Report on Financial Stability May 2013

1. Reporton Financial Stability May 2013 21 May 2013

2. Financial stabilityheat map Source: MNB.

3. Overall assessment I. – Banking sector remains strongly pro-cyclical • Credit conditions: The banking system is still barely supporting the economy. • Owing to the low willingness to lend, the banking system is strongly pro-cyclical in corporate lending, which impedes access to credit particularly for SMEsrelianton bank funding. • Resilience to shocks: The increase in capital need under stress is manageable due to the proven commitment of parent banks. • LIQUIDITY: Liquidity risks remain low, based on stress test results as well. At the same time, most of the liquidity reserves denominated in HUF; therefore, in a protracted stress situation the smooth functioning of the FX swap market is indispensable. • CAPITAL: Capital position has improved on aggregate level. However, given the worse initial capital position at some banks, the solvency stress test indicates higher capitalneed. Taking into account the parent bank commitment this amount can be consideredmanageable.

4. Overall assessment II. – Key risk and mitigationmeasures

5. Credit conditions

6. The banking sectordoesnotsupporttherealeconomy Financial Conditions Index (FCI) and real GDP growth • Note: The annual growth in the FCI shows the contribution of the financial intermediary system (banking sector) to the annual growth rate of real GDP. Source: MNB.

7. Domesticcorporate lendinghas been steadilycontractingsince the onsetof the crisis Net quarterly change in domestic loans to corporate sector Source: MNB.

8. Bothdemand and supply factors contributedtothecontractionin corporate lending Decomposition of the cumulative decline in corporate lending into supply and demand effects (relative to 2008 Q3) Source: MNB.

9. The monetary easing cycle has a positive impact on price conditions in corporate lending… Interest rate of corporate loans and the MNB policy rate Source: MNB.

10. …hence corporate credit forecastwasmodifiedupwards Credit forecast to NFCs along different scenarios Source: MNB estimation.

11. As opposed to corporate lending, demand factors remain the key driver in household lending Net quarterly change in domestic loans to household sector Source: MNB.

12. The trend of plummeting new lending continued last year New loan volumes of credit institutions to household sector Source: MNB.

13. Resilience to shocks

14. In the low level of the System-Wide Financial Stress Index (SWFSI), benign market conditions are reflected System-Wide Financial Stress Index (SWFSI) • Note: Higher level denotes higher stress. Source: MNB.

15. The stress scenario of liquidity stress test Note: The liquidity stress test is 30-day forward looking. Source: MNB.

16. The Liquidity Stress Index (LSI) indicates low level of liquidity risk Liquidity Stess Index, liquidity surplus and need of banks relativetothe regulatory minimum • Note: The ratio is the liquidity need to 10 percent of balance sheet total weighted by balance sheet total. Higher ratio denoteshigher liquidity risk along thestressscenario. Source: MNB.

17. The scenarios of the solvency stress test • Over the 8 quarter forecast horizon beginning end-2012, the shock hits in 2013 Q2. • Our baseline scenario is the forecast of the Report on Inflation 2013 Q1. • Our stress scenario relative to our baseline scenario: • 4.3 percentage points lower GDP growth; • 15 per cent deprecation of HUF; • 300 basis points risk premium shock; • 10 per cent drop in house prices. • Along the stress scenario we accounted for additional loan loss provisioning on outstanding non-performing loans as in a markedlydeteriorating economicenvironment their recovery rate falls. • As regards the exchange rate cap scheme, we assumed 50 per cent participation ratio both along the baseline and the stress scenario. • The postponement of halving the bank levy and the pass-through of the entire financial transaction tax are taken into account.

18. The impact of key risks on the banking sector profitability in the stress test on 2-year forecast horizon Source: MNB.

19. Inthe baseline scenario no additional capital is needed, however along the stress scenario several banks need capital injection Source: MNB.

20. The Solvency Stress Index (SSI) shows an increasing, but still manageable capital need Stress test index, capital buffer and need in stress scenario at the end of 8 quarter horizon Note: The indicator is the sum of normalised capital shortages relative to the 8 per cent level, weighted by the capital requirement. The higher the value of the index, the higher the solvency risk in the stress scenario. Source: MNB.

21. Key risks and mitigation measures

22. Key risks • Protracted euro-area sovereign debt crisis. • Despite the recovery from the technical recession the vulnerabilities of the domestic economy are still present. • Credit supply constraints on companies, particularly on SMEs • Exchange rate exposure of companies without natural hedging • Reliance on external funding, of which a high share is short-term financing • The banking sector is heavily burdened by the high share of non-performing, which will rise further based on our forecasts. • Lack of competition among banks is causing welfare losses and real economic costs.

23. Risks in the external environment • Protracted euro-area sovereign debt crisis. • Several „peripheral countries” are compelled to implement stricter fiscal consolidation. • In some of the core countries, meaningful austerity measures will be implemented as well. • Significant deterioration in the economic outlook of the euro area, while investor sentiment might remain volatile. • Owing to high funding costs and deteriorating portfolio quality the profitability outlook of European banks is weak. • Worsening economic outlook weighs on banks’ balance-sheet. • In several peripheral countries banking systems need substantial capital injections.

24. Credit supply constraints hit the SME sector more severely Change in new lending to corporations and its decomposition by corporate size Source: CCIS, MNB estimation.

25. Exchange rate exposure of SMEs without natural hedge poses a significantrisk Distribution of exchange rate depreciation of individual contracts (by end-2012) Source:CCIS, MNB estimation.

26. The first two pillars of the MNB Funding for Growth Scheme (FGS) areaimed at reversing contraction in lending and reducing exchange rate exposure of SMEs Growth rate of domestic loans to corporate sector Corporate sector total SME segment Source: MNB.

27. The thirdpillar of the FGS accelerates the decrease in short-term external funds without any deleveraging Foreign funds of the banking system and the loan-to-deposit ratio Source: MNB.

28. The third pillar of the FGS is aimed at rationalisingthe debt structure and reducing the costs of MNB • The reduction of short term external funds translates into lower level of foreign exchange reserves and MNB bills outstanding • Without higher vulnerability • The effects of MNB swaps on the banking system balance sheet: • Changes in the consolidated balance sheet of the general government, incasethe reduction of short term external funds is achieved with the cooperation of the Debt Management Agency

29. Banks remain reliant on external funding even in the case of loan-to-deposit ratio decreasing under 100 per cent Schematic balance sheet of the banking sector at a 100 per cent loan-to-deposit ratio Source: MNB.

30. Managing deteriorating portfolio quaility remains a key challenge Ratio of non-performing loans and cost of provisioning Corporate sector Household sector Source: MNB.

31. In the corporate segment the I. and II. pillars of the FGS, while in the household portfolio the planned introduction of personal bankruptcy may improve portfolio quality The planned personal bankruptcy procedure Source: MNB.

32. Increasing participation in the exchange rate cap scheme would have a benign effect on household portfolio quaility Participationinthe exchange rate cap Source: MNB.

33. Banks are striving for offsetting high costs through raising net interest income Net interest income to interest bearing assets Net interest income to total assets (June 2012 – consolidated data) Source: ECB CBD, MNB.

34. Market failures in pricing should be managed byenhancingcompetition • Expedient to cut the regulatory maximum of the early repayment fee to 1–1.5 per cent in the case of refinancing from another bank. • In agreement with the proposal of the Hungarian Competition Authority, the possibility of bank switching in the case of government subsidies should be examined. • It may be justified to reduce the maximum amount of notary fees, which are charged not by competing and not even by public bodies, as such fees represent a significant disincentive in the case of refinancing. • Most mortgage loans are tied to other products (predominantly current accounts); therefore, the switching of current accounts should be facilitated. • The entry of participants should be promoted which would help households to seek the most favourable offers.

35. Thankyoufortheattention!