XI. Financial Markets in Hungary
Author: Ms. Rachel Elkan
Language:
English
Keywords:
OP; enterprise; deficit; bank-issued securities; recapitalization program; banking sector; bank privatization; bank securities; Commercial banks; Loans; Bank credit; Foreign banks; Global
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Abstract

Ten years after the initiation of reforms, Hungary has in place much of the infrastructure necessary for an efficient financial system that is well integrated with world capital markets. While the bulk of the legislative reform and institution-building were undertaken early on, the successful implementation of the 1995–97 macroeconomic stabilization program had a significant impact on the development of domestic financial markets. It contributed to a sharp increase in financial activity and improvements in the soundness of financial institutions. However, the financial system remains dominated by the banking sector: although activity in the domestic securities markets has accelerated rapidly, primarily in response to greater foreign participation, the size of the market for corporate debt securities remains limited.

Ten years after the initiation of reforms, Hungary has in place much of the infrastructure necessary for an efficient financial system that is well integrated with world capital markets. While the bulk of the legislative reform and institution-building were undertaken early on, the successful implementation of the 1995–97 macroeconomic stabilization program had a significant impact on the development of domestic financial markets. It contributed to a sharp increase in financial activity and improvements in the soundness of financial institutions. However, the financial system remains dominated by the banking sector: although activity in the domestic securities markets has accelerated rapidly, primarily in response to greater foreign participation, the size of the market for corporate debt securities remains limited.

This chapter discusses recent developments in Hungary’s financial markets. Reflecting the dominant role of the banking sector, the discussion focuses primarily on that sector. The chapter then reviews developments in the securities markets and considers the effect of recent reforms on the future development of nonbank institutions. It also examines factors that may have held back development and competition in some areas.

The Banking System

A remarkable transformation has taken place in the banking sector since the establishment of the two-tier banking system in 1987. Burdened by an inheritance of nonperforming loans, and coupled with inadequate prudential regulations and lax supervision, the health of large state-owned banks deteriorated further in the early 1990s following the output decline that accompanied the transition process. Nonetheless, numerous small (mainly foreign or jointly owned) banks were able to compete successfully in this environment owing to their greater efficiency and the absence of a bad-loan burden, by skimming off the more profitable clients of the state-owned banks. Against this background, a costly series of state-financed operations were undertaken during 1992–94 to reduce the volume of nonperforming loans and to recapitalize the large state-owned banks. This chapter focuses on developments in the banking sector since the implementation of the consolidation and recapitalization programs, which laid the foundation for the recent extensive privatization of the banking sector.1

Structural Changes in Bank Lending and Deposits

Financial innovation, capital market liberalization, and the heavy tax burden on banking activities (including through reserve requirements) have contributed to a number of structural changes in the banking sector over the past four years, including a drop in the real level of bank credit and private savings in banks, an increased share of domestic bank credit absorbed by the enterprise sector at the expense of households, and a decline in banks’ maturity transformation ratio.

The most apparent phenomenon affecting the banking system in the last few years was a sharp decline in the intermediation of financial resources. Between 1993 and 1995, bank deposits and bank-issued securities held by the private sector (non-cash M3) declined by 10 percent in real terms (Table 11.1). During the same period, the stock of outstanding discount treasury bills increased from 12 percent of noncash M3 to more than 25 percent of noncash M3. Although some banking sector disintermediation would be expected from the introduction of nonbank-issued financial instruments, disintermediation was hastened by the heavy taxation of banking activities through the imposition of high reserve requirements (which peaked at 17 percent in 1995), coupled with low rates of remuneration (especially on reserves accumulated against forint-denominated deposits). As a result of these regulations, during 1993–95, banks gave up interest of 3–3½ percentage points on their forint liabilities (Figure 11.1). Following the decline in the burden of reserve requirements and the overall improvement in macroeconomic conditions in 1996, deposit-taking activities began to recover, with non-cash M3 rising in real terms by 3½ percent. It is still premature to assess whether this increase marks a change in trend. In early 1997, bank deposits declined sharply once again, but this reflected bank-specific problems faced by Postabank, the second largest deposit-taking institution in Hungary. More recent data show that by mid-1997, real noncash M3 had recovered to its end-1996 level (in seasonally adjusted terms).

Table 11.1.

Banking Sector Liabilities

(In percent; end of period)

article image
Sources: National Bank of Hungary, Monthly Report, various editions; data provided by the National Bank of Hungary; and IMF staff calculations.

Enterprise foreign exchange deposits increased temporarily in December 1995 owing to the privatization of MATAV.

Figure 11.1.
Figure 11.1.

Opportunity Cost of Reserve Requirements 1

Sources: National Bank of Hungary, Monthly Bulletin; and IMF staff calculations.1 Reserve ratio times the difference between the yield on a three-month treasury bill and the remuneration rate on mandatory reserves held against forint-denominated liabilities.

The deceleration in deposits was particularly strong for enterprise deposits, possibly reflecting the wider array of assets available to enterprises. Between 1993 and 1996, corporate deposits fell by 20 percent in real terms.2 In contrast, real household savings held in banks increased slightly during this period, as the domestic banking system maintained its position as the primary depository for household financial savings (Table 11.2). This was due in part to the regional monopolies held by the National Savings Bank and the 250 savings cooperatives, and to the relatively high per unit transaction cost associated with purchases of government paper.3

Table 11.2.

Household Financial Savings

(End of period)

article image
Sources: National Bank of Hungary, Monthly Report, various editions; and IMF staff calculations.

As to the currency composition of bank deposits, the share of household savings at banks denominated in foreign currency increased from 22 percent at the end of 1993 to 30 percent at the end of 1995, as households attempted to preserve the real value of their savings in the context of accelerating inflation and foreign interest differentials that discouraged forint saving. Moreover, the share of corporate deposits held in foreign exchange increased sharply in 1995 as enterprises were permitted (from April 1995) to retain their export proceeds in bank deposits, thereby avoiding the surrender requirement. The proportion of household and enterprise deposits held in foreign exchange has, however, declined since the end of 1995 (to about 26 percent at mid-1997), reflecting the growing credibility of the crawling peg exchange system and (in the case of households) the relaxation of controls on the purchase of foreign exchange.

The contraction in bank deposits was mirrored by a decline in real bank credit (Table 11.3). This fall initially affected both credit to the government and to the private sector. During 1993–96, credit to the corporate sector contracted by more than 15 percent.

Table 11.3.

Bank Credit to the Nonbank Sector

(End of period)

article image
Sources: National Bank of Hungary, Monthly Report, various editions; data provided by the National Bank of Hungary; and IMF staff calculations.

Including banks’ holdings of government securities.

This contraction occurred in the context of capital account liberalization and was triggered by the large intermediation spreads of domestic banks (Figure 11.2), which made foreign financing relatively cheap. This tendency was reinforced in 1995 with the reversal of the foreign interest differential following the introduction of the crawling peg exchange regime (Figure 2.3 in Chapter II), which made borrowing in foreign exchange relatively cheaper. As a result of these factors, and the strong presence of foreign companies in Hungary, the share of corporate credit source abroad increased from 24 percent in 1993 to 44 percent in 1995 (Figure 11.3).4 With the decline in domestic bank intermediation spreads in 1996 and the recovery in real activity, domestic bank lending to enterprises recovered rapidly, particularly during 1997. As a result, the share of corporate credit in total bank credit rose from 47 percent in 1993 to 51 percent in 1996, and to almost 60 percent at mid-1997. As to households, their share of bank credit declined slowly from 15 percent to 8½ percent, reflecting limited provision of mortgage financing following the termination of the state-subsidized housing loan scheme in 1991. The establishment in 1997 of the first mortgage lending institution is expected to relieve the credit constraints facing the household sector.

Figure 11.2.
Figure 11.2.

Intermediation Spread 1

(Three-month moving overage)

Source: National Bank of Hungary, Monthly Bulletin.1 On loans and deposits of less than one year.2 Weighted average of all loans and deposits.3 Budapest Bank, Hungarian Credit Bank, Credit and Commercial Bank, and Foreign Trade Bank.
Figure 11.3.
Figure 11.3.

Composition of Corporate Credit

(In percent)

Source: National Bank of Hungary.

Maturity transformation by banks declined over the past four years. Less than 29 percent of short-term enterprise and household deposits and bank securities were transformed into loans in excess of one year in 1996, down from 39 percent in 1993. This may reflect improvements in banks’ lending practices, which have reduced the tendency for “automatic” long-term lending to unviable enterprises. In addition, banks’ ability to assess the creditworthiness of potential clients—especially start-up firms—may not be fully developed yet, leading to greater caution in extending long-term credits. Finally, uncertainty about the pace of disinflation may have discouraged banks from locking-in long-term interest rates on loans when the majority of deposits are short term.

Market Structure, Competition, and Specialization

Despite several mergers and license revocations, the number of banks operating in Hungary declined only slightly from 43 in 1993 to 42 at present.5 Seven of these banks have a market share (measured in terms of total assets) in excess of 4 percent, and 10 banks have a market share between 1 percent and 4 percent. Five of the seven large banks are remnants of the monobanking system, which was disbanded in 1987.6

Market concentration in Hungary’s banking system continued to decline over the past four years, with the market share of the seven large banks falling from nearly 80 percent in 1993 to 70 percent in 1996. The main beneficiaries were the medium-sized banks, which have seen their market share expand by 8 percentage points to more than 19 percent of total assets. Concentration, however, remains more significant on the deposit market, particularly for retail deposits: the large retail banks (notably OTP and Posta-bank) still account for more than 80 percent of household deposits, largely reflecting their continued branch monopoly in the regions of the country.7 As a result of this liquidity segmentation, these banks (particularly OTP) retain their systemic position as the major source of funds for the interbank market, while the large commercial banks remain the main borrowers in the market. Nevertheless, improved access to foreign credit by Hungarian banks has tended to weaken commercial banks’ reliance on OTP.

The increase in foreign ownership of the banking system—especially of medium-sized banks (see next section)—has led to heightened competition in corporate banking. Large commercial banks (including the recently privatized banks) have seen their share of corporate loans decline by nearly 10 percentage points between 1993 and 1996, to 62 percent, whereas the proportion of corporate loans provided by medium-sized banks has risen by the same amount to 27 percent. Competition among banks for elite corporate clients (including multinationals and large Hungarian firms) has been active, leading to a sharp drop in intermediation spreads from over 9 percent at the end of 1993 to about 4 percent at the end of 1996 (Figure 11.2).8 Spreads at large commercial banks have consistently remained above those at other banks reflecting, inter alia, a less aggressive approach to attracting corporate clients and higher operating costs. More recently, however, the margin between spreads at large commercial banks and other banks has narrowed considerably, which could reflect a more forceful approach to competition by banks’ new foreign owners. Moreover, increased competition has contributed to a greater pass-through of changes in money market rates to lending rates in all banks.9

Ownership Structure and Privatization

Over the past four years, foreign ownership in Hungary’s banking sector increased substantially. While the number of foreign or jointly owned banks rose from 28 in 1993 to only 31 in 1996 (out of a total of 42 banks), the share of bank assets under foreign or joint ownership increased from less than one-third to over three-fourths, reflecting the privatization of several large state-owned banks. Moreover, the share of foreign ownership in registered capital exceeded 55 percent in June 1997, up from 12 percent in 1993, and is expected to reach about 70 percent by the end of 1997.10

The increase in foreign ownership is attributable to several factors: privatization of state-owned banks to foreign owners; exit of Hungarian-owned banks and establishment of new foreign-owned financial institutions in Hungary; and foreign banks raising their equity capital at a faster rate than Hungarian-owned banks. With respect to the first factor, privatization of majority stakes in the large and medium commercial banks was carried out through strategic foreign investors in order to raise banking efficiency and to meet internationally based prudential regulations, and is the most important contribution to the increase in foreign ownership.11 As a result, nearly two-fifths of bank capital is currently held by foreign banks (as opposed to foreign institutional investors).12 Foreign investors were attracted to Hungary’s commercial banks to meet the demand for banking services from foreign firms operating there, to establish a platform for operations in the region, and to tap the underdeveloped retail banking market. The relatively rapid increase in equity in foreign-owned banks is due in part to the requirement in several of the privatization agreements that foreign strategic owners inject new capital into the banks.13

Bank Soundness and Profitability

The quality of banks’ portfolios improved substantially over the past four years. While in 1993,28 ½ percent of loans were classified as problematic and more than 13 percent were classified as bad, at the end of 1996, these ratios had fallen to 11½ percent and 3 percent, respectively (Table 11.4).14 Several factors contributed to this turnaround. First, bank recapitalization and loan consolidation schemes carried out in 1993–94 replaced banks’ nonperforming loans with government paper and injected sufficient capital to enable banks to fully provision against, and subsequently write off a large part of their problem loans.15 Second, foreign owners instituted more prudent lending practices, and state-owned banks were required to implement restructuring programs to participate in the recapitalization schemes.16 Third, increased profitability in the enterprise sector improved the outlook for corporate loans.

Table 11.4.

Quality of Banks’ Loan Portfolios1

(In percent of total loans)

article image
Sources: National Bank of Hungary; and IMF staff calculations.

From December 1993, includes savings cooperatives.

Prior to loan consolidation.

After loan consolidation.

According to 1991 classification rules.

According to 1993 classification rules.

Reflecting the improvement in loan quality, banks at present are required to hold fewer specific risk provisions.17 As a result, at the end of 1996, the level of banks’ specific provisions declined to 3½ percent of total loans (one-third of classified loans), from 15 percent of total loans (one-half of classified loans) at the end of 1993. However, while the current level of risk provisions satisfies minimum prudential requirements, it falls short of the upper bound of existing provisioning requirements (see footnote 17) by about 14 percent of classified loans.18

In contrast to their management of specific risk, Hungarian banks have tended to adopt a more cautious approach to systemic risk, holding general reserves well in excess of the level required to achieve the minimum mandated 8 percent risk-weighted capital adequacy ratio (CAR). Moreover, the average CAR has continued to increase steadily, rising from 11½ percent in 1993 to nearly 19 percent in 1996. Reflecting the impact of bank recapitalization, the CARs of large banks almost doubled in 1994 from below the minimum required level. Small and medium-sized banks have tended to maintain higher-than-average CARs.

Several factors explain the tendency to maintain CARs in excess of the minimum required level. First, the 8 percent “Basle Capital Accord” rule may not be sufficient in transition and developing countries, which have less stable macroeconomic environments. Second, according to the Bank of International Settlement’s (BIS) accounting rules, government paper is accorded a zero-risk weighting. However, large commercial banks, in particular, hold a large stock of long-term, fairly illiquid government paper that they acquired during the bank recapitalization program. Owing to the relative illiquidity of these assets, a higher risk weighting could be applied, thereby lowering the effective CAR. Moreover, with the decline in yields on government paper, in the near future, banks may choose to switch their assets to corporate loans (this trend is already apparent in the first half of 1997), which carry a 100 percent risk weighting, again tending to lower CARs. Third, banks require a large amount of capital to finance their risky expansion into the retail sector.

The profitability of the banking system improved markedly during 1993–96, after-tax profits increased to 1½ percent of total assets from a loss of more than 6 percent (Table 11.5). The turnaround in profitability was due primarily to improvements in loan quality: the cost of accumulating specific provisions within a given year declined by more than 7 percent of total assets, while net revenues from reducing previously accumulated provisions rose by 1 percent of total assets. In contrast, the contribution from net interest income was quite modest overall. Prior to 1996, however, growth in interest income outpaced that of the income base (also a reflection of improvements in loan quality). More recently, increased competition contributed to an erosion in intermediation spreads and a decline in the net interest earnings ratio.

Table 11.5.

Banks’ Profit Accounts

(As percentage of average total assets)

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Sources: National Bank of Hungary, Annual Report, various editions; and IMF staff calculations.

Despite the increase in private sector ownership and anticipated productivity improvements, the costs of banking operations have shown little improvement. The ratio of operating costs to net interest income and revenues from fees and commissions remained about 50 percent in 1993–95, and increased to 56 percent in 1996, while operating costs have risen continuously as a share of total assets, in both state-owned and private banks. The persistence of high cost ratios comes despite a 7 percent reduction in financial services employment between 1994 and 1996, and reflects the tendency for relatively high wage increases in the financial sector (relative to the rest of the economy). In addition, cost increases also reflect the improvement in the quality and the increase in the range of services offered by banks. Large up-front expenditures on much-needed technology upgrading and the installation of a network of automated teller machines also reduced profitability, but these costs should be recoverable through future productivity improvements. A major element in banks’ costs in 1996 was the extension of branch networks. However, this extension will be sustainable only if the demand for banking services rises sufficiently to match the increased supply.

Bank Supervision

Against a background of improved portfolio quality and greater bank profitability, supervision of the banking system suffered from several shortcomings prior to the adoption of the new Banking Law on January 1, 1997. The deficiencies of the previous system were due primarily to the fractured nature of supervision and to a severe shortage of resources. Under the previous system, responsibility for bank supervision was divided somewhat arbitrarily between the State Banking Supervision (SBS) Agency and the National Bank of Hungary. Moreover, the securities operations of banks’ subsidiaries were supervised by a separate agency, thereby precluding a consolidated approach to the supervision of financial institutions. These problems have been remedied under the new Banking Law by merging the two supervisory bodies to form a unified agency capable of supervising a universal-type banking system. The supervisory responsibilities of the National Bank of Hungary have been restricted to those areas related to the operation of monetary policy and the foreign exchange system. Banking supervision also suffered from a serious shortage of qualified technical staff, owing to insufficient revenues from fees collected from banks and the fact that employees were covered by the civil service pay scale. As a result, staff turnover was extremely high as employees of the SBS left for better-paying jobs in private financial institutions: thus, although faced with a staff ceiling of 120, the average number of staff at the SBS in 1994 was only 101. In addition, owing to inadequate funding, the SBS was unable to contract sufficiently with external auditors to fully compensate for its own staff shortage. As a result, bank audits were carried out infrequently, and on an ad hoc basis, with many banks never having undergone a comprehensive audit.

The new Banking Law addresses these problems by exempting staff of the supervision agency from the civil service pay scale—thereby enabling the agency to match private sector salaries—and raises the fees the agency levies on banks. In addition, the staff ceiling was raised to 260. Concurrent with the improvement in funding, the new law requires the supervision agency to perform continuous off-site inspections and to undertake on-site examinations of each bank and savings cooperative at least once every other year. These changes, however, are quite recent, and thus their effectiveness has yet to be fully tested in the field.

Exchange Activity and Growth of Institutional Investors

The activity of the Budapest Stock and Commodities Exchanges, while still limited, has developed rapidly in the last few years, partly because of the increased importance of institutional investors.

The Budapest Stock Exchange (BSE) reopened in June 1990, trading exclusively in shares until the listing of government bonds and treasury bills in 1992. Following several years of stagnation, activity on the BSE was extremely heavy in 1996, with the volume of spot trading increasing by more than 350 percent during the year (Figure 11.4). Turnover of equities increased by 460 percent, while government securities (bonds and treasury bills) trading rose by nearly 300 percent. Underlying this performance was a sharp increase in foreign interest in the domestic securities following Hungary’s admission to the OECD in mid-1996 and the upgrading of Hungary’s international credit rating by several rating agencies. As a result, foreign investors account for 70–80 percent of the total turnover on the BSE.

Figure 11.4.
Figure 11.4.

Activity on the Budapest Stock Exchange

Source: Bloomberg Financial Markets.1 Volume of spot trading at market prices, deflated by the consumer price index.

While retaining its dominant position on the BSE, the share of trades accounted for by government debt declined to 54 percent in 1996 from 63 percent in 1995.19 This was due in part to the continued decline in the interest premium on forint-denominated debt, and the growing importance of over-the-counter (OTC) trading in government securities.20 Reflecting the lengthening of the maturity structure of public debt and the introduction of indexed debt, the weight of government bonds in trading increased at the expense of treasury bills.

Equities accounted for 42 percent of BSE trades in 1996, up from 34 percent in the previous year, and market capitalization of shares more than doubled from 6 percent of GDP in 1995 to about 13 percent of GDP.21 While some of this was due to new listings (including the privatization through public offerings on the exchange of several strategic companies), the increase in capitalization reflected primarily an increase in prices. As a result, the Budapest Stock Exchange index (BUX)—which measures the performance of the top 22 shares ranked by market capitalization—increased by 170 percent in 1996 and by 133 percent in U.S. dollar terms, making the BSE the third best-performing stock market in the world (after China and Russia).22 Nonetheless, capitalization remains small in comparison with industrial countries and the market remains thin, with only 45 equities listed on the exchange at the end of 1996 (up from 8 in 1990 and 42 in 1995).

In addition to the more traditional range of commodities, the Budapest Commodity Exchange (BCE) has offered financial contracts since 1993, primarily foreign exchange futures. Activity in these instruments increased more than 30-fold since 1994, following the introduction of the crawling peg exchange regime and the rapid expansion in foreign trade. In addition, while foreigners were not officially permitted to trade in foreign exchange futures prior to January 1997, it is likely that prior to that time, foreign investors in domestic securities nonetheless covered their exchange risk locally through the exchange.23

At the end of 1996, the value of institutional investment reached Ft 360 billion (5½ percent of GDP), up from Ft 210 billion (3¾ percent of GDP) in 1995. Of this, 14 insurance companies accounted for the largest share (about Ft 210 billion), and the majority of their investments were in government securities. Investment funds accounted for Ft 128 billion, of which 55 percent was in open-end funds. Private pension funds accounted for most of the residual (less than ½ percent of GDP). While relative newcomers (the legislative framework for pension funds was established in 1993), the number of these funds has expanded rapidly. The popularity of pension funds, which may be organized on a regional, sectoral, or company basis, has been boosted by the income-tax exemption of this form of saving (since 1993). Following the phasing in, from 1998, of a compulsory fully funded component of the pension system, savings channeled through these funds are expected to increase substantially, with mandatory contributions projected to reach 1.2 percent of GDP in 2000 and 2.3 percent of GDP in 2003.24 Moreover, since the preferential tax treatment of pension funds will remain in place, voluntary contributions to pension funds are also likely to continue to grow.

Concluding Remarks

Over the past four years, the Hungarian financial system has undergone a dramatic transformation. Within the banking system, the heavy burden of nonperforming loans has largely been eliminated, the majority of the sector has been privatized (largely through strategic foreign investors), and competition in corporate banking activities has strengthened. While profitability has improved on average, the banking sector will face a new set of challenges brought on by greater competition. These challenges will arise from the greater inroads into household banking by nontraditional retail banks, the increase in banks’ exposure to more risky segments of the economy in response to the saturation of the market for elite corporate clients, and the greater capital and financial market liberalization agreed to in the context of OECD membership. These changes may well portend some further consolidation in the banking sector within the next few years. Financial liberalization, completion of the privatization process, and reform of the pension system will have substantial effects on other segments of the financial system. The privatization of additional shares in strategic companies through the BSE and the broadening of the range of foreign securities that may be traded within Hungary, together with the start of negotiations on NATO and EU enlargement, can be expected to increase trading on Hungarian exchanges. However, with the further liberalization of outward investment by Hungarians and the completion of privatization, interest in Hungarian securities may well subside over the longer term. Moreover, the gradual liberalization of outward investment by pension funds may also contribute to dampening activity on domestic securities markets.

References

  • Balassa, Ákos, 1996, Restructuring and Recent Situation of the Hungarian Banking System, National Bank of Hungary Workshop Studies, No. 4 (Budapest).

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  • Cottarelli, Carlo, 1997, “Comments on the Paper by György Surányi and János Vincze,” in Moderate Inflation: The Experience of Transition Economies, edited by Carlo Cottarelli and György Szápary (Washington: International Monetary Fund and National Bank of Hungary).

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  • National Bank of Hungary, 1994, “Consolidation of the Hungarian Banking System,” Monthly Report (Budapest: National Bank of Hungary, October).

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  • Világi, Balázs, and János Vincze, 1995, “The Interest Rate Transmission Mechanism in Hungary (1991–94),” paper presented at the conference on Hungary: Towards a Market Economy, held in Budapest on October 20–21, 1995, at the Hungarian Academy of Sciences.

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1

For a more extensive discussion of earlier developments in the banking sector, see Balassa (1996) and National Bank of Hungary (1994).

2

The decline in corporate deposits accelerated sharply in the first half of 1997, as firms drew down their savings to finance their investment needs.

3

The role of banks as a depository for personal savings will be buoyed beginning in 1998, when wages of public sector employees will be transferred automatically to bank accounts.

4

At the end of 1996, nearly one-fourth of foreign credit was due to loans from foreign parent companies to their Hungarian subsidiaries.

5

Reflecting Hungary’s liberal licensing regulations and the initially underbanked nature of the economy, the number of banks in Hungary increased sharply from 20 in 1990 to 35 in 1993. Most of these new institutions were foreign or jointly owned small or medium-sized banks. A new Banking Law, which came into effect on January 1, 1997, tightened regulations for bank licensing and imposed more stringent requirements on the qualifications of bank managers and members of the board. In particular, banks must hold at least Ft 2 billion in registered capital (double the previous minimum requirement that was set in 1991, and whose value has been substantially eroded), and the previous one-step automatic licensing process has been replaced with a two-step application for establishment and operation, which must be approved by the Banking and Capital Markets Supervision Agency.

6

The National Savings Bank (OTP) and the Foreign Trade Bank (MKB) existed under the previous system to collect household savings and to provide foreign-exchange related services, respectively. The other three banks that are remnants of the monobank system were established to assume the commercial banking activities of the National Bank of Hungary. The loan portfolio of the National Bank of Hungary was allocated to these banks on a sectoral basis, with the loans of the Credit and Commercial Bank (K&H) concentrated in agriculture, those of the Hungarian Credit Bank (MHB) concentrated in the chemical and machine-building sectors, and those of Budapest Bank (BB) concentrated in the coal mining and construction sectors. At present, the other two large banks are the retail-based Postabank, established in 1988 with the post office and the Ministry of Finance having the largest stakes, and the National Bank of Hungary and foreign-owned Central-European International Bank (CIB), established in 1979. Until 1997, the CIB operated as an offshore bank and therefore was not strictly part of the domestic banking system.

7

A factor behind the continued dominance of these banks is the relatively high cost of establishing a branch network. While there are no legal restrictions on the establishment of branches by banks already operating in Hungary, the costliness of establishing such a network has so far acted as a constraint on competition. This said, the establishment by nontraditional retail banks of home banking facilities and automated teller machines, which obviate the need for a costly retail network, are expected to undermine the existing regional retail banking monopolies. Competition in the banking sector will be further enhanced from 1998, when foreign-operated offshore banks will be permitted to open branches in Hungary without having to establish expensive local headquarter facilities.

8

Also contributing to the drop in intermediation spreads is the improvement in the quality of loan portfolios (see below), which reduced the need to generate provisions out of net interest income.

9

Cottarelli (1998) finds that in Hungary, the effect on, and subsequent pass-through to, bank lending rates from a change in treasury bill yields is higher in the period since January 1994 than during January 1989 and May 1993. See also Vilagi and Vincze (1995).

10

Owing to the 1993—94 state-financed bank recapitalization program, the share of bank capital owned by the State (defined as the Ministry of Finance, the privatization agency, and the social security funds) rose from 40 percent in 1992 to nearly 70 percent in 1993. With the privatization of the recapitalized banks, this share declined to 33 percent in 1996.

11

Prior to 1995, the State maintained effective control of the five large banks that formed the basis of the domestic financial system. Bank privatization accelerated in 1995, with the privatization of Budapest Bank and the partial sale of OTP. In 1996, privatization of the Foreign Trade Bank was completed and Magyar Hitel Bank was sold. The privatization of a minority share of Kereskedelmi & Hitel (K&H—Credit and Commercial) Bank was concluded in July 1997.

12

In contrast, a minority holding in the National Savings Bank was privatized through public share offerings, primarily to foreign financial investors.

13

The State’s legally mandated permanent shareholding in OTP was reduced from 25 percent plus one vote to a single golden share, following approval of an amendment to the Privatization Law. With the privatization and related equity injection in K&H, the State (as defined in footnote 10) will not hold a majority interest by the end of 1997 in any of the large banks inherited from the monobank system. A capital increase in Postabank in mid-1997 reduced the State’s interest in the bank to 38 percent.

14

Amongbanks that participated in the recapitalization program, the share of loans classified as problematic fell from 40½ percent in 1995 to 30 percent in 1996, with a larger percentage decline in doubtful and bad loans.

15

The amount of government bonds issued to banks by the end of 1994 for recapitalization or to replace their nonperforming loans was equivalent to more than 100 percent of banks’ bad, doubtful, and substandard loans.

16

The effectiveness of these commitments was, however, weakened by the absence of quantitative performance targets, and sanctions for noncompliance. These so-called consolidation agreements were replaced in 1995 with preprivatization plans that corrected the earlier deficiencies.

17

Current regulations require banks to provision against classified loans as follows: 0–10 percent, 11–30 percent, 31–70 percent, and 71–100 percent against their to-be-watched, substandard, doubtful, and bad loans, respectively.

18

In addition, banks are required to provision against their off-balance-sheet items. Owing to the rapid growth in contingent and future liabilities, the size of off-balance-sheet items increased from less than 10 percent of the balance sheet total in 1993 to more than one-fourth in 1996.

19

In contrast, trading in corporate bonds is almost nonexistent on the BSE, and OTC trading is also quite small. While this reflects the added riskiness of corporate debt during the transition period, several blue-chip Hungarian companies have established their credit-worthiness by tapping the international syndicated loan market.

20

About 47 percent of government bonds and 29 percent of treasury bill trades were transacted on the BSE in 1996. In 1995, the volume of government securities traded over the counter was 10 times greater than the volume turned over on the BSE.

21

In comparison, market capitalization of shares in 1996 in the Czech Republic and Poland was 35 percent of GDP and 6 percent of GDP, respectively.

22

The BUX increased rapidly during the first seven months of 1997, although it dropped significantly during the second half of the year, following the worldwide decline in stock prices.

23

Since 1995, the BSE has also offered futures foreign exchange contracts, but the trading volume has remained much smaller than at the BCE.

24

Investment of mandatory pension contributions will be subject to the following restrictions: (1) up to 30 percent may be held in category A stocks listed on the BSE (corresponding to highly liquid stocks in the largest companies); (2) bank-guaranteed domestic bonds may not exceed 20 percent of total assets, while foreign bonds may not exceed 5 percent of assets; and (3) investments in foreign equities issued by firms registered in OECD countries are permitted up to a ceiling of 10 percent until 2000, and 20 percent thereafter. No limits will be placed on holdings of government securities.

Within Same Series

Other IMF Content

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Cover Hungary
Hungary
Economic Policies for Sustainable Growth
Author: International Monetary Fund
ISBN:
9781557757098
ISSN:
0251-6365
Publication Date:
12 Feb 1998
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557757098.084
Pages:
108

Opportunity Cost of Reserve Requirements 1

Intermediation Spread 1

(Three-month moving overage)

Composition of Corporate Credit

(In percent)

Activity on the Budapest Stock Exchange