Research guide to banking services in eastern Europe
BackgroundA two-tier banking structure was created out of the 1987 reforms of the banking system after the fall of communism, and by the end of 1995 there were 43 banks with assets of over $25 billion in Hungary's banking sector.A number of the large state-owned banks dramatically reduced their capital bases to reduce their bad debts. For instance, Magyar Hitel Bank, previously the second largest bank cut its capital base tenfold to Ft7.2 billion. While the consolidation that has taken place to clean up banks' balance sheets resulted in an increase in the state's ownership in the banking sector to around two-thirds, the state is actively trying to withdraw, and the privatization process continues. One weak link has been the fact that increased competition in the banking sector has resulted in falling lending margins, while domestic banks' operating costs remain high and there is still room to increase productivity and diversify risk portfolios. Local and western banks are targeting the same blue-chip companies and the second tier of smaller companies have not yet been fully developed in terms of lending potential. The personal loans market is still underdeveloped and the retail market remains dominated by the competitive arena of deposit-taking. Operating costs are around 60% to 70% of net banking income according to the EBRD, ratios that are very close international banking standards. BANKING LEGISLATIONThe financial sector was fully regulated under the aegis of the Banking Act of December 1991 and the Act on Financial Institutions. The former act was mainly based on Basle Committee recommendations, EU directives and western European best practice.The latter act provided for the establishment of the banks' supervisory body, the government-controlled State Banking Supervision (SBS), which works independently of, but in close alignment with, the central bank, the National Bank of Hungary. The SBS issues licences for banks and monitors and regulates their activities. The central bank has certain supervisory responsibilities in maintaining short-term liquidity, conducting monetary policy and regulating foreign exchange. Overall, the regulatory framework is perceived by market players to be very sound. Even so, a new act that is due to go before the government in May 1996 is designed to review the legal regulations that currently apply to banks. One of the main elements of this act will be to harmonize the laws with regulations and directives prevailing at an EU level and to ensure that Hungarian banks do not suffer competitive disadvantages with the EU. Minimum capital requirements will be raised and regulations governing acquisitions will be toughened. Licensing requirements will be changed to ensure that applications take account of their impact on the market as a whole. To increase the efficiency of banking supervision, the decision-making mechanism and the role and composition of the Banking Supervisory Committee is to be changed to develop a controlling body within the SBS that is suitable for operational activities and has clear responsibilities and competence. A number of high-profile banking collapses, culminating most notably in the Agrobank crisis of 1994, have warranted a change in liquidation procedures. There will a be a toughening of bank liquidation procedures to allow for a so-called "quiet exit" for problem banks. Quick liquidation and provisions to minimize losses from the devaluation of assets as a bank is liquidated will help reduce possible losses for depositors. FOREIGN EXCHANGE CONTROLSThere are no limits placed on the repatriation of profits under the Act on the Investments of Foreigners in Hungary. Meanwhile, the authorities have been managing Hungary's foreign exchange position through a crawling peg system of devaluation. Market players are able to hedge rates in the normal course of business.Improving inflationary expectations, fiscal position and better export performance mean Hungary is to look at reducing the 1.2% per month rate at which the central bank allows the forint to depreciate against a basket of currencies weighted 70% Ecu and 30% US dollars. RESTRICTIONS ON FOREIGN BANKSAt the end of 1995 there were 21 banks with foreign capital, accounting for around 23% of market share. There is no differentiation between foreign and domestic banks in terms of supervision, but if a foreign bank wishes to participate in a joint venture that exceeds 10% of the registered capital of the local bank, prior government approval is required. Foreign banks are not yet able to open branches in Hungary, but this will change in 2003.CAPITAL AND LIQUIDITY RATIOSTremendous efforts have been made by both the authorities and state-owned banks to clean up their balance sheets. However, while capital adequacy ratios are governed by the BIS ratio of a minimum 8%, the actual average values have been twice these legal limits.The SBS asserts that behind these high averages lie wide differences in individual performances and points out in a research note that the 8% requirement was "designed for economic conditions from which the Hungarian economy is still far". According to its estimates the "ordinary level" for Hungary would be around 12% to 14%. The extensive consolidation of the sector in the past year has improved the capital adequacy situation, but internal efforts have not yet had any major effect on their own. Without this consolidation, many banks would still be making losses. Joint-venture banks still have the best capital adequacy figures, while small banks were only capitalised up to 40%. Restructuring asset portfolios according to risk groups deteriorated the capital adequacy ratios of all banking sectors. In terms of risk profile, the SBS notes the portfolio is least risky in large banks from a capital adequacy perspective. Even so, their average risk weighting of 53.8% in 1995 was still considerably higher than the 40.6% prevailing in 1994. Joint-venture banks' risk weightings were 56.2% in 1995, up from an average 43.2% while smaller banks' average risk weightings climbed to 63.3% from 57.6% over the same period. The Act on Financial Institutions requires that for large exposures (loans equivalent to 15% of equity capital) the maximum amount of credit that can be extended to a single borrower is 25% of liable capital and the maximum total of large exposures is eight times the banks' liable capital. Many banks do, however, have loans exceeding the single borrower rules, despite capital increases. The NBH regulates the degree of minimum liquid capital assets, which should be 10% of an adjusted balance sheet total. This rule is also widely violated, mainly because banks have been attempting to swap part of their bad debts into equity. There are also rules limiting total internal loans (such as loans to managers, employees, auditors and regulators) and property investments of banks. The central bank also requires minimum reserves to be held by it. In addition, under the Act on Financial Institutions, banks are not allowed to trade securities, so many have brokerage arms. The minimum capital requirements for operating a commercial bank is Ft1 billion, while for a specialized financial institution (including investment banks) that requirement is Ft500 million. Smaller capital requirements apply to the 249 cooperative savings banks (that at the end of last year with combined assets equivalent to $1.1 billion), and to other non-banking financial institutions. There had been speculation over the level of reserves when the new administration launched a stabilization plan to limit money supply growth and inflation, and penalized the ability of banks to lend. However, most bankers see this as being in line with what should be expected from any government stabilizing monetary policy. DEPOSIT INSURANCEIn 1993, following the first bank failure after communism in 1992, the National Deposit Insurance Fund was set up to guarantee deposits up to a maximum of Ft1 million per person or bank. It is funded by mandatory contributions from financial institutions according to their perceived risk levels.PRIVATIZATIONSOf the five dominant state-owned banks, three have been partially privatized. The largest commercial bank, with a market capitalization of Ft38.3 billion, is Orszagos Takarekpenztar (OTP Bank), which has been partially privatized. Foreign and domestic investors bought 49% of OTP Bank in August 1995. While OTP has been losing a degree of its share in commercial lending, its retail banking share has increased and it plans to set up a mortgage banking unit.In December 1995, GECC agreed to pay $87 million for a 60% stake in the second largest Hungarian bank, Budapest Bank. In the third quarter of last year, Budapest Bank had capital of Ft17.2 billion and assets in excess of Ft192 billion after a capital increase at the end of 1994. Most recently, the state offered to sell its 24.7% stake in Magyar Kulkereskedelmi (MKB), Hungary's foreign trade bank in January. First refusal was offered to the three existing foreign shareholders, Bayerische Landesbank Girozentrale (which owned 25% of the bank), the EBRD (which owned 16%) and Deutsche Investitions- und Entwicklungsgesellschaft (8%). In January, 8% of MKB's Ft9 billion equity traded OTC in Budapest, the rest was owned by individual shareholders, the bank itself and a group of state-controlled companies. Total assets of Hungarian Banks (1995)
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