Economy 2 November 2011, 5:10pm

Hungary cenbank: What will parent banks do with daughters' losses? (2)

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The attitude of foreign parents towards local subsidiaries amid the expected massive losses will be of crucial importance to Hungary's financial stability risks, researchers at the National Bank of Hungary said in Wednesday's press conference which presented the NBH's latest Financial Stability Report. By this statement, the analysts were alluding to the uncertainty of whether multi-national banks were ready and willing to invest new capital in Hungarian subsidiaries in order to fill the holes created by large-scale losses. If not, another avenue open to the local branches to meet the required capital adequacy level (8%) would be do eliminate a major part of their credit portfolios; however this would further increase the threat of another recession cycle for the national economy.

In the latest Financial Stability Report released on Wednesday, the National Bank of Hungary has once again demonstrated the banking sector's additional capital requirement in a baseline macro and financial scenario vs. a so-called stress scenario. The following table is a summary of the assumptions that the the two macro paths are based on. It is worth noting that at present Hungary's financial sector is facing a situation halfway between the two model scenarios.

Assuming the conditions above, assuming a baseline scenario and 20% participation in the repayment scheme, the researchers project no need of a capital injection for the banking sector, although several banks may end up on the verge of depleting their capital resources. Therefore, unless these banks receive new capital, they cannot be expected to rev up lending activity significantly. Assuming a stress scenario (that is, an escalating Eurozone crisis and a higher debt repayment rate of 30%) as many as about 25% of banks would get dangerously close to the 8% minimum capital adequacy requirement and create a need for capital injections totaling about HUF 200 billion. This calculation does not include the EUR 600 million capital injection plan recently approved by Erste Bank.

The table below draws attention to the dramatic impact of the stress scenario in which banks' capital buffer would melt to just above a third of its current size.

In a brief summary of the stress scenario, NBH Director Márton Nagy said the key question was whether banks (more exactly, their parents) would respond to the need to meet capital adequacy requirements by re-capitalization or by downsizing credit portfolios. It all depends on what parent banks' real objectives are; whether they are just aiming for the required minimum of 8% capital adequacy, or whether they are aiming for higher in order to have surplus capital readily available for future lending, Nagy explained. It is increasingly becoming a concern that parent banks might seek to meet the capital adequacy requirement by scaling back on lending (first of all corporate lending) rather than through capital injections, he noted. The threat is especially real since, as demonstrated by the following table, banks are expected to face significant negative impacts on profitablity, which makes parent banks' (unending) commitment towards subsidiaries in Hungary doubtful.