Economy
Hungary cenbank report: Banks able but unwilling to lend
The NBH's stability report lists several external and internal risks to the functioning of the banking system:
1. Protracted sovereign debt crisis in the eurozone
2. Deteriorating economic growth outlook in Hungary
3. Potentially accelerating outflow of external funds, coupled with high net FX swap exposure
4. Continued deterioration of loan portfolios with a threat of insufficient loan loss coverage
5. Low banking sector profitability due to deteriorating loan portfolios and high taxes
6. Banks have partially offset loan losses by increasing interest rate margins, however this is not sustainable in the long term.
The latest stability report deserves special attention on account of recent trends in the banking sector as well as the new research tools employed by NBH's research team, Director Márton Nagy said on the release of the document. One novel feature of the report are financial stability "heat maps" used to demonstrate banks' shock-absorbing capacity and procyclicality of the financial system. The sector has seen major improvement in terms of shock-absorbing capacity since the April stability report, however the procyclicality of the banking system has increased; that is, the way banks operate has a higher tendency to exacerbate economic recession. These contrasting trends could possibly have arisen from banks' improved lending capacity coupled with a decline in willingness to lend. The latter might be due partly to deteriorating loan portfolio quality and partly to the government's fiscal consolidation measures with a negative impact on banks' profitability.
The culprit: reluctance to lend
A key issue highlighted by the National Bank of Hungary is that while there has been an improvement of shock-absorbing capacity both in terms of liquidity and solvency, willingness to lend has declined especially in corporate banking. The outflow of external funds has continued at an accelerated pace, but due to the appreciating forint, decreasing FX swap exposure and the drop in CDS spreads (which has ceased to be a major cause for concern to central bankers), this has not led to liquidity tensions as opposed to end-2011. As for solvency, a similar improvement has taken place with the capital position of the financial sector considerably stronger despite high taxes and significant loan losses, thanks to capital injections by parent banks. The banking sector has responded to deteriorating profitability by increasing the interest rate margin on the existing loan portfolio, i.e. higher interest rates. The report warns that this trend may lead to the development of a negative spiral: a higher debt service burden is likely to impair households' and other economic actors' ability to repay loans promptly, potentially feeding into higher debt default ratios.
Banking sector could exacerbate economic downturn
The National Bank of Hungary has started to use new indicators in its latest stability report. One of these, the so-called Financial Conditions Index, designed to measure the contribution of the banking sector to real GDP growth, shows economic recession in Hungary is exacerbated by a malfunctioning financial system (lending inactivity). During years of heavy FX lending, the banking sector was a positive contributor to GDP by 1 to 2 percentage points; this contrasts with recent quarters which saw banks' performance exacerbate GDP contraction by about 2 percentage points. That is, the banking sector displayed typically procyclical behavior in earlier years as well as more recently, mostly through a decline in corporate lending. Analysts at the central bank have in fact become more pessimistic in their forecasts, claiming an upswing in lending is unlikely to happen before 2015 due to supply side factors in corporate lending.
Nagy has also called attention to increasing lending risks, noting that despite tighter lending conditions, banks have been financing more and more risky companies as a result of deteriorating economic conditions. Although banks have asserted that they continue to approve the most creditworthy companies for loans (which is actually true), a deteriorating macroeconomic environment has resulted in a deteriorating portfolio of corporate debtors (since current balance sheets and P/L statements do not project future negative changes resulting from tightened macroeconomic conditions). At the same time, the weight of short-term debt has significantly increased as a percentage of newly approved loans.
Household lending continues to be dominated by demand-side factors, which have resulted in a trend of eased credit conditions. Subsidized interest has played a key role in decreasing interest mortgage rates, in spite of which NBH analysts are not projecting a turnaround (i.e. increase) in retail lending anytime soon. The only sense in which a turnaround is expected to take place is a decline in interest rates.
Improved shock-absorbing capacity, too fast deleveraging
Hungary's financial system has done well in the central bank's liquidity and solvency stress tests. Banks with a liquidity surplus, as well as those with a liquidity deficit, have been able to improve their liquidity positions. In the solvency stress test, the central bank assumed a baseline scenario of HUF 555 billion aggregate loan loss and HUF 36 billion cost of the exchange rate cap scheme; these figures compare with a respective HUF 971 billion and HUF 65 billion, along with significant interest rate risks in a stress scenario. Another newly adopted statistical tool, the current value of the Solvency Stress Index is close to its lowest since the onset of the crisis; the improved solvency situation is the result of capital injections by parent banks coupled with a contraction in lending. Foreign parent banks have carried out EUR 2.4 billion worth of recapitalization since 2009, while profit outflow was only 25% to 30%. Recapitalization is coupled with the outflow of external funds; foreign funds outflow from the banking sector totaled EUR 14 billion during the same period (mostly by foreign shareholders). The average loan-to-deposit ratio could drop to about 116% by the end of 2012. Deleveraging is taking place too quickly, which results in adverse effects on economic growth, Nagy warned.
Need for loan loss provisioning declines, but...
Portfolio quality in corporate banking is inferior to household loans, with the non-performing loan ratio exceeding 20% as opposed to 13% of retail loans; however thanks to the exchange cap mechanism the latter could easily peak at 17%, according to the NBH. Meanwhile, loan loss provisioning requirements are on the decline in both segments, owing to contraction. The non-performing ratio is very high compared with other countries in the region, mostly due to slow portfolio cleaning. At present, boosting lending activity is not a viable means of lowering the NPL ratio; instead, the process of improvement could be accelerated by tighter provisioning regulations as well as portfolio cleaning.
Based on international studies, higher non-performing loan ratios result in higher coverage. The reason for this is that portfolio cleaning results in price pressures in asset pricing, which in turn necessitate higher loan loss reserves. However, Hungary is not complying with this formula, with several countries boasting higher loan loss coverage ratios at similar NPL levels. The NBH sees a threat of inadequate converage especially where project loans and restructured FX mortgage debt are concerned, warning that loan loss provisioning rules should be revised in these portfolios.
Compared with regional peers, one key strength of Hungary's banking sector is that it is able to pass the costs of losses incurred on to promptly paying clients. This is especially prevalent in the interest rate margin on existing FX mortgage loans. Benchmark-based interest rates remain nonexistent in this segment, which allows banks to widen the margin.
1. Protracted sovereign debt crisis in the eurozone
2. Deteriorating economic growth outlook in Hungary
3. Potentially accelerating outflow of external funds, coupled with high net FX swap exposure
4. Continued deterioration of loan portfolios with a threat of insufficient loan loss coverage
5. Low banking sector profitability due to deteriorating loan portfolios and high taxes
6. Banks have partially offset loan losses by increasing interest rate margins, however this is not sustainable in the long term.
The latest stability report deserves special attention on account of recent trends in the banking sector as well as the new research tools employed by NBH's research team, Director Márton Nagy said on the release of the document. One novel feature of the report are financial stability "heat maps" used to demonstrate banks' shock-absorbing capacity and procyclicality of the financial system. The sector has seen major improvement in terms of shock-absorbing capacity since the April stability report, however the procyclicality of the banking system has increased; that is, the way banks operate has a higher tendency to exacerbate economic recession. These contrasting trends could possibly have arisen from banks' improved lending capacity coupled with a decline in willingness to lend. The latter might be due partly to deteriorating loan portfolio quality and partly to the government's fiscal consolidation measures with a negative impact on banks' profitability.
The culprit: reluctance to lend
A key issue highlighted by the National Bank of Hungary is that while there has been an improvement of shock-absorbing capacity both in terms of liquidity and solvency, willingness to lend has declined especially in corporate banking. The outflow of external funds has continued at an accelerated pace, but due to the appreciating forint, decreasing FX swap exposure and the drop in CDS spreads (which has ceased to be a major cause for concern to central bankers), this has not led to liquidity tensions as opposed to end-2011. As for solvency, a similar improvement has taken place with the capital position of the financial sector considerably stronger despite high taxes and significant loan losses, thanks to capital injections by parent banks. The banking sector has responded to deteriorating profitability by increasing the interest rate margin on the existing loan portfolio, i.e. higher interest rates. The report warns that this trend may lead to the development of a negative spiral: a higher debt service burden is likely to impair households' and other economic actors' ability to repay loans promptly, potentially feeding into higher debt default ratios.
Banking sector could exacerbate economic downturn
The National Bank of Hungary has started to use new indicators in its latest stability report. One of these, the so-called Financial Conditions Index, designed to measure the contribution of the banking sector to real GDP growth, shows economic recession in Hungary is exacerbated by a malfunctioning financial system (lending inactivity). During years of heavy FX lending, the banking sector was a positive contributor to GDP by 1 to 2 percentage points; this contrasts with recent quarters which saw banks' performance exacerbate GDP contraction by about 2 percentage points. That is, the banking sector displayed typically procyclical behavior in earlier years as well as more recently, mostly through a decline in corporate lending. Analysts at the central bank have in fact become more pessimistic in their forecasts, claiming an upswing in lending is unlikely to happen before 2015 due to supply side factors in corporate lending.
Nagy has also called attention to increasing lending risks, noting that despite tighter lending conditions, banks have been financing more and more risky companies as a result of deteriorating economic conditions. Although banks have asserted that they continue to approve the most creditworthy companies for loans (which is actually true), a deteriorating macroeconomic environment has resulted in a deteriorating portfolio of corporate debtors (since current balance sheets and P/L statements do not project future negative changes resulting from tightened macroeconomic conditions). At the same time, the weight of short-term debt has significantly increased as a percentage of newly approved loans.
Household lending continues to be dominated by demand-side factors, which have resulted in a trend of eased credit conditions. Subsidized interest has played a key role in decreasing interest mortgage rates, in spite of which NBH analysts are not projecting a turnaround (i.e. increase) in retail lending anytime soon. The only sense in which a turnaround is expected to take place is a decline in interest rates.
Improved shock-absorbing capacity, too fast deleveraging
Hungary's financial system has done well in the central bank's liquidity and solvency stress tests. Banks with a liquidity surplus, as well as those with a liquidity deficit, have been able to improve their liquidity positions. In the solvency stress test, the central bank assumed a baseline scenario of HUF 555 billion aggregate loan loss and HUF 36 billion cost of the exchange rate cap scheme; these figures compare with a respective HUF 971 billion and HUF 65 billion, along with significant interest rate risks in a stress scenario. Another newly adopted statistical tool, the current value of the Solvency Stress Index is close to its lowest since the onset of the crisis; the improved solvency situation is the result of capital injections by parent banks coupled with a contraction in lending. Foreign parent banks have carried out EUR 2.4 billion worth of recapitalization since 2009, while profit outflow was only 25% to 30%. Recapitalization is coupled with the outflow of external funds; foreign funds outflow from the banking sector totaled EUR 14 billion during the same period (mostly by foreign shareholders). The average loan-to-deposit ratio could drop to about 116% by the end of 2012. Deleveraging is taking place too quickly, which results in adverse effects on economic growth, Nagy warned.
Need for loan loss provisioning declines, but...
Portfolio quality in corporate banking is inferior to household loans, with the non-performing loan ratio exceeding 20% as opposed to 13% of retail loans; however thanks to the exchange cap mechanism the latter could easily peak at 17%, according to the NBH. Meanwhile, loan loss provisioning requirements are on the decline in both segments, owing to contraction. The non-performing ratio is very high compared with other countries in the region, mostly due to slow portfolio cleaning. At present, boosting lending activity is not a viable means of lowering the NPL ratio; instead, the process of improvement could be accelerated by tighter provisioning regulations as well as portfolio cleaning.
Based on international studies, higher non-performing loan ratios result in higher coverage. The reason for this is that portfolio cleaning results in price pressures in asset pricing, which in turn necessitate higher loan loss reserves. However, Hungary is not complying with this formula, with several countries boasting higher loan loss coverage ratios at similar NPL levels. The NBH sees a threat of inadequate converage especially where project loans and restructured FX mortgage debt are concerned, warning that loan loss provisioning rules should be revised in these portfolios.
Compared with regional peers, one key strength of Hungary's banking sector is that it is able to pass the costs of losses incurred on to promptly paying clients. This is especially prevalent in the interest rate margin on existing FX mortgage loans. Benchmark-based interest rates remain nonexistent in this segment, which allows banks to widen the margin.
