Report on Financial Stability May 2013 21 May 2013.

Report on Financial Stability

May 2013

21 May 2013

2

Financial stability heat map

Source: MNB.

Procyclicality Shock-absorbing capacity

November 2012

November 2012

May 2013May 2013

• Credit conditions: The banking system is still barely supporting the economy.

Owing to the low willingness to lend, the banking system is strongly pro-cyclical in corporate lending, which impedes access to credit particularly for SMEs reliant on bank funding.

• Resilience to shocks: The increase in capital need under stress is manageable due to the proven commitment of parent banks.

LIQUIDITY: Liquidity risks remain low, based on stress test results as well. At the same time, most of the liquidity reserves denominated in HUF; therefore, in a protracted stress situation the smooth functioning of the FX swap market is indispensable.

CAPITAL: Capital position has improved on aggregate level. However, given the worse initial capital position at some banks, the solvency stress test indicates higher capital need. Taking into account the parent bank commitment this amount can be considered manageable.

Overall assessment I. – Banking sector remains strongly pro-cyclical

3

4

Overall assessment II. – Key risk and mitigation measures

Key risks: Risk mitigation measures:

1. Protracted euro-area sovereign debt crisis

1.  Maintaining prudent fiscal policy and supporting sustainable economic growth in Hungary remain a priority to mitigate the impact of potential adverse shocks from the euro area.

2. Vulnerabilities of the domestic economy

2.1.Credit supply constraints on companies, particularly on SMEs

2.1. The first pillar of the Funding for Growth Scheme (FGS) may improve access to credit with favourable interest conditions for SMEs.

2.2.Exchange rate exposure of companies without natural hedging

2.2. The second pillar of the Funding for Growth Scheme is aimed at converting foreign currency loans of SMEs into forint loans.

2.3.Reliance on external funding, of which a high share is short-term financing

2.3. The third pillar of the Funding for Growth Scheme will reduce the country’s external debt and extend its maturity.

3. Deterioration in portfolio quality

3.1.High share of non-performing loans in the domestic banking sector

3.1. The planned introduction of the personal bankruptcy process could help the management of non-performing loans, while at the same time allowing over-indebted customers to start with a ‘clean sheet’.

3.2.Risk of surge in new defaults 3.2.1. Increasing participation in the exchange rate cap scheme could slow the deterioration in household portfolio quality.

3.2.2. The first and second pillars of the FGS may contribute to an improvement in SME loan portfolio quality.

4. Lack of competition among banks in mortgage lending

4.1. Expedient to cut the regulatory maximum of the early repayment fee to 1–1.5 per cent in the case of refinancing from another bank.

4.2. In agreement with the proposal of the Hungarian Competition Authority, the possibility of bank switching in the case of government subsidies should be examined.

4.3. It may be justified to reduce the maximum amount of notary fees, which are charged not by competing and not even by public bodies, as such fees represent a significant disincentive in the case of refinancing.

4.4. Most mortgage loans are tied to other products (predominantly current accounts); therefore, the switching of current accounts should be facilitated.

4.5. The entry of participants should be promoted which would help households to seek the most favourable offers.

Credit conditions

5

6

The banking sector does not support the real economy

Source: MNB.

Note: The annual growth in the FCI shows the contribution of the financial intermediary system (banking sector) to the annual growth rate of real GDP.

Financial Conditions Index (FCI) and real GDP growth

-10

-8

-6

-4

-2

0

2

4

6

-10

-8

-6

-4

-2

0

2

4

6

2006

I. II. III.

IV.

2007

I. II. III.

IV.

2008

I. II. III.

IV.

2009

I. II. III.

IV.

2010

I. II. III.

IV.

2011

I. II. III.

IV.

2012

I. II. III.

IV.

per centper cent

FCI - banking system FCI - aggregate Real GDP

7

Domestic corporate lending has been steadily contracting since the onset of the crisis

Source: MNB.

Net quarterly change in domestic loans to corporate sector

-15

-10

-5

0

5

10

15

20

25

-300

-200

-100

0

100

200

300

400

50020

05 Q

1Q

2Q

3Q

420

06 Q

1Q

2Q

3Q

420

07 Q

1Q

2Q

3Q

420

08 Q

1Q

2Q

3Q

420

09 Q

1Q

2Q

3Q

420

10 Q

1Q

2Q

3Q

420

11 Q

1Q

2Q

3Q

420

12 Q

1Q

2Q

3Q

4

per centHUF Bn

Long-term bank loans Short-term bank loansLong-term nonbank loans Short-term nonbank loansAnnual growth rate (right-hand scale)

8

Both demand and supply factors contributed to the contraction in corporate lending

Source: MNB.

Decomposition of the cumulative decline in corporate lending into supply and demand effects (relative to 2008 Q3)

-25

-20

-15

-10

-5

0

5

-25

-20

-15

-10

-5

0

520

08 Q

4

2009

Q1

Q2

Q3

Q4

2010

Q1

Q2

Q3

Q4

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

percentage point

percentage point

Demand effect Supply effect

9

The monetary easing cycle has a positive impact on price conditions in corporate lending…

Source: MNB.

Interest rate of corporate loans and the MNB policy rate

0

2

4

6

8

10

12

14

0

2

4

6

8

10

12

14

Jan-

08M

arM

ay Jul

Sep

Nov

Jan-

09M

arM

ay Jul

Sep

Nov

Jan-

10M

arM

ay Jul

Sep

Nov

Jan-

11M

arM

ay Jul

Sep

Nov

Jan-

12M

arM

ay Jul

Sep

Nov

Jan-

13

per centper cent

HUF - new lending HUF - outstanding MNB policy rate(monthly average)

EUR - new lending EUR - outstanding

10

…hence corporate credit forecast was modified upwards

Source: MNB estimation.

Credit forecast to NFCs along different scenarios

-12

-10

-8

-6

-4

-12

-10

-8

-6

-4

2010

Q1

Q2

Q3

Q4

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

2013

Q1

Q2

Q3

Q4

per centper cent

ActualBaseline scenario (with FGS)Inflation Report - March 2013Baseline scenario excluding rate cuts (with FGS)

11

As opposed to corporate lending, demand factors remain the key driver in household

lending

Source: MNB.

Net quarterly change in domestic loans to household sector

-72-64-56-48-40-32-24-16-80816243240

-900-800-700-600-500-400-300-200-100

0100200300400500

2005

Q1

Q2

Q3

Q4

2006

Q1

Q2

Q3

Q4

2007

Q1

Q2

Q3

Q4

2008

Q1

Q2

Q3

Q4

2009

Q1

Q2

Q3

Q4

2010

Q1

Q2

Q3

Q4

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

per centHUF Bn

Bank loans - HUF Bank loans - FXNonbank loans - HUF Nonbank loans - FXAnnual growth rate (right-hand scale)

12

The trend of plummeting new lending continued last year

Source: MNB.

New loan volumes of credit institutions to household sector

0

50

100

150

200

250

300

350

400

450

500

550

600

0

50

100

150

200

250

300

350

400

450

500

550

600

2005

Q1

Q2

Q3

Q4

2006

Q1

Q2

Q3

Q4

2007

Q1

Q2

Q3

Q4

2008

Q1

Q2

Q3

Q4

2009

Q1

Q2

Q3

Q4

2010

Q1

Q2

Q3

Q4

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

HUF BnHUF Bn

Mortgage loans Other loans Refinancing for early repayments

Resilience to shocks

13

14

In the low level of the System-Wide Financial Stress Index (SWFSI), benign market

conditions are reflected

Source: MNB.

Note: Higher level denotes higher stress.

System-Wide Financial Stress Index (SWFSI)

-0.4-0.3-0.2-0.10.00.10.20.30.40.50.60.70.80.91.0

-0.4-0.3-0.2-0.10.00.10.20.30.40.50.60.70.80.91.0

Jan-

07M

ar-0

7Ju

n-07

Sep-

07Nov

-07

Feb-

08M

ay-0

8Ju

l-08

Oct

-08

Jan-

09Ap

r-09

Jun-

09Se

p-09

Dec

-09

Feb-

10M

ay-1

0Au

g-10

Oct

-10

Jan-

11Ap

r-11

Jun-

11Se

p-11

Dec

-11

Mar

-12

May

-12

Aug-

12Nov

-12

Jan-

13Ap

r-13

SWFSI Correlation contribution

15

The stress scenario of liquidity stress test

Source: MNB.

Note: The liquidity stress test is 30-day forward looking.

Assets Liabilities

ItemDegree (per

cent)

Currencies

affectedItem

Degree (per

cent)

Currencies

affected

Default on interbank

assets20 HUF

Withdrawals in

household deposits10 HUF/ FX

Exchange rate shock on

swaps15 FX

Withdrawals in

corporate deposits15 HUF/ FX

Depreciation of assets

eligible at the central

bank

10 HUF

16

The Liquidity Stress Index (LSI) indicates low level of liquidity risk

Source: MNB.

Note: The ratio is the liquidity need to 10 percent of balance sheet total weighted by balance sheet total. Higher ratio denotes higher liquidity risk along the stress scenario.

Liquidity Stess Index, liquidity surplus and need of banks relative to the regulatory minimum

-125

-100

-75

-50

-25

0

25

50

75

-2,500

-2,000

-1,500

-1,000

-500

0

500

1,000

1,500

Jan-

09 Mar

May Ju

lSe

pNov

Jan-

10 Mar

May Ju

lSe

pNov

Jan-

11 Mar

May Ju

lSe

pNov

Jan-

12 Mar

May Ju

lSe

pNov

per centHUF Bn

Liquidity need to meet the regulatory requirementLiquidity buffer above the regulatory requirementLiquidity Stress Index (right-hand scale)

17

The scenarios of the solvency stress test

• Over the 8 quarter forecast horizon beginning end-2012, the shock hits in 2013 Q2.

• Our baseline scenario is the forecast of the Report on Inflation 2013 Q1.

• Our stress scenario relative to our baseline scenario:

4.3 percentage points lower GDP growth;

15 per cent deprecation of HUF;

300 basis points risk premium shock;

10 per cent drop in house prices.

• Along the stress scenario we accounted for additional loan loss provisioning on outstanding non-performing loans as in a markedly deteriorating economic environment their recovery rate falls.

• As regards the exchange rate cap scheme, we assumed 50 per cent participation ratio both along the baseline and the stress scenario.

• The postponement of halving the bank levy and the pass-through of the entire financial transaction tax are taken into account.

18

The impact of key risks on the banking sector profitability in the stress test on 2-year

forecast horizon

Source: MNB.

Baseline scenario Stress scenario

Loan losses on corporate and household

portfolio498 875

Loan losses on new non-performing corporate

loans264 382

Loan losses on new non-performing household

loans234 368

Additional loan losses on the already non-

performing loans125

Loan losses on local government portfolio 10 23

Exchange rate risk of open position -63

Interest rate risk 60

Bank levy 234 234

Interest cost of the exchange rate cap scheme 28 45

Main components of losses of banking

system in eight quarter horizon (HUF

Bn)

19

In the baseline scenario no additional capital is needed, however along the stress scenario

several banks need capital injection

Source: MNB.

Baseline scenario Stress scenario

End of

first year

End of

second year

End of

first year

End of

second year

Capital need of banks (HUF Bn) 0 0 6 62

Capital buffer of banks above

8 percent CAR (HUF Bn)1,331 1,518 969 889

Total capital buffer (HUF Bn) 1,331 1,518 963 827

20

The Solvency Stress Index (SSI) shows an increasing, but still manageable capital need

Source: MNB.

Note: The indicator is the sum of normalised capital shortages relative to the 8 per cent level, weighted by the capital requirement. The higher the value of the index, the higher the solvency risk in the stress scenario.

Stress test index, capital buffer and need in stress scenario at the end of 8 quarter horizon

-10

0

10

20

30

40

-300

0

300

600

900

1,200

2005

Q1

Q2

Q3

Q4

2006

Q1

Q2

Q3

Q4

2007

Q1

Q2

Q3

Q4

2008

Q1

Q2

Q3

Q4

2009

Q1

Q2

Q3

Q4

2010

Q1

Q2

Q3

Q4

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

per centHUF Bn

Capital buffer above the regulatory requirementCapital need to meet regulatory requirementSolvency Stress Index (right-hand scale)

Key risks and mitigation measures

21

1. Protracted euro-area sovereign debt crisis.

2. Despite the recovery from the technical recession the vulnerabilities of the domestic economy are still present.

• Credit supply constraints on companies, particularly on SMEs

• Exchange rate exposure of companies without natural hedging

• Reliance on external funding, of which a high share is short-term financing

3. The banking sector is heavily burdened by the high share of non-performing, which will rise further based on our forecasts.

4. Lack of competition among banks is causing welfare losses and real economic costs.

22

Key risks

• Protracted euro-area sovereign debt crisis. Several „peripheral countries” are compelled to implement stricter fiscal

consolidation. In some of the core countries, meaningful austerity measures will be

implemented as well. Significant deterioration in the economic outlook of the euro area, while

investor sentiment might remain volatile.

• Owing to high funding costs and deteriorating portfolio quality the profitability outlook of European banks is weak.

• Worsening economic outlook weighs on banks’ balance-sheet.• In several peripheral countries banking systems need substantial capital

injections.

Risks in the external environment

23

24

Credit supply constraints hit the SME sector more severely

Change in new lending to corporations and its decomposition by corporate size

Source: CCIS, MNB estimation.

2007 2011 TotalDemand effect

Supply effect

Micro 1,730 828 - 52.2 - 61.7 9.5 Small 1,120 999 - 10.8 28.5 - 39.3

Medium 1,160 785 - 32.4 - 4.7 - 27.7 Large 1,460 1,250 - 14.4 - 49.3 34.9 Total corporate sector

5,740 3,862 - 29.5 - 14.3 - 15.2

Volume of new lendings (HUF Bn)

Change from 2007 to 2011 (per cent)

25

Exchange rate exposure of SMEs without natural hedge poses a significant risk

Source: CCIS, MNB estimation.

Distribution of exchange rate depreciation of individual contracts (by end-2012)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

-8 0 8 16 24 32 40 48 56 64 72

per centper cent

Frequency of exchange rate depreciation

Exchange rate movement (%)

26

The first two pillars of the MNB Funding for Growth Scheme (FGS) are aimed at reversing contraction in lending and reducing exchange

rate exposure of SMEs

Source: MNB.

Growth rate of domestic loans to corporate sector

Corporate sector total SME segment

-12

-10

-8

-6

-4

-2

0

2

4

6

-12

-10

-8

-6

-4

-2

0

2

4

6

2010

Q1 Q2

Q3

Q4

2011

Q1 Q2

Q3

Q4

2012

Q1 Q2

Q3

Q4

2013

Q1 Q2

Q3

Q4

2014

Q1 Q2

Q3

Q4

2015

Q1

per centper cent

Actual Baseline scenario

March 2013 Optimistic scenario

-12

-10

-8

-6

-4

-2

0

2

4

6

-12

-10

-8

-6

-4

-2

0

2

4

6

2010

Q1 Q2

Q3

Q4

2011

Q1 Q2

Q3

Q4

2012

Q1 Q2

Q3

Q4

2013

Q1 Q2

Q3

Q4

2014

Q1 Q2

Q3

Q4

2015

Q1

per centper cent

Actual Baseline scenario

March 2013 Optimistic scenario

27

The third pillar of the FGS accelerates the decrease in short-term external funds without

any deleveragingForeign funds of the banking system and the loan-to-deposit ratio

Source: MNB.

20

40

60

80

100

120

140

160

180

0

5

10

15

20

25

30

35

40Ju

n-10

Aug

Oct

Dec

Feb-

11 Apr

Jun

Aug

Oct

Dec

Feb-

12 Apr

Jun

Aug

Oct

Dec

Feb-

13 Apr

Jun

Aug

Oct

Dec

Feb-

14 Apr

Jun

Aug

Oct

Dec

per centEUR Bn

Foreign fundsBaseline scenarioGross loan-to-deposit ratio (right-hand scale)Net loan-to-deposit ratio (right-hand scale)

28

The third pillar of the FGS is aimed at rationalising the debt structure and reducing

the costs of MNB• The reduction of short term external funds translates into lower level of

foreign exchange reserves and MNB bills outstanding

• Without higher vulnerability

• The effects of MNB swaps on the banking system balance sheet:

• Changes in the consolidated balance sheet of the general government, in case the reduction of short term external funds is achieved with the cooperation of the Debt Management Agency

Change in the banking system's stylized balance sheetLiquid HUF assets EquityExternal assets External debtLoans Deposits

Change in the consolidated stylized balance sheet of the general government

MNB FX reserves MNB securitiesOther assets Other central bank liabilities

FX securitiesHUF securities

29

Banks remain reliant on external funding even in the case of loan-to-deposit ratio decreasing

under 100 per cent

Source: MNB.

Schematic balance sheet of the banking sector at a 100 per cent loan-to-deposit ratio

0

10

20

30

40

50

60

70

80

90

100

0

10

20

30

40

50

60

70

80

90

100

Assets Liabilities

EUR BnEUR Bn

Loans to private sector

Deposits and securities of the private

sector

External liabilities

External assets

MNB-bill

Government bonds

Equity

30

Managing deteriorating portfolio quaility remains a key challenge

Ratio of non-performing loans and cost of provisioning

Source: MNB.

Corporate sector Household sector

0

5

10

15

20

25

30

0

1

2

3

4

5

6

2007 2008 2009 2010 2011 2012 2013 2014

per centper cent

Loan loss provisioningLoan loss provisioning - forecastNon-performing loan ratio (right-hand scale)

0

3

6

9

12

15

18

21

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 2014

per centper cent

Loan loss provisioningLoan losses related to the early repayment schemeLoan loss provisioning - forecastNon-performing loan ratio (right-hand scale)

31

In the corporate segment the I. and II. pillars of the FGS, while in the household portfolio the planned introduction of personal bankruptcy

may improve portfolio quality

Source: MNB.

The planned personal bankruptcy procedure

Eligible

Permanent repayment

procedure

Fulfilment of the

agreement

The debtor fails to meet the

repayments

The debtor meets

the repayments

The

procedure

ceases

The debtor gets a "clean record"

Monitoring the eligibility

criteriaThe procedure

ceasesNot eligible

Strive to come to an

agreement with the creditors

No agreement, or the debtor

fails to meet the agreement Agreement

32

Increasing participation in the exchange rate cap scheme would have a benign effect on

household portfolio quaility

Source: MNB.

Participation in the exchange rate cap

0

5

10

15

20

25

30

35

40

45

0

150

300

450

600

750

900

1,050

1,200

1,350

Jan-

12 Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan-

13 Feb

per centHUF Bn

Outstanding amount

Percentage of eligible FX-denominated mortgage loans (right-hand scale)

33

Banks are striving for offsetting high costs through raising net interest income

Net interest income to interest bearing assets

Net interest income to total assets (June 2012 – consolidated data)

Source: ECB CBD, MNB.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Ger

man

y

Belg

ium

Ital

y

Aust

ria

Lith

uani

a

Latv

ia

Slov

enia

Pola

nd

Czec

h Re

publ

ic

Esto

nia

Slov

akia

Bulg

aria

Rom

ania

Hun

gary

per centper cent

2.5

2.6

2.7

2.8

2.9

3.0

3.1

3.2

3.3

3.4

3.5

0

100

200

300

400

500

600

700

800

900

1,000

Jan

-09

Mar

May Ju

lSe

pNo

vJa

n-1

0M

arM

ay Jul

Sep

Nov

Jan

-11

Mar

May Ju

lSe

pNo

vJa

n-1

2M

arM

ay Jul

Sep

Nov

per centBn HUF

12-month rolling net interest income

Net interest income as a propotion of the gross interest-bearing assets (right-hand scale)Net interest income as a propotion of the net interest-bearing assets (right-hand scale)

34

Market failures in pricing should be managed by enhancing competition

• Expedient to cut the regulatory maximum of the early repayment fee to 1–1.5 per cent in the case of refinancing from another bank.

• In agreement with the proposal of the Hungarian Competition Authority, the possibility of bank switching in the case of government subsidies should be examined.

• It may be justified to reduce the maximum amount of notary fees, which are charged not by competing and not even by public bodies, as such fees represent a significant disincentive in the case of refinancing.

• Most mortgage loans are tied to other products (predominantly current accounts); therefore, the switching of current accounts should be facilitated.

• The entry of participants should be promoted which would help households to seek the most favourable offers.

Thank you for the attention!

35