May 2014 Financial Stability Report Analysis

Financial Stability Report May 2014 Bal zs Vonn k 22 May 2014

Banks vulnerability decreased further, however, they still does not adequately support sustainable growth Shock-absorbing capacity: Capital injections announced in 2014 improved capital position, while liquidity of the banking sector is also sufficient even in a stress scenario. Procyclicality: Lending activity was stimulated markedly by the MNB s Funding for Growth Scheme (FGS) and the policy rate cuts. However, market-based corporate lending is still restrained. 2 Magyar Nemzeti Bank

Commitment of parent banks plays an important role in the improvement of resilience November 2013 November 2013 May 2014 May 2014 Procyclicality Shock-absorbing capacity Financial stability heat map Source: MNB. 3

Shock-absorbing capacity of the banking system is strong 4

The stress level in domestic financial markets remains low 1,0 1,0 0,9 0,9 0,8 0,8 0,7 0,7 0,6 0,6 0,5 0,5 0,4 0,4 0,3 0,3 0,2 0,2 0,1 0,1 0,0 0,0 -0,1 -0,1 -0,2 -0,2 -0,3 -0,3 -0,4 -0,4 Jun-07 Jun-10 Jun-11 Feb-09 Apr-10 Feb-12 Apr-13 Jul-09 Jul-13 Sep-07 Oct-09 Sep-10 Oct-12 Oct-13 Nov-08 Nov-11 May-08 May-09 May-12 Jan-07 Mar-07 Mar-08 Aug-08 Jan-10 Mar-11 Aug-11 Aug-12 Jan-13 Mar-14 Dec-07 Dec-10 Dec-13 SWFSI Correlation contribution (smoothed) System-wide Financial Stress Index (SWFSI) Source: MNB. 5

Liquidity position remains solid even under stress scenario HUF Bn per cent 2 400 90 2 000 75 1 600 60 1 200 45 800 30 400 15 0 0 -400 -15 -800 -30 -1 200 -45 -1 600 -60 -2 000 -75 -2 400 -90 May May May May May Jan-09 Jan-11 Jan-12 Jan-10 Jan-13 Jul Jul Mar Jul Jul Jul Mar Mar Mar Mar Nov Nov Nov Nov Sep Sep Sep Nov Sep Sep Liquidity need to meet the regulatory requirement Liquidity buffer above the regulatory requirement Liquidity Stress Index (right-hand scale) Liquidity Stress Index, and banks' liquidity surplus or deficit relative to the regulatory level in the stress scenario Source: MNB. 6

Decreasing vulnerability, but substantial outflow of external funds may continue to pose a considerable risk EUR Bn per cent 30 190 25 160 20 130 15 100 10 70 5 40 0 10 Sept Mar Jun Mar Jun Mar Jun Dec-14 Mar Jun Sept Sept Sept Sept Dec-11 Dec-12 Dec-13 Dec-15 Jun-10 Foreign funds Baseline scenario Loan-to-deposit ratio (right-hand scale) Development of banking system's foreign funds and the loan to deposit ratio through the forecast horizon Source: MNB. 7

Despite significant losses, the banking systems need for capital in stress scenario is minimal HUF Bn per cent 1 200 40 900 30 600 20 300 10 0 0 -300 -10 Q2 Q4 Q3 Q4 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q2 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 2006 Q1 2013 Q1 2005 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 Capital need to meet regulatory requirement Capital buffer above the regulatory requirement Solvency Stress Index (RHS) Solvency Stress Index Source: MNB. 8

due to capital injections carried out this year HUF Bn HUF Bn 400 400 350 350 300 300 250 250 200 200 150 150 100 100 50 50 0 0 2000 2009 1998 1999 2001 2002 2003 2004 2005 2006 2007 2008 2010 2011 2012 2013 2014 Q1 Capital injections Parent bank fund forgiveness Capital injections in the banking system Source: MNB. 9

Although average capital adequacy is solid, the aggregate indicator conceals significant heterogeneity per cent per cent 40 40 36 36 32 32 28 28 24 24 20 20 16 16 12 12 8 8 Minimum regulatory capital requirement 4 4 0 0 End of first year End of second year End of first year End of second year Stress scenario Baseline scenario Capital adequacy ratio of banking sector Distribution of the capital adequacy ratio based on the number of banks Source: MNB. 10

Lending does not adequately support economic growth 11

Positive turnaround in corporate lending in the second half of 2013, mainly due to the FGS per cent per cent 5 5 4 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 -4 -5 -5 -6 -6 -7 -7 -8 -8 Q2 Q3 Q4 Q2 Q4 Q2 Q3 Q2 Q3 Q4 Q2 Q3 Q4 Q3 Q4 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2016 Q1 2015 Q1 Fact - total corp. Forecast - total corp. (new) Forecast - SME (prior to FGS) Forecast - total corp. (prior to FGS) Fact - SME Forecast - SME (new) Forecast of lending to non-financial corporations (transaction-based, y-o-y data) Source: MNB. 12

Utilization of the second phase of FGS is proportionally higher than in the first billion HUF billion HUF percent percent 100 100 800 800 90 90 700 700 80 80 600 600 70 70 500 500 60 60 50 50 400 400 40 40 300 300 30 30 200 200 20 20 100 100 10 10 0 0 0 0 FGS, first phase FGS, second phase FGS, first phase FGS, second phase The diagram on the right shows the utilization of the credit line in percentage (Credit line of the first phase: HUF 750 billion, Credit line of the second phase: HUF 500 billion) Source: MNB. 13

While the utilization of new investment loans is even higher billion HUF billion HUF billion HUF billion HUF 350 350 210 210 300 300 180 180 250 250 150 150 200 200 120 120 150 150 90 90 100 100 60 60 50 50 30 30 0 0 0 0 FGS, first phase FGS, second phase FGS, first phase FGS, second phase Utilization of new loans in terms of time proportionality Utilization of new investment loans in terms of time proportionality Source: MNB. 14

But rebound in market-based lending is needed as well for supporting sustainable economic growth per cent per cent 100 100 Tightening 80 80 60 60 40 40 20 20 0 0 -20 -20 Easing -40 -40 -60 -60 -80 -80 2008 H2 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 2014 H1 (e.) 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013 Q1 Capital position Economic outlook Risk tolerance Changes in credit conditions Liquidity position Industry-specific outlook Market share goals Changes in credit conditions and factors contributing to the changes in the corporate segment Note: Net percentage balance of respondents tightening/easing credit conditions weighted by market share. Source: MNB, based on banks' responses. 15

Increase in Household lending, which may be prudent by regulating LTV/PTI standards HUF Bn HUF Bn 700 700 600 600 500 500 400 400 300 300 200 200 100 100 0 0 Q3 Q3 Q3 Q3 Q3 Q3 Q3 Q3 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q1 2016 Q1 Confidence band New disbursements Refinancing for early repayments New disbursements in the Household segment Source: MNB. 16

Measures of the MNB are aimed at mitigating vulnerability by changing asset composition of banks Asset side of banks Measures SME lending is increasing FGS pillar I Contraction in loans to companies without natural hedge Loans FGS pillar II Household lending increases, risk of imprudent lending may increase LTV, PTI regulation may contribute to more sound lending practices FX household debt is shrinking, risks are decreasing Problem/ risky loans Government, Supreme court decision National Asset Management Agency mitigates the problem Household NPLs is decreasing Regulatory steps are needed to boost portfolio-cleaning Corporate NPLs is decreasing The volume of 2-week central bank instruments is decreasing Liquid assets Self-financing concept gives incentives Government securities holdings are increasing Preferred directions in the change in banking sector asset structure and steps supporting them Source: MNB. 17

The sluggish portfolio cleaning of corporate loans is a significant macroprudential risk 18

In the case of corporate loans, quality improvement and portfolio cleaning decreased the NPL ratio by the end of 2013 per cent per cent 22 22 20 20 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 Q2 Q3 Q4 Q2 Q3 Q2 Q3 Q4 Q2 Q3 Q4 Q3 Q4 Q2 Q4 Q2 Q3 Q4 Q2 Q3 Q4 2007 Q1 2008 Q1 2009 Q1 2011 Q1 2012 Q1 2013 Q1 2010 Q1 30-90 days delinquency 90+ days delinquency ratio Share of non-performing corporate loans of the banking sector by customers Source: MNB. 19

Movements in the cleaning component may be mostly accounted for one-off effects percentage point percentage point 4,0 4,0 3,5 3,5 3,0 3,0 2,5 2,5 2,0 2,0 1,5 1,5 1,0 1,0 0,5 0,5 0,0 0,0 -0,5 -0,5 -1,0 -1,0 -1,5 -1,5 -2,0 -2,0 -2,5 -2,5 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 2012 Q1 2013 Q1 2010 Q1 2011 Q1 Stock component Portfolio impairment component Portfolio cleaning component Change of NPL ratio Factors affecting changes in the ratio of non-performing corporate loans in the banking sector Source: MNB. 20

The corporate NPL ratio is expected to stagnate per cent per cent 6 30 5 25 4 20 3 15 2 10 1 5 0 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 Loan loss provisioning Loan loss provisioning - forecast Non-performing loan ratio (RHS) Ratio of non-performing loans and the cost of provisioning in the corporate segment Source: MNB. 21

Share of defaulted loans stuck for years within the non-performing portfolio is significant... per cent per cent 30 30 25 25 20 20 15 15 10 10 5 5 0 0 0-6 6-12 months 1-2 years 2-3 years 3-4 years 4-5 years Above 5 years months By number of contracts By outstanding amount Distribution of corporate NPL according to time elapsed since becoming non-performing Source: CCIS. 22

in which the share of project loan portfolio is significant per cent per cent 30 30 25 25 20 20 15 15 10 10 5 5 0 0 IV. IV. III. III. 2012.I. 2013.I. II. II. Other corporate NPL/total coporate loans Project loans NPL/total coporate loans Project loans restructured/total project loans Portfolio quality in the corporate segment Source: MNB. 23

High vacancy rate among commercial properties compared to other European markets thous. EUR/m2 per cent 25 50 20 40 15 30 10 20 5 10 0 0 France Spain Poland Hungary Netherlands Germany United Kingdom Italy Ireland Russia Czech Rep. Belgium Luxembourg Vacancy rate (2010 Q4) Vacancy rate (2013 Q4) Capital value (2013 Q4, RHS) Vacancy rate and capital value of the office market in an international comparison Source: Jones Lang LaSalle. 24

Portfolio cleaning: mid-term benefits may outweigh short-term costs Improving portfolio quaility Improving maturity mismatch Growing risk appetite Released liquidity Decreasing funding costs Improved liquidity Increasing lending activity Released human resources Decreasing risk of future losses Improving profitability Released capital Potential for increased loan loss provisioning on the remaining stock 25

Low profitability may lead to consolidation in the banking sector 26

Domestic banking sector continues to be characterised by weak profitability per cent percent 30 30 25 25 20 20 15 15 10 10 5 5 0 0 -5 -5 Hungary -10 -10 -15 -15 2007 2008 2009 2010 2011 2012 2013 H1 Return on equity in an international comparison Source: EKB CBD. 27

Persistently weak profitability hampers lending in support of sustainable growth Deterioration in asset quality and weak profitability are endogenous. Deleveraging Deteriorating ability to attract funds and capital Decreasing net incomes Weak profitability Reluctance to realize further losses Higher funding costs External vulnerability Subdued portfolio quality Increasing loan losses Source: MNB. 28

Subdued profitability poses risks to growth 20 10 Average ROE (2010-2013, per cent) 0 -10 -20 -30 -40 -50 -60 -20 -15 Annual change of lending to corporations (YoY, per cent) -10 -5 0 5 10 15 Return on equity (2010-2013) and decline in the corporate loan portfolio (2013) by bank Source: MNB. 29

Persitently low profitability may lead to consolidation and a higher concentration of the banking sector HUF Bn HUF Bn 1500 1500 1000 1000 500 500 0 0 -500 -500 -1000 -1000 -1500 -1500 2008 2009 2010 2011 2012 2013 Unprofitable banks Profitable banks Net profit after taxation Cumulative net profits of profitable, unprofitable banks and the banking sector since 2008 Source: MNB. 30

Increasing concentration in Household lending since the onset of the crisis 0.40 0.40 0.35 0.35 0.30 0.30 0.25 0.25 0.20 0.20 0.15 0.15 0.10 0.10 0.05 0.05 0.00 0.00 May-05 May-06 May-08 May-09 May-10 May-11 May-13 May-07 May-12 Jan-05 Jan-06 Jan-08 Jan-09 Jan-10 Jan-11 Jan-13 Jan-14 Jan-07 Jan-12 Sep-05 Sep-06 Sep-08 Sep-09 Sep-10 Sep-11 Sep-13 Sep-07 Sep-12 Housing loans Unsecured loans Home Equity loans Herfindahl-Hirschmann-index based on new disbursements in each segment Source: MNB. 31

Thank you for your attention! 32