The National Bank of Hungary (MNB) does not tolerate it any further that the total stock of problem project loans still exceeds 700 billion forints. Posing a key financial stability risk these “may be a source of further, unexpected losses and may adversely affect the banking sector’s willingness to lend, thereby reducing its role in supporting economic growth," it said on Wednesday. Consequently, the MNB has decided to introduce the Systemic Risk Buffer (SRB) in order to manage that risk. Should credit institutions sweep out their problem portfolios by January 1, 2017, when the SRB will become activated, the new capital requirement will not be binding for them. The adequately long phase in period is therefore expected to encourage credit institutions to clean up their problem portfolios and to enhance financial stability by improving the banking sector’s resilience to shocks, the bank added. The measure suggests that some banks are to incur hefty losses by the end of 2016.
The MNB issued the following statement today (highlighting by Portfolio):
“The persistently high amount and institutional concentration of problem project loans pose a key financial stability risk. The MNB has decided to introduce the Systemic Risk Buffer (SRB) in order to manage that risk. Should credit institutions sweep out their problem portfolios by January 1, 2017, when the SRB will become activated, the new capital requirement will not be binding for them. The adequately long phase in period is therefore expected to encourage credit institutions to clean up their problem portfolios and to enhance financial stability by improving the banking sector’s resilience to shocks.
“The persistently high amount, ratio and concentration of problem project loans pose a key financial stability risk. The total stock of such loans, at more than HUF 700 billion, may be a source of further, unexpected losses and may adversely affect the banking sector’s willingness to lend, thereby reducing its role in supporting economic growth. The stock of non-performing project loans rose sharply after the outset of the financial crisis; however, continued restructurings have also failed to manage the risks arising from such debts. Consequently, the use of macroprudential tools has become warranted.
“In October 2015, the MNB’s Financial Stability Board decided to introduce the Systemic Risk Buffer in order to adequately manage risks arising from problem project loans. The rate of the SRB will be set in proportion to the individual institutions' contribution to systemic risk. This rate is derived from the ratio of problem project loans to the domestic Pillar 1 capital requirement.
The MNB added that the systemic risk buffer is "not expected to exert a significant impact on the Single Market, since it has to be accumulated with regard only to exposures in Hungary."
The Systemic Risk Buffer will be applied individually, between 0 and 2 per cent of total domestic risk-weighted assets, and credit institutions will be required to build it up at consolidated level, from Common Equity Tier 1 capital (CET1), in addition to other capital buffers.
A ‘de minimis’ threshold has also been introduced in order to take into account systematically relevant assets: institutions with problem project exposures below HUF 5 billion are exempted from the SRB requirement.
“The MNB will set Systemic Risk Buffers for institutions in the form of individual decisions in the final quarter of 2016. Institutions will be required to comply with the new capital buffer requirements from 1 January 2017. This schedule will allow adequate time for banks to accommodate, i.e. to effectively clean up their non-performing project loans.
"Even if the clean-up of portfolios does no take place, the additional capital requirement may strengthen the stability of the domestic financial intermediary system by improving banks’ resilience to shocks. Should credit institutions sweep out their problem portfolio by January 1, 2017 the new capital requirement will not be binding for them. The MNB has held consultations with the European authorities and market participants on the new capital requirements."
The measure will primarily affect large banks that have been actively extending project loans. In view of the relative size of the affected portfolios, CIB, Raiffeisen and Erste will be especially impacted. Portfolio cleaning may be taken care of at MKB, as the MNB is expected to complete a resolution procedure there by the end of the year, so it can dodge this bullet.
The measure suggests that the central bank is dissatisfied with the influence of market incentives on the sale of problem project loans. One of the reasons is the inferior size of market outlet and the other is that asset management company MARK Zrt. is also buying “only" at market price.
The drastic capital requirement is yet another (this time negative) incentive for the banks to clean their portfolio. The short-term profit impact will certainly be negative (especially during portfolio cleaning taking place in 2016), as the measure spurs the banks to rid of their receivables for less than book value. The market price is generally below this level and this is part of the reason why portfolio cleaning has been progressing at a snail’s pace so far.
The MNB also noted that “the other provisions in the MNB Act, in the Credit Institutions Act and in Regulation (EU) No 575/2013 of the European Parliament and of the Council - with the exception of Articles 458-459 of Regulation (EU) No 575/2013 of the European Parliament and of the Council - are not sufficient or appropriate for managing the risks linked to project financing loans and the related real estate exposures, as these instruments are not targeted enough, they have limitations and they cannot manage the associated negative effects that are multiplicative at the system level.
How does it work?
The size of the systemic risk buffer depends on the ratio of the gross stock of problem exposures to the domestic Pillar I capital requirement imposed on the credit institution or on the group containing the credit institution and subject to consolidated supervision.
If this stock exceeds 30% of the capital requirement and is greater than HUF 5 billion, the systemic risk buffer is set at or above 1%.
The systemic risk buffer rate cannot be higher than 2%.
The SRB does not apply to the Hungarian Development Bank (MFB), the Hungarian Export-Import Bank Zrt. and clearing house KELER Zrt.
The systemic risk buffer is determined in view of the data reported for Hungary on a consolidated basis, and it needs to be created for Hungarian exposures on a consolidated basis.
Problem exposure refers to the gross value of domestic commercial real estate project loans or domestic on-balance sheet held-for-sale real estate. Domestic commercial real estate project loans need to be taken into account if they are: (i) loans past due by over 90 days; (ii) restructured project loans, with the exception of loans restructured more than a year ago that have become performing loans since then; or (iii) other project loans deemed non-performing by the credit institution.
The individual decisions governing the systemic risk buffer rate shall be made by the MNB in the fourth quarter of 2016 on the basis of 2016 Q3 data. Consequently, the systemic risk buffer has to be maintained from 1 January 2017.
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