REPORT

on Activities of the Hungarian Banking Association

1^st Quarter 2004

Budapest, May 2004

CONTENTS

I. PROFESSIONAL ACTIVITIES - LEGISLATION REVIEWS *

II. LOAN SCHEMES *

IV. INTERNATIONAL COOPERATION - EUROPEAN BANKING FEDERATION *

IV. ASSOCIATION EVENTS *

I. PROFESSIONAL ACTIVITIES - LEGISLATION REVIEWS

1. Legislation on amendments to certain Acts related to financial services

This legislation includes amendments to the Credit Institutions Act, the Capital Market Act, the Insurance Act, the Act on Building Societies, the Act on Mortgage Credit Institutions and the Act on Venture Capital Companies.

Amendments to the Credit Institutions Act cover issues related to deposit insurance, branches of third-country credit institutions, auditors and the obligation to provide information in Hungarian. Third-country credit institutions are not required to join the National Deposit Insurance Fund provided they have adequate deposit insurance, in accordance with the relevant EU requirements. The rules for complementary insurance provided by the National Deposit Insurance Fund are now more precise. The provisions related to bank auditors have been modified: natural persons may be appointed auditors for a maximum period of five years; the same person be reappointed only after a lapse of three years from expiry of his assignment.

The regulation on supervisory fees has been amended: branches of EU-based credit institutions will also be required to pay a supervisory fee. The Association submitted a proposal for a substantial reduction of the fee for branches, to be set as 30% of the standard fee. In this context, we proposed that supervisory fees for branches be based on their total assets.

The rules for the provision of customer information have been modified: unless otherwise agreed by the parties, financial institutions are now required to make available their general terms and conditions of contract, business rules, information on interests and fees and account turnover and deposit insurance information in Hungarian. Based on the Association's proposal, the amendment to the provisions on bank secret allows the provision of information on the amount of the claim and its due date to those third parties who have provided collateral for the risks; in case of contracts concluded through agents, a written statement by the client or its legal representative will now suffice for supplying the agent with the necessary data.

The amendment to the Act on Mortgage Credit Institutions now allows the recognition of derivative transactions concluded on mortgage loans in the value of collateral for mortgage bonds. The amendment stipulates the prohibition of alienation and encumbrance as a statutory right. Mortgage credit institutions are required to stipulate the prohibition of alienation and encumbrance in their mortgage, mortgage loan and independent mortgage purchase contracts. Based on these contracts, mortgage credit institutions may request the registration of prohibition of alienation and encumbrance in the land register. The amendment also allows the purchase of mortgage loans and independent mortgages from other credit institutions if the mortgage credit institution in question does not have the right to impose a prohibition of alienation and encumbrance.

In our summarised comments sent to the Ministry of Finance we submitted a proposal to amend the Insurance Act in respect of registration of insurance mediators. According to this proposal, credit institution, when selling insurance services as agents, would have been exempted from the rules for registration.

In our comments related to the Credit Institutions Act we proposed that the provision of financial services by non-financial institutions be subject to the relevant authorisation stipulated in the Credit Institutions Act. Our proposal was accepted. Our proposals to make the provisions on bank secret more specific were also accepted. The draft law annulled point d) of Paragraph 3 of Section 78 of the Credit Institution Act (long challenged by banks) prohibiting banks from accepting shares of business organisations which have a controlling interest in the debtor organisation or in which the debtor organisation has a controlling interest. As for the Act on Mortgage Credit Institution, the text of the version of the draft law presented to Parliament was substantially different to the text agreed.

The proposed amendment to the Act on Building Societies was aimed at simplifying borrowings: if the beneficiary of the contract is a minor, the utilisation of the loan in favour of a minor is also realised if the home purchase is made in favour of a home saver who is a close relative of the minor and has lived in a common household with the minor for at least one year. This provision is also applicable for existing contracts. The draft law (submitted under No. T/9842 on April 16, 2004) was passed by Parliament.

2. Amendments to the Capital Market Act

Most comments of the Association on the proposed amendments to the Capital Market Act were accepted. These can be summarised as follows:

Definition of position closing netting

The Association supported the proposal to amend the definition of position-closing netting to read as follows: "Position-closing netting is the transformation, based on an agreement between the parties and effected upon the non-fulfilment of the agreement or the onset of other events specified by the parties, into a single receivable or liability, as an accepted method of settlement on the market of the product in question, of debts and claims arising from prompt foreign exchange and securities transactions, derivative transactions, repo or reverse repo transactions, securities lending agreements, pledge agreements or other financial collateral agreements, as a result of which the debt or claim is confined to the net amount so determined."

Offering schedule

If securities are offered under an offering schedule, the individual data of the offering shall be reported by the issuer to the Supervisory Authority at least five days prior to the issue and shall be made public. Upon our proposal, the five days time-window - considered as too long - was reduced to 3 days.

Abolishing mandatory listing on the stock exchange

The Association proposed that apart from government securities, mandatory listing on the stock exchange also be abolished for mortgage and corporate bonds. These instruments are not expressly stock exchange instruments, their prices are normally not subject to demand or supply on the stock exchange; the abolition of their mandatory listing would give a substantial boost to their markets.

The Ministry of Finance in principle accepted our proposal, with special regard to the fact that the proposed new EU legislation is expected to abolish mandatory listing; however, with a view to strengthening the position of the stock exchange, the Ministry does not see the abolition of mandatory listing viable for the time being.

 

Supervisory fee for repo transactions

We proposed that the supervisory fees for short-term repo transactions be revised, as the current rates are barriers to the development of the repo market. For example, the supervisory fee for a HUF 100 million overnight repo is currently HUF 4,000. The market interest income on this type of deal is around 12%. The high supervisory fee increases transaction costs. In other words: the current regulation annihilates the conclusion of repo transactions with clients. Although our proposal was not accepted, the issue is now being investigated.

On the other hand, it was accepted that no supervisory fees be charged on repo transactions concluded with the State Debt Management Agency to manage liquidity purposes, just as for inter-credit institution operations, transactions between credit institutions and investment firms and transactions between credit institution and the central bank (liquidity and risk management operations), including such deals concluded with foreign credit institutions and investment firms.

Supervisory fees for brokers

We proposed that the supervisory fees for brokers be reviewed in respect of foreign interdealer brokers and electronic interdealer system operators (trading systems providers) versus the Government Debt Management Agency (GDMA), given that primary dealers are not the GDMA's agents. (The issue had probably arisen due to a wrong interpretation of the legislation).

Supervisory fees for branches

We proposed that in respect of supervisory fees payable by branches of EU-based credit institutions operating in Hungary (Sub-Section 8, Section 380) the law should specifically provide that such fees are payable on financial and investment services provided by such branches; namely, based on the principle of home country control, the branch is mostly subject to home country supervision, the scope of authority of the supervisory authority in the host country is limited.

Definitions of investment advisors, salespersons and sales representatives.

The definitions for investment advisors, salespersons and sales representatives were reformulated.

Securities secret (bank secret)

We proposed that the transfer of data within a banking group that is subject to consolidated supervision should not be considered as a breach of securities secret (bank secret); or if this definition is too wide in scope, then such data transfer is not deemed as a breach of securities secret (bank secret) if it is required for compliance with legal obligations for data managers.

3. Insolvency Act


Under its Resolution No. 1128/2003 (XII. 17.) the government decided to draft a new legislation on insolvency for companies and business organisations. Under this resolution, a codification committee was set up. The committee is led by László Keller, Political State Secretary in charge of controlling public finance affairs. The concept of the new legislation is to be completed by September 2004 and the draft law is to be submitted to Government by September 30, 2005; however, the Committee would like to finalise the draft law by May 2005, before the start of the campaign period for the 2006 general elections.

Represented on the Committee are the Ministries involved, the Hungarian Chamber of Auditors, the Tax and Financial Control Administration, the Supreme Court, the Attorney General's Office, the Hungarian Association of Insolvency Practitioners (FOE), the Hungarian Banking Association and liquidation judges. Sub-working groups, including specialists, have been set up to address the following areas: company law, accounting, taxation, civil law, revision of procedural laws, labour law, criminal law, environment protection, reorganisation and agriculture. The Prime Minister's Office has requested the participants to provide their comments on the areas involved. In connection with the treatment of secured claims in liquidation proceedings the Association proposed that assets encumbered by mortgage or pledge should not be included in the liquidation assets but should be separated and promptly put at the disposal of the mortgagee or pledgee.

The Committee's documents, review areas, codification schedule and the composition of the working groups are made available on the internet for discussion at the following address

http://www.meh.hu/szolgaltatasok/kodifikacio/fizeteskeptelensegi

The documents available have been sent to the legal counsels of our member banks and the colleague in charge of work-out issues in the general working group is regularly communicating with work-out experts a the banks.

4. Amendments to provisions on pledge in the Civil Code and the Bankruptcy Act

The Association reviewed the proposed amendments to the provisions on pledge in the Civil Code and related amendments to the Bankruptcy Act. Pursuant to the new bankruptcy legislation, if the debtor has provided a pledge against any of its liabilities before the starting date of liquidation, the pledgee may satisfy its claim by using such pledge irrespective of the commencement of the liquidation proceeding and then settle the balance with the liquidator.

With this new regulation, pledges will constitute a real financial collateral, adding legal security to lending and money and capital market operations.

5. European Company (SE)

European Council Regulation No. 2157/2001/EC enters into force in October 2004. The European Company (Societas Europaea - SE) will be a sui generis form of company of a transnational character. The objective of SEs is to enable companies established under national laws in member states to create a European form of a public limited company operating under a regulation directly applicable in all member states.

SEs may be formed by mergers, by the formation of a holding company and by the foundation of a subsidiary by companies or legal entities. SEs are free to move their registered office within the EU according to their economic interests, without having to wind up the SE in either location.

SEs are legal entities created through incorporation in the Companies Register, with a minimum subscribed capital of EUR 120,000 (unless a higher capital requirement is provided by statute for the activities in question). The regulation specifies five ways for creating an SE, depending on the type of the founding organisation. A general requirement is that the registered office and administrative head office of the founders should be within the Community and each of at least two of the founding companies should be governed by the laws of different member states.

The regulation shall be applicable from its date of coming into force. The proposal designed by the Ministry of Justice is aimed at creating a national legal framework for the creation and operation of Hungarian-based SEs, including employee participation rules harmonised with the relevant EU legislation.

The registration of Hungarian-based SEs shall be governed by Hungarian company registration laws. If a company decides to participate in creating an SE through a merger, a settlement shall be provided to minority shareholders who oppose the merger. A company participating in the creation of an SE shall provide its creditors with guarantees for outstanding claims, unless they have already received such guarantees or if the provision of such guarantees is unwarranted in light of the company's financial position.

The transfer of the SE's registered office is a particularly sensitive issue from the point of view of creditor protection. In case of transfer of registered office, settlements with minority shareholder who oppose the transfer and the exercising of creditor rights shall be governed by the provisions on settlement and guarantees.

In its comments on the proposed legislation the Association submitted observations concerning the rules for minority and creditor protection. Regarding the obligation to provide guarantees we proposed that this obligation be relinquished only in case the creditor's claim and its dues are sufficiently guaranteed by law or under a contract. In addition, we proposed that minority shareholders who have voted against the merger be given the option to join the SE, in alternative to a settlement.

Our comments were only partly accepted. The draft law was presented to Parliament under No. T/9445 on March 19 and submitted to detailed debate on April 26.

6. Supervisory reporting requirements

The regulatory changes setting the supervisory reporting requirements for 2004 (the Credit Institution Act, the Accounting Act and their implementation decrees) were passed as late as the end of 2003. Consequently, the Finance Ministry's draft decrees on the new reporting requirements were only completed by the beginning of 2004, whereas banks should have received the appropriate information at the end of last year to be able to prepare themselves.

Based on comments received from banks on the reporting requirements on investment services and credit institution operations (indicating interpretation and deadline problems), the Association initiated consultations with the Hungarian Financial Supervisory Authority and the Ministry of Finance.

At the meeting organised by the Association with the cooperation of the National Bank of Hungary, the regulators explained the reasons for the regulatory changes (keeping track of cross-border services after accession, controlling the process of opening and activities of branches of foreign banks operating in Hungary, and fair value accounting) and then responded to banks' comments. The Hungarian Financial Supervisory Authority accepted the comments made on the deadlines and agreed to provide practicable dates. (For this, the central bank's consent was also required, given that certain basic reports are required by both authorities). Thus, the parties managed to avoid that the first two months of the year are reported in two different formats (according to the new rules to the central bank and the old rules to the Supervisory Authority).

Further, questions concerning reversal of write-off, the weighting of undisbursed credit lines and the breakdown of home loans by loan objective were clarified. However, despite a lengthy debate, the questions concerning the rules for the computation of adjusted capital on a consolidated basis and the treatment of banking group elements subject to consolidated supervision, to be recognised retrospectively in the reports on 2003 remained open.

While the decree on reporting requirements for investment services was issued fairly soon after the consultation, the regulation on credit institution reporting requirements was published with a substantial delay. To add to the problems, the Supervisory Authority's "pre-filtering" control programme was erroneous.

7. Interest tax reporting

Reporting requirements between EU member states on the taxation of interest income were incorporated in the Finance Ministry's draft amendment to the Act on the Rules of Taxation. Reporting between member states on the taxation of interest proceeds received by a beneficiary based in another member state is regulated by Council Directive No. 2003/48/EK. The objective of this regulation is to ensure that all member states have a set of harmonised laws in place so as to ensure that beneficiaries who have received interest income cannot avoid taxation. In practice, individuals are taxed on the interest income they have received in another member state. For this, a regular exchange of information between national authorities is required. According to the Directive, for an interim period, three members states will tax interest income by applying a withdrawing tax; accordingly, the relevant rules are yet to be established.

The amendment to Act XCII of 2003 on the Rules of Taxation sets tax reporting requirements for domestic interest payers (credit institution, etc.). It specifies those subject to reporting, provides definitions for interest and beneficiary and specifies the contents of the reports and their dates. The new provisions are to take effect as of January 1, 2005; however, it is expected that a regulation will be issued to postpone this date.

In our comments on the draft law we pointed out that the proposed regulation would cause substantial extra work and costs for banks and significant development in IT systems and internal procedures. We made comments to make certain details in the report more specific and proposed further consultations on the issue. At the meeting held on February 25, 2004 with the participation of the Taxation Department of the Ministry of Finance and specialists from member banks, the operation of the new system and the issues raised were reviewed in details. Our proposal for modifications to the provision on bank and securities secrets was accepted. Also, we indicated our intention to participate in the drafting of the implementation decrees and rules for electronic reporting.

The above amendment to the Act on the Rules of Taxation was incorporated in Act No. XXVII of 2004 on amendments to certain financial laws within the framework of law harmonisation. The new provisions will take effect as of January 1, 2005 and will apply to interest proceeds received after that date.

8. Local trade tax

The Association turned to the Minister of Finance to seek short and long-term solutions to anomalies in the regulations on local trade tax.

In our opinion, the rules for determining the tax base for local trade tax in the relevant Act are discriminative and professionally unjustified. There is no plausible reason why revenues from investment and other financial services should be treated differently to those from interest. While the law allows the recognition of interest costs when determining income from interest, sales revenues from investment services are taken into account on a gross basis in the tax base. In other words, expenses cannot be deducted from revenues in the latter case (as opposed to the rules applied to interest revenues and revenues from other business activities, where cost of goods sold and material costs can be deducted from revenues). To eliminate these anomalies, the Association also filed a motion with the Constitutional Court.

The regulation enacted in 2004 is even more detrimental, notwithstanding the fact that under the accounting rules in force from January 2004, netting is now allowed in the case of hedging transactions. The Act on Local Taxes "re-adjusts" this solution by separating and picking out and taxing the profitable element of the transaction.

From budgeting point of view the main problem is that under the current rules, local trade tax is unplannable. When concluding a forward transaction (and the subsequent counter-transaction closing the position), the hedging margin is fixed, while the actual price difference and thus, the profit or loss, are determined by future market developments, while the return/result of the closed transaction remains fixed. For example: taking a pair of forward deals for EUR 1 million concluded at HUF 265.4 and HUF 265.5, the actual rate of local trade tax, depending on the price on maturity (e.g., HUF 266/EUR or 250/EUR), may vary to the extreme and take unrealistic values (12% or 310%!) The rate of the local trade tax payable may be multiple the result fixed under the closed deal; consequently, the deal would result in a loss and would therefore be uneconomical. Under these circumstances, shareholders would re-consider operations in this market segment.

The consequence of the above regulation is that although the maximum rate of local trade tax is 2% of the tax base, with the 18% corporate tax and the current distorted local trade tax regulations the actual tax rate on profits in this industry might be as high as 40% or even higher. In no other EU member state or accession country have we seen a discriminative regulation of this kind. It causes a serious competitive disadvantage and in certain cases taxes the company's assets!

We find it injurious and constitutionally questionable that the amendment enacted as of January is applied not only to hedge transactions concluded after entry into force of the regulation, but all existing agreements concluded before and expiring after that date are to be taken into account in the tax base based on the new rules (retrospective regulation!).

The problem is aggrevated by the introduction of an innovation contribution payable to the Innovation Fund from 2004. The creation of an Innovation Fund in itself is applaudable. The problem is that the basis of this contribution is the same as that for trade tax and its current rate is 0.2%, which means a 10% increase in the local tax burden.

The regulation is also detrimental to corporate clients. When applying fair value accounting as provided in the Accounting Act, as a new element, 50% of the gains on interest hedge transactions should be included in the trade tax base.

Foreign exchange hedging, as an efficient risk management tool has been increasingly popular among clients in recent years A similar process might begin now with interest hedging, as an indispensable tool for covering risks in a volatile interest market. This is a positive process, the engine of growth in these markets and one of an overall economic importance. Current regulations are counter-productive to this process.

The problem is not marginal: it affects all banks and investment firms offering hedges and investment services.

Our proposal to resolve the problem is as follows:

• as a prompt measure: recognising the costs of derivative transactions to reduce the tax base, in line with the relevant international practice, and
• recognising investment services on a net basis in the tax base; for other financial services: allowing the deduction of all costs that can be specifically linked to commission revenues.
• as a long-term objective: determine the tax base on a new basis, e.g.: align with corporate tax base.

We requested the Minister of Finance to address the matter not just as a trade tax issue but to also consider its overall effect on the financial markets and on the size and future development of the entire banking sector. Beyond resolving this issue we proposed that a comprehensive work be launched to review all potential areas where the conditions or regulatory constraints cause banks a competitive disadvantage and to identify positive measures whereby it could be ensured that, for example, the government securities market stays in Hungary. We also proposed to identify appropriate measures to promote the continued growth of the financial sector as a whole and delay the migration of markets to other countries (a process that is expected to intensify with the introduction of the Euro); however, it should not necessarily happen: some member states have successfully retained these markets by ensuring an appropriate regulatory framework (Spain, Austria).

1. Payments

1. Draft regulation on payments

Proposed amendments to current payment regulations have been on the agenda for quite some time, but despite several reviews, have not materialised up until now. The issue has been pending for more then a year and a half now. The only reason why it has not caused a serious trouble is that law harmonisation has been essentially completed in this area and most of the issues that have arisen in the meantime have been resolved in day-to-day practice. Nevertheless, banks were hoping that by reviewing and finalising the latest version sent for review in the first quarter the remaining issues will be resolved.

After soliciting our member banks' opinions we submitted our comments to the Ministry of Finance. Although the draft has been revised in several points, we had to repeatedly raise the following issues:

• the applicability of certain payment methods in Hungary/abroad is not clear-cut,
• some basic definitions are missing (e.g., client, [card]holder, value date),
• the liability rules for intra-EU transfers are not clear enough,
• the regulation is focused on bank cards, the regulator's requirements for other electronic banking channels (internet banking, telephone banking transactions) are not clear,
• the customer protection concessions contained in the draft regulation would unreasonably extend the liability of banks and might be misused by some clients.

With reference to the approaching accession date, we were given a relatively short notice to provide comments; however, the regulation has not been issued to this date (one of the reasons may be that no agreement has been reached on the division of regulatory responsibilities between the government and the central bank).

1. Changes on the currency exchange market

The Ministry of Finance requested the Association's assistance in assessing the effects of a major development in the currency exchange agents' market: the bank that had employed the most currency exchange agents (approx. 200 in number) has quit this business; those few banks that have remained in the currency exchange market have only taken over a limited number of agents. The Ministry wanted to know how this drop in the number of players would affect the market.

Based on the assessments received from our member banks, we provided the Ministry the following information: the information that the number of currency exchange agents has significantly decreased is correct, one of the reasons being that the banks that have still remained in this line of business are selecting between the agents. However, this should not affect clients given that some of those agents that have dropped out had operated in saturated market segments, while in the case of some others there had been some doubts anyway as to whether they would have been able to cope with an adequately stringent control system. The general opinion was that the process may be regarded as a purification process in the market and a tight control by banks is better fitted to the spirit of the preceding amendment to the law whereby currency exchange operations have been put under a full banking control.

It is true that some market players offering low rates have disappeared from the market; however, banking experts say these low rates could only be maintained by evading a tighter banking control and thus, savings the costs involved. Banks are not concerned about the developing of any blank spots in the market: in their opinion the remaining currency exchange agents do have the flexibility and financial strength to be able to fill any potential gaps in the market.

2. Act on electronic money institutions

Professional reviews of the proposed law were conducted by banks between November 2003 and end February 2004. The Ministry of Finance and the Association were also involved in the reviews. Act XXXV of 2004 on Electronic Money Institution was passed by Parliament on April 26, 2004. This Act regulates electronic money issuing activities and their prudential supervision, in accordance with Directives No. 2000/46/EC, 2000/12/EC és a 2000/28/EC.

1. Banking instruments to guarantee customs payments

1. Bank guarantees

Customs laws have changed significantly upon Hungary's accession to the EU. The new Customs Act creating the conditions for the application of the EU Customs Code was enacted in time. The Act stipulates that upon Hungary's accession to the EU as of May 1, 2004, all previously issued customs licences are null and void; meanwhile, enough time has been provided in the Act for submission of new preliminary applications for licence by April 30, 2004. Under the new Act, all applications must be accompanied by appropriate customs guarantees. However, the Act is not specific enough on the most important guarantee instrument, that is, bank guarantees: the Act fails to provide that expiry date is a mandatory element of the guarantee. Many applications had been rejected on the ground that their bank guarantees were improper. Based on banks' indications, we requested the competent State Secretary of the Ministry of Finance to take appropriate measures for an early review and issue of the implementation decree to the Act, whereby the current problems could also be resolved.

The draft decree was received for review soon after. At the consultation held on the issue, experts from member banks insisted that the decree should expressly provide that bank guarantees must contain the expiry date in addition to the mandatory elements stipulated in the law. Failing this, banks cannot provide bank guarantees; they must know the date until which the guarantee is provided and a fixed expiry date is also a requirement for bank guarantees under the Civil code.

This standpoint was firmly represented in our comments provided to the Ministry; it is probably partly owing to this fact that the issue of bank guarantee is now adequately regulated in the implementation decree to the Act.

2. Customs Account

Citing budgetary reasons, the Ministry of Finance once again mooted the issue of customs accounts to be used as a customs guarantee instrument (the idea had previously been rejected as unreasonable). Responding to the request of the State Secretary of the Finance Ministry we once again solicited our member banks' opinion on the issue. Banks repeated their previous standpoint that the setup provided in the draft was not workable and they would only support a solution that is one based on a common banking infrastructure (giro) and ensure equal opportunities for all banks. Banks' opinion was forwarded to the Ministry. Notwithstanding, the government incorporated the idea of customs accounts in a financial law package which was then passed by Parliament.

2. Money laundering - bank security

Anti-money laundering activities in the first quarter were substantially affected by regulatory problems.

The President of the Republic did not sign the amendment to Act XV of 2002 on the prevention of money laundering but sent it to the Constitutional Court for constitutional review in December 2003. As a result, the amendments that were initiated by banks did not take effect and the current, unworkable rules, seriously endangering banks' business interests, remained in force.

The Association turned in a letter to the Ministry of Finance in January, asking for a resolution to this controversial situation. The Ministry of Finance drafted a new proposal to resolve the problems raised by the banks; however, the solution proposed was unacceptable for the National Police Headquarters and most regulatory organs that were involved in the review. After lengthy discussions aimed at having the law passed by early March, it case as a surprise that the draft law was not presented to Parliament and the deadline for client data identification was extended to March 31. As a result of a continuous follow-up with the Ministry and the Hungarian Financial Supervisory Authority, both bodies issued communications to the public calling upon people to meet their legal obligations. The Association also issued a statement on the issue and launched a media campaign to mobilise clients to call on their banks.

Banks successfully completed the task of identifying the huge number of unidentified accounts by the deadline required. No client complaints on account blocking were reported. The remaining unidentified accounts (a few ten thousands) were basically dormant accounts. The Supervisory Authority verbally promised to consider the extraordinary situation during the relevant inspections. With the law amendment having been passed by the Constitutional Court, some other issues related to the Money Laundering Act were also brought to a resolution in the meantime.

MP motions on three remaining issues were presented and discussed by the competent bodies of Parliament:

• amending the Credit Institutions Act in respect of data content requirements for cross-border bank transfers, exempting, for specific transfers, certain data from the provisions on bank secrets.
• confining the identification of non-EU financial institutions to those countries where anti-money laundering laws are inadequate,
• allowing client identification in specific cases and by specific methods without the need for the client to call on the bank in person.

It should be mentioned that the relevant EU legislation has also been applicable to the area of money-laundering since May 1, 2004; this entails some additional tasks and issues to be resolved.

1. Data protection

The Data Protection Ombudsman's written position on certain interpretation issues raised by banks concerning the Data Protection Act was received in February 2004.

The document was forwarded to banks' legal counsels at our member banks. The Ombudsman's interpretation of what a database is tighter than that provided by the Ministry of Justice. Under the client's information autonomy and the principle of purposefulness, personal data are provided by the client always for a specific contract. Any general authorisation by the client, allowing the processing and transfer of all data that might be necessary for the fulfilment of contracts under business relationship with the bank, would be against the rules for authorisation provided in sub-section (7) of Section 3 of the Data Protection Act.

In respect of data transfer to third counties the Ombudsman admitted that the current regulation is tighter than the EU Data Protection Directive, in that it does not contain the provision that data transfer to a third country can be carried out even if the laws of the country in question do not provide adequate protection, provided the data manager certifies that sufficient legal or contractual protection is present. In the Ombudsman's opinion, for the regulations to be in harmony with the relevant EU Directive, amendments to the Data Protection and Credit Institutions Acts would be required

The Ombudsman modified his position concerning the interpretation of sub-section (3) of Section 53 of the Credit Institutions Act on the conditions for supplying data: according to his current ruling, the first condition (debtor's default in excess of the minimum wage and beyond 90 days) is also present if the amount does not exceed the minimum wage. In the first step, the continuous presence of the debt is to be looked at and then, from 91^st day, the point in time where this continuous debt reaches the minimum wage (the principle of first parallel presence).

In summary: the Ombudsman was supportive of the consultations carried on with the Hungarian Financial Supervisory Authority; at the same time, he continued to reject the idea of a positive list debtor database.

In February we attended a round-table discussion organised by the magazine IT-Business concerning the setting up of a debtor databases. The discussion also covered issues related to a proposed inter-bank debtor database and the maintenance of subscriber information by communications providers and related data protection issues.

2. Transformation of the primary dealers system

The Government Debt Management Agency (GDMA), in cooperation with primary dealers, developed a set of standard contractual conditions for non-Hungarian-based European banks and investment firms to join the primary dealers system.

The Association was also involved in the drafting work and obtained the opinions of the Ministry of Finance and Ministry of Justice on the proposed changes.

The gist of the proposal is that the primary dealers network is established not by statue but by civil law contracts and the contractual conditions may be freely determined by the parties within the constraints of the relevant laws and regulations.

It is at the GDMA's discretion to decide on the trading systems it wishes to apply in managing primary and OTC market listings, there are no standard EU requirements; the current MMTS system of the stock exchange can be used, provided all players have access under equal conditions to the system.

The presence of a subsidiary, branch or customer service office is mandatory. Identification of the investor groups to be targeted is a strategic issue, and infrastructure requirements can be set in the contract accordingly.

The availability of a separate licence from the Hungarian Financial Supervisory Authority may not be stipulated as a condition even where the performance of government securities operations in Hungary is a requirement, as it would be against the EU principle of free provision of services. Personal participation in meetings invited by the GDMA may be prescribed, as this may be necessary in certain market situations.

The language of the primary dealers system is Hungarian, as is that of the Budapest Stock Exchange and the MMTS trading system and the governing law is Hungarian law. Consequently, the Hungarian language may be stipulated in the contract; there is no EU legislation to prohibit this, all the less so, as the Hungarian language is an official language of the EU.

3. European Master Agreement

The Hungarian translation of the European Master Agreement (EMA) providing a standard framework for repo and securities lending transaction has been completed and reviewed by banking professionals and is now available at the Association's website: (www.bankszovetseg.hu/velemenyek, members only). The text provided by the EMA can be freely used by any bank. The supervisory recognition process is now underway and, once concluded, the Allen & Overy law office will issue its legal opinion.

4. Rules for mandatory reserves under the Act on the National Bank of Hungary

The rules for mandatory reserves have also been changed under a recent amendment to the Act on the National Bank of Hungary. In respect of mandatory reserves, the former Act provided that any changes in the rate, computation, creation and depositing of reserves should be announced at least 15 days in advance. The original proposal was that this 15-day notice be abolished so that mandatory reserves as a monetary policy instrument can be flexibly applied, in accordance with the ECB's requirements.

At the Association's request the legislators accepted that while the rate of mandatory reserves should not be subject to any preliminary announcement date (so it can be flexibly changed similarly to the central bank primary rate), but any changes in the computation, creation or method of depositing of reserves may only be introduced after a 15-day notice. Namely, these changes require modifications in the IT and administrative systems at the banks, which take time.

Our proposal, according to which "if, in response to market conditions, the reserve rate is raised by at least 2%, then a market interest should be paid by the central bank on the increased amount over a period of 15 days", was rejected.

5. National Qualifications Register (OKJ) qualification requirements

A Decree on Examinations Stipulated in a Separate Law is currently being drafted at the Ministry of Finance. The purpose of the decree is to provide qualification requirements for persons acting as salespersons, sales representatives and investment advisors at investment firms.

We expressed our opinion several times during the review process that the proposal was basically wrong and disregarded a number of important factors. We challenged the provision that former qualifications would not be acknowledged and the jobs in question would be subject to acquiring a qualification listed in the National Qualifications Register within a certain time limit. The professional curricula of OKJ-certified training courses are too complex and contain unnecessarily high requirements and the training is long and expensive.

Only few certificates have been issued for the jobs in question (specialised bank clerk, bank advisor/certified bank clerk, bank clerk, banking/investment product salesperson, investment advisor, investment consultant, insurance advisor, insurance clerk, insurance broker, foreign currency teller, foreign currency clerk). These qualifications do not cover all the areas involved and can normally be acquired in higher vocational training courses outside the schooling system (most of them are not available in high-school education). There are different accredited adult education institutions which organise training courses and examinations for certain qualifications (in accordance with the relevant Finance Ministry Decree), with several hundred hours of training time, very high requirements and very high costs.

A further problem is that investment products and currency exchange services are also provided by commercial banks, savings cooperatives and Post Office branches. It should be noted that these are normally simple and standard products, whose sale, in our opinion, does not require any OKJ qualification. Pursuant to the proposed decree, all staff members of those organisations listed in the decree should acquire the professional qualifications required for the jobs in question (several certificates at a time). Post office and savings cooperative clerks working at single customer service points would have to acquire three different qualifications at a time (banking/investment product salesperson, insurance broker and foreign currency teller qualifications).

The draft decree does not distinguish between investment product salespersons or insurance brokers pursuing these jobs on a full time basis and those performing these activities on a part-time basis. It also disregards the fact these sales activities are performed in office organisations (not door-to-door sales like in the case of certain insurance contracts).

The Association and the National Federation of Savings Co-Operatives are of the opinion that in its present form the proposed decree is unreasonable and impracticable and serves nobody's interests (except those companies who organise training courses and examinations). Therefore, the two organisations turned to the Minister of Finance with the following proposal:

1. A new OKJ training category: product sales assistant, should be established, with a substantially shorter training period and simplified curriculum, adjusted to and covering the areas specific for the job. It should be ensured that those training courses that have thus far not been recognised in the National Qualifications Register be recognised as modules of OKJ training and the various modules should be built upon each other; or, the current regulations in respect of professional qualification and examination requirements for bank clerks and banking and investment product salespersons be modified so that product sales assistants would only have to complete a legal training module and pass a simplified (verbal) examination.
2. the Act should provide that at each point of sale (branch, representative office) there should be a person with a higher OKJ qualification, while for the rest of staff working in customer relationship areas the qualification of product sales assistant should suffice.
3. the principle of equivalence of examinations should be recognised, that is, if an assistant acquires a qualification in another module, then he/she should be entitled to sell other auxiliary products (insurance products, currency exchange);
4. internal training programmes should be recognised in the statues regulating qualification and examination requirements;
5. former certificates and qualifications, legally acquired and thus should be accepted as a requirement;
6. training for banking, investment ad insurance product sales assistants should be incorporated in the curricula of professional high-school education.

1. Mandatory legal representation in Land Office procedures launched upon request

Act XI of 2003, amending the Act on Lawyers, provides for mandatory legal representation in Land Office procedures launched upon request, effective from May 1, 2004. Legal representatives include lawyers, legal counsels and notaries public acting on behalf of clients. Although Legal representation does not necessary imply a personal presence, it is certainly an extra burden for banks and clients. The requirement of mandatory legal representation weakens the favourable provisions in the Land Register Act allowing the registration of mortgage (independent lien) based on a private deed properly signed by the credit institution. The situation is further complicated by sub-section 4 of Section 27 of the Act on Lawyers, which provides that where the condition for starting the procedure is the availability of a deed attested by a lawyer (real estate purchase contract), legal representation may be provided solely by the lawyer who has attested the deed.

Given that this regulation directly affects banks' lending operations, we took up the matter with the Ministry of Justice and the Ministry of Agriculture and expressed our opinion that the regulation was professionally unjustified and injurious to clients. While the Administrative State Secretary of the Ministry of Agriculture agreed with our opinion, the State Secretary of the Ministry of Justice rejected our proposal to modify the Act. Subsequently, we contacted the Deputy Chairman of the Parliament's Housing Policy Committee with a proposal for an independent MP motion. The Deputy Chairman did address the proposal but the effort failed due to the short time and opposition by the counter-interested parties. At the beginning of May we requested the Agriculture Ministry's Department of Lands and Mapping to issue an implementation guide for the Act. The guide is now under preparation.

2. Ruling of the Budapest Municipal Court in the proceeding related to student loans

In 2001 the Association as a reporting party initiated a proceeding with the Competition Authority for illegal conduct by the Student Loan Centre, violating the competition law, by requiring all student loan beneficiaries to open an account with its owner, Postbank and Savings Bank. The Competition Authority instituted a supervisory proceeding for abuse of market power. This proceeding was terminated through the Competition Authority's Resolution No. Vj-190/2001/76 on the grounds that the Student Loan Centre is not subject to the Competition Act, student loans are not market products and the same applies to accounts to be opened under such loans as an integral element of the disbursement process.

Based on its Board's decision, the Association challenged this resolution before the Budapest Municipal Court. In our claim we requested the Municipal Court to establish that the Student Loan Centre abused is market power. The claim was filed as a matter of principle only, given that by then, the relevant regulation had been amended to allow for student loan accounts to be opened at any bank. To support our eligibility to filing a lawsuit we argued that in accordance with the relevant provisions of the Competition Act we had filed a report with the Competition Authority and the Authority had not questioned our involvement and the fact that the conduct in question affects our rightful interests. As the interest representation organisation of commercial banks, it is the Association's duty to represent and defend its member's interests. The Association is interested in ensuring that professional aspects are taken into account and the principles of fair competition are enforced in banks' operations in developing the regulatory framework for the banking sector.

After multiple sessions, the Budapest Municipal Court rejected our claim (without even charging any procedural fee, due to the Association's personal exemption from such fee). The Court established that we were not eligible for initiating a proceeding, in light of the Court's previous ad hoc decisions, in which it had established that for initiating a public proceeding, the client's rights or rightful interests should be directly affected (not indirectly). Unless specifically so authorised by a statute, interest protection organisations (associations, chambers, other social organisations) may not initiate any judicial review of the rulings or ad hoc decisions adopted in relation to their members in public authority proceedings. Accordingly, with reference to the governing practice of the Supreme Court, the Association's claim was rejected by the Budapest Municipal Court's ruling 2.K.30302/2003/11. on the round of lack of entitlement to a claim. We decided not to appeal and the ruling went into effect on March 5, 2004.

II. LOAN SCHEMES

1. Agricultural loans

With a view to meeting the requirements ensuing from Hungary's accession to the EU and promoting competitiveness, the government introduced its Europe Plan Agricultural Loan Scheme in February.

The loan scheme envisages loan placements to a total value of HUF 100 billion, 50% of which will be financed by the National Development Bank and 50% from bank resources. The National Development Bank has borrowed funds from abroad for this purpose and the government assumed an exchange rate guarantee for these borrowings. Refinancing is available on a EURIBOR basis, which ensures favourable interest rates for the beneficiaries. In line with this, the government decided to grant a 70% interest subsidy for the loans to be provided from bank resources.

In addition, the government has assumed a 100% guarantee for investment loans to be granted from the refinancing loan to SMEs in the agricultural and food sectors.

In coordination with the Association, the banks involved took an active part in developing the rules and procedures of this complex loan scheme and through their proposals have greatly contributed to setting up a workable system. With the great interest shown in the scheme, the government increased the total amount of the loan scheme, first to HUF 160 billion and then to HUF 220 billion. The loan scheme was open for applications until April 30, 2004. Information on the results will be provided in our next report.

2. Home loans

1. Average Percentage Rate of Charges (APRC)

Under a financial law package passed at the end of 2003, Parliament endorsed the government's proposal to apply APRC to home loans, as is done for consumer loans. Although the President of the Republic did not sign the law package and forwarded it to the Constitutional Court, the Ministry of Finance requested the Association to formulate the conditions under which APRC could be used for comparison between different home loans.

Upon consultations and detailed professional discussions with member banks, the following common standpoint was reached: the Association basically disagrees with the proposal to apply APRC to home loans and to include APRC in the home loan contracts. The reason is that home loans are complex products, including variable cost and fee elements, most of which cannot be foreseen for a long loan period. Major simplifications may (and must) be applied when determining the APRC, but these would be of an extent that would basically question the applicability of APRC.

The reason why it would be impracticable to indicate the APRC in home loan contracts is that the very purpose of this indicator is to enable the client to compare the offers of different banks made before concluding the loan contract. When the client decides and concludes the contract, the indication of APRC in the contract may lead the client to believe that the APRC would remain unchanged throughout the entire loan period, which is just an unrealistic assumption. While emphasising the above, the Association specified the conditions under which APRC could be applied to home loans:

• in line with the practice applied in the National Bank's reporting requirements, the assumption should be that the entire loan amount has been disbursed in one and on the first disbursement (we know this is a rare case),
• the indicator should not contain fees and commissions that are received by parties other than the bank (eg. appraisal fees, notarisation fees, charge for page of titles in the Land Register)
• unforeseenable ad hoc costs arising after disbursement (partial disbursements) should not be included in the APRC (commitment fees, technical administration fees, posterior collateral rating).
• a standard 2-month period is to be set for mortgage banks to take over financing (banks' conditions within this preliminary phase vary),
• a standard regulation should be introduced for conversion rates for certain cost elements of foreign currency loans, arising in HUF.

According to bank specialists the interpretation of current regulations in respect of overdraft and credit cards is unclear. Therefore, the Association drafted a proposal for the rules to be applied to these products. While appreciating our proposals, the Ministry of Finance said it would make the application of APRC to home loans subject to the Constitutional Court decisions. The Constitutional Court decision, adopted in the meantime, did not address the APRC-related provisions of the Act. Contrary to our proposal, the government presented the draft law to Parliament in an unchanged form and the law was passed. The only essential change was that the first application of APRC was postponed from May 1 this year to January 1, 2005.

1. Amendment to the Government Decree on Home Subsidies

The Ministry of Interior's Housing Office sent us for review the proposed amendment to the Government Decree on Home Subsidies. The proposal addressed regulatory issues related to the new tenement-dwelling concept and contained some new elements in relation to subsidised loans.

Banks expressed doubts over the workability of the tenement-dwelling concept. Under this concept, successful applicants (contractors) would build tenement houses in partnership with local governments and the government would provide a significant rental fee support for those in need. Due to the high overhead and basic living costs, tenants would probably be unable to pay even the 20% own resource provided in the draft decree. This would endanger the lessor housing contractors, who would mostly finance the investment from subsidised bank loans. Thus, the tenants' solvency and financial capacity is not indifferent from a banking point of view.

We also challenged those provisions of the decree according to which important issues related to the disbursement of home subsidies would have been referred to be regulated by the contracts to be concluded between banks and the Ministry of Finance. To ensure legal security, certain detailed elements of the scheme should also be regulated by statue, not by a contract in which one of the parties is an authority, while the other one is a bank subject to that authority.

We also proposed to re-define more precisely the scope of those eligible for support after accession to the EU and the different construction categories (building up a garret-space, new flats, adding a new floor). The new version of the draft decree was received for review at an unrealistically short notice. The time given was only enough to establish that the main change, the tenement-dwelling concept, was removed and some of our proposals were accommodated in the draft. (According to our information, the economic cabinet reviewed the draft decree several times and repeatedly resent it to the submitters for revision).

IV. INTERNATIONAL COOPERATION - EUROPEAN BANKING FEDERATION

1. Banking Supervision Committee - Capital Adequacy Working Group

1. Basel II

January publications of the Basel Committee

In its press release following its January 15 meeting, the Basel Committee confirmed that the new capital accord would be finalised by mid-2004. However, the press release reveals that "finalisation" is to be interpreted flexibly, that is: some issues would be resolved after "finalisation" and there would also be a room for re-opening certain issues (such as calibration) during the introductory period.

According to the press release, the Committee's October proposal for the treatment of expected and unexpected loss was received favourably. Most of the 52 comments received were supportive of the proposed new approach. At the same time the Committee accepted the criticism regarding the cap for the Tier 2 eligibility of excess provisions; accordingly, the cap on the recognition of excess provisions will not be based on Tier 2 capital but set as a percentage (to be determined) of certain risk-weighted assets.

Since the Committee's October meeting, significant progress has been made on major issues: a specific proposal has been presented for the treatment of expected versus unexpected losses (the risk weight curves were modified); the treatment of securitisation has been simplified (the "Supervisory Formula" has been eliminated) and principles have been set for the acceptance by the home and host country supervisions of the AMA framework for determining capital requirements for operational risk. The Committee published three documents on these issues at the end of January. These and the Press Release can be found at: www.bis.org.

Based on the comments received, the committee continues to work on credit risk mitigation techniques and on the treatment of revolving retail loans. Also, the committee plans to undertake a review of counterparty credit risk and trading book issues in coordination with the International Organisation for Securities Commissions (IOSCO).

The issue of calibration of capital requirements was scheduled to be addressed at the Committee's next meeting in May. The text, aimed to provide a solid basis for national implementation processes and the industry's preparations to proceed, is expected to be available by mid-2004.

Pillar 2

In the attachment to the press release the Committee provided a more detailed explanation of its views concerning Pillar 2. The Committee is conscious of the need to maintain adequate flexibility in the application of Pillar 2 in different jurisdictions. The Committee emphasises the need for a combination of information-sharing on supervisory practices between supervisors on the one hand and constructive dialogue between banks and supervisors on the other to help promote consistency in the implementation of Pillar 2. The onus is on banks to take account of risks not included in Pillar 1 and determining the related capital requirements. Pillar 2 then puts the onus on supervisors to satisfy themselves as to the appropriateness of banks’ approaches and the adequacy of banks’ capital. A supervisory review does not automatically require a capital add-on. However, it is an expectation of the Committee that internationally active banks should operate above the Pillar 1 minimum. Certain risks were included in Pillar 2 to allow for reasonable flexibility in dealing with them and the Committee does not intend to reintegrate these into Pillar 1. The Committee does not expect there to be perfect uniformity of approaches across jurisdictions. Some countries may have more formalised approaches, but information on these different approaches should then be shared among supervisors to promote consistency in application of the Accord. The implementation of the New Accord is not a reason to change the legal responsibilities of national authorities for the supervision of their domestic institutions.

Mr. Le Pan, Chairman of the Basel Committee's Accord Implementation Group (AIG), in his letter of response to the FBE, summarised the most important aspects in implementing Pillar 2. In addition to the factors mentioned above, the letter indicates that the Committee does not consider it necessary to re-formulate the contents of Pillar 2, as that would lead to additional uncertainties. In view of the different regulatory frameworks the Committee does not intend to change the discretionary rights of supervisors under Pillar 2.

Collaboration between home and host countries will promote uniform implementation of the Accord. The Committee does not expect a full uniformity of approaches, nor are host countries expected to fully and exclusively accept the home country's approach. It cannot be declared that Pillar 2 should only be applied on group level. The AIG is conducting case studies on practical issues related to the division of responsibilities between home and host countries. The Group's objective is to mitigate the risk of inconsistent implementation; regular consultations between AIG and representatives of the industry are aimed to promote this objective.

Response of the European Commission to comments received on the CP3 of July 2003

The European Commission responded in a feedback document in March to comments received on CP3. In its response the Commission reaffirms its plan to have the draft-directive finalised and submitted this summer. The Commission firmly supports the simultaneous introduction of Basel II and CAD3, and confirms that the EU framework should be consistent with the new Basel Capital Accord. The Commission recognises the need for the directive to be adequately flexible and is committed to carrying on further consultations on future amendments to be made to annexes and to reflect subsequent amendments to Basel on the treatment of the trading book.

At the same time the Commission does not see any possibility to reduce the complexity of the regulation; nevertheless, the Commission will try to make the text as straightforward as possible and relax on the prescriptive and detailed character of the regulation.

The Commission considers it necessary to modify the consolidation requirements, appreciating that consolidation on each sub-consolidation level would be burdensome. Also, the possibility of retaining the waiver of individual application is being investigated. (Member states may decide not to apply the Directive on an individual level). The waiver could be exercised if the allocation of capital within the group is adequate.

In the Commission's view, Pillar 2 requirements should be applied at the top level of the group and sub-group within an individual member state. The review process should be managed by banks (institution) and supervisors should satisfy themselves on the appropriateness of the process.

The Commission accepts the coordinator supervisor concept. Robust coordination will be needed in validation the IRB and AMA approaches. The Directive should stipulate the requirements for supervisory disclosure.

The Commission recognises the need to minimise national discretions and agrees that procyclicality is an important issue that must be kept under review. At the same time, the Commission is of the view that the recognition of the diversification of portfolios is untimely: credit institutions' assumptions on their own correlations are not advanced enough to be taken account of in the computation of the capital requirement.

In relation to SMEs, the Commission is now working on resolving the problems caused by hard thresholds. Replacement of the use test is being considered. The 10% LDG floor will be retained for residential mortgages.

The Commission continues to develop the treatment of securitisation based on European practices. The treatment of unsettled transactions will depend on the Basel review of the regulations on trading books.

The Commission appreciates the comments made on the need for consistency with accounting standards and has reconfirmed its intention to limit disclosure costs.

EU directive-making process

In line with the above, the European Commission commenced the work of adjusting its capital adequacy directive to the Basel decisions. A new working group has been set up to promote the finalisation of CAD3. Member states will have the chance to express and coordinate their views in the working group. The group is made up of representatives from Finance Ministries and national supervisors (the Hungarian regulatory and supervisory authority also represents itself in the group).

The Commission plans to present the new capital adequacy directive to the European Parliament and Council in July. (A change compared to previous plans is that the new capital accord will actually be incorporated in the EU legislation through amendments to Directives 2000/12/EC and 93/6EEC, not through adopting a new directive). Consultations with member states for fine-tuning the text are expected to be focused on expected versus unexpected loss, consolidation levels, the concept of lead (or coordinator) supervisor, supervisory disclosure requirements, the treatment of investment firms and the streamlining of Pillar 2.

Main FBE priorities in the EU Capital Adequacy Directive (main directions of lobbying)

The FBE's working group in charge identified the main priorities and professional aspects to be represented in drafting the new capital adequacy directive. These are as follows:

• The EU Capital Adequacy Directive should be consistent with and implemented at the same time as, the new Basel Accord.
• A fourth Quantitative Impact Study may be useful provided it does not hinder the introduction of the capital adequacy directive. The relevant EU legislation should have enough flexibility to allow recalibration. Flexible legislation is a key issue, a lack of flexibility would lead to extra costs.
• The FBE supports the roll-out proposals of the European Commission and suggests the following addition: if an institution commits itself to the full application of the advanced IRB approach, then it should be allowed, for an interim period (for example, three years after introduction of the new framework), to use the Basel I rules for portfolios not included in the advanced IRB approach.
• The FBE intends to actively participate in drafting the details for supervisory disclosure requirements.
• The FBE welcomes the Commission's objective to minimise national discretions. Discretions on the standardised treatment of claims on institutions and the maturity adjustment should be removed by all means..
• In the FBE's opinion, capital requirements should be applied at the highest group level, the highest group levels in member states and at solo level. The solo requirement should not apply if the following conditions are met:

• capital distribution within the group is adequate,
• exposures are controlled and managed within the group on an integrated basis
• the parent undertaking has in place a policy to provide financial support to members of its group
• the parent undertaking and its subsidiary are subject to the same national/consolidated supervision.

• The FBE welcomes the inclusion of a model for coordination between supervisors in the directive; however, there is a need to proceed further: the FBE would support setting up supervisory colleges, whose chairpersons would be provided by the home country supervisors and members by the host country supervisors, to develop the supervisory review process in consultation with members of the banking groups.
• The FBE disagrees with the Basel Committee's "hybrid" approach to determining the capital requirements for operational risk in the home and host countries by using the AMA approach. This would set stand-alone capital requirements for significant subsidiaries for covering operational risk, undermining the business line approach and leading to substantial extra costs, and would eliminate the incentives to use more advanced approaches. The FBE proposes that in the single European market, AMA should only be used at the highest group level; this would allow the proper recognition of diversification effects.
• The FBE agrees that amendments concerning trading books should be adjusted to the Basel Committee's decisions.
• The FBE will set up a sub-working group to develop a technical proposal for the treatment of securitisation, by taking into account European market specifics. Actions should be taken in both Basel and Brussels to consider this proposal.
• The FBE welcomes the intentions to streamline Pillar 2. The supervisory review process should be applied at group level, to ensure the best possible assessment and understanding of the risk profile of the group. Consistent application across Europe should be promoted.
• Further consultations are needed on possible instruments to mitigate procyclicality.
• The FBE regrets that the geographical diversification effect is ignored in the directive. It is a wrong approach, penalising concentration while disregarding the counter-effects. Geographical diversification should primarily be recognised in Pillar 1, but should at least be taken account of in Pillar 2 as an adjustment to additional capital requirements.

U.S. developments

Introduction of the new capital accord is the subject of fierce political debates in the US. Although the new capital accord is to be adopted by the regulatory authorities, not the Congress, politicians are trying to put pressure on the Basel process by sharply criticising the regulators (especially the FED) for failing to take a common position. The OCC and FED both think the accord will be formally adopted in Basel by mid-2004 but do not believe that important issues such the treatment of credit cards, LDG estimates for recession periods and amendments to regulations on trading books would be resolved within that time-window. John Hawke, head of the OCC, considers even the end-2006 introduction date as unrealistic.

Basel II is envisaged to be introduced in the U.S. according to the following schedule:

• September 2004 - 1^st Quarter 2005: Fourth Quantitative Impact Study
• 2^nd Quarter 2005 (at the earliest): submission of the Notice of Proposed Rules for consultation
• 90-day consultation period; may be extended to 180 days
• issue of final regulation (realistically 3 months after conclusion of the consultation period).

Apparently, QIS4 would to be launched at the time when the European Parliament starts the first reading debate of the capital adequacy directive. (For the directive to be listed for debate, Members of Parliament should be convinced on the stability of the Accord and its calibrations). By comparing the dates, it is also apparent that any subsequent amendments to Basel Capital Accord may only be accommodated in the annexes to the Accord, after adoption by the competent committee, given that there is no room for any amendments during second reading.

1. Extension of the Lámfalussy procedure to the banking sector

A package of measures aimed at extending the Lámfalussy procedure to the banking sector was adopted by the European Commission on November 6, 2003. The following are the elements of this package:

• the references to committees in the banking and insurance directives will be replaced with references to Lámfalussy Level 2 committees. (For banks, the Banking Advisory Committee will be replaced with the European Banking Committee)
• establishing an EBC advisory capacity, as a prerequisite for the EBC's regulatory powers in the directive-making process.
• Setting up the CEBS (Committee of European Banking Supervisors) Level 3 Committee as of January 1.

The extension of the Lámfalussy framework to the banking and insurance sectors will be regulated by a new directive to be adopted by the European Parliament and Council. Although the legislative process is progressing under a tight schedule, the new directive is unlikely to be adopted before the European Parliamentary elections.

A problem in this process is that in the course of applying the Lámfalussy procedure, the European Parliament has the power to comment on the application rules (of Level 2) but may not block them. The European Parliament should be given the power to stop the debate on the application rules if they are not in accordance with the objectives and principles set in the directive; for this, however, an amendment to the European Agreement would be required.

1. Financial Services Action Plan (FSAP)

The FBE and the Banking Supervision Committee jointly reviewed the progress of the Financial Services Action Plan and, in relation to the integration of EU financial markets, concluded the following:

• The convergence of supervisory practices is a primary objective.
• Improving transparency and the application of a lead (coordinator) supervisory model are prerequisites for achieving convergence.
• The future structure of banking supervision in the EU continues to be a debated issue. (It was mooted that the supervision of internationally active banks could be performed by the CEBS; however, member states have different opinions on this issue).
• The few constraints to integration are:

• National supervisors' resistance to supervision by a foreign supervisor.
• The Deposit Guarantee Directive may hinder banks operating across-borders to restructure their operation.

1. Implementation of the Financial Conglomerates Directive

The FBE's Secretariat met with representatives of the European Commission and national supervisors to review issues related to the implementation of the Financial Conglomerates Directive. Member states reaffirmed their conviction that the Directive will be adopted in national legislations before the August 2004 deadline. Issues encountered in the implementation of the Directive are being investigated by the Mixed Technical Group on the prudential supervision of financial conglomerates. Issues addressed by the MTG will be made available on the DG Internal Market's web site. The list of potential groups affected by the Directive will be made public once finalised.

1. Accounts Committee

1. Portfolio hedge of interest rate risk

After issuing the new (modified) international accounting standards in December, the IASB in a press release announced that the draft of the working paper titled "Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk" under IAS 39 has been completed. While addressing a number of problems regarding hedge accounting under IAS 39, the draft fails to resolve the issue of recognition of sight deposits and the equity volatility not reflecting the reality. The IASB promised to set up a high-level working group to find a resolution to the controversies. It also announced that the proposed modification, aimed at restricting the options of fair value accounting as proposed by the regulatory authorities, would be revisited in April.

In its announcement the FBE welcomed the plan to set up a working group, emphasising that main outstanding issues related to IAS 39 should be resolved before the application of the standard becomes mandatory in the EU.

The first meeting of the high-level working group had been postponed several times, the latest date was May 26. The first meeting is to identify the issues to be addressed by the two sub-working groups (banking and insurance), the composition of the sub-groups (to also include non-Europeans) and to determine whether any satisfactory solution can be found in the short-term.

2. IAS 32, IAS 39

While acknowledging that the standards made public in December have improved significantly, apart from the treatment of macro-hedging which is still being shaped, the FBE's Accounts Committee found the treatment of internal contracts, netting, credit derivatives and trading in own stock indexes and market making unsatisfactory in the new IAS 32 and IAS 39. Appropriate transition rules will be indispensable, especially for those banks, which already apply IAS 39. Member associations urged for an early amendment to IAS 30, as it contains several exemptions from the disclosure requirements under IAS 32. Associations expressed concern over the deadlines provided, given the current uncertainties, for which there are no quick solutions. Accordingly, the process of introduction of the IFRS will be more difficult than expected. Some proposed that the FBE ask for a year postponement, others opposed this, especially with regard to those banks, which already apply IAS 39.

3. Effect of changes in accounting standards on capital adequacy regulations

Changes in accounting standards raise the need to adjust the definition of regulatory capital (own funds). The Basel Committee seems willing to revise the capital defined by IAS for regulatory purposes, if the IAS definition is economically wrong. The European Commission will rely on the work being performed within the Basel Committee, under which simpler issues are expected to be resolved by May 2004 and the more complex issues (such as consolidation and pension funds) at the beginning of the autumn.

The European Commission decided not to change the definition of the own funds in the period between January 2005 and December 2006 (in that period, IFRS will already be in force, while Basel II not); instead, the Commission will promote a uniform interpretation and practical application through committee proposals or rulings adopted within the framework of the Lámfalussy procedure.

The European Directive based on Basel II will take effect as of January 1, 2007. This will require the consequential amendments of the EU Own Fund Requirements (Sections 34 to 39 of Directive 2000/12). The adjustments will be made mainly by means of an Annex containing the necessary technical provisions. A revision to the definition of own funds is planned by both the Basel Committee and the European Commission. The new definition would be first applied from 2008 or 2009.

2. ECBS

The European Committee for Banking Standards (ECBS) Technical Steering Committee (TSC) held its 46^th meeting on February 10, 2004 in Brussels. At this meeting, a proposal for restructuring the ISO TC68 Financial Services Technical Committee was discussed, for which three models were proposed by the Swiss delegate. The debate was about setting up a working group to address the issue of standardising basic banking operations (for example, developing an IBAN standard in order to simplify the automated processing of small-value financial transactions). A meeting organised by the ECBS with European Banks and representatives from the ISO TC68 was held on March 24 on this issue.

3. Payments Systems Committee

The FBE's Payments Systems Committee addressed a number of issues that are already or will be relevant to the Hungarian banking sector. (The Association is also represented on this Committee).

The Committee evaluated the activities of the supreme payments body of the European banking sector, the European Payments Council - EPC. (A member representing the Hungarian banking community has been delegated to the EPC recently). The EPC has set itself the objective to play a key role in creating a Single Euro Payments Area (SEPA) and to accomplish this objective primarily through self-regulation. In this, the EPC is now faced with two key questions:

• how can the EPC's decisions be implemented once membership in the EPC is voluntary, some members are banks, some are banking associations, and the EPC's decisions do not apply to banking associations.
• it is unclear how inter-bank cooperation (supported at the highest levels in the EU) would relate to competition laws or, more specifically, anti-cartel laws in member states.

The committee expressed its satisfaction with the progress of the Target 2 project, aimed at developing a Pan-European payments system for large value payments (the Hungarian banking sector will probably be involved in this project through the National Bank of Hungary). The EPC was critical about the regulatory process of intra-EU payments. The draft regulation allows less room for self-regulation and, with its tight rules, may put European banks at a disadvantage to non-EU banks. The legal form of the proposed regulation is also unclear (whether a Regulation or a Directive). Anyway, unsatisfied with the slow progress of the reviews, the European Commission decided took out the section on money-laundering and will issue a separate regulation for this area within short. (Basically, this is the most important area, given that financial control, one of the key elements of combating money laundering, is currently ineffective due to differences in national anti-money regulations).

All FBE members may join the review process. The review process is hoped to commence in Hungary, as well: the Ministry of Finance plans to have a review with the participation of banks, the Hungarian Financial Supervisory Authority, and the National Bank of Hungary.

One of the EPC's major accomplishment is the Recommendation to the European banking community, containing the banking community's requirements for a Pan-European payments and settlements system for small-value payments. While establishing that any system may be capable of meeting these requirements, the EPC specifically named EBA STEP2, a system already in operation, as the one that already today meets the requirements. A key point in the Recommendation that all countries in Europe must be capable of receiving payments in Euro through this system. Naturally, this does not apply to all banks; however, it will be the task of the national banking communities to establish at least one entry-point institution in each country to perform the local delivery of the payments.

This project will affect all banks in Hungary. Accordingly, in accordance with the FBE's request, the Recommendation containing detailed descriptions of the financial, IT and settlement processes has been translated and will be forwarded to all member banks.

1. Finance Committee

The FBE's Finance Committee held its 77^th meeting on March 20, 2004. The meeting reviewed the proposed Directive on the taxation of savings. Since the adoption of the Directive raises a number of questions in some member states, a special working committee was set up to address the issue. Another special committee is now looking at issues related to VAT charged on financial services (VAT categories).

The Committee was given an overview of the latest developments affecting taxation laws in the U.S.

2. Social Affairs Committee

The FBE's Social Affairs Committee held a plenary meeting on March 22 in Brussels. The importance of promoting social dialogue between employers and employees was emphasised at the meeting. Trade unions were also represented at the meeting.

Fleming Larsen offered a presentation on demographic impacts in the banking sector. The ageing of workforce in the banking industry was highlighted and supported with statistics.

Social problems expected after EU enlargement were also addressed. A special dialogue with new member countries will be launched to better identify and understand these problems. Hungary, Slovakia and the Czech Republic will be involved in the first round of this project.

IV. ASSOCIATION EVENTS

1. Annual general meeting

The Hungarian Banking Association held its annual general meeting on April 23, 2004. Promoting the adoption of international regulatory standards, coordination of opinions on the proposed new EU Capital Adequacy Directive (CAD3) and promoting preparations for their implementation were pointed out by the Secretary General as focus areas in the Association's activities in 2003.

2003 saw an increasing financial market volatility due to inconsistent monetary and fiscal policies, causing serious problems and losses in the financial institutions' sector in 2003. The Association voiced its opinion on several occasions, urging monetary and fiscal measures to reduce volatility and to restore market confidence.

The setting up of the Payment System Forum was an important step forward in the self-regulation of the Hungarian banking community. This is an important forum for forming opinions and preparing decision-making in the main areas of payment operations. The Association continued to organise a series of popular seminars in 2003.

First among the banking associations of accession countries, the Hungarian Banking Association has become a full member of the European Banking Federation, effective from January 1, 2004. From this year, the Association will participate as a full member in the work of the FBE's working committees and professional review processes.

The most important tasks for the Hungarian Banking Association for 2004 were summarised by the Secretary General as follows:

• A main task for the banking community is to regularly formulate views on economic policy issues, especially on the relationship and consistency between fiscal and monetary policies, and to communicate these views to the government and the central bank.

• The Hungarian banking community seeks to participate in channelling EU funds to the Hungarian corporate sector. Enforcing banking requirements in developing the conditions for the various loan facilities (agricultural schemes, SMEs, road construction, etc.) will be a key issue.

• Participation in the international review process aimed at establishing a Standard European Payment Area and the implementation of ensuing development and regulatory tasks in Hungary will be a priority.

• The Association will continue to give special attention to organising professional seminars and training courses.

The General Meeting adopted the reports on the Association's activities and financial management in 2003.

After a short debate, the proposal presented by the Board for the Association's new membership fee system was adopted at five votes against and one abstention.

Amendments to the Association's Rules, required due to tasks ensuing from accession to the EU were unanimously adopted by the General Meeting.

Géza Egyed, CEO of WestLB, was elected board member until expiry of the term of board members in 2005.

Miklós Pulai, Dr. Iván Szentivány and Gyula Czirják were elected members of the Association's Ethics Committee for a three-year term.

1. Meeting with the Interior Ministry's Deputy State Secretary in charge of Crime Prevention

At the Interior Ministry's request, András Hegedűs, Deputy State Secretary in charge of crime prevention at the Ministry of Interior held a short meeting with the Association's Secretary General and staff members on March 12, 2004. At the meeting, brief information was provided on the status of the review of the concept for "the regulation on civil security, information gathering and protection obligation". The main topic of the meeting was the possible contribution of banks to the prevention of crimes. In the Interior Ministry's opinion, the reduction of cash payments has an outstandingly important role in combating crimes against property. The colleague in charge of payments systems at the Association gave a briefing on developments in promoting the use of smart cards and on preparations related to the proposed Act on electronic money. The Ministry proposed to hold regular meetings to identify potential cooperation areas.

2. Payment System Forum

In addition to the three Technical Committees set up in the fourth quarter of 2003 (Technical Committee on the development of Cashless Payment Methods, the Cards Technical Committee and Technical Committee on Cash Transport and Processing) a GIRO Technical Committee was set up on February 24, 2004. Two of the six planned technical committees (the Technical Committee on VIBER/RTGS and KELER and the Standardisation Technical Committee) had not been set up as of the end of 1st quarter 2004.

The documents drafted by four working groups of two committees (OCR, Direct Debit, List Payments and Chip Migration) will have to be sent by the Coordinating Committees (the Hungarian Banking Association, the National Interest Representation Association of Savings Co-Operatives [TÉSZ] and the National Federation of Savings Co-Operatives [OTSZ]) to their members for review. Comments on these documents were sent by the Association to the Payment System Forum Secretariat. The Payment System Forum will decide on the next tasks. It is also the Payment System Forum's responsibility to decide on whether the committee proposed by some member banks on November 25, 2003 to address issues related to a proportionate sharing of burdens between banks and clients and indemnity obligations for card payments and electronic banking services can be set up.

3. Information Society Inter-Ministerial Coordination Committee, IT Security Sub-Committee

The Strategy for a Hungarian Information Society (MITS) Special Programme was adopted at the meeting of the Information Society Inter-Ministerial Coordination Committee (ITKTB) of March 30, 2004. The IT Security Sub-Committee (INBA) is charged with implementing the Central Special Program (called KKP-16 eSecurity). The Association is a member without voting rights on this Committee. The Programme is aimed at increasing user confidence, by attaining a level of IT security level and user awareness that would allow a shift to the exclusive use of electronically sent and stored data in administrative and business processes, to increase efficiency. The programme is aimed at implementing major developments in the areas of IT security certification, network security, promoting electronic signatures and creating the conditions for a secure and efficient handling of affairs and data security.

4. Chip migration - round table and lectures

The Association and the Johann von Neumann Computer Sciences Society Smart Cards Forum launched a round-table discussion and a series of lectures to promote the introduction and use of chip bank cards. The round table took place on March 2, the first lecture was held on March 4. Three more lectures are planned to be held this year to promote banks' cooperation in this area.

5. Information Security Working Group

The Information Security Working Group was formed and held its first meeting on March 26, 2004, as an independent working group attached to the Bank Security Working Group of the Association's Bank Security Working Committee. (The Bank Security Working Group is charged with addressing issues related to the mechanical, physical, and human protection of financial institutions). The Information Security Working Group sets its own work plan and work schedule and meets as necessary, but at least bi-monthly. Members of the Working Group may regularly obtain information on new threats to IT systems and the latest development results in information technology, participate in the drafting, adoption and review of legislation and standards affecting information technology; develop information security recommendations for member banks, provide assistance in providing professional training and keep contact with fellow organisations performing similar tasks.

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