PSzÁF, he cannot take a position at any of the institutions supervised by the authority for one year. He sees this as an opportunity to take some time off and do something other than working. He now spends his days relaxing, traveling and catching up on his reading. He has not stopped giving lectures though, primarily at the Corvinus University of Budapest, where he has been teaching since 1991. And of course he is making plans for the future, but unfortunately these are not yet public. The Budapest Business Journal's reporter asked him, among other things, about his years he spent as head of PSzÁF and about the effect of the recent goverment's measures on the financial sector.

Q: What was your year as the chairman of financial watchdog PSzÁF enough for?

A: We took a few very important steps during that year. The first was in connection with the PSzÁF’s operational independence, as an amendment to the law on PSzÁF introduced during that year strengthened its autonomy, while the governance structure and management of the organization was streamlined and made more transparent. As the PSzÁF’s legal status was changed from being a government agency into a so-called autonomous administrative body, it now answers directly to parliament, thus the government cannot intervene in its activities. I would say that it was the beginning of a process, as this law has changed again since then to further strengthen the PSzÁF’s independency.

The other steps are more of a technical nature, but equally important. We initiated a shift in the PSzÁF’s activities towards more focus on assessing and forecasting risks rather than purely ensuring formal compliance, and we placed a greater emphasis on consumer protection by drawing up a code of conduct in cooperation with the representatives of the banking sector.

In addition, we established the institutional framework for the regular cooperation between the MNB, the PSzÁF and the ministry responsible for the financial sector, by setting up the Financial Stability Council in order to better ensure the stability and the security of the financial system. One of the most important lessons learned from the global crisis was that more effective cooperation between the institutions responsible for economic policy and the supervisory authorities is crucial in preventing a similar downturn.


Q: How did you resign?

A: I resigned after the new parliament accepted and approved PSzÁF’s 2009 annual report with an 88% majority, which has great significance, as this was the first time the PSzÁF reported to Parliament. I do hope that this is going to become a tradition, and that Parliament will continue to exercise control over the PSzÁF.

I resigned because I believe that it is very important for both the financial sector and the PSzÁF to create a cooperative atmosphere and trust between the supervision and the government even if the PSzÁF is formally independent from it. I wanted to provide the new government with the opportunity to decide whether it wished to work with me or someone else. I have to say that the entire handover-takeover process as well as the dialogue with the new chairman was exemplary.


Q: What is your opinion about the latest amendment to the law on PSzÁF?

A: I completely agree with the new legislation. It was another step towards ensuring the PSzÁF’s undisturbed operations and I think that both the supervision and the financial system will benefit from it.

The significance of giving the PSzÁF powers to issue technical regulations is that the watchdog, which has the necessary expertise and oversight, will have a direct competence in working out certain detailed rules affecting the financial system. This has been an old initiative of the watchdog for years.

I cannot yet give an opinion on the new independent financial reconciliation body, as we have to wait and see how it is going to operate and whether it will serve its purpose. The devil is in the details, but I hope that it will help to reduce the number and depth of conflicts between financial institutions and their customers.


Q: Could the PSzÁF more effectively react to another potential crisis, as a result of the recent measures?

A: The recent structural changes have been made to allow PSzÁF to detect problems early and to respond proactively. I think that the current legal framework enables the PSzÁF to act in time, if necessary, to prevent another crisis. Certainly, there is no 100% safety. We cannot rule out bad decisions, or problems at a given sector, country, activity or institution. The question is whether the supervisory authority can detect them in time and manage them without serious damages or without the need to spend billions in taxpayer money.


Q: What are the impacts of the new framework of financial supervision in the EU, which came into effect on January 1?

A: The EU reform has two key elements. One is the launch of the European Systemic Risk Board, which basically identifies and analyzes the systemic risks that could endanger the safety of the entire financial system. For instance, In Hungary such a systemic risk is the much-debated issue of forex lending. If there is a similar development at the European level, then the board will have to deal with it.

The other key element is the establishment of three new European authorities for the supervision of financial activities – for banks, financial markets, insurers and pension funds – as of January. The PSzÁF was a member of their predecessors, namely the three associations of the national authorities for the same sectors. Now, the chairmen of the national authorities will make up the supervisory boards of the new organizations.

In the short run, we expect stronger cooperation between the national authorities primarily in the supervision of international and cross-border institutions. Furthermore, the biggest European banks, which include Hungary’s OTP Bank, will get special attention. Thus, the operations of the Hungarian authority will be more closely followed, and will be fully integrated into the European process.


Q: What do you think about the latest PSzÁF proposal to ease conditions for the conversion to euro-based loans?

A: According to my understanding, the PSzÁF has suggested that lenders make the necessary preparations, meaning technical and procedural requirements, to be able to convert loans denominated in Swiss francs or other currencies to euros under favorable conditions at the request of the borrowers. Under favorable conditions I mean without high one-off conversion costs. While the PSzÁF cannot directly interfere in pricing decisions, it recommends that banks should charge their clients less than or equal to conversion costs, but definitely not more, which, to be frank, was not without precedent. Banks could even benefit from “swallowing” some of the costs due to a drop in their risk premiums, as converting the loans would make repayments more stable and predictable.

We must not forget that a loan conversion always generates an operational procedure at the financial institutions. The bank sector could not handle massive demand for conversions without at least some preparation.


Q: How will the recent government measures affect the financial sector?

A: The general economic environment is unfortunately still not favorable. The quality of loan portfolios is still deteriorating, thus risk costs are still on the rise in both retail and corporate banking, including project financing. This damages banks’ profitability as risk costs reduce their net income as well as their risk appetite. Profitability is very important, as the accumulated capital from profits finances their growth. Without a steady accumulation of capital, owners will have to invest more funds to allow further growth in lending.

I believe that a healthy banking sector that is willing to take reasonable risks is a prerequisite of economic growth. There are signs that the increase of risk premiums might turn around. There are some stronger sectors of the economy, and here I am referring primarily to exporters, which have already regained full access to financing.

When we are talking about economic policy relating to the financial sector, I would like to stress that a predictable business environment is crucial for the banking sector, as it is for others. If there is an extraordinary tax burden, without discussing now whether it is justified or excessive, shareholders of banks should know how long they have to carry it, as it could influence significant business and strategic decisions. If the burden is clearly temporary, they do not need to make potentially negative decisions, such as withdrawing capital or refinancing. In case the burden is intended to remain in place in the long run, they will probably modify their strategy, but at least the rules are clear. Eliminating uncertainties and revealing the government’s true intentions should be a top priority.


Q: What do you think about the independence of the central bank?

A: A conflict between the central bank and the government is not unique and is a natural consequence of the central bank’s primary mandate, which is often unpopular with governments. Generally speaking, it is very important that a central bank, in any country, should be able to freely and independently fulfill its anti-inflationary mandate. Everybody agrees that inflation could seriously hurt an economy, and especially badly affects the poor. There is a consensus everywhere in the world that achieving price stability and keeping inflationary expectations low should be primary objectives for every economic policy maker, and independent central banks have a key role in achieving them. (Gabriella Lovas)







Dr. Ádám Farkas, born in 1968, started his career as a lecturer at the Budapest University of Economics and a financial advisor of the European Bank for Reconstruction and Development. He was the executive director of the National Bank of Hungary (MNB) between 1997 and 2001, and then headed CIB Bank together with co-CEO Ferenc Karvalits for three years. In 2006, he was appointed CEO of the then-newly formed Allianz Bank. He was on a shortlist to become governor of the central bank in 2007.