Report on Financial StabilityNovember 2013

Financial stability heat map

2

Prociklikusság Sokkellenálló-képesség

May 2013

May 2013November 2013

November 2013

Procyclicality Shock-absorbing capacity

Key messages of the Report on Financial Stability

1. The contraction in corporate lending is expected to halt in the coming years, in which the Funding for Growth Scheme play a dominant role.

• Sustained recovery in lending will require further easing of credit conditions on the supply side.

• Some of the activities of deleveraging large banks may be taken over by smaller banking market participants. This, however, will require improving the capital position and funding capacity of those institutions

2. The indebtedness of households in foreign currency poses significant financial stability risks, thus its management is in the interests of all parties.

• The most important duty is the elimination of exchange rate risk.

• The rules of transparent pricing should be mandatory in the case of outstanding mortgage loans.

• It should be considered to cap the interest margin above the benchmark rate on mortgage loans in order to limit the interest risk of households.

3. The domestic banking sector is marked by persistently weak profitability outlook, which may prompt some banks to revise their market strategies.

• This may lead to the consolidation of the market, whereby smaller banks and cooperative credit institutions may boost significantly their market share; while the entry of new participants cannot be ruled out either.

3

Key risk and their mitigation measures I.

Key risk:

1. Deteriorating investor sentiment undermines the growth outlook

2. Domestic banking sector does not support economic growth through lending

2.1. Credit market problems in lending to the corporate sector, particularly in SME lending

2.2. High interest margins on loans to households

4

Risk mitigation measures:

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

2.1. The second phase of the Funding for Growth Scheme is expected to lead to a further improvement in SMEs’ access to credit at favourable interest conditions.

2.2.1. The rules of transparent pricing should be extended bindingly to cover outstanding mortgage loans.

2.2.2. Maximising the interest margin on mortgage loans, even on outstanding ones.

Key risk and their mitigation measures II.

Key risk:3. Households’ unhedged foreign currency

exposure may speed up the deterioration in portfolio quality

4. The high share of non-performing loans is leading to profitability problems and impedes bank lending

4.1. Ratio of non-performing corporate loans continues to rise

4.2. In the household sector, the high share of non-performing household mortgage loans poses a risk

5

Risk mitigation measures:3. Adjusting the exchange rate cap scheme so that the

exchange rate risk is mitigated more than previously or completely for households without a natural hedge.

4.1. Speeding up the process of portfolio cleaning, which could be facilitated by regulatory measures and/or incentives as well.

4.2. Introducing the institution of family bankruptcy as soon as possible would help manage non-performing portfolios,, while ensuring a ‘clean-sheet’ for overindebted customers.

Key risk and their mitigation measures III.

Key risk:5. Banks’ profitability remains persistently

low

5.1. Competitive disadvantage in access to external funding

5.2. Market consolidation accompanied by stronger deleveraging

6

Risk mitigation measures:

5.1.1. The FGS has helped ease financing constraints by providing access to cheap central bank funding.

5.1.2. Foreign currency funding is ensured in large part under Pillar 3 of the FGS without an increase in swap market exposure.

5.2.1. Paying increased attention to banks’ resilience in issues affecting the banking sector.

5.2.2. Strengthening participants (smaller-sized banks, cooperative credit institutions) which could partially replace larger-sized credit institutions even over short run.

Lending developments

The drop in corporate lending occured at large banks, while their role in new lending remains dominant

Annual growth rate of and cumulative changes in corporate loans by types of

institutions

8

Quarterly volumes and annual average of loans granted to corporations broken

down by lenders

Source: MNB.

0

100

200

300

400

500

600

700

800

900

1,000

1,100

0

100

200

300

400

500

600

700

800

900

1,000

1,100

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

2013

Q1

Q2

HUF BnHUF Bn

Large banks Other domestic banksForeign branches Cooperative credit institutionsAnnual average

*

Note: (*) annualised average.Source: MNB.

-12

-10

-8

-6

-4

-2

0

2

4

6

-3,000-2,750-2,500-2,250-2,000-1,750-1,500-1,250-1,000

-750-500-250

0250500

2009

Q1

Q2

Q3

Q4

2010

Q1

Q2

Q3

Q4

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

2013

Q1

Q2

per centHUF Bn

Large banks Other domestic banksForeign branches Cooperative credit institutionsFinancial enterprises Growth rate, YoY (right-hand scale)

Policy rate cuts translate into more favourable SME lending rate, but only for a narrow range of companies

Pricing of new corporate HUF loans in Hungary and the MNB’s policy interest rate

9Source: MNB.

0

2

4

6

8

10

12

14

16

0

2

4

6

8

10

12

14

16Ja

n 20

05M

aySe

pJa

n 20

06M

aySe

pJa

n 20

07M

aySe

pJa

n 20

08M

aySe

pJa

n 20

09M

aySe

pJa

n 20

10M

aySe

pJa

n 20

11M

aySe

pJa

n 20

12M

aySe

pJa

n 20

13M

ay

per centper cent

Margin on policy interest rateInterest rate on new corporate loans up to 1 million EURPolicy interest rate of MNB

Owing to the FGS the interest burden of SME-s has eased significantly both for new and refinanced loans

Fall in interest rate on loans refinanced in Pillars I and II

10

Source: MNB.

3.4 3.3

1.2

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Investment loans Working capital loans

percentage point

percentage point

Pillar I Pillar II

The FGS has significantly improved the credit availability of the SME segment

Loans disbursed under the FGS by size of business

11

(*): Including loans granted to pre-finance EU financial support.Source: MNB.

Micro enterprises Small enterprisesMedium

enterprisesTotal sum

Contracts HUF Bn Contracts HUF Bn Contracts HUF Bn Contracts HUF Bn

Sum 4,554 214 3,596 226 1,694 261 9,844 701

New loans 3,159 84 2,053 99 752 107 5,964 290

Investment* 2,145 66 1,133 54 401 56 3,679 176

Working capital 1,014 18 920 45 351 51 2,285 114

Redemption 1,395 130 1,543 127 942 154 3,880 411

Pillar I 536 26 976 66 655 90 2,167 182

Pillar II 859 104 567 61 287 64 1,713 229

Due to the FGS, corporate loans outstanding have increased substantially for the first time since the onset of the financial crisis

Quarterly net changes of loans outstanding and annual growth rate

12

Source: MNB.

-25

-20

-15

-10

-5

0

5

10

15

20

25

-500

-400

-300

-200

-100

0

100

200

300

400

500

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

2013

Q1

Q2

Q3

per centHUF Bn

Corporates - net flowSME - net flowCorporates - annual growth rate (right-hand scale)SME - growth rate (right-hand scale)

Given the success of the FGS, the Monetary Council decided to continue the programme

Comparison of the first and second phases of the Funding for Growth Scheme

13

Source: MNB.

FGS - first phase FGS - second phase

Refinancing interest rate 0 percent 0 per cent

Maximum spread 2.5 percentage point 2.5 percentage point

Time window

4 months

J une 2013 - September

2013

15 months

October 2013 - December

2014

Allocated sum425 billions (I. pillar)

325 billions (II. pillar)

Initially 500 billions, can be

extended to the maximum

of 2,000 billions HUF

Form of allocation"in accordance with rules

of card dealing""first come first serve"

Estimated effect on GDP 0.2-0.5 per centIn the first period: 0.2-0.4

per cent

The contraction in corporate lending will stop, while rebound is already expected in SME lending this year

Forecast for lending to non-financial corporate segment

Forecast for lending to SMEs

14

Source: MNB. Source: MNB.

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

2013

Q1

Q2

Q3

Q4

2014

Q1

Q2

Q3

Q4

2015

Q1

Q2

Q3

Q4

per centper cent

Actual Forecast - J une Forecast - Sept

-8

-6

-4

-2

0

2

4

6

8

10

-8

-6

-4

-2

0

2

4

6

8

10

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

2013

Q1

Q2

Q3

Q4

2014

Q1

Q2

Q3

Q4

2015

Q1

Q2

Q3

Q4

per centper cent

Actual Forecast - J une Forecast - Sept

Sustained recovery in lending requires further easing of large banks’ credit conditions, however part of the market may be taken over by small- and medium size banks and credit cooperatives

• The lending capacity of the small- and medium size banks amounts to HUF 450 bn, which is 7 and 12 per cent of total corporate loans and SME loans outstanding, respectively.

• Given that liquidity constraints are binding here, the FGS means additional buffer.

• The lending capacity of credit cooperatives amounts to HUF 450 bn, which is 6 and 10 per cent of total corporate loans and SME loans outstanding, respectively.

• Given that capital constraints are binding here, the planned capital injection may improve markedly the lending capacity.

15

Portfolio quality

The corporate NPL-ratio of the banking sector is expected to peak

Ratio of non-performing loans and cost of provisioning in the corporate segment

17

Source: MNB.

0

5

10

15

20

25

0

1

2

3

4

5

2007

Q2

2008

Q2

2009

Q2

2010

Q2

2011

Q2

2012

Q2

2013

Q2

2014

Q2

2015

Q2

per centper cent

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

Due to one off effects the household NPL-ratio of the banking sector has risen substantially

Share of non-performing household loans of the banking sector by contracts

18

Source: MNB.

0

2

4

6

8

10

12

14

16

18

20

0

2

4

6

8

10

12

14

16

18

20

2010

Q1

Q2

Q3

Q4

2011

Q1

Q2

Q3

Q4

2012

Q1

Q2

Q3

Q4

2013

Q1

Q2

per centper cent

30-90 days delinquency 90+ days delinquency ratio

Indebtedness in foreign currency concerns large part of households, thus a solution is in the interests of all parties

Household loans of the banking sector and branches broken down by currencies and products

19

Source: MNB.

Total Subsidized Market

Amount

(HUF bn) 6,633 5,377 3,298 882 2,416 2,079 1,256

Contracts

(thousand) 5,687 1,030 673 243 431 357 4,605

Amount

(HUF bn) 2,789 1,878 1,485 882 604 393 911

Contracts

(thousand) 4,822 584 450 243 208 134 4,237

Amount

(HUF bn) 3,844 3,498 1,812 0 1,812 1,686 345

Contracts

(thousand) 865 446 223 0 223 222 368

FX

Housing loans Home

equity

loans

Other

loans

Tota

lHUF

TotatMortgage

loans

In the rise of debt servicing burdens, besides the appreciation of the CHF, the increase of lending rates exceeding the rise in risk premia play a dominant role as well

Average estimated cost of foreign funds and the average interest margin on outstanding of Swiss

franc mortgage loans

HUF/CHF exchange rate

20

Source: MNB. Source: MNB.

140

160

180

200

220

240

260

140

160

180

200

220

240

260

Jan-

07Ap

r-07

Jul-

07O

ct-0

7Ja

n-08

Apr-

08Ju

l-08

Oct

-08

Jan-

09Ap

r-09

Jul-

09O

ct-0

9Ja

n-10

Apr-

10Ju

l-10

Oct

-10

Jan-

11Ap

r-11

Jul-

11O

ct-1

1Ja

n-12

Apr-

12Ju

l-12

Oct

-12

Jan-

13Ap

r-13

0

1

2

3

4

5

6

7

8

9

10

0

1

2

3

4

5

6

7

8

9

10

Jan-

07 Mar

May Ju

lSe

pN

ovJa

n-08 Mar

May Ju

lSe

pN

ovJa

n-09 Mar

May Ju

lSe

pN

ovJa

n-10 Mar

May Ju

lSe

pN

ovJa

n-11 Mar

May Ju

lSe

pN

ovJa

n-12 Mar

May Ju

lSe

pN

ovJa

n-13 Mar

May Ju

l

per centper cent

Estimated cost of foreign fundsInterest margin on outstanding loansAPR of outstanding loans

The debt servicing burden has reached critical levels in the case of low income households

Debt service burden of households by denomination in proportion of disposable

income

Payment-to-income ratio of indebted households by income deciles

21

Source: MNB. Source: GfK, MNB.

0123456789101112131415

0123456789

101112131415

2003

Q1

Q3

2004

Q1

Q3

2005

Q1

Q3

2006

Q1

Q3

2007

Q1

Q3

2008

Q1

Q3

2009

Q1

Q3

2010

Q1

Q3

2011

Q1

Q3

2012

Q1

Q3

2013

Q1

per centper cent

Principal payments - FX Interest payments - FXPrincipal payments - HUF Interest payments - HUF

0

5

10

15

20

25

30

35

40

45

0

5

10

15

20

25

30

35

40

45

1 2 3 4 5 6 7 8 9 10 Mean

per centper cent

Payment to income (obligation) Payment to income (paid)

The participation rate in the exchange rate cap scheme is below our expectations, thus default risk remains elevated

Utilisation of the exchange rate cap

22

Reasons for not entering the exchange rate cap scheme

Source: MNB. Source: GfK, MNB.

Increase in payment after

scheme(30 per cent)

Low confidence in

banks(20 per cent)

Do not need it(6per cent)

Did not know about the scheme

(3per cent)

Waiting for a more

favourable programme

(25 per cent)

Short remaining maturity

(2per cent)Not eligible

(14 per cent)

0

10

20

30

40

50

60

70

0

200

400

600

800

1,000

1,200

1,400

Jun-

12 Jul

Aug

Sep

Oct

Nov

Dec

Jan-

13 Feb

Mar

Apr

May

Jun

per centHUF Bn

Stock within the exchange rate cap scheme

Percentage of eligible loans (right-hand scale)

In the case of non-performing loans, increased activity of the NET (National Asset Management Agency) and the expeditious introduction of the private bankruptcy may be the solutions

Non-performing household loans of the banking sector broken down by currencies and products

23

Source: MNB.

Total

outstanding

Mortgage

loans

Housing

loans

Home equity

loans

Other

loans

NPL

(HUF Bn)1,092 900 407 493 192

NPL

(Thousand

contracts)

747 120 627

NPL ratio

(per cent)17.7 18.0 12.9 26.7 16.6

NPL

(HUF Bn)328 191 113 77 138

NPL

(Thousand

contracts)

593 42 552

NPL ratio

(per cent)12.8 10.9 7.9 24.0 16.9

NPL

(HUF Bn)764 709 293 416 54

NPL

(Thousand

contracts)

154 79 75

NPL ratio

(per cent)21.2 21.8 17.0 27.2 15.9

FXTot

alHUF

An improvement is expected in the household segment over the forecast horizon

Ratio of non-performing loans and cost of provisioning in the household segment

24Source: MNB.

0

3

6

9

12

15

18

21

0

1

2

3

4

5

6

7

2007 Q2

2008 Q2

2009 Q2

2010 Q2

2011 Q2

2012 Q2

2013 Q2

2014 Q2

2015 Q2

per centper cent

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

Profitability

The profitability of the Hungarian banking sector remains severely low in international comparison

Pre-tax profit/loss of the banking sector and branches

26

Profit after tax ROE in international comparison

Source: MNB.

Note: The chart depicts the 46–60, 20–80 percentile value of the member states' banking systems together with the Hungarian banking systems' ROE.Source: ECB CBD.

-250

-150

-50

50

150

250

350

-250

-150

-50

50

150

250

350

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep

Oct

Nov

Dec

HUF BnHUF Bn

2009 2010 2011 2012 2013

-15

-10

-5

0

5

10

15

20

25

30

-15

-10

-5

0

5

10

15

20

25

30

2007 2008 2009 2010 2011 2012

Hungary

per cent per cent

The persistently subdued profitability may lead to the exit of some major foreign-owned banks

Relationship between the invested capital of selected groups of institutions and the present equity capital and dividends disbursed

Note: between 1997 and June 2013, amounts calculated not at present value. Invested capital means the initial equity capital and the capital increases carried out in the period under review.

27Source: MNB.

-6,000

-4,500

-3,000

-1,500

0

1,500

3,000

4,500

6,000

-6,000

-4,500

-3,000

-1,500

0

1,500

3,000

4,500

6,000

Foreign owned large banks

Small and medium sized banks

Cooperatives

EURmillionEURmillion

Invested capital (reverse scale) Dividend Own capital "Profit"

The consolidation may be slowed down by the high ratio of parent bank funding

Role of foreign and parent funding in the banking sector

28Source: MNB.

0

10

20

30

40

50

60

70

80

90

0

5

10

15

20

25

30

35

40

45Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Mar

-08

Jun

Sep

Dec

Mar

-09

Jun

Sep

Dec

Mar

-10

Jun

Sep

Dec

Mar

-11

Jun

Sep

Dec

Mar

-12

Jun

Sep

Dec

Mar

-13

Jun

per centEUR Bn

Foreign - longFoeign - shortParent bank funds/ foreign funds - banking system (RHS)Parent bank funds/ foreign funds - banks with foreign ownership (RHS)

Stress test results

The liquidity stress test indicates strong resilience, but only in HUF

Liquidity Stress Index and banks’ liquidity surplus or deficit relative to the regulatory level in the stress scenario

Note: The LSI is the sum of normalised liquidity deficits relative to the 10 per cent regulatory limit, weighted by the balance sheet total. The higher the value of the index, the higher the liquidity risk in the stress scenario.

30Source: MNB.

-90

-75

-60

-45

-30

-15

0

15

30

45

60

75

-2,400

-2,000

-1,600

-1,200

-800

-400

0

400

800

1,200

1,600

2,000

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-

13M

arM

ay

per centHUF Bn

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

Increasing, but still manageable capital need in the stress scenario

31

Source: MNB.

Stress test result with the 8 per cent regulatory capital adequacy ratio

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 1 33 116

Capital buffer of banks above

8 percent CAR (HUF Bn)1,386 1,594 1,104 1,108

Total capital buffer (HUF Bn) 1,386 1,593 1,071 992

There has been only a slight change in the Solvency Stress Index since our last Report

Solvency Stress Index, capital buffer and need along the stress scenario

32Source: MNB.

-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

2013

Q1

Q2

per centHUF Bn

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

Thank you for your attention!