REPORT

on Activities of the Hungarian Banking Association

1^st Quarter 2003

I. MAIN ECONOMIC AND FINANCIAL PROCESSES IN 2002 *

II. PROFESSIONAL ACTIVITIES *

III. LOAN SCHEMES *

IV. INTERNATIONAL COOPERATION *

V. EVENTS, ASSOCIATION LIFE *

I. MAIN ECONOMIC AND FINANCIAL PROCESSES IN 2002

1. Economy

GDP grew by 3.3%, picking up speed in each quarter: 2.9% in Q1, 3.1% in Q2, 3.5% in Q3 and 3.7% in Q4. Although the annual growth rate was lower than the average in previous years in Hungary (4.5 % p.a. between 1997 and 2001), it was still high by international comparison.

Industrial production figures in 2002 also show an economy picking up again: manufacturing grew by 3.6% (within this, electrical machinery and instrument manufacturing expanded by 4.8%). Exports grew by 5.7%, domestic sales stagnated. While a higher increase in 2001 (3.6%) was mainly due to the rollover impact of a dynamic growth in 2000, the increment in 2002 was entirely fresh growth: production in December 2002 grew by 9.6% over December 2001.

The construction sector grew by 20.1% in 2002, with a 12.5% increase in housing (32.000 new homes built).

In external trade, exports grew by 12.6%, imports by 17% (based on Central Statistical Office data in USD); the balance of trade showed a deficit of USD 3.3 billion. According to data of the National Bank of Hungary, measured in EUR, the monthly deficit between 1996 and 1998 was around EUR 200 million; this number doubled in 1999 and 2000, to a monthly average of EUR 400 million, then dropped to almost half in 2001 (200 million monthly), to double again by the end of the year (EUR 400 million monthly).

The current account deficit - after statistical adjustments - was EUR 2.777 billion in 2002 (EUR 1.967 billion in 2001). Foreign direct capital investments covered less than half of the deficit (EUR 1.281 billion). Most direct capital investments came from Holland; manufacturing (instruments) was the main target sector.

Capital expenditure in 2002 increased by 5.5% over 2001. Within this, capital expenditure grew only in the services sector, while decreasing in the manufacturing sector by 6% and by an even higher rate in the construction sector.

The economically active population grew by 30,000, employment increased by 10,000; the employment rate grew by 0.8%. The unemployment rate (computed according to the ILO methodology) rose by 0.5%, to 6.1%. The structure of employment is mature; industry and business and public services provide 30% of the jobs, each, construction and agriculture 4%, each.

Earnings, consumption, savings. Monthly average net earnings grew by 19.6% in 2002 (more than double the GDP growth rate in current terms). Earnings grew by 16% in the competitive sphere and by 27.5% in the public sphere. Average net earnings exceeded HUF 100,000 in December. Average earnings in the public sphere were 44% higher than in the competitive sphere. With consumption stimulated by rising earnings, retail sales grew by 16% in real terms. The number of Hungarian citizens travelling abroad increased by 16%. End consumption grew during the year, gross accumulation decreased. The chart below shows the difference between the nominal GDP growth rate and the growth rate of households' net financial wealth, the wealth gap: net household savings fell behind the nominal GDP growth rate for the third year in 2002.

Following the logic of political cycles, state expenditures increased substantially, with increased spendings by the outgoing government before elections (and also subsequently) and then by the new government meeting its election promises in the first 100 days. All this resulted in a general government deficit of 9.4% relative to the GDP, 2% of which came from one-off accounting items.

2. Financial processes

2002 was a significant year in the financial sector:

• The excess liquidity of economic actors was drained,
• Inflation fell from the 10% level of previous years to 5%,
• Backed by an anti-inflationary interest rate policy, the HUF exchange rate remained within the 15% band, mostly hovering at the strong edge of the band.

Simplified Balance Sheet of Commercial Banks (Other Monetary Financial Institutions)

The above graph and table are a rough aggregate of banks' and co-operative credit institutions' balance sheets, intended to present the funding structure. Net client deposits (non-financial + financial corporate deposits - borrowings + household and supporting institutions' deposits - borrowings) decreased but remained positive all the time, which means that client deposits also financed loans other than client borrowings. It is also apparent that net loans to the central bank moved parallel with client deposits, while net foreign loans barely changed. If excess liquidity in the economy was measured by the rate by which client deposits exceeded client loans, then it is right to say that the draining of excess liquidity ended in 2002.

Simplified Balance Sheet of the Central Bank

HUF Billion

Central bank assets (foreign exchange + government bonds) basically remained unchanged between the beginning of 2000 and the end of 2001 (sterilised intervention): the stock of government bonds decreased by the same volume (from HUF 1,800 billion to HUF 900 billion) as foreign exchange grew (from HUF 700 billion to HUF 1,500 billion - 1,600 billion). Half of the stock of government bonds was sold to banks, bringing banks' government bonds portfolio from HUF 900 billion to HUF 1,300 billion. While foreign direct capital inflow fell behind the current account deficit, foreign exchange reserves of the central bank decreased by HUF 200 million (from HUF 1,400 billion to HUF 1,200 billion) in 2002; the volume of government bonds held by the central bank rose by a bare HUF 100 billion, from HUF 900 billion to HUF 1,000 billion (a liquidity tightening of HUF 100 billion). Within liabilities of the central bank, bank deposits decreased continuously over the past three years, due to an increased demand posed by clients: in the first year and a half, corporate borrowings increased dominantly, while in the second year and a half, household borrowings grew more (while household earnings kept increasing).

The central bank's interest rate policy and its impacts. The relation between central bank and commercial bank interest rates can be best illustrated by looking at the time series.

The above graph reveals that banks were quite quick in following central bank interest rate changes, at least in terms of asset pricing.

Central bank real interest rates. The evolution of central bank real interest rates shows a V shape, with real interest rates declining from 3% in January 2000 to 0% in the first half of 2001 and then rising to around 5% by August 2002. If market players thought that demand for loans could be controlled by comparing sales possibilities and interest costs, then a meaningful fact is that low real base interest rates were always applied when the economy was on the rise (and so were sales possibilities) and were raised when growth slowed.

Rather than controlling interest rates under an anti-cyclical economic policy, the central bank even added to the process. The chart below clearly shows the impact of a procyclical regulation, with the difference between real interest rates and the GDP growth rate showing a downward curve rather than a horizontal line.

Exchange rates. From the exchange rates chart, where the top is at the strong edge of the band and the bottom is near the mean rate, it can be clearly seen that since the widening of the intervention band the exchange rate has stayed in the same half, continuously drifting towards the strong edge of the band. The previous charts also reveal that high interest rates clearly contributed to a strong forint.

Inflation. The evolution of inflation can be split into various periods in the past decade. In 1995 - as a consequence of economic rectification measures - inflation rose from 18% to 28%; between 1995 and 1999 it fell by an annual 4.5%, to settle at an annual 10% between 1999 and 2001. In 2002, inflation dropped to 5%. The exchange rate policy that promoted this drop drifted internal equilibrium problems into an external disequilibrium; the pace of price increase was also slowed by the postponement of certain warranted regulated price increases.

In summary: in 2002, fiscal stimulation and changes in monetary policy caused serious disequilibrium problems in an economy beginning to pick up. These problems will have to be rectified by economic policy in 2003.

3. The banking sector

As of the end of 2002 there were 39 banks operating in Hungary. (41 in 2001). The share of foreign ownership decreased by 2.5%, to 60.5%. The ratio of aggregate balance sheet total of the banking sector to the GDP was the same as a year before, 68.4%. 80% of aggregate balance sheet total was produced by large banks, 13% by medium-sized banks, 2% by small banks and 6% by specialised banks. The distribution of employees by bank size was similar (74%, 14%, 2% and 9%, respectively). The average number of employees grew by 2.6% (27,000 people). Concentration in the banking sector decreased somewhat: while 24% of the banks held 76% of total assets in 2001, 73% of total assets was held by 26% of the banks in 2002.

Performance in 2002 cannot be assessed on an overall sector basis, because the picture would be distorted by special losses posted by the Hungarian Development Bank. Accordingly, we will look at the performance of commercial banks. The profitability of commercial banks improved further in 2002. ROE before tax rose by 0.03%, to 18.65% in nominal terms (representing an ROE growth from 9.4% to 13.9% in real terms). Nominal ROE showed a sharp decrease by bank size (19.2% for large banks, 10.7% for medium-sized and 5.9% for small banks); capital adequacy ratio by bank size showed just an opposite trend (9.3%, 13.3% and 42.5% respectively).

The internal structure of the balance sheet changed significantly in 2002. The share of client loans (corporate and retail) rose from 48.5% in 2001 to 50.4% in 2002. Within client loans, the share of loans to financial and non-financial corporate clients decreased from 83% in 2001 to 75% in 2002. The stock of retail loans relative to the GDP grew from 5.8% to 8.4% over a year.

The table below shows the main data in respect of banks and co-operative credit institutions. For an easier assessment, all placements are taken as loans and all resources are taken as deposits. The first column contains data in HUF billion, the second column shows variance vs. December 31, 2001 and the last column shows the share of items in the balance sheet total. Changes were unusually marked. Household lending increased by nearly two-thirds in real terms, while corporate lending slightly decreased in 2002. The change in loans to general government was roughly one-third in real terms. The stock of loans placed abroad decreased substantially. The liabilities side followed the movements of the assets side: corporate deposits grew by more than 15% in real terms, retail deposits by a bare 3%, deposits from general government increased at a rate between the two; deposits from abroad declined in real terms. Loan and deposit transactions with the central bank diminished. Other liabilities, including equity elements, increased by one-fifth in real terms, to exceed HUF 2,000 billion in total.

Banks and Co-Operative Credit Institutions, December 31, 2002

	HUF Billion	Variance	Share
Loans to the non-financial corporate sector	3763.0	2.6%	32.4%
Loans to other financial corporate clients	653.4	63.2%	5.6%
Loans to households	1418.3	69.2%	12.2%
Loans to general government	2013.0	32.9%	17.3%
Loans to the National Bank of Hungary	1254.4	-3.3%	10.8%
Loans to other financial institutions	1047.5	36.4%	9.0%
Loans to non-residents	977.1	-20.6%	8.4%
Deposits from the non-financial corporate sector	2143.9	19.9%	18.5%
Deposits from other financial corporate clients	344.8	142.1%	3.0%
Deposits from households	4009.0	8.3%	34.5%
Deposits from general government	255.4	12.9%	2.2%
Deposits from the National Bank of Hungary	21.1	-52.7%	0.2%
Deposits from other financial institutions	873.5	17.3%	7.5%
Deposits from non-residents	1682.6	0.8%	14.5%
Other liabilities, equity elements	2173.7	25.4%	18.7%
Aggregate balance sheet total	11611.5	14.4%	100.0%

While commercial banks' interest expenses only grew by HUF 5.9 billion, to HUF 435.3 billion in 2002, interest revenues rose by HUF 37.2 billion, to HUF 782.9 billion. Thus, profit from interests grew by HUF 31.3 billion compared to 2001. (This, with an increase of HUF 27.2 billion in non-interest profits and HUF 35 billion in operating expenses resulted in a HUF 22.3 billion increase in aggregate profit before tax).

An analysis of the portfolios of commercial banks reveals that the qualified portfolios (sub-standard + doubtful + bad debts) were under 2.5% in all three bank size categories, although the proportion of problem-free portfolios decreases with the size of the bank.

Qualified portfolios	Large banks	Medium-sized banks	Small banks
Problem-free	91.6%	96.4%	97.8%
Monitored	6.0%	2.6%	1.4%
Sub-standard	1.2%	0.4%	0.4%
Doubtful	0.6%	0.3%	0.1%
Bad	0.6%	0.3%	0.2%
Total	100.0%	100.0%	100.0%

Aggregate ROA of commercial banks grew from 1.60 to 1.71.

Following declining inflation and changes in the central bank nominal base rate, interest rates declined by 5-8 per cent over the past three years. Surprisingly, however, the difference between short and long-term lending rates was just 0.2%-0.3%, showing market players' confidence in a continued decline of inflation, with big differences in expected real interest rates. With deflation expectations diminishing at the beginning of 2003, the difference between short and long-term lending rates rose to 2%-3%. In deposits, the situation was different: short- and long-term rates often intersected in the past three years: long-term interest rates were higher in the first year and a half, while the trend turned in the second year and a half. As a result, short-term interest margins declined from 3.5% to 3%, while long-term interest margins varied hectically between 1% and 5%, typically growing rather than decreasing in the past three years.

Short-term deposit rates declined sharply over the past three years, from 11%-12% at the beginning of 2001 to 5% at the beginning of 2003; long-term deposit rates were a few percentage points higher than short-term rates. Lending rates remained at the 22% - 24% level of 2000; long-term lending rates often approached the level of deposit rates (sometimes even sinking below it), but overall remained above it. Interest margins, not decreasing during the past three years, rose from the initial 11%-12% to 15%-18%.

II. PROFESSIONAL ACTIVITIES

1. Credit Institutions Act

The draft law on amendment to Act CXII of 1996 on Credit Institution and Financial Enterprises (Credit Institutions Act) was presented to Parliament under No. T/2822 in March 2003.

The proposed amendments are primarily required for harmonising Hungarian laws with the relevant EU legislation and address two main issues:

• Re-regulation of consolidated supervision of credit institutions,
• Adoption of the provisions of Directive 2001/24/EC of the European Parliament and the Council on the reorganisation and winding up of credit institutions.

1.1. Consolidated supervision is connected to a simultaneous amendment to the Capital Market Act.

The objective of the regulation of associated companies connected through ownership or other control relations is to ensure a transparent risk management and to prevent the "concealing" of exposures from the supervisory authority. Subject to consolidated supervision are credit institutions, which hold a participation in a credit institution or a financial enterprise or are a parent company of such institution or whose parent company is a financial holding company. Consolidated supervision also extends to subsidiaries, participations and financial, investment and auxiliary enterprises of the institution subject to supervision on a consolidated basis. Consolidated supervision also applies to the parent company of the credit institution subject to consolidated supervision, if it is a holding company, as well as its credit institutions, financial enterprises, investment enterprises and auxiliary enterprises. In the first place the Supervisory Authority can take action against the credit institution, which is subject to consolidated supervision.

Credit institutions and financial holding companies subject to consolidated supervision are responsible for the prudent operation of the group on a consolidated basis. This means that the limits for large exposure must be complied with also on a consolidated basis and the consolidated solvency ratio may not be less than 8%. The relevant computations on a consolidated basis will have to be performed by the credit institution (or by the financial holding, if the parent company is a financial holding) subject to consolidated supervision, as the organisation that has the required comprehensive information on a group level. Group members will have to provide data to the credit institution (or financial holding) falling under consolidated supervision, which will have to have the IT infrastructure required for processing such information.

1.2. In line with European Parliament and Council Directive No. 2001/24/EC, the proposed amendment to the regulations on the winding up of credit institutions will strengthen client protection in cases where the winding up of a credit institution affects clients in other member states (foreign branches, cross-border services).

Court decisions on winding up or final accounting will be effective across the entire territory of the EU. Bankruptcy, winding up or final accounting procedures instituted against an EU-based credit institution will be governed by the legislation of the home country. The Hungarian branches of credit institutions based in other EU member states will not be subject to winding up or final accounting. A credit institution's licence shall be revoked if its winding up has been ordered by a court. The relevant court decision shall be published in the Companies Gazette and the official gazette of the European Communities and in two national daily newpapers of the member state where the branch operates or the cross-border services have been provided.

The law amendment also specifies the exceptions with which the provisions of the Hungarian Bankruptcy Act shall be applied.

1.3. Adoption of the EU legislation requires amendments to the regulations on the foundation of companies. In the future, the supervisory authority will have to reject the application for foundation if the owners fall under the jurisdiction of such a third country, where supervision cannot be adequately performed.

1.4. Amendments to the Act on Mortgage Institutions and the Act on Building Societies. According to the proposed amendment, preliminary home savings contracts may in the future be concluded by non-residents as well; however, only residents or those citizens of member states who have a residence in Hungary for employment purposes will be eligible for government support as preliminary savers or beneficiaries.

1.5. The proposed draft law will amend the Act on Co-Operatives, to prevent investment co-operatives from gathering investors through public calls or advertisements with promises for extraordinary returns.

Versions of the draft law were furnished by the Ministry of Finance for review in several rounds.

Our member banks' opinions were solicited before each review and the relevant proposals were summarised and forwarded to the Ministry. Part of the comments was aimed at adjusting certain provisions of the amendment enacted as of 2003, such as those related to the outsourcing of activities of financial enterprises and the amendment to the regulations on risk assumption in Schedule 2 to the Credit Institution Act (in respect of these points our proposals were accepted and incorporated in the Act).

We also proposed simplifying the form of customer consent required for the disclosure of bank secrets so that a private deed should suffice. Based on practical experience we also proposed that the circle of exceptions to bank secret be extended.

We also raised again the issue of early repayment of debts and proposed a concrete solution within the framework of the Credit Institutions Act. Further, we proposed that deals concluded with owners be excluded from the relevant restriction under the Companies Act; we also proposed to ease certain unnecessarily stringent provisions concerning advertisements and consumer protection.

Most proposals were not adopted by the Ministry on the grounds that the law amendment would be confined to the most urgent issues that are directly related to law harmonisation.

In a letter to the Finance Minister we requested that amendments not enacted this time be incorporated in the legislation prior to accession to the EU.

We submitted several proposals in relation to the interpretation of and wording adjustments to the draft. We proposed that an interim period be provided for the entry into force of provisions on consolidated supervision, to provide a temporary exemption for existing contracts from the limits provided.

We raised the need to reconcile the provisions of the Credit Institutions Act with those of the Accountancy Act; also, we urged for the harmonisation of provisions on the liability of members of groups subject to consolidated supervision and submitted proposals for a more lucid formulation of the scope of application of consolidated supervision.

2. Capital Market Act

A draft amendment to Act CXX of 2001 on Capital Market, also required for harmonising the laws with the relevant EU legislation, was presented by the Ministry of Finance simultaneously with the draft amendment for the Credit Institutions Act in March. The proposed amendment provides new regulations related to capital adequacy requirements and complements the provisions on supervision with those related to consolidated supervision.

Investment enterprises subject to consolidated supervision will have to meet a solvency ratio of at least 8% and must at any time have, on a group level, the regulatory capital required for covering risks related to trading book positions, partner risks, large risks and product and exchange rate risks, computed on a consolidated basis.

Another main subject of the draft law are the requirements for fund managers of European investment funds. Fund managers managing European investment funds will have a single European passport after accession. Existing fund managers who wish to manage or set up a European investment fund will also have to meet these requirements.

European investment funds are investment funds formed in Hungary under regulations that are in full conformance with the relevant EU directives. Accordingly, the investment units of such funds will be freely saleable in all EU member states. Most of the amendments proposed are related to special regulations applicable to European investment funds; new and more detailed rules for investing will be introduced and new forms of investments will be added.

In addition to these major changes, the draft law provides for the rules for data supply and provision of information for cross-border services. Also, the rules for portfolio management and securities lending will be fine-tuned.

The qualification and examination requirements for foreign currency cashiers and administrators and investment consultants were developed in the first quarter and are now under incorporation in the National Training Register.

In addition to the above mentioned comments, we submitted proposals for the interpretation and wording of the proposed amendment.

We provided comments on the regulations for investment funds investing in other investment funds, the qualification requirements for Supervisory Board members of commodity exchange service providers and the requirement of using a separate custodian in connection with portfolio management.

In addition, we submitted comments in relation to certain definitions in the Capital Market Act, the exercising of call options, keeping the share book, custodian activities and amendments to certain other laws correlated with the Capital Market Act. (Mandatory elements to be included in the business rules of business organisations pursuing investment service provider activities).

3. Act on Legislation

The concept for the draft law on Legislation and related amendments to the Constitution was received from the Ministry of Justice for review in February.

In its comments we raised the questions of the place ordinances of the National Bank of Hungary (MNB) have in the hierarchy of legislation and called attention to the need to settle the relationship between Government Decrees and MNB ordinances, pointing out that there may be contradictions in the regulations on payments.

We proposed that the deadline for correcting regulations be increased from 15 days to 30 days.

The proposal containing draft laws related to amendments to the Constitution, the Act on Legislation and the Acts on procedures related to international treaties, on the Promulgation of the Statute of the International Criminal Court adopted by the UN Diplomatic Conference of July 17, 1998 and on amendments to certain Acts of public law in relation to the promulgation of the Statute of the International Criminal Court was received from the Justice Ministry for review in April.

In our comments to the draft law on amendments to the Act on Legislation we drew attention to the absence of a reference to EU sources of law. Namely, EU Regulations as sources of law will be mandatory and shall be directly applied after accession.

We once again raised that the question of the position of NBH Ordinances in the hierarchy of sources of law was unsettled and the ranking provided in the draft law needed adjustments.

We challenged the concept according to which - while draft laws are public - only those organisations whose right of review is provided by a separate law would be involved in the review of draft laws. This provision is a step back compared to the current situation; namely: laws seldom specify by name the professional interest representation organisations that have a right of review. Instead of the mentioned provision, we proposed applying clause c) of subsection (1) of Section 27 of the current Act, providing for the involvement of "the social and interest representation organisations concerned". Further, we submitted specific wording proposals for the draft law.

We also submitted proposals for adjustments to the Act on Constitutional Court. We proposed that the remuneration of the President of the Constitutional Court should not be regulated in a separate Act. In relation to the obligation of informing the Court we drew attention to the need to reconcile bank secret provisions in the Credit Institutions Act and the Act on Constitutional Court.

4. Amendments to the Companies Act and the Company Registration Act

The proposed amendments to Acts No. CXLIV on Business Organisations and Act CXLV on Companies Register and on Registration Court Procedures are primarily required for harmonising the legislation with the relevant EU Directives. (Third Directive on the merger of public limited liability companies, Sixth Directive on the division of public limited liability companies, harmonisation with the First and Second Directives on corporate law; proposed amendment to the First Directive on corporate law in relation to electronic company registration procedures).

The draft law contains provisions for the distribution of subsequently found assets of cancelled companies between creditors and provides clearer rules for the procedure of cancellation ex officio.

The provisions on transformation in the General section of the Companies Act will be made more specific. Supplementary cash payments by the acquiring company to shareholders of the acquired company will be allowed during the merger or division of joint stock companies.

The provisions on capital safeguards of the Second Directive on corporate law will be incorporated in the provisions for joint stock companies and will apply to both public and private joint stock companies. The draft law also contained provisions on European economic interest groupings, in accordance with Directive No. 2137/85 EEC of the European Council.

The purpose of European economic interest groupings is to develop their members' activities; it is not their purpose to make profit for themselves. Members of a grouping may be based in different member states but all members must be operating in EU member states.

The proposed amendment to the Act on Company Registration is mainly aimed at adjusting to the First Directive on corporate law. Announcements on registration shall indicate the place where the documents that have served as a basis for the registration can be viewed.

The Companies Gazette will be made available in an electronic form from the beginning of 2005; the print version will be discontinued and only the electronic version will be available from then on. The persons that have controlling positions in the company (senior officers, chief executives) will be registered as authorised representatives of the company, with an indication whether the person in question is a single signatory or co-signatory and his/her term in office. The draft law also contains more specific provisions for agents to receive service of process.

The First Directive specifies the cases in which the foundation of a company is null and void. These will be adopted through the proposed amendment, which will provide that lawsuits for nullity may be filed within 6 months from the promulgation of the registration of the company.

A separate draft law will be drafted for amendments to Act CXXXII of 1997 on Branches and Commercial Representative Offices of foreign-based companies and, in relation thereto, Act XXIV of 1988 on Investments of Foreigners in Hungary.

Banks submitted proposals in relation to the Companies Act and the Company Registration Act. In relation to Section 9, adding a Subsection A to Section 221 of the Companies Act, according to which, in respect of joint stock companies the preliminary approval of the general meeting will be required for the transfer of shareholding between the company and shareholders having a voting right of at least 10%, if such transfer is to take place within 2 years from foundation, banks proposed that this requirement should only apply to deals reaching at least 1/10 of the share capital. It was also proposed that the Statutes of joint stock companies should allow for the requirement of a general meeting approval to be imposed in respect of other deals to be concluded with shareholders, as well.

In relation to the regulations on non-financial contributions (Section 222 of the Companies Act) we proposed that that the contract of association should stipulate a procedure for determining the value and settling the difference in cases where the value of the contribution when paid differs from the value of contribution stipulated in the contact of association.

We also submitted proposals for the regulations on own shares and for reconciling provisions in the Companies Act and the Securities Act.

In relation to the Act on Company Registration we drew attention to the current legal uncertainties concerning representation and signatory rights and discrepancies in the regulation of representation in the various laws. We proposed that companies be required to report their holding relations to the Court of Registration and such data be included in the registration statements. For limited liability companies we proposed that the company register should contain the details on any mortgage on the company's business quotas, including names of the mortgagees.

A meeting invited by Dr Gábor Gadó, Deputy State Secretary was held on March 19 to review the comments received, with the participation of the commenting banks. Dr Gadó announced that a separate Act containing amendments related to the Accounting Act was being drafted as well as another separate law on procedures for the electronic registration of companies. Electronic registration will only apply to the registration of joint stock companies and the related costs will be included in the 2004 budget. A study on a retrospective digitalisation of company registration documents will be completed by June.

Clause 3 of the draft resolution attached to the proposal will change: a drafting committee will be set up with members from the Supreme Court, the National Judicial Council, the Attorney General's Office, the Banking Association and the Stock Exchange. The committee will have the task of drawing conclusions from experiences in applying the law for the purpose of a comprehensive revision of the Companies Act.

5. Regulation on payments

After repeated requests, the National Bank of Hungary (MNB) invited a consultation on the proposed regulation on payments, prior to the official inter-ministerial review. As a result of this consultation

- the regulations on bank cards have become more favourable: the customer's duties in case of disputes have been specified more lucidly, in accordance with the relevant EU Recommendation,

- the category of customs accounts and their use has been included in the draft,

- MNB insisted on the content requirements for banks statements (which we challenged as too detailed); however, the introduction of the requirements has been postponed for the beginning of next year.

- banks have been allowed to terminate account contracts with undesirable customers during queuing (with the proviso that the items already accepted shall be managed as required),

- banks' tasks related to account identification have been specified in a more clear-cut manner (the cases of identification by account and by account and name, respectively),

- adequate preparation time was included in the draft.

For the time being it has not been clarified which payment modes shall or may be used in relation to the different account types.

Although the draft regulations have not been submitted for formal review yet, the Association has informed all member banks in details on the results of the consultation.

6. Draft law on settlement finality in payment and securities settlement systems

The objective of this draft law is to create the conditions for a secure operation of the system in case of any payment limitations imposed at any participant in the payment or securities settlement systems.

The adoption of the relevant EU directives is aimed at providing suitable legal protection and thus, increased security, to settlement systems adherent to the law.

Based on our member banks' observations we submitted the following comments to the Ministry of Finance:

- the cases where the system operator should not execute the payment order are not clear enough,

- we expressed our objection to the provision requiring the system representative to prove, in case of dispute, that he had no knowledge of certain essential information (negative proof).

- from interpretation points of view we drew attention to the fact that the wording of the draft regulation was difficult in terms of both professional and general language; we recommended using the respective Hungarian legal categories (also requesting that, for the sake of clarity, a specific reference to "payment restrictions", as a key element in the regulation, be included in the title of the regulation).

- we contended that the draft regulation failed to specify the authentic ways of communication of the decision by the bodies (court, supervisory authority) imposing the payment restriction;

The proposal was reviewed in several instances verbally as well as in writing. During the reviews, some new and basic questions arose, in addition to those raised (which settlement systems should be protected, what should the responsibility relations between members of the system be, who may represent the system).

- After multiple revisions made based on the reviews, the draft was submitted to Parliament (only a few of our comments were accepted).

7. Use of bank cards for preferential public healthcare services

The Head of the National Health Insurance Fund (OEP) requested a meeting with the Association to discuss the possible ways for using bank cards/electronic purses for financing public healthcare services.

At the meeting, the Head of OEP explained that in view of the substantial damages caused lately by frauds, the OEP is required under a separate law to modernise and strengthen the control of instruments used for financing preferential public healthcare services. The OEP expects that the use of bank cards will help keep subsidies per patient under control. The OEP said they did not want to issue chip cards and bank cards would suit the purpose.

Specialists from member banks attending the meeting found the proposal of interest. We offered to put together a banking proposal for the OEP in which OEP's tendering aspects would also be given due consideration.

The issue was reviewed at a discussion held with banks involved in bank card operations. According to the proposal developed at the meeting, magnetic cards would be used, which would be distributed by the municipalities to those eligible for preferential public healthcare services. The bank cards would then be used by the patients when paying their pharmacy bills; there would be a special account behind each card, which would be regularly re-filled by OEP.

We stressed that banks cannot undertake to provide all pharmacies in Hungary with POS terminals; for this, substantial support would be required from the state and the Health Insurance Fund. In the proposal we tried to give maximum consideration to the client's objective for the project to be implemented as simply and as soon as possible. Our proposal, containing the most important elements required for a tender document was sent to the OEP.

8. Customs accounts

The Customs Authority (VPOP) requested the Association to join the working group set up to develop a customs account pursuant to a 2002 amendment to the Customs Act, aimed at improving the collection of duties.

Responding to the request, the Association organised three meetings for the working group, including a consultation with banks.

The following issues were raised by the banks:

• The proposed regulation would give the Customs Authority an exclusive right to dispose of the customs account. However, this account is mentioned in the Act as a payment account, which means that banks would have to report the account to the Registration Court and the Tax Authority; in addition, based on the relevant authorisation provided by law, private individuals would have the right to initiate a prompt collection against this account (which would prejudice the exclusivity of the Customs Authority); accordingly, a regulatory adjustment will be required to resolve this issue.

• How to ensure from transaction points of view that the client is denied access to its own funds (e.g. funds transferred to the account and later becoming superfluous);

• How to ensure from IT points of view that the Customs Authority has access to all customs accounts at all banks and can - simultaneously - perform transactions on the accounts (fixing, releasing).

• What inter-bank coordination is required for opening/cancelling a customs account or re-locating it to another bank (one client may only have one account).

We took up the matter with National Bank of Hungary to include customs accounts in the proposed amendments to the regulation on payments in such a manner that the Customs Authority's exclusivity is preserved. Also, we developed a proposal to resolve the problems connected with a direct intervention by the Customs Authority's into the banks' IT systems: the Customs Authority's could view the customs accounts and, instead of the executing the complex processes of fixing and releasing, it would perform the transactions in its own IT system virtually and collection would then take place in the form of multiple collection. Since the account holder (the client) would have no access to the funds on the account, the Customs Authority could exercise real control over the account through these virtual steps.

While thanking for the Association's efforts in respect of regulations, due to the reference in the Customs Act to the customs account as a payment account, the Customs Authority turned down the idea virtual accounting.

9. Data Protection Act

Within the framework of legal approximation, an amendment to Act LXIII of 1992 on the protection of personal data and on the disclosure of data of public interest is currently under drafting by the Ministry of Justice. The draft law is aimed at a comprehensive revision of the current Act. The draft law was first submitted for review in 2001, but given the numerous comments received, the review will only take place some time later on. At the same time, the relevant legislation will have to be harmonised with Directive No. 94/46/EC of the European Parliament and the Council on the protection of the individual with respect to the processing of personal data by accession at the latest.

The proposed amendment determines the scope of application of the Act and provides some additional definitions. Data management required for the performance of private law contracts is mentioned in the amendment as a special category in terms of the legal basis for data management. The proposed amendment also has a special provision on automated individual decisions, which will require the express consent of the party concerned or a respective authorisation by law. The amendment will allow restricting the rights (information, correction, cancellation) of the party concerned in case of any disciplinary or ethical offences related to inspection or pursuit of profession or breach of duties under the labour code. Preliminary inspection will be added to the data protection ombudsman's authorities.

In their comments banks challenged the close date for the entry into force of the Act, fearing that the time allowed will not be enough for preparing themselves, drafting the required internal procedures and training the staff. In addition to specific comments related to the wording of certain provisions, banks challenged subsections 9/A on the prohibition of data linking and 9/B on automated individual decisions, saying that based on the text provided in the draft these would make banking operations impossible.

A similar case is that of the provisions on automated individual decisions: the party concerned may challenge the data manager's decision before a Court; this, in case of loan contracts, may result in contracts established by judicial decision; being against the liberty of contract, this could not be the legislators' intention. Also, informing the client on the mathematical methods applied would result in a possible dodging of the banks' risk management approaches and processes.

Serious concerns were raised in connection with the position of internal data protection officer, his/her responsibilities and his/her right to institute proceedings. The relation between the data protection ombudsman and the internal data protection officer is not clear enough; employing an internal data protection officer is not compulsory under the directive.

10. Reporting requirements of the Hungarian Financial Supervisory Authority

The Supervisory Authority (PSZÁF) advised as late as the end of January that reports to be submitted in January should be provided according to the new formal requirements. Banks requested the Association's urgent intervention in view of the fact that

• the required IT developments could not be implemented within the short time allowed,

• no practical help has been provided by the Supervisory Authority regarding the required changes; the supervisory authority's checking program was not completed in time (this program must be run for all reports without any error before submission) and the Supervisory Authority failed to provide for a testing period to test the changes.

• the common central bank/supervisory authority report structure, compiled with a painstaking work, seemed to disintegrate, as the tables which thus far have had the same contents would have been required to be submitted in different formats to the two authorities (with substantial costs and extra work).

The Association requested a consultation with the Supervisory Authority to review the issue; the issue was also addressed by the Association's Presidium.

At the consultation, representatives of the Supervisory Authority explained the reasons for the change. Banks submitted the problems in implementing the new requirements and the Presidium's position was presented.

The Supervisory Authority admitted that there had been communication errors and confirmed that sufficient time would be allowed for banks to prepare themselves. Following the consultation, a program helping to resolve the differences between the central bank and supervisory reports was completed and made available to the banks.

11. Reporting bank account data to the Tax Authority

The Tax Authority (APEH) requested the Association's assistance in arranging a consultation on the form and contents of bank account information to be reported the Tax Authority. The issue that gave rise to the problem was that from June 2002, banks have been required to report bank account data only to the Court of Registration and the Tax Authority would have received the respective data from the Registration Court. Namely, credit institutions could only report data for entities falling under the Company Registration Act, other organisations (such as associations) were not included in the system; consequently, such organisations were missing from the Tax Authority's database. This error was corrected under an amendment to the Act at the end of 2002, requiring banks to report non-Registration Court data directly to the Tax Authority.

The respective letter of the Tax Authority, which was distributed by the Association to all member banks, specified the required data structure and the cases where the data supply may be qualified by the Tax Authority as erroneous. To properly prepare the consultation invited by the Tax Authority, the Association requested member bank to submit their comments in writing.

In the summary compiled based on the banks' comments we drew attention to the following:

• Although the relevant regulation has been in force since the beginning of this year, banks could not provide data by January 15, as such data would refer to the year 2002, when the law was not in effect. We proposed that bank account information be first reported on the first month of 2002; this would allow banks enough time to prepare themselves.

• The letter failed to specify which groups of clients and what types of accounts should be involved in the report.

• Banks requested the Tax Authority to hold a consultation to determine what bank account data are maintained on their customer base in the Tax Authority's information systems.

• a number of technical issues were also raised.

At the meeting held with the participation of some 60 specialists from banks, the Tax Authority tried to do its best to answer all questions, whether submitted in writing or asked on the spot. The deadline for the first report to be submitted was extended. The participants tried to clarify the scope of organisations that should be covered by the reports. Since this attempt failed, the participants decided to ask the central bank to take position in this matter. Banks' consultation request was rejected by the Tax Authority due to the absence of a respective legal basis. At the same time, progress was made in determining formal requirements.

The Tax Authority promised to answer the remaining questions within the framework of Minutes to be drawn up on the meeting.

12. Competition Authority proceeding on student loans

In November 2001 the Association initiated a proceeding with the Competition Authority on the grounds that the procedure of the Student Loans Centre, making it compulsory for all clients to open their student loan accounts at Postbank, the owner of the Student Loans Centre, violated the competition law. The Competition Council cancelled this proceeding on the grounds that in their view the Student Loans Centre and its activities do not fall under the Competition Act because student loans are not market products. Based on a resolution adopted by the Association's Presidium on January 20, the Association filed for remedies in Court (as a matter of principle, given that in the meantime the issue has been settled by respective measures by the government, allowing for student loans to be disbursed by any bank so authorised).

In the complaint, filed on January 31, we requested the Court to pronounce that the Student Loans Centre misused its dominant position in the period in question: in our opinion the decision of the Competition Office was based on wrong factual and legal conclusions. Our objective with the complaint was to prevent that a final decision of the Competition Authority is used as an argument in similar competition law situations in the future.

13. Incorporation of qualification and examination requirements for foreign currency cashiers and administrators in the National Training Register

The draft decree, received for review, was basically supported by banks. Notwithstanding, the following proposals were submitted:

• knowledge of the Anti-Money Laundering Act should be added to the curriculum;

• in view of the rapid development of the profession, foreign currency cashiers should be required to pass examinations on a recurrent basis (every 3 or 4 years);
• higher requirements should be specified for bank note training instructors (the requirement of one year of experience at a financial institution is too short).

A meeting to review the comments received from the Association and other organisations was organised by the Ministry of Finance, the drafter of the decree. In the meeting, our proposal regarding anti-money laundering requirements was accepted, while the issue of recurrent examinations was referred to the discretion of the employer (the Ministry did not wish to impose regulations in this respect).

There was a debate in relation the curriculum of bank note training. On the one hand, it was acknowledged that a year of banking experience was not enough; in turn, however, this requirement was replaced by 2 years central bank experience. Banks say that with this, the circle of potential instructors will be reduced to a couple of people, whereas banks have qualified and experienced staff for the purpose.

III. LOAN SCHEMES

1. Preferential SME loans

1. Facilities granted by the Ministry of Economy and Transport

As in the previous years, the Ministry of Economy and Transport announced various facilities for SMEs, to be awarded under an application scheme and associated with different sizes of non-repayable capital contribution.

One of these facilities is associated not with capital contribution but with interest subsidy. The allocation for this scheme is HUF 300 million, which, according to the Ministry, can cover 70 to 80 applications. A condition for banks to participate is that gross interest rate may not exceed the central bank base rate (or the 3-month BUBOR) + 4%.

The draft of the invitation for applications was reviewed by banks; only minor comments were made, as the scheme basically follows the practice of previous years.

 

2. Micro loans

The Ministry of Economy and Transport initiated the further developing of the micro loan scheme to involve additional bank resources in the scheme.

Responding to this request, the Association, in consultation with bank specialists, developed a set of conditions under which banks could participate with their own resources in the scheme. The following proposal was made:

- Several banks indicated their interest in participating- under acceptable terms and conditions - in the Micro Loan Scheme. As the loans would be provided from their own resources and at their own risks, banks will perform credit rating in accordance with their respective rules and procedures (irrespective of the involvement of any other institutions or local enterprise centres in the preparation of the application).

- As for guarantees, the procedures and practices to be followed would be developed jointly by the banks and Creditguarantee Ltd. (or the Start Guarantee Fund). The guarantee fee shall be borne by the client.

- All tasks related to the loan transaction (from disbursement to any lawsuit and collection) will be referred to the banks' competence.

- Reporting requirements will be agreed by the banks with the organisation managing the Micro Loan Scheme.

- Banks will charge a monthly service charge equal to the 3-month BUBOR + 4% (with 4% to be possibly reimbursed by the state).

- As, foreseeably, there will be limited government support for the scheme, banks wish to agree with the managing organisation on the consequent practice to be followed.

The ministry has not responded to our proposal yet. According to our information, Local Enterprise Centres would like a solution that would give them a major role in managing the micro loan scheme, which they would do against a commission. We have not seen the relevant proposal and we do not know the Ministry's opinion on the proposal. It is likely that further discussions will be needed on the issue.

2. European Technology Development Program

The European Technology Development Program is aimed at promoting the technical development of SMEs and large enterprises with HUF 120 billion - HUF 150 billion in loans. Funds for the program are provided through refinancing by the Hungarian Development Bank (MFB). Out of the total allocation, approx. HUF 40 billion has been appropriated for SMEs.

Loans are provided in three forms:

• HUF 10 million to HUF 150 million, for SMEs, with a 1.3% interest subsidy provided by the government;

• HUF 50 million to HUF 1.5 billion, by co-financing (refinancing + banks' own resources;

• HUF 150 million to HUF 1.5 billion, through direct refinancing by the Hungarian Development Bank.

Bank specialists reviewed the Procedures for the implementation of the program with MFB in several sessions. Both sides were highly receptive and open to seeking mutually acceptable solutions to all issues raised.

The biggest debate was over the procedure to be applied for SME subsidies. Reaching agreement was also difficult because the new procedures provided by the Ministry for MFB are fundamentally different from those applied in the previous years. Finally, if not perfect though, agreement was reached in respect of what the duties of MFB and what those of the banks will be.

Banks failed to agree on a common proposal for splitting up the allocation for SMEs. Hence, it was decided that the issue would be regulated by MFB under a Framework Agreement.

Banks challenged the 2% premium, as unfair: the premium for any other facility where banks assume the risks is 4% and this would be warranted in this case, as well; banks felt it important to point out this fact and to emphasise that this provision of the program should not be a precedent in the future.

After several discussions, 21 banks signed up to the Framework Agreement with MFB, on April10.

3. Agricultural loans

3.1. Amendment to Ministry of Agriculture Decree No. 3/2001/II.24./FVM

The Ministry of Agriculture failed to send us for review its decree on government subsidies in 2003 for the implementation of agricultural and rural development objectives. As a result, the Decree contains a serious error that is contrary to the relevant Government Decree and causes disturbances between banks and clients.

The error is in Section 261 of the Decree:

"Section 261. Interest subsidies shall only be available on those loan contracts on which

a) total charges on credit exceed by a maximum 4 percentage points the central bank base rate effective of the date of concluding the contract. Should this condition not be met in any year during the loan period, no interest subsidy shall be available in the interest payment period stipulated in the contract in the year in question".

Following the issue of the Decree the Association promptly sent an amendatory motion to the Ministry of Agriculture to provide that total charges on credit should meet the central bank base rate + 4% criterion not only in respect of the base rate effective as of the contract date but in respect of that effective at all times.

Our proposal was accepted. However, as of March 31, the amended decree was not issued.

3.2. Settlement of debts of agricultural businesses operating in adverse regions

Parliament allocated HUF 12.5 billion for businesses operating in adverse regions to convert part of their long-term annual loan debts (50%, according to the plan) into 3-year preferential loans, the annual instalments of which would be paid by the state in case the conditions undertaken by the applicants in their accepted applications are met.

The procedure for the practical administration of the loan is similar to that of the former evolution loans. However, only those agricultural businesses will be eligible for application, whose greater part of land is rated lower than 17 gold crowns. Appraisal criteria also include the rate of employment and public utility coverage in the region.

The relevant regulations and the invitation for applications were reviewed by banks. With experiences obtained during the evolution loan scheme, most issues were successfully agreed on with the Ministry.

At the same time, despite several discussions, the Ministry rejected our proposal that in cases where the loans to be involved are with several banks, there should be more solutions provided for managing the scheme, other than taking over such loans. The Decree and the invitation for applications were issued in April, applications are to be submitted to the banks latest by May 15.

IV. INTERNATIONAL COOPERATION

European Banking Federation

Basel II conference: The new Basel Capital Accord and the European banking system

A conference on the expected impacts of the new Basel Capital Accord on the European banking system was jointly organised by the European Banking Federation, the European Savings Banks Group and the European Association of Co-Operative Banks on March 11 in Brussels. Speakers included European and Basel standard-setters and senior officials from European banks (Presidents, CEOs). The profession is still divided over the new Accord, which, in general, is regarded as a token for stability of the financial sector, while there are also concerns that the introduction of the new capital requirements will involve serious risks for the banking system. Concerns are mainly related to small banks and banks in the pre-accession countries.

Speakers of the regulatory authorities - while emphasising the importance for Basel II and CAD 3 to be developed simultaneously - were focused on issues of key importance on the European level. In line with the objectives of a single market and a level playing field, the new capital accord will apply to all European banks and investment firms, irrespective of size or complexity of activities; therefore, the standardised approach will be of special importance. The treatment of SMEs will also be a priority. National supervisory discretions and the objective of a level playing field may conflict; therefore, supervisory convergence within the EU will be of fundamental importance.

The scope of national discretions is too wide and should therefore be narrowed. Remaining national discretion will have to be referred to the community level, otherwise operations of banks active in several member states would be made difficult. The proposal for capital requirements for operational risk does not encourage the use of advanced measurement approaches; quantifications are still to be fine-tuned. The issues related to maturities, securitisation and specialised lending are immature. Pillar 2 (the exercising of national discretions, cross-border supervisory cooperation, relationship between home and host countries) will have to be worked out in more details. Pillar 3 will have to be simplified and harmonised with IAS. The Basel Committee is prepared to adjust Pillar 3 to the IAS, once the latter is finalised.

Results of QIS 3 show the proposal is suitably motivating; however, some points will have to be adjusted and fine-tuned. The new capital accord will be adoptable in the new member states as well, given that the standardised approach will not be much more complicated.

The presentations and comments offered by senior bank officials agreed in several points. They emphasised that the introduction of the new capital accord will involve substantial costs and additional administrative requirements for banks; banks' risk management capabilities and consequently, their competitiveness are expected to improve; pricing will be adjusted to exposures; the new regulation will have a positive impact on the lending market and will result in better capital allocations.

At the same time, the regulation is procyclical and the "flock spirit" may involve new system risks. Procyclicality may be reduced by anticyclical provisioning regulations and buffer capital requirements. Flexibility will be of fundamental importance during introduction of the new capital accord; the partial use of advanced approaches will have to be allowed for a longer period of time. Some presenters doubted that the use of historic data could be suitable for estimating future losses for corporate portfolios.

Calibration will be critical, the volatility of QIS 3 calls for caution; consistency of the new accord with the new international accounting standards should be ensured (including the provisioning requirements); the treatment of short-term interbank receivables proposed by the Committee is inadequate; the proportionality of the recognition of real estate collateral is questionable; the proposal for the treatment of the retail portfolio should be reconciled with the directive on consumer loans.

Bank officials expressed concern over the fact that only 12 American banks would apply the advanced IRB approach, while the rest would stay with the well-proven Cooke ratio. This may lead to a competitive disadvantage of European banks applying the new standardised approach. In the absence of SME ratings, small banks would anyway be at a disadvantage, as it will be much more difficult for them to prove the quality of their portfolios.

Speakers from European banks found it imperative for supervisory authorities to find the fine balance between national discretions and a consistent implementation of the new accord, otherwise the new Basel Accord would prejudice the objectives of a single European financial market and a level playing field.

Accounts Committee

The IAS Board met twice in March with representatives of the organisations that have provided comments on IAS 32¹ and IAS 39² Exposure Draft. The 51^st session of the FBE Accounts Committee in February formulated the FBE position to be represented during these meetings.

Consultations with the IASB provided an opportunity for reconciling standpoints; however, most differences between standard-setters and banks (some apparently unbridgeable) remained. Therefore, the FBE jointly with the European Association of Co-operative Banks wrote a letter to the IASB and the European Commission, providing their standpoints and reservations concerning the proposed standards. Attached to the letter were the documents compiled by the Association's experts on macro hedging, derivative hedge accounting and other essential issues related to IAS 32 and IAS 39.

European banks are challenging the FFV treatment of derivative transactions in the trading book and are calling for a solution whereby the real financial situation of the unit can be duly presented. If the IASB continues to insist on accounting for derivatives at Full Fair Value, then the value of the portfolio whose interest exposure is macro hedged by derivatives in the trading book should be adjusted to full fair value in a (non-capital) balance sheet line.

The IASB's proposals regarding impairment, internal transactions and derecognition of financial instruments were also challenged.

Notwithstanding the current differences, both the IASB and the banks emphasised the importance of continuing the consultations in order to arrive at mutually acceptable solutions.

V. EVENTS, ASSOCIATION LIFE

1. Extraordinary Board Meeting

An Extraordinary Board Meeting of the Hungarian Banking Association was convened on January 30, 2003, with two items on the agenda: amending the Association's Rules and modifying the Association's participation in the Money and Capital Market Arbitration Court and setting up the Credit Institutions Chamber of the Court.

The relevant proposals were duly adopted; all arbitrators received the required number of votes. Their term will expire on June 30, 2007, except those arbitrators, who simultaneously are members of the Board of the Court; their mandate will expire on June 30, 2008.

2. Seminar on EU Directives on retail lending and the taxation of savings

A seminar on EU Directives on retail lending and their possible impacts on banking practices in Hungary and on issues related to the EU taxation package (that is, the end of tax exemption of savings) was jointly held by the Association and the White & Case International Law Office on March 25, 2003. Presenters were Jacquelyn MacLennan és Thomas Tindemanns from the Brussels office. The seminar was attended by legal counsels, compliance officers and sales, risk management and product development professionals from our member banks.

The Draft Directive on the taxation of savings is expected to be enacted as of the beginning of 2005. The Directive will apply to cross-border interest payments, without affecting, however, the regulations on the taxation of interest revenues in the individual member states. Most member states will use the method of mutual information: if a payer based in a member state makes an interest payment to a private individual of another member state as a beneficiary, then such payer shall report the payment to its own tax authority, which, in turn, will inform the tax authority of the beneficiary's state; some member states will impose a temporary withholding tax, 75% of which will be transferred to the beneficiary's country. Hungary will join those using the method of mutual information. Accordingly, the relevant laws will have to be modified.

The objective of the Directive is to prevent tax dodging through placing deposits abroad and to avoid double taxation in respect of the country where the interest is actually taxed.

The Draft Directive on retail lending will be adopted at the end of 2004 at the earliest. The objective of the Directive is to regulate cross-border lending, prevent excessive customer indebtedness and to provide a uniform regulatory environment and standard requirements in all member states. Given the current debates, the Directive will need substantial revisions. Corporate and mortgage lending will not be affected by the Directive. The Directive proposes for creditors to set up common databases on debtors in default; these databases should be used by creditors on a mandatory basis prior to making credit decisions. The Directive also allows for setting up positive databases, including data on the client's existing loan contracts. The Directive addresses issues related to loan mediators, agents, their registration, supervision and the conditions of concluding loan contracts. It will allow an early repayment of the loan under a fair and equitable compensation. The Directive contains detailed provisions in respect of the indicator of charges on credit, unfair contractual conditions and prohibited methods for collecting overdue debts.

Copies of the Draft Directives were distributed to all participants.

3. Consultation on land registers

The Administrative State Secretary of the Ministry of Agriculture in the fall of 2002 requested the Association to organise a consultation on current issues related to land registration, including a faster registration of mortgages, the TAKARNET system /a cartography-based cadastral system with access to data of land offices nationwide/ and other issues raised by banks. Banks' comments were summarised and sent to the Ministry and copied to the commenting banks. A consultation on the subject was held on March 26, 2003 (the Ministry could not fit the consultation in its schedule earlier due to other engagements). The meeting was attended by the Land and Cartography Department, the Institute of Geodesy, Cartography and Remote Sensing of the Ministry of Agriculture (FÖMI), legal counsels and risk management and collateral rating specialists from banks. The TAKARNET system was presented by the Geodesy Institute.

Participants were briefed on the services of the Geodesy Institute, the conditions for linking up to the TAKARNET system and the related service charges. All title page data are now on computers at the land offices and are available for outside users (local governments, Courts, Notaries Public, lawyers, banks, etc.) through the TAKARNET system.

A practical presentation of the system was held at the meeting, including the running of queries.

Banks' comments, collected in advance, were reviewed; some of the issues will be clarified through direct consultations with the banks involved. Dr Olga Latóczky, Deputy Head of the Ministry's Land and Cartography Department advised that the Implementation Decree to the Act on Land Registration will be amended in the near future to harmonise the relevant provisions with those of the Mortgage Act. Also, issues related to the registration of independent mortgages, attestation, floating policy mortgage, acquisition of arable land, the foundation of condominiums and the adding of attics were reviewed in details.

4. Bank security

With the first anniversary of the Mór bank robbery approaching, bank security issues have been again in the forefront of media attention. A Government Decree on bank security, drafted by the Ministry of Finance is now under review.

The Bank Security Working Committee reviewed professional proposals made by various firms. A proposal for the organisation of a common security technology system was submitted by BVL Kht. The proposal was reviewed by the Committee and was found of interest. The protection of ATMs was also reviewed.

5. Measures for the prevention of terrorism and money laundering

Act XV of 2003 on the Prevention and Impeding of Money Laundering was enacted on March 18, 2003. Our proposals made during the preliminary review of the Act and presented in the form of MP motions were duly accepted. Accordingly, no identification is now required in dealings between domestic financial and credit institutions and will not be required in dealings with any financial or credit institution in the EU following our accession in May 2004. The requirement of a full identification in respect of other clients, to be introduced on a mandatory basis latest by the end of this year will be a more complex issue. Although the Act is not new for banks, we found it important for a consultation to be organised for our member banks to ensure a uniform interpretation of the law.

The relevant consultation was held with the participation of 40 people from 25 banks. The meeting was attended by László Balogh, Government Commissioner on behalf of the Hungarian Financial Supervisory Authority, Bernadett Marton on behalf of the Ministry of Finance and Csaba Molnár on behalf of the National Police Headquarters.

6. First joint event of the Associations and the Bank Card Forum

The organisers of an American-Hungarian joint research project on the credit card market requested the Association to arrange for an opportunity to present their research plan to domestic bank card market players.

The event was jointly organised by the Association and the Bank Card Forum. The opening presentation gave an overview of the credit card market. Researchers explained that their work was basically focused on countries where credit cards were introduced just a few years ago; however, they would like to treat separately the more advanced states (such as Hungary and Poland), those in the early stages of transition (Bulgaria, Ukraine) and the quasi-market economies, functioning within socialist settings (Vietnam, China). The research is aimed at the process of shifting from a confidence-based lending built on individual customer relations to a statistical probability-based credit card market using the most modern IT infrastructures. The presentation was followed by a Q&A session. The topic was received with keen interest, many of the participants said they would consider joining the project.

Issues related to the standardisation of bank cards were also reviewed. First, the colleagues representing the Association in the ECBS gave a presentation about the ECBS and its activities, with special regard to the work of the Bank Cards Sub-Committee. Then, the colleague from the National Bank of Hungary, representing the banking profession on the Hungarian Standardisation Board gave a briefing on standards related to the profession. The participants agreed to seek ways to involve the Bank Card Forum more actively in the activities of these organisations.

7. Consultation with the SWIFT User Group

Member banks requested the Association to organise a consultation to prepare the election meeting of the Hungarian SWIFT User Group.

This organisation had been headed for many years without any special formal framework by a reputable person of the profession, whose sudden death left the organisation without management and guidance. Members of the group turning to the Association sought to have an informal consultation to clarify the operational framework of the organisation: the rights and obligations of leaders and members of the organisation, its financing and the rules for electing the head of the organisation (and possibly, his or her deputies).

All issues raised were reviewed at the consultation arranged by the Association (and attended with keen interest). Consensus was reached on many issues (such as financing), other questions will have to be settled during formal meetings of the User Group.

According to our information, the subsequent formal meeting of the User Group was concluded successfully. A president was elected temporarily for one year to develop operational framework of the organisation.

8. Discussion of the study titled "The Almost Operating Market"

The discussion of this study, prepared under the coordination of the International Training Center for Bankers was attended by representatives of the National Bank of Hungary, the Budapest University of Economics, the International Training Center for Bankers, the Stock and Commodity Exchanges and investment funds.

In his brief introduction, the Association's Secretary General commended for the high professional standards of the study, a thought-provoking work that helps recognise market development potentials from the perspective of risk management and better understand the magnitude of the exposures assumed and their coverage; certain specific initiatives can also be built on the conclusions of the study (e.g., IAS 39).

The authors of the study presented the objective and structure of the study, emphasising their efforts in using a standard terminology and analysing the development of the derivatives market by a breakdown by customer segments and market players.

Despite new processes seen in the derivatives market in terms of products and maturities, the Hungarian market is at a disadvantage compared to Poland or the Czech Republic, one of the reasons being that the question whether the products are really needed by the end users and what the obstacles that hinder the use of these product are have not been answered in Hungary. Accounting and financial regulations are prerequisites but not sufficient conditions for the wide-spread use of derivatives. It will take companies a paradigma change. Companies are not adequately informed; exporters in many cases think in terms of expected exchange rate changes rather than using derivatives products.

The authors pointed out that derivatives can be used not only for covering risks but also for generating additional income and are therefore expected to have a pull on the capital market.

In his summary, the Secretary General said the Association will disseminate the conclusions of the study through all possible channels. He requested the authors to summarise their conclusions in the form a specific proposal to be presented to the competent forums. The study will be published in the next edition of the Credit Institutions Review. It may also be a topic at the seminar to be organised by the Association in cooperation with ISDA in June.

9. Discussion of the study titled "Competition and Profitability in the Banking Sector"

This study was written by Éva Várhegyi on assignment by the Competition Authority. The Competition Authority asked the Association to review and discuss the study. The discussion was attended by representatives from the Competition Authority, the Hungarian Financial Supervisory Authority, the International Training Centre for Bankers, the Association and member banks.

In her brief introduction Éva Várhegyi presented the study, in which she aimed at assessing the specific features of competition in Hungary, competition in the banking sector and to establish whether or the welfare impacts in this sector are different from those in other sectors.

To answer these questions, the author looked into the correlation between competition and market stability, the applicability of the various and generally known models and international examples. A conclusion was that concentration in the Hungarian banking market - and particularly in the retail market - slowed down in the nineties.

The restructuring of the banking market created the conditions for the evolution of competition and vulnerability. The study showed an apparent interest rate flexibility in the market, indicating that competition in the corporate banking sector is satisfactory; in other words, banks are forced to adjust their interest rates to their marginal costs and returns; in the retail market, interest rates are not so much correlated with changes in the money market and therefore, in the current market structure banks can still realise monopolistic gains.

Looking at pricing behaviour, a general practice in deposit pricing is that banks primarily respond to positive impacts reducing their funding costs; on the other hand, banks tend to ignore interest rate moves of central bank that are unfavourable for them. There is barely any bank in Hungary to adopt a flexible deposit pricing. At the same time, a downward flexibility is just apparent.

The corporate lending market is more balanced; the conditions for competitions are there, most banks active in corporate lending are flexibly responding to marginal costs and competitor rates.

Pricing behaviour largely impacts the profitability of banks. Interest margins and operating costs are double those in the EU. The share of interest income is 50% in the EU and around 70% in Hungary.

Participants complemented the conclusions of the study with their own experiences. The representative from the Supervisory Authority noted that variety, quality and prices play a major role in the benefits of competition in the banking market from the point of view of the consumer; impact on competition should be a criterion during bank privatisations.

The representative from the Competition Authority noted that based on the complaints they receive its appears that price increases in Hungary are not always associated with an improvement in service standards; banks' information discipline is not satisfactory, customers are defenceless against misinformation.

Concluding the debate, the representative of the Competition Authority said the study offered useful conclusions and the research on competition in the banking sector will continue based on additional criteria.

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