Banking system in Hungary

Sectoral analysis

Autumn, 2005

ICEG EC Sectoral analysis, Banking sector 

Executive summary

Banks of the euro zone (Economic and Monetary Union, EMU) went on

placing emphasis on the development of the retail sector in 2004.

Profitability of the sector had shown further improvement, as

compared to the level of one year before. The growth of non-interest

type incomes, reduction of costs (cut in staff number) and the

reduced special reserves were found in the background of the

profitability growth. Cross border interbank credits have not become

important in the private sector, basically the banks grant credits for

the clients of the domestic market. While – on the medium term the

prospects of the bank sector of the EMU and more widely those of the

EU25 countries, the high oil prices and the increase in long-term

interests can deteriorate the quality of the credit portfolio. The

banking sector of the newly accessed countries produced higher

profitability in 2004 than that of the euro zone, thus improving the

aggregate performance of EU (EU25) as a whole.

The main regulation task for the domestic and the Western-European

credit institutions is the implementation of the new regulations for

capital adequacy of the Bank Supervision Committee in Basel. More

real and prudent measurement and treatment of the credit risks, as

well as more exact identification and acknowledgement of the

operating risks can be expected of its implementation in banking

practice. Credit granting for certain business sectors (the sector of

small and medium-size enterprises) may become cheaper, that would

stimulate the banks’ activities towards clients from this sphere.

The Hungarian banking sector showed excellent performance in the

first half year, that was also promoted by the favourable external

environment. Reduction in inflation induced steps for gradual decrease

in interest rates of the central bank, however the banks could keep on

maintaining their previous high interest margins. The low interest

rates of the euro and the Swiss franc made the new foreign exchange

credit construction of the banks attractive both for the households

and the companies.

In the first six months of 2005 the aggregate balance sheet total of

the credit institution sector expanded by 6,4 %, exceeding the growth

of the economy, consequently financial intermediation has further

deepened. The main source of growth remained domestic credit

granting, including expansion of the retail credits. Among the new

placements dominance of the foreign exchange credits is evident both

in the company and the retail sectors, in addition to stagnating

outstandings of HUF placements, whole of the outstandings increase

was practically due to foreign exchange loans, both in case of the

personal housing credits and consumer credits, as well as the company


Increase in outstandings in case of the company credits, both in

respect of their rate and volume lags behind also the data that were

characteristic for the first and second half of 2004. Its reason is

that a part of the required resources is provided by the companies – typically

by the large companies – through the involvement of foreign bank

credits, proprietory credits and employed capital in the form of share

capital. The rate of credits of the small- and medium-size enterprises

(SMEs) being more dependent on the resources granted by the

domestic banks represents an increasing share within the company

placements of the credit institutions.

As concerns the excellent profitability of the domestic banks – even at

an international level – there are several transitional causes (housing

support system, price-earnings ratio realized by the securities of

trading purpose due to the suddenly decreasing yields, high interest

margins, that cannot be maintained at a longer term, thus we have to

account on reducing profitability of the sector


1. Trends in the European Union and in the region

Performance of the banking sector of the EMU member

countries in 2004

Due to the fact that concerning the performance of the region’s

banking sector only data of the end of 2004 are available, we could

rely in our analysis on them. Our analysis was made on the basis of

the following studies of the European Central Bank: Report on EU

Banking Structures (October 2005), Financial Stability Review (June


The banks kept on concentrating on the development and expansion

of the retail sector. Several products and services – being previously

accessible only by the institutions – became available for the private

clients (e.g. the possibility of investments in hedge funds, bonds

indexed to the performance of shares). Crediting on mortgage, as well

as credit granting for small- and medium-size enterprises (SME) has

developed by the low interest rates.

Rapid increase in loan outstandings

The rate of credits among the means of the banks in the region has

begun to increase in 2004 again. The reason for this growth is to be

explained. Mainly retail placements and those for the small- and

medium-size enterprises, are in the background of this increased, the

role of the banks in financing of the large companies – in particular in

the countries of the euro zone –has shown slight reduction, as

compared to the 10 % rate of growth of retail credits granted by the

large banks of the euro zone, the debts of non-financial companies

towards the credit institutions has expanded only by 5 %. Capital

leverage of the non-financial companies has reduced, however at the

same time their profitability improved, suggesting that they could

have acquired internal financial resources with more favourable

conditions as before. Taking the advantage of the low interest

environment a part of the large companies has rather decided on

issuing long-term bonds.

Contrary to the slowing company credit granting the low interest rates

gave an impetus to the increase of the retails credits. Placements for

housing purposes have shown outstanding measures. Contrary to the

Hungarian sample the volume of retail credits in the banking portfolio

exceeds that of the credits for non-financial companies, based on the

summarized data of the euro zone. It is important to note, however,

that foreign placements of the banks – mainly interbank and company

placements – are not included in this statistics.

Cross border credit accommodation for the private sector is still insignificant

Providing services for the retail clients remained within national

frontiers, cross border services are not characteristic in this segment.

Namely easy access and nearness of the banking agencies is

important for the clients in case of retail credits.


Decrease in the ratio of deposits among the bank resources

The resources needed for credit granting have been financed by the

banks from the clients’ deposits in minority and the market sources in

majority. Namely involvement of the cheap clients’ sources is even

more difficult with the low euro-interests. The private sector invests

its savings into constructions that ensure potentially higher returns

(investment shares, structured products with capital guarantee)

instead of bank deposits with low yields.

Good-quality credit portfolio and reducing special reserve accumulation for the moment

The level of special reserves accumulated for the possible losses of

credit portfolio dropped to a historical depth, it reduced from the 0,27

% in 2003 to less than its half, to 0,13 % in 2004 expressed in the

percentage of the aggregate balance sheet total. Its reason was the

improving credit risk environment (increasing profitability of the

companies) and decrease of the rate of non-performing credits within

the portfolio. It can be assumed that more developed credit risk

management techniques applied by the banks and the fact that the risks

are calculated better and better also played role in the reduction of

special reserves. However it is a question how the banks counted on

those factors – such like volatile nature of the oil prices - that affect

prospective credit solvency of their clients when they determined the

level of the present special reserves.

Further increasing profitability

The profitability of the region’s banks has significantly improved in

2004. Return on equity (ROE) of the large banks of the euro zone

increased to 11 % in 2004 on the average, as compared to 5 % in

2003. The profitability of the banking sector of EU25 was even higher,

it reached 12,2 % by the end of 2004. This trend is specially

favourable if we take into account that improvement has been

experienced even in those countries whose economies lagged behind

the average growth. It seems that the banking sector can better

comply with the changes of the rate of economic growth, as compared

to the experience of the last decade

Increase in non-interest type incomes, reduction of costs (cut in staff

number), rise of crediting activity and the reduced special reserves

were found in the background of the profitability growth. Interest

returns giving approximately half of the banks’ returns have further

decreased due to the lower interest margins. The interest margin

dropped to about 1 % in 2004. Narrowing of the margins was the

result of the low nominal interest level and the growth of interbank

competition. The fact that loan outstandings exceed the level of

clients’ deposits for years, thus continuously enforcing the financial

institutions to replace the lacking resources from the more expensive

interbank markets influences the interest returns in a negative


Net charge and commission incomes provide the most important item

within the returns of non-interest type.

Stable capital adequacy

Profitability and capital adequacy of EMU’s banks have improved

simultaneously in 2004. The ratio of capital adequacy (adjusted

capital/risk corrected balance sheet total) exceeded 11 % at the end

of 2004, as compared to the minimum specified 8 %.


Contribution of the new member countries to the results of the banking sector of the euro zone

As the banks of the new EU member countries (EU10) belong, in

majority, to the field of ownership of the euro zone, they contribute to

the profitability of the EMU’s banks in a direct way through their

return on equity. Above average growth rate and profitability of the

banking systems of the newly accessed countries are resulted by the

dynamic expansion of loan outstandings.

Generally speaking the favourable macroeconomic environment and

the low or reducing interests facilitated the rapid expansion of credit

granting. (including especially retail credits). Country-specific factors

(e.g. introduction and maintenance of housing support system in

Hungary) also contributed to the above. Retails loan outstandings –

and mainly that of housing credits – have shown special growth

(although from a low basis) in these countries in the previous years.

Company loan outstandings showed slight increase on the average,

although there is a great variance in this segment among the

countries of the region. Within the complex credit portfolio still the

company credits were overwhelming in 2004 despite the fact that the

majority of the domestic company debts manifests itself not in

domestic bank credits (but credits from foreign banks and the


It can be stated in general that foreign exchange of the region’s

countries contain certain interest surcharge as to interest of the euro

and the Swiss franc, that can, in itself, make attractive indebtedness

in foreign exchange. However its measure is strongly influenced – in

addition to the difference in the interest – by the stability of the

national exchange rate system (the chance of a possible devaluation

making the difference disappear), by the level of development of the

credit supply (e.g. there was no retail foreign exchange crediting in

Slovakia till 2003) as well as the fact whether there is a system of

state housing support and in what form does it work (in majority of

the cases the support concerns only indebtedness in domestic


On the resource side the credit institutions of the newly accessed

countries are still in a better position than those of the EMU’s region,

since they can finance their activities from the cheap clients’ deposits

in two-third.

Profits of interest type are going on having higher importance in the

results of the banks of the newly accessed countries, as compared to

the level characteristic for the old member countries.

High oil prices and increasing euro interests can mean

risk at a longer term


While the prospects of the banking sector in the countries of the euro

zone are generally positive on the medium term certain risk factors

must be mentioned. On the one hand deterioration in the banking

credit portfolios can occur because of two reasons. The high oil prices

increase the production costs of the companies, only a part of which

can be charged on the clients by means of raising the prices. In the

sphere of the companies working in sectors being better influenced by

the rise in oil prices (e.g. air transport, tourism) an increase in the

credit losses may be expected. The income of the households will also

be negatively affected by the rise of the oil prices (due to the

increased company costs the growth of the wages can be hindered).

As a result of the two effects expansion in domestic demands can

reduce that would tangibly concern also the sector of small and

medium-size enterprises that involves significant dependence on the


On the other hand the quality of the retail credit portfolio can only

deteriorate, however significant worsening may only be expected in

case of simultaneous emergence of several unfavourable effects (rise

in interests, growth of unemployment, reduction in the value of real

estate securities). Increase in long-term interests may also

unfavourably concern profitability. Higher interest level is usually

accompanied with higher margins, but at the same time it decreases

demands for credits and rises the burdens of the debt settling clients.

(this latter effect may manifest itself in deterioration of the quality of

the already existing portfolio.) Rise of the interest may also reduce

the value of the bond portfolios of the banks and these negative

effects can probably dominate over the positive ones.

In addition to contributing to the profitability of the banks in the EMU

region the banks of the newly accessed EU member countries also

affect their dependence. Dependence on the exchange rate risk of the

banks in the EU10 countries is usually higher than that of the financial

institutions of the West-European states. It manifests itself

characteristically not in a direct way, occurs not from the own open

foreign exchange position of the banks (the ratio of the foreign

exchange sources and assets is usually compensated) but

indebtedness of their clients in foreign exchange may cause – at a

longer term – (in indirect way) sudden deterioration in the quality of

the credit portfolio. However at the same time capital adequacy of

these banks remained at a high level – despite of the outstanding

expansion of loan outstandings – and their aggregate balance sheet

totals is only a fraction of the assets of the euro-regional mother

banks, thus they do not really increase their dependence on the risk of

exchange rate.


2. The impact of the EU accession on the management of

the banking sector

The greatest challenge for the banks is still the

implementation of the rules of Basel II.


Acceptance of the most important legal provisions in respect of the

banking system has been realized at the time of accession.

At present the main task for the domestic and the West-European

credit institutions is the implementation of the new capital adequacy

regulations of the Bank Supervision Committee of Basel. The new

stipulations will expectedly come into force from the end of 2006.

The rules of Basel II make it possible for the banks to apply more

sophisticated models, approved by their own national supervisions for

determination of the expectable losses of the credit portfolio and the

demand for adjusted capital instead of the previous principles that

concerned all of them in a uniform way. In addition an other

important change is the measurement of operating risks – not stated

in figures so far – as well as their consideration when determining the


For the purpose of quantification their credit risks the financial

institutions may also choose the „standard" model that was centrally

developed by the European regulators, that calculates also on the

basis of a new method. The capital demand changes, in theory, also

by the application of the standard method, because it better considers

the evaluation of the credit qualifiers when stipulating the risks of the


In case of credits granted for the small- and medium-size enterprises

– similarly to the retail placements – the credit risks may be

managed at the level of the portfolio, involving lower capital demand

as in the previous practice. However the risk of bankruptcy is getting

higher in parallel with the smaller size of the enterprise, the risks in

the banking portfolio involving numerous small credits are spread, and

the probability that many separate small companies become insolvent

at the same time is lower or of the same level, than the probability of

non-payment on the part of a large company with the same volume of

credit. The stipulations of Basel make credit granting for the small- and

medium-size enterprises cheaper, thus they can contribute to the

development of this segment.

Based on the effect study of State Supervision of Financial

Organizations (SSFO) in June, 2003 the minimum capital demand will

expectedly raise by 12 % (probably to 9 %) as compared to the

present level of 8 %. Some uncertainty is involved in the result by the

fact that each of the banks involved in the test survey selected the

standard model, and not every bank participated in the study.(market

share of the involved financial institutions was 70 % on the basis of

the balance sheet totals). Capital demand of the retail credits and that

for the small- and medium-size enterprises reduces – on the basis of

the study – as a whole, while the level of special reserves to be

accumulated behind the credits granted for large companies and

demands from the budget are raising. This latter can be explained

with the changes in weighting the risks of the OECD countries and the

local self-governments. Slight increase may be expected in the capital

demand of portfolios of the trading accounts. However the new type of

consideration of the credit risks explained only 1.6 % of the growth of

12 % in capital demand on the whole. Operating risks were much

more the reasons of the growth than the involvement of the new risk


Following coming into force of the new regulations more real and

prudent measurement and management of the credit risks, more

exact identification and acknowledgement of the operating risks may

be expected. Granting credits for certain business sectors (sector of

the small- and medium-size enterprises) may become cheaper, that

would stimulate the activity of the banks towards the clients of this


Application of new principles of accountancy (IFRS)

Since 1st Jan. 2005 each company listed in the stock exchange within

the European Union is obliged, in principle, to publish its consolidated

accounts in compliance with the international, financial account

making standards (IAS, IFRS) As concerns individual reports and

companies not involved in the stock exchange the member state may

decide on their accounting obligations in their own authorities, based


The new stipulations concern the calculation of adjusted capital, too.

Certain assets (securities for trading purpose, derivatives) must be

recorded on their market values, according to the new stipulations. In

case of the derivatives stating of the real price may cause troubles in

case the product does not have liquid secondary market. Certain

incomes and costs, previously accounted as extraordinary items

(profits and losses gained in trading portfolio, costs related to

reorganization) are given in the new system in the operating profit.

The market experts were afraid that the above mentioned changes

would extremely increase volatility of the profits and own capital of

the banks. As a result certain sphere of the stipulations was subjected

to revision by the IASB (committee for creating international

accounting standards), and initiated further agreements with the

market players in order to define the expectable effects of the new

rules. Based on information available so far a modified version of the

standard will be introduced from 1st Jan. 2006. That is the regulation

has not been put into force so far.

Involvement of a directive on the agreements of financial


It is an important step that the directive on the agreements of

financial guarantees of the European Union was involved in the

Hungarian law in 2004. (it necessitated first of all modifications in the

Civil Code and the bankruptcy law). The aim of the directive is to

achieve enforceability of cash, securities or other financial guarantees

should be regulated on a uniform basis in the transactions of the

financial market players.

Introduction of cross border credit granting covered with securities

may become possible this way. In accordance with the new

regulations the requirements of the creditor can be completely and

unconditionally satisfied in case of the partner’s non-payment, if cash

or securities of public subscription are behind the transaction as a

caution. In case privately issued security guarantees (or financial

assets whose market value cannot be clearly stated) the partner have

to agree upon the method of evaluation of the means of guarantee in

advance. By the introduction of the directive the partner risks of the

banks granting credits by financial assets based on caution can be



3. Present position and prospects of the sector

Effects of the macro environment on the bank sector


We are going to illustrate in our study the development of the

domestic banking market up to the first half of 2005. During the

analysis we have used up the reports of the Hungarian National Bank

and the statistics published by the State Supervision of Financial

Organizations (SSFO). The figures and tables used for the introduction

of the processes on the source and assets sides of the banking sector

were made based on the data of the Hungarian National Bank, the

sources from the SSFO are separately referred to. The expressions

„sector of credit institutions" and „banking sector" are used in the text

as synonyms and both mean credit institutions.

The domestic banking sector showed outstanding performance in the

first half year what was also supported by the favourable external

environment. Gross domestic product (GDP) increased by 3,9 % as

compared to the first half of 2004, which rate significantly exceeds the

average economic growth of the European Union.(1,3 %). Decreasing

inflation offered the possibility for gradual cut in interest rates, the

banks could, however, keep their previous high interest margins. The

low interest rates of the euro and of the Swiss franc made the new

foreign exchange constructions of the banks attractive both for the

households and the companies.

Further improving intermediation of the banks

Main processes on the source and assets sides of the banking


In the first six months of 2005 the aggregate balance sheet total of

the sector of credit institutions increased by 6,4 %, exceeding the rate

of economic growth, thus further deepening financial intermediation.

The main source of growth remained domestic credit granting,

including expansion of the retail loan outstandings.


Expansion of the domestic loan outstandings

Expansion of the placed domestic loan outstandings amounted to 682

thousand million HUF in the first half of 2005, slightly exceeding the

amount of loans placed in the first six months of 2004, but shows

already slowing down as concerns its space (due to higher basis)


Domestic l

Population is the engine

Growth in domestic placements was promoted mainly by the

population (almost 290 thousand million HUF)- Debts of the nonfinancial

companies and of the budget have increased by almost the

same volume, by 146 and 150 thousand million HUF. Financing

demands of the central budget in respect of highway constructions

generated this way important additional credit demands.


Increase in the balance sheet total and the domestic

loan outstandings of the credit institutions sector

(thousand million HUF)


Distribution of the domestic loan outstandings according to client


As a result of all these processes the rate of company placements in

the domestic credit portfolio reduced below 50 %, while that of the

retail placements increased over 30 % by the end of the half year.

The debts of the other financial intermediators (financial and

investment companies, investment funds) make up a stable share of

about 12 %, while the debts of the budget represented 8 % within the

total loans.

Dominance of the foreign exchange credits is evident

Denomination of the domestic credits

Among the new placements the dominance of the foreign exchange

credits is evident both in the company and the retail segments,

besides stagnation of the loan outstandings of HUF placements, the

foreign exchange loans compose practically the complete stock

increased both in case of the retail housing credits and the consumer

credits, as well as the company placements. Only approx. 200

thousand million from placements of 682 thousand million HUF during

the first half of 2005 represented HUF placement and almost this

whole amount served for covering the source demands of the budget.

By the end of the half year 42 % of the domestic credit stocks

represented foreign exchange credits.

The share of consumer credits is increasing in the portfolio

Retail segment

Increase in loan outstandings of the households

Since tightening of the promotion system in 2003 the volume of

placing housing credits has slightly decreased from one half year to

the other. This recession has not been drastic so far as a result of the

introduction of cheap foreign exchange constructions of the banks.

Much smaller but also positive effects were generated by launching

the Home Establishing Program. The importance of the consumer

credits is determinant among the other credits. Appearance of

consumer credits for free use with mortgage cover is a new

development. It provides cheaper financing possibilities for the

population as compared to the previous constructions without

coverage. In case of the consumer credits the dominance of foreign

exchange credits is overwhelming, in the first half of 2005 practically

the whole increment was provided by foreign exchange placements.

According to our expectations the consumer credits will be in the

highlight at a longer term as compared to the real asset credits. It can

already be seen that the process has begun, in the first half of 2005

the volume of other credit placements – being mainly consumer

credits – (150 thousand million HUF) slightly exceeded the expansion

of the housing credits (144 thousand million HUF).

Growth of the consumer credits is also supported by the changing

consumption habits of the population, in addition to the product

development of favourable construction (by the improving prospect of

incomes the households buy on credit more bravely), that is the share

of consumption increases irrespective of the effects of the housing

credit program. As a result of the above illustrated process the share of real asset credits within the household loan outstandings has slightly decreased by the end of June, 2005. (from 63 % at the end of 2004 to 62 %)

Company segment

Growth of the company loans outstandings

The increase in loans outstandings of the companies lags behind the

characteristic data of the first and second half of 2004, both in respect

of its rate and volume. The reason is that a part of the required

sources is ensured by the companies – and typically the large

companies – through the involvement of foreign bank credits,

proprietory credits and operating capital in the form of equity capital.


Denomination of the company credits

Within the company placements of the banks the share of foreign

exchange credits has further increased (based on the data from 2005,

it reached almost 45 %, at the end of 2004 it was 43 % and in the

first half of 2004 made up 42 %.)

While the population received new credits in the first six months in

foreign exchange in 94 %, this ratio makes up 100 % in case of the

non-financial companies. The HUF debt outstandings of the companies

showed practically stagnation.


The share of placements for the small- and medium-size enterprises increase within the company credits

The proportion of credits provided for the small- and medium-size

enterprises being more dependent on the sources granted by the

domestic banks represents an increasing share within the company

placements of the financial institutions. According to the estimates of

–SSFO half of the total loan outstandings is composed of the debts

from the SME by the end of the first half of 2005. However we have to

add two remarks to this proportion:

• Since 1st January, 2005 the official classification of the

domestic companies is in compliance with the standards of the

union, consequently several companies previously classified by

the domestic method among the large companies, were

re-listed into the sector of small- and medium-size enterprises.


Company loan outstandings of the credit institutions,

thousand million HUF


Irrespective of the official category of small- and medium-size

companies the credit institutions decide themselves what kind

of size and other conditions must be fulfilled in order to classify

the individual companies among client’s group of small- and

medium-size companies (their credit granting policy and risk-taking

willingness influences this decision).It means that the

stipulations for this category are different in case of the

different financial institutions, consequently it may occur that

one bank regards a placement as credit granting for small and

medium-size company, while the same may be a part of the

large-company portfolio in case of another bank. That is why it

is difficult to evaluate the size of the credit market for small-

and medium-size companies, as well as judgement of the

market positions of the banks, exact data are available only on

the total company loan outstandings.

As a result of our official transition to the measure limits used in the

European Union (see the summary table) several companies that

belonged so far to the category of large companies are re-classified

and this way can apply for the aids made for the small- and mediumsize

companies despite the fact that the banks did not modify the

classification of their clients.


The quality of the credit portfolio is still good, however

the first signs of deterioration have already manifested



The quality of the portfolio

The proportion of problematic (under average, doubtful, bad) credits

is still low in the credit portfolio of the banks.

Slight improvement of the company portfolio may be noticed in the

first half of 2005. Although the number of items subject to special

attention has increased, the proportion of the problematic credits has

decreased, that can be evaluated as a positive development on the


On the contrary clear but slight deterioration could be noticed in the

household credit stocks in the first six months. In this segment the

proportion of both the items subject to special attention and that of

the problematic ones has increased. 


Reducing deposit sources

Structure of sources

The banks can decreasingly finance their growth from the clients’

deposits. The increase in domestic deposit stocks amounted only to

218 thousand million HUF in the first half of 2005, as compared to the

increment of 682 thousand million HUF in the sphere of credits. It

means that two-thirds of the new placements must have been granted

by the credit institutions from other sources.


Growing involvement of foreign sources

Due to the bottleneck of the deposit sources the credit institutions

financed their activities – in an ever increasing ratio - on account of

the profit reserves and sources of their mother (foreign) banks

Foreign commitments contributed to the increase of 1080 thousand

million HUF of the aggregate balance sheet total by 526 thousand

million HUF while the growth of equity capital by almost 200 thousand

million HUF. The banks covered from the cheap foreign exchange

sources mainly their foreign exchange placements, and put a part of

them into liquid means (typically two-week deposits of the central


The domestic deposit stock is denominated in 85 % in HUF. While on

the credit side the foreign exchange products become more attractive

through the low foreign exchange rates of interest, then examining

from the investment side deposits in HUF, granting higher yields are

preferable. Despite this fact the foreign exchange means and source

appear within the balance of the banks in a compensated form as a

result of the above mentioned increased involvement of the foreign



Domestic deposit and credit stocks of the credit institutions,thousand million HUF


Re-drawn profits also promote financing

Thanks to their previous outstanding profitability the credit institutions

could re-draw significant profits for financing their activity. The

proportion of equity capital within the total sources has slightly

increased by the first half of 2005 and it exceeded 9 %. The value of

capital adequacy index (risk corrected balance total/adjusted capital)

stood at the end of the half year at an average 11,4 % and the

individual indices of each bank exceeded the specified value of

minimum 8 %.

Preserved high profitability

At the European scale and as compared to the sectors of the closer

region the Hungarian banks show outstanding profitability. The

average profitability of the sector in proportion with the equity capital

(ROE) was 23.5 % in 2003, 29,7 % in 2004 and it exceeded 31 % in

the first half of 2005, while returns in proportion of equity capital---

(ROA) increased from the value of 2 % in the first half of 2004 to 2,5

%. Profit cutting effect of the special bank tax was not considerable in

the first six months.

As its main reason we can mention the still high interest margin (4 %)

at the international comparison (interest profits/balance sheet total).

The central bank – in relation with the decrease in inflation – reduced

significantly –by 350 basis points from 9,5 % to 6 % - its valid rate of

interest in the first half of 2005, and still the credit institutions could

maintain the high margins. The reason is that while by pricing of the

deposits the steps of the central bank were quickly followed, they

were slower in case of reducing the interest rates of the credits.

Maintaining credit interest rates relatively high is also explained by the

condition that the banks – as a result of saturation of the market and

induced by the more and more intensive competition, turn more

extensively towards the more risky clients (population, small- and

medium-size companies) and gradually ease the conditions of credit


It means that maintaining of the margin is destined for covering

increased risks. On the other hand the previously placed, supported

housing credits are re-priced typically only in 5 years, thus producing

in the meantime high and fix returns for the credit institutions.

Reduced creation of special reserves also contributed to maintaining

high profitability, however in itself it does not mean an increasing

trend in risk undertaking willingness of the banks, namely the special

reserves of the first half of 2004 were distorted by the fact that a

great bank accounted an outstanding loss in value.

The proportion of non interest type incomes increased in the profits of

the banks in the first half year, and the highest growth was achieved

in this respect by the profits of the traditionally volatile financial

operations. This was due - in overwhelming majority – to the rise in

rates achieved by the securities of the credit institutions maintained

for trading purposes and realized only in part.

The banks tried to charge their clients with the effects of the bank tax

by means of increasing their charges and commissions. The rises were

performed characteristically in 2004 and at the beginning of 2005.


4. Development of the market structure

Market structure and concentration

During examination of the structure and concentration of the banking

sector we use the data from SSFO and the individual, published

reports of the banks, because these pieces of statistics contain

detailed breakdown needed for the analysis. Contrary to the statistics

of the Hungarian National Bank, those from SSFO do not include the

mutual savings banks.

In the first half of 2005 the number of the domestic banks and

specialized credit institutions did not change, there were altogether 30

banks (7 large, 8 medium and 15 small banks) and 5 specialized

credit institutions operating. According to the conditions of

classification the large banks possess individually at least 3 %, the

medium banks at least 1 % of the aggregate balance sheet total of

the sector.

Large banks: Small banks:

At the end of the half of 2005 the following specialized credit

institutions were in operation:

• FHB Land Loan and Mortgage Bank Co. Ltd.

Fundamenta-Housing Savings Bank Co. Ltd.

HVB Mortgage Bank Co. Ltd.

OTP Mortgage Bank Co. Ltd.

OTP Housing Savings Bank Co. Ltd.


The proportion of foreign property is still determinant: at the end of

the half year 82 % of the subscribed capital of the sector was in direct

foreign property.

The concentration of the bank sector – as it is characteristic for the

member countries of the European Union, is high in Hungary, too,

despite the fact that by the end of the first six months the large banks

suffered slight losses from their market share based on the balance

sheet total (70,5 % at the end of 2004, 69,6 % by June, 2005) This

reduction can be explained by the above-average rate of growth of

the medium banks.

At the end of the first half of 2005 the large banks possessed 78,4 %

of the company credit outstandings meaning again slight market loss

(at the end of 2004 the rate was 1 % higher) Their position in

company deposit collection however shows small improvement (in

June, 2005 72 % of the deposits of non-financial companies, while at

the end of 2004 71,5 % of the same was at the large banks)

Practically no change in retail credit granting occurred during the first

half year: the 7 big banks possessed 68,6 % of the household credits,

including 79,5 % of the housing credits. Concentration is even higher

in this market if we take also the specialized credit institutions

(mortgage banks owned by the large banks and being active in

granting real asset credits) into account. Market share of the first 7

banks made up 70,2 % in June, 2005, as concerns personal deposits.

Traditionally the market of the self-governments is the most

concentrated, this relatively small market is served by the banks

specialized for this sphere of clients (National Savings Bank and

Raiffeisen in the first place).At the end of the half year the large banks

possessed 92 % of the credits and 91 % of the deposits of the self-governments.

Opening of bank branches by the foreign banks

Although Dresdner Bank is among the small banks in the classification

from the beginning of July, 2005 it has been working as a branch.

By the end of the half year two foreign banks – not existing previously

in the domestic market – announced for SSFO their intention to open

up branches (Fortis – working actively in the Benelux states and the

French Cofidis), and the branch of Fortis Bank has already begun its

operation in the second half year.

Closer and closer cooperation among the banks and the insurance

companies is the sign of increasing integration among the financial

sectors. The banks offer more and more insurance products for their

clients (passenger insurance, home insurance) and for the case of

granting real asset credits most of the banks stipulates conclusion of

life insurance or real asset insurance.


5. Regulation and policy measures

Effect of the government’s tax and cost reduction plans

Planned tax and cost reduction steps of the government do not affect

directly the sector of credit institutions, but through changing the

credit solvency of the clients they can exert indirect influence.

Reduction of the rate of the general turnover tax from 25 % to 20 %

to be introduced from January, 2006 supports consumption, including

sales of motor vehicles as well as other consumer durables, that can

favourably affect the demand for retail commodity loans.

5 % decrease in the rate would expectedly generate similar reduction

in the price of newly built flats. A part of the consequently increasing

requirements in the housing market may occur as an additional

demand for real asset credits. However planned reduction in

budgetary costs will negatively influence the position of the companies

providing services from state funds, that of the employees of the

budgetary sphere, the income position of certain budgetary

institutions and consequently their credit solvency.

Introduction of the tax on interest rate has been a question on the

agenda for years. According to the present plans this rate will increase

from today’s 0 % up to 10 % from 1st January, 2007, that would

significantly affect the investment decisions of the savers. By the

reducing interest rates the investors show increased interest in

alternative products, involving higher risks (more and more banks

offer so called structured products and savings products made by the

combination of investment shares and fixed deposits).

This tendency – increase in risk-taking desire of the investors – will be

expectedly strengthened by the tax on interest rate. In case the

changes would not concern the returns from investment shares, a part

of the deposits will be expectedly re-grouped towards the investment


Tax burden on the market price earnings will be imposed

simultaneously with the tax on interest rates from the beginning of

2007 and the same rate of 10 % will be applied. Direct personal

investments in market shares have not been important since the

Russian crisis in 1998, they represented about 1 % among the

financial savings, consequently no significant displacement (e.g. rise

in the demand for investment shares) by the appearance of the tax

may be accounted for

The above mentioned changes in taxation (tax on interest rate, tax on

price earnings) do not concern the companies, since they pay taxes

after their profits from investments uniformly by means of company

tax rates.


Banks’ special tax is a one-time important cost for the banks in 2005-2006


In compliance with the government’s decision the banks have to pay

one-time special tax in 2005 and 2006, out of which 30-30 thousand

million HUF income is accounted for by the budget. During the two

years in question the credit institutions pay a tax of interest rate

difference of 6 %, it can be depreciated from the tax base.

Based on the data of the first half of 2005 this extraordinary cost item

did not worsen sensibly the profitability of the section because the

banks – even if at a moderated and differentiated rate – were capable

of charging their clients with a part of it (by means of rising charges

and commissions at the end of 2004 and in the beginning of 2005)

though communicated the same to the contrary.


6. Short and long term prospects

As it is reflected by the already started processes slowing down of the

crediting activities, reduction of the interest margins (consequently

that of the interest returns) and growth of risk-taking by the banks

can be accounted for in the coming years, which factors can

deteriorate the present outstanding profitability of the sector.

Negative displacement may be expected in the quality of the credit

portfolios of the banks, the first signs of which can be found at

present in the increasing number of debtors with payment delays.

The rapid growth of the retail housing credit portfolio exerts

favourable influence on the quality of household loans outstandings at

the short term, because the proportion of covered assets (therefore

with less non-payment risk for the banks) is increasing. In general the

rate of non-payment is also lower in case of the covered credits,

payment discipline of the clients is much stronger in view of the fact

that in case of non paying the installments their own property (real

asset) gets into danger.

At a longer term, however, the banks place less and less new housing

credits, so an increase in the proportion of bad credits can be

expected due to several reasons. On the one hand the problems with

payment traditionally occur with some delay after taking the credit

(the debtor pays the installments in time for a while). On the other

hand by this dynamic development of the sector the means of credit

risk management could – presumable – hardly keep space, thus a part

of the banks has probably underpriced the credit risks or did not

define the conditions of crediting strictly enough. Strengthening of the

competition in the field of housing credits counter-affects stricter

conditions of credit granting.

Although the foreign exchange loans outstandings of the companies

are significant, the households are usually less protected in case of a

more important displacement of the rates of exchange, because their

incomes are generated characteristically in the domestic currency. The

great majority of the company foreign exchange credits belongs to

multinational firms, that are naturally better covered against the

displacements in the rates of exchange (in case they possess

considerable incomes in foreign exchange).

Households with foreign exchange credits that could not be able to

finance HUF credits of similar duration and amount mean specially

high risks for the banks.

Slowing growth of the European economy – including the worsening

performance of countries being important export markets for the

domestic companies (e.g. Germany, Italy) would negatively influence

the profitability and creditworthiness of the companies supplying these

markets, and it can also manifest itself in the quality of company

credit portfolio of the banks. The process described in respect of the housing 

credits (due to market saturation and strengthening

competition the banks grant credits for more and more risky clients

with looser and looser conditions) it is also valid for the company

placements that the proportion of credits granted for financially more

tangible small- and medium-size enterprises is continuously growing

within the placements.

According to the expectations the profitability of the banking sector

will drop due to the decreasing interest margins and the slowing

growth of housing credits. Driving force may be expected from the

consumer credits, and free use mortgage credits and the card credits

can be especially popular in this sphere. The Program of Home

Establishment can generate more credit requirements by raising the

age limit from 30 to 35 years. The growth in commission incomes and

cut in the operating costs can partly compensate the reduction of the

margins. In respect of cost effectiveness the domestic sector lags

behind the indices characterizing the developed countries,

improvement must be achieved.

In summary several transitional effects (high interest margin, housing

aid system, exchange profits due to suddenly reducing yields in case

of the securities for trading purposes) play role in the outstanding

profitability of the domestic banking system even at an international

level, that cannot be maintained at a longer term, thus anyway a

reduction in the profitability of the sector must be accounted for.


7. Sectoral SWOT analysis

Strengths Weaknesses

• High profitability

• Very strong competition in certain

sectors (company sector, foreign

exchange credits)

• Universal activity and movement

towards dimension economicalness

• Continuous growth of the depth of

financial intermediation

• Good quality credit portfolios

• Sphere of products and services similar

to that of the developed countries (see

structured deposits, credit card and

general purpose mortgage credits etc)

• High concentration due to historical

and actual economic policy reasons,

low competition in certain sectors (e.g.

supported housing credits)

• Lack of sources, dependence on

external sources

• Low (although improving) cost


Opportunities Threats

• Increasing personal bank savings due

to growing real incomes

• Potential in mortgage market – growth

of general purpose mortgage crediting

in addition to the housing credits

• Still low penetration of consumer


• Development of the investment

services, bank- and credit card as well

as electronic services

• Increasing risk of new credit debtors

(population), worsening credit


• Worsening quality of the credits for

small- and medium-size companies

(especially in case of foreign exchange


• Further reduction in the operating

costs can favourably affect profitability


(c) 2001Copyrights, Hungarian Trade Office, Taipei   
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