REPORT

on Activities of the Hungarian Banking Association

2^nd Quarter 2003

Budapest, July 2003

CONTENTS

I. PROFESSIONAL ACTIVITIES *

1. Draft laws on amendments to the Constitution, on Legislation, on the Constitutional Court and on other subjects *

2. Electronic company registration process *

3. Bank security *

4. Measures for the prevention of terrorism and money laundering *

5. Negative impacts of current derivative accounting rules and computation rules for local taxes *

6. Basel II - CAD 3 Working Group *

7. Transformation of the primary dealers system *

8. Finance Ministry Decree on register related to determining the usual market price *

II. LOAN SCHEMES *

1. Banking issues related to SMEs schemes *

2. Agricultural loans *

2.1. Loan schemes for businesses operating in adverse regions *

2.2 Evolution loans *

2.3 Bank guarantees for application fees under loan schemes of the Ministry of Agriculture *

III. INTERNATIONAL COOPERATION *

1. Basel Working Group *

2. Accounts Committee *

3. Economic and Monetary Affairs Committee *

4. 16^th Meeting of Associate Members of the European Banking Federation - Bratislava *

5. Meeting of the FBE's Financial Markets Committee *

6. 34^th Meeting of the FBE Fraud Working Group - Berlin *

IV. EVENTS, ASSOCIATION LIFE *

1. Visit of the Financial Committee of the Italian Parliament *

2. ISDA Seminar *

3. Payment Systems Forum *

4. Discussion of the study titled The Almost Operating Market *

5. Discussion of the study titled Competition and Profitability in the Banking Sector (by Éva Várhegyi) *

6. Meeting of the TC1 Committee *

I. PROFESSIONAL ACTIVITIES

1. Draft laws on amendments to the Constitution, on Legislation, on the Constitutional Court and on other subjects

Certain questions related to legislation in the Constitution and provisions on the Constitutional Court need to be amended in connection with Hungary's accession to the European Union.

The proposed law package contained a new draft law on the Constitutional Court.
In this regard, we submitted some comments to make certain provisions of the draft law more specific. Also, we proposed to extend the scope of incompatibility and to include a provision for the event of failure by Parliament to elect the Justices of the Court. We also proposed that the requirements of reporting to the Constitutional Court be reconciled with bank secrecy regulations of the Credit Institutions Act.

The law package also included a new draft law on legislation (we had offered comments on a previous version of this draft law). We proposed to reduce the scope of issues to be regulated under omnibus legislation, to define more specifically the position of ordinances of the President of the National Bank of Hungary (NBH) in the hierarchy of legislation and to include the professional reasons for the various laws in electronic law publications or on the home pages of the legislative organisations.

Finally, as a critical issue for the Association, we challenged the proposal that only those organisations whose right of review is provided for by a separate statute would be entitled to comment on regulatory proposals to be presented to the government. We pointed out that this would be a step back compared to the current regulation; statutes seldom stipulate the right of review of social and interest representation organisations in respect of specific issues; for example, the right of review of the Hungarian Banking Association is not specified by name in the Credit Institutions Act; the current text of the Act on Legislation, providing for the right of review of the social and interest representation organisations concerned, is satisfactory in this respect. We consider it important for legislators to know the opinion of professional associations in the preparatory and review stages of the legislation.

2. Electronic company registration process

The proposal and draft law on procedures for the electronic registration of companies and on electronic access to register documents was sent by the Ministry of Justice for review in two rounds, in April and May. During the first review we proposed that the proposal specify the rights and obligations of those accepting and using electronic register documents. We suggested that the proposal specify the ways in which credit institutions should meet their obligations of data supply and certification. According to the proposal, official licences required for founding a company would be obtained for the founders by the Registration Court. The proposal specifically named the Hungarian Financial Supervisory Authority, the Competition Authority and the Gaming Board as competent authorities, with whom an on-line connection would be established for this purpose. We challenged this provision as impracticable. Our comment was accepted and the provision in question was omitted from the draft law. Also, we submitted some comments to make certain provisions of the draft law more specific.

During the second round of review we drew attention to the fact that the provisions on the payment of fees and administrative service charges in the proposal were not reconciled with the regulations on payments and the relevant provisions of the Act on the National Bank of Hungary. According to the draft law, registration and publication fees could be paid through the home page of the Company Register and Information Service, with the publication fees to be transferred by the Service to the relevant account of the Ministry of Justice. We pointed out that this solution was not feasible and was against the relevant payment regulations. We proposed that the issue be reviewed with the National Bank of Hungary and offered banks' cooperation in drafting a workable proposal. We also proposed that implementation decrees should be drafted together with the draft law, given that the Act would only enter into force as of January 1 2005.

3. Bank security

Due to the complexity of the issue, no government decree has been put in place yet to regulate bank security requirements. Some additional data protection and security aspects were raised in relation to the last version of the proposed decree. To speed up the review process and to have our arguments accepted, we invited competent professionals from the Ministry of Interior to attend Association's Bank Security Committee meeting. The purpose of the meeting was also to establish direct working relations and to open up new opportunities for banks to have their interests enforced during the preparation of draft laws.

Upon our approach, Dr András Hegedűs, Deputy State Secretary of the Interior Ministry, proposed widening cooperation with the Association in the prevention of robberies against banks and commercial outlets and other crimes. An important area of cooperation would be the promotion of non-cash payment methods and the reduction of cash payments.

4. Measures for the prevention of terrorism and money laundering

Hungary has been removed from the FATF list of countries to be monitored. Nevertheless, to preserve our status, at least the current level should be kept up and the provisions of Act XV of 2003 should be complied with.

Pursuant to the provisions of that Act, banks should, by the end of this year, fully identify their customers: from January 1, 2004, transactions of only those customers may be executed whose company and personal details required and specified by the Act are available and properly recorded.

Professionals responsible for the area have indicated that there are still many customers for whom banks do not have the data required and therefore, banks branches may expect large numbers of customers showing up in the last quarter of the year.

The mapping of missing data is now underway at most banks.

The Association's Working Committee for the Prevention of Terrorism and Money Laundering initiated a coordination of wording and timing of announcements to the public to avoid any "competitive disadvantage" for either bank. The coordination would also include the joint issue of announcements and notices with the Hungarian Financial Supervisory Authority to make customers aware that those are not the banks' initiatives but a legal requirement.

The Committee proposed that - similarly to the previous initiatives of the Authority (complaints, insurance issues) - customers are mailed a Supervisory Authority circular enclosed with their September bank account statements.

The Supervisory Authority was receptive to this proposal, the drafting of the announcement is currently in progress. Meanwhile, a circular was sent out, calling all banks for a coordinated action.

5. Negative impacts of current derivative accounting rules and computation rules for local taxes

A discussion on the impact of current accounting rules on profits and on the possibility to change these rules was held at the initiative of one of our member banks. In the introduction, professionals from PriceWaterhouseCoopers explained that the current accounting and taxation rules distort banks' profits and tax liabilities. When determining the tax base for local taxes in respect of investment services, only the revenues side is taken into account, excluding expenses. Pursuant to current accounting rules, unrealised profits from forward transactions cannot be accounted for, while unrealised losses are subject to provisioning; this hinders creating a true view. The difference the relevant valuation rules, unlike to the international standards, may cause in relation to the various transactions depends on the market price, which leads to unpredictability. (Earlier the Association had proposed a modification to these rules and the Ministry had agreed to change them).

The Dezső, Réti & Antall Landwell law office presented the legal arguments that may serve as a ground for the Constitutional Court to pronounce the current regulation unconstitutional (in which case these taxes would have to be refunded). A respective motion with the Constitutional Court was filed by the National Association of Securities Dealers at the end of last year on the grounds that the current rules violate the constitutional principles of generality, equality and proportionality of taxation. Participants in the meeting found it warranted for the Association to join that motion or to file a similar motion on the grounds of a substantial injury to banks' interests. The latter proposal was favoured by the Board of the Association and the Secretary General was requested to consult on the joining motion with the law office that drafted the motion of the National Association of Securities Dealers. The Ministry of Finance is being kept informed on all steps of the Association in order to promote the regulatory change.

6. Basel II - CAD 3 Working Group

In connection with the proposed reform of the Basel Capital Accord, an ad hoc working group was set up in May to develop a position on behalf of the Hungarian banking community on the Third Consultative Paper of the Basel Committee (CP3) and the new EU Capital Adequacy Directive (CAD 3). After a review with our member banks, our response to the Third Consultative Paper was sent to the Hungarian Financial Supervisory Authority, the body responsible for developing the Hungarian position in the consultative process. The next task for the working group will be to discuss the proposed new European capital adequacy directive. The deadline for comments is October 22. The Directive will be incorporated into the Hungarian legislation from 2006.

7. Transformation of the primary dealers system

Government securities primary dealers requested the Association to provide a forum and cooperation in developing a new government securities market strategy, with special regard to Hungary's accession to the EU. Also, the introduction of the EURO a few years after accession will be key issue and a challenge that will bring major changes to this market segment. An anticipatory strategy developed by Government Debt Management Agency was presented for review at a working meeting on July 2. At the discussion, also attended by the Association, all participants were asked to present their opinions. In this context the most important questions are: what short and long-term measures will be required for an efficient integration while ensuring that the securities market and, in broader terms, the fixed income market stays in Hungary; what price quotation methods should be applied, what kind of trading system, and when should such system be introduced in order for these objectives to be accomplished.

8. Finance Ministry Decree on register related to determining the usual market price

With a view to developing an international regulatory framework in view of the ever strengthening role of multinational companies in international economy, the OECD is working on a directive on the developing of transfer prices to be reported by multinational companies to the tax authorities. Regulations on transfer pricing are outstandingly important also in the EU, although corporate taxes will continue to be a cardinal issue of sovereignty. In line with international practice, Act LXXXI of 1996 on Corporate and Dividend Taxes contains a provision which requires the adjustment of the tax base in case of a significant difference between a transfer price applied between members of a company group and the usual market price applied between independent parties. The proposed decree provides the content requirements in respect of setting and documenting transfer prices.

The Association has been involved in the review of the draft decree and developed its stance based on member banks' comments, with special regard to banking group specialities.

II. LOAN SCHEMES

1. Banking issues related to SMEs schemes

SMEs loan schemes of the Ministry of Economy and Transport often require the presentation of bank declarations e.g. powers of attorney, guarantee bonds or letters of intent. Upon our member banks' proposals, we have taken several initiatives to standardise the required documents. In response to our proposals, a meeting was held at the Ministry of Finance on developing sample documents. After a long time, its seems our proposal is now going to materialise.

A key issue in the regulation related to the Europe Technical Development Loan Scheme for SMEs was the administration of interest subsidies granted by the government. Since the government has provided an exchange rate guarantee for borrowings of the Hungarian Development Bank, the Hungarian Development Bank can now apply Eurolibor instead of Bubor when setting its interest rates. As a consequence, interest rates have declined and interest subsidies have been abolished.

In our previous report we advised that a government decree on the further development of the micro loan scheme was under preparation. At the discussion held on the subject at the Ministry of Ecomony and Transport we expressed our support for the main directions of development of the scheme. At the same time, we proposed that the lending limit for classic micro loans be lowered to HUF 3 million, that for Széchenyi Cards raised to HUF 5 million and banks provide government-subsidised loans between HUF 3 million and 10 million from their own resources (mini loans). According to the proposal presented to the government, there would be no interest limit for government subsidies for loans provided from the banks' own resources (the government's decision is not yet known).

2. Agricultural loans

2.1. Loan schemes for businesses operating in adverse regions

In our first quarter report we advised that the government has allocated HUF 12.5 billion for the purpose of reducing the loan debts of businesses operating in adverse regions. Pursuant to the respective decree of the Ministry of Agriculture and Regional Development, applications were to be submitted to banks and county offices of the Ministry until May 31. Banks took a major share in the preparatory work to ensure the reconciliation of loan data and the proper drafting of the applications.

After submission of the applications, banks will have to state whether they are prepared to provide a 3-year regional loan for 50% of the outstanding loan amounts eligible for the scheme, the annual instalments of which would be made available to the applicant by the government as a government subsidy on condition that commitments undertaken by the applicant in the application and approved by the Ministry have been met.

According to information received from the Ministry, about 1,200 applications were submitted and are now under appraisal.

2.2 Evolution loans

The last self-evaluations under this 3-year loan scheme, launched in 2000, were to be submitted to banks and the Ministry by May 31. Banks are to appraise the evaluations and send their opinion to the Ministry for final decision. At our initiative, a discussion on the appraisal criteria was held between the Ministry and the banks involved. The appraisal of self-evaluations is now underway at the banks.

After lengthy discussions, Section 261 of Decree No. 3/2001./II.29./FVM has been finally amended. As advised in our first quarter report, the purpose of the amendment was to ensure that for government subsidies for loans over one year, the central bank base rate effective as of the date of calling the subsidies (not the contract date) is applied.

3. Bank guarantees for application fees under loan schemes of the Ministry of Agriculture

The Ministry of Agriculture and Regional Development wants to change the practice of paying application fees in cash: pursuant the relevant EU regulation, application fees are not paid in cash but are to be covered by bank guarantees. Banks were actively involved in the review of the proposed amendment and in drafting the required Letters of Guarantee.

Meanwhile, reassessing the ensuing tasks, the Ministry decided to issue a new decree rather than amending the current one. The idea is to draft a decree that could also be applied to the administration of application fees under export and import application schemes after May 1, 2004. The new draft decree is now under review by the banks involved, the relevant proposals and comments will be forwarded to the Ministry.

III. INTERNATIONAL COOPERATION

EUROPEAN BANKING FEDERATION

1. Basel Working Group

Basel II - Third Consultative Paper (CP3)

The Third Consultative Paper of the Basel Committee was issued on April 29. The document contains a number of changes compared to the Technical Guidance of the Third Quantitative Impact Study conducted at the end of 2002. Accordingly, it will allow the choosing of a simplified standardised approach, which essentially is a synthesis of the simplest options and will offer an alternative for smaller institutions with simpler product structures. The recognition of provisions in the IRB approach has been modified, the risk weight of revolving retail exposures has been adjusted and the treatment of residential mortgages, high volatility commercial real estate loan portfolios, specialised lending, credit derivatives and securitisation has been modified. The weighting of past due loans, under certain conditions, is now more favourable in the standardised approach. The partial use of advanced measurement approaches will be allowed for credit risk and operational risk. In addition, an alternative standardised approach has been offered for the measurement of operational risk. The second pillar has been extended in contents: in addition to banking book interest risk, the issues of operational risk, stress test under the IRB approach, the definition of default, residual (legal, documentation and liquidity) risks, concentration risk and securitisation have been addressed in detail. Disclosure requirements under the third pillar have been substantially scaled back, especially in respect of the IRB approach and securitisation.

Comments on the Third Consultative Paper are to be submitted to the Basel Committee by July 31. Meetings of the Basel Working Group were focused on drafting the FBE's response to CP3.

The draft letter emphasises that for a consistent implementation of the new Capital Accord, the contents and scope of competence of supervisory reviews (Pillar 2) should be clarified. The new criteria appearing in CP3, to be taken into account by banks and supervisors when determining the capital requirement, will automatically lead to the imposition of an additional capital requirement, not just in special and exceptional cases. This is unacceptable, all the less so, as this capital requirement has not been included in the calibration under Pillar 1.

The FBE proposes that another comprehensive quantitative impact study be conducted prior to the introduction of the new Capital Accord in 2006; this would help to assess methodology convergence and increase confidence in the new Accord.

The FBE agrees that for a successful implementation of the new Capital Accord, a closer cooperation between national supervisors will be required. Directives of the Accord Implementation Group will not suffice in this respect: the fundamental principles of cooperation between the home and host country supervisors should be laid down in the Capital Accord itself. The notion of a Lead Supervisor should be introduced; accordingly:

• No bank will have to apply more than one method in determining its capital requirement;
• Capital requirements determined under Pillar 1 (at the home and host country level) should be consolidated on group level into a single capital requirement. Thereby, the home country supervision will be maintained.
• Pillar 2 would be applied at the top consolidated level and supervisory responsibilities would be exercised by the home state supervisor. Only in exceptional circumstances should Pillar 2 requirements be exercised by a host state supervisor.

In light of the results of QIS3, the FBE proposes for national discretions to be substantially reduced, especially in issues affecting the competitive situation of banks of different nationalities operating on the same market (treatment of claims on banks in the Standardised Approach, maturity adjustment).

According to the FBE, the possible methods for reducing procyclicality should be reviewed in detail prior to the implementation of the new Accord.

The FBE's detailed comments on CP3 are contained in an enclosure to the letter. The most important observations are related to the treatment of revolving retails exposures, equity exposures and securitisation, the recognition of provisions, minimum requirements for applying the IRB approach and the measurement of operational risk. The enclosure contains detailed comments on Pillar 2. In relation to Pillar 3 (Market discipline), the FBE welcomes the significant improvements made; however, it is of the opinion that the disclosure requirements are still too prescriptive and require disclosure of information related to ownership.

There are two other enclosures to the FBE's letter. One discusses the advantages and disadvantages of the various methods for reducing procyclicality, once more highlighting the importance of this issue. The second presents an alternative proposal for maturity adjustment.

Joint letter by banking federations to the Basel Committee regarding Pillar 2

New issues raised in the second pillar and details of the supervisory review, in general, need clarification. In this context, the FBE and the Australian, Canadian, Japanese and U.S. Banking Federations wrote a joint letter to the Basle Committee. The letter explains that the purpose of the Pillar 2, in its original form, was clear: it provided a framework for banks to determine their own capital requirements and for supervisors to intervene, if necessary, and prescribe a higher capital requirement for the bank in question. The banking community supported this approach. Both banks and supervisors agreed that the uniform application of Pillar 2 should be ensured through the convergence of supervisory practices rather than through detailed regulations. This consensus was reflected in the forming of the Accord Implementation Group. The original purpose and the scope of application of Pillar 2 in CP3 are now confused. The connection between Pillar 1 and Pillar 2 is unclear, as is the reason for introducing new special exposures. Pillar 2 has shifted in a direction that would result in the automatic prescription of an additional capital requirement, which is unacceptable.

The signatories to the letter express their intention to review conceptional issues in Pillar 2 with representatives of the Basel Committee and list the specific points to be discussed. (Capital adjustment under Pillar 2 to be applied only in exceptional cases; using an objective benchmark when prescribing any additional capital requirement, new specific risk issues to be re-integrated into the general framework; capital requirement to be adjusted on a net basis under Pillar 2 (possibility of reduction); application Pillar 2 at the highest level of consolidation; capital adjustments carried out under Pillar 2 not to be subject to mandatory disclosure).

Upon the criticising comments received the Basel Committee accepted that Pillar 2 should be further clarified and has took up the issue on its agenda for the July 15-16 meeting.

Results of the Third Quantitative Impact Study (QIS3)

The Third Quantitative Impact Study involved 365 banks from 43 countries, including 8 banks from Hungary. Out of the participants, 365 banks used the standardised approach, 159 the foundation IRB approach, 74 the advanced IRB approach. (Some banks completed the exercise for several methods). Banks were split into two groups (large, diversified and internationally active banks with Tier 1 capital over EUR 3 billion, and smaller and, in many cases, specialised banks) and three sub-groups (G10, EU and other countries). Results show that capital requirements increased in all sub-groups using the standardised approach and decreased in almost all sub-groups using the IRB approach. The increase in capital requirements is caused by the capital requirement for operational risk; in the IRB approach this increase is offset by a decrease in capital requirements for credit risk. Capital requirements decreased slightly for the corporate portfolio, more significantly for the retail and SMEs portfolio; those for inter-bank and sovereign exposures increased a little. Capital requirements for those "Other" countries which applied the standardised approach showed a 12% increase, of which 11% was due to the recognition of operational risk. (See detailed results in the table below). The results for Hungarian banks are very similar to the latter group. Combined results for the eight banks show an average 12.2% increase in capital requirements, of which 10.6% is due to the recognition of operational risk. However, in contrast to global results, in the case of Hungarian banks the capital requirements for the corporate portfolio increased.

(Based on the May 5 report of the Basel Committee and the results published on the home page of the Hungarian Financial Supervisory Authority.)

Contributions to change in capital (%)

2. Accounts Committee

IAS 32 és IAS 39

Following the March roundtable discussion, the FBE's working group met on five occasions with representatives of the IASB. The main objective of the meetings was to develop alternative accounting rules for macro hedging in IAS 39. As a result of these consultations the IASB acknowledged the need to develop a treatment that takes account of the banks' practices and allows a portfolio level treatment of macro hedging transactions. (The portfolio hedging is based on the expected re-pricing dates. Effectiveness is tested on the base of hedging transactions and if the transaction is ineffective, the impact will immediately be taken to the profit and loss account).

At the same time, no agreement was reached as to when should a hedging transaction be considered as effective and whether or not certain core deposits (such as sight deposits) can be recognised in hedge accounting. In light of the above, it is unlikely that any agreement can be reached in respect of macro hedging before the planned issue of the new IAS Exposure Draft this autumn.

In addition to macro hedging, the IASB is addressing other important issues, such as provisioning on loans, effective interest rate and fair value.

Expected timetable:

July 22-24 IAS Board Meeting - Finalisation in September

Autumn 2003 Macro Hedging Exposure Draft

Winter 2003 IAS 32 and IAS 39 final standards, without macro hedging

April 2004 IAS 32 and IAS 39 full standards

EFRAG’s Strategy

The Task Force set up for this purpose has reviewed the activities of EFRAG since it’s foundation a year and a half ago and presented a proposal for EFRAG's future strategy. According to the Task Force, EFRAG's long-term goal is to represent European interests in the international standardisation process vis-á-vis the IASB. It should promote the consistent and uniform application of standards, while increasing transparency in its own activities. It should prepare for enlargement of the EU and should involve in its activities experts from the accession countries already at this stage. There is a need to enlarge EFRAG's staff and resources and to enhance dialogue with regulators and the founders of EFRAG.

The proposals put forward by the Task Force will be reviewed by EFRAG's supervisory Board in September. Accordingly, the Accounts Committee's meeting could not discuss the proposals in depth. At the same time, members of the Accounts Committee emphasised that European interests are not represented strongly enough in the IASB and in the standardisation process; it would be desirable to strengthen Europe's role.

Basel II Pillar 3

The Pillar 3 Working Group of the Accounts Committee drafted the FBE's opinion on Pillar 3 in the Third Consultative Paper. The working group proposes to further scale back disclosure requirements and to omit those details which, in the absence of proper background information, would confuse, rather that orient the market. Despite the modifications made in respect of the IRB approach and securitisation, there is still a lot of superfluous and misunderstandable information in the scope. In an appendix, the working group presents the scope of information it regards expedient and warranted under Pillar 3.

European Commission Directive on Transparency Obligations

The latest version of the Commission's new directive on transparency obligations of securities issuers operating in regulated markets was published on March 26, 2003. Although all decision-makers appreciate the importance of this directive, major modifications will still be required for the directive to live up to industry expectations. The most debated issues are: the obligation of quarterly disclosure, the deadlines, the method of disclosure and consistency with other directives.

Opinions vary on whether the benefits of quarterly reporting are higher versus the costs of compiling the reports. Those in favour of quarterly reporting argue that this system is well-proven in the U.S. and ensures a better information of investors; those against it worry about the prevalence of short-term decisions, in addition to the costs involved. The profession maintains that the 90-day deadline for disclosure is too short for presenting audited reports. The terms and definitions provided in the new directive should be consistent with other relevant directives, especially the prospectus and investment service directives and the IAS.

An early adoption of the directive is also hampered by a competence dispute between the economic and legal committees. Since this directive is not among the priorities of the Italian presidency, the parliamentary procedure is expected to resume under the Irish presidency, finalisation is expected by end 2004.

Revision of IAS 30

A committee consisting of auditors, regulators and standard-setters has been set up to review and revise IAS 30. The committee is working closely together with the IASB. The new IAS 30 is intended to rectify problems experienced in the current standard: it will be risk-based and flexible and will extend to all economic units with financial assets. It will set rules for disclosure without addressing any measurement issues. The emphasis will be on the principles of disclosure rather than on setting detailed requirements.

According to the new IAS 30, reports shall contain a descriptive section on the exposure of the unit, its risk management policy, with quantitative details, all "through the eyes of management". Reports shall at least address credit risk (asset quality, past due and impaired assets), liquidity, interest rate, market and operational risks. The balance sheet and profit and loss account shall be compiled in accordance with the measurement principles laid down in IAS 39. The reports will have no compulsory format; however, the idea is to have a standard format within the EU.

In parallel with IAS 30, the capital-related provisions of IAS 1 will be amended so that the information provided allow a uniform assessment of the capital position of the unit and adequately present management's capital objectives. It will have to be reported if the capital falls short of the internal target or the relevant regulatory requirements and the report shall contain management's recovery plan.

The IAS 30 Exposure Draft is planned to be published in the first half of 2004, to be finalised in 2005 and introduced on January 1, 2007.

3. Economic and Monetary Affairs Committee

The Association represented itself for the first time, through the CEO of one of our large banks, at the meeting of the FBE's Economic and Monetary Affairs Committee (comprising chief economists from large European banks). The meeting reviewed global economic outlooks, the Euro Area, growth forecasts for the U.S. and Europe, monetary policy issues, exchange rate of the EURO and consequences of the war in Iraq.

Members of the Committee met with Dr Ottmar Issing, the ECB Executive Board member in charge of economic and monetary affairs. Issues discussed included the ECB's monetary strategy, the advantages and disadvantages of the system of inflation targeting, potential targets for central banks, potential development of the Euro Area, including economic trends in the candidate countries, reform of the ECB's decision mechanism and transformation of the Governing Council.

4. 16^th Meeting of Associate Members of the European Banking Federation - Bratislava

The Association's Secretary-General attended the 16^th Meeting of Associate Members of the FBE in Bratislava. It was confirmed at the meeting that candidate countries will become full members of the FBE upon their accession to the EU. Accordingly, membership fees will change (no major change for Hungary, the increase in fee will be insignificant).

5. Meeting of the FBE's Financial Markets Committee

The FBE's Financial Markets Committee held its 38^th Meeting on July 4, 2003 in Rome. The Committee is an important player in the Lámfalussy process, representing the European Banking Federation, and thus, the entire European banking community in the EU financial legislation process. (As a reminder: the legislation process proposed by the Lámfalussy Committee is based on the concept that EU legislation should be adopted through consultation with actors of the sector affected throughout the legislative process. This means a consultation obligation for drafters and legislators, resulting in a regulation adopted based on mutual compromises).

The Committee reviewed the tasks accomplished over the past four months and activities of the various working groups and determined the tasks for the forthcoming period. There are a number of draft directives and proposals in different stages of the legislative process; the relevant necessary steps were defined. The Committee addressed current professional issues related to the prospectus directive and the directives on market transparency, investment services, securities settlements, mergers and acquisitions and UCITS, including the relevant position of the European Banking Federation, with special regard to actions to be taken under the Italian presidency.

It should be mentioned here, that the Ministry of Finance is now getting engaged in the European legislative process and is following closely the activities that are going on in the various stages and levels of legislation. After accession, the Ministry will have the obligation to develop its standpoints in consultation with actors of the Hungarian capital market sector. Although we are not involved in the EU legislative process yet, it would be expedient to start developing the institutional framework for the consultative mechanism required. Accordingly, the Ministry has set up an expert committee, comprising representatives from professional associations of the various market actors (private persons may also participate), the stock exchange, the Central Clearing House and Depository (KELER), international law offices and the Ministry of Justice.

During the consultations held thus far, the proposed transparency directive, mergers and acquisitions directive and investment services directive were reviewed.

6. 34^th Meeting of the FBE Fraud Working Group - Berlin

The following were the main agenda items of the meeting:

• Current directions of crime,
• Launch of a crime prevention magazine,
• Review of the forty recommendations of the FATF,
• Directions of anti-money laundering legislation in the EU member states,
• Issues related to impeding terrorist financing.

The most common fraud methods:

• A new technique in ATM fraud: the Lebanese Loop, through which the fraudster gets hold of the card number and code,
• Forging documents required for collecting cash at bank branches (changing the photograph; stealing bank statements, stealing letters; copying card details in shops and restaurants),
• Borrowing by using stolen card details,

• Forging cheques,
• Nigerian begging letters, typically through the Internet,
• Other kinds of fraud through the Internet; for example, offering phones for sale and asking for an advance payment, the goods never delivered.

IV. EVENTS, ASSOCIATION LIFE

1. Visit of the Financial Committee of the Italian Parliament

Within the framework of a series of visits to accession countries, a delegation of the Financial Committee of the Italian Parliament arrived in Budapest. During its visit the delegation had talks with the Ministry of Finance, the Hungarian Financial Supervisory Authority, the State Audit Office, the National Bank of Hungary. The delegation also had a meeting with the Hungarian Banking Association. The state of the Hungarian economy and current issues related to the financial system were reviewed, with special regard to stability of the financial system and the forthcoming privatisation of banks yet in state ownership.

2. ISDA Seminar

The Association held a one-day seminar on the role of derivatives in the money markets, in cooperation with the ISDA (The International Swaps and Derivatives Association) and the London Office of TAIEX (Technical Assistance Information Exchange Office) on June 2.

The seminar was attended by economists and jurists of banks, the Ministry of Finance, the Hungarian Financial Supervisory Authority, the Government Debt Management Agency and PriceWaterhouseCoopers (around 50 people altogether).

During the morning session, a presentation was offered by dr. David Mengle, head of the research unit of ISDA, Guest Professor at Fordham University. In the introduction, the role and areas of use of derivatives, risk management and the various types of swap transactions were reviewed. In the second part, yield curves, the zero coupon yield curve, the computation of forward yields, the pricing and valuation of options and the most frequently used pricing models were presented.

In the afternoon session, Professor Mengle gave a review of the various areas of use of derivatives. The use of derivative instruments for interest and credit risk hedging and the expected results were presented.

Dr. Lengyel Zoltán from Allen & Overy reviewed legal issues arising from Hungary's accession to the EU and hedging transactions and their application in the Hungarian legal environment. The relevant EU Directive (2002/47/EC) and ISDA sample agreements were presented.

The session was concluded by a presentation by Dr Júlia Király and Zoltán Kurali on the evolution of the HUF derivatives market, forex and interest rate swaps, the foreign exchange option and forward markets, and the use of derivative products in the corporate and retail sectors and among importers and exporters. Main challenges for the banking sector in connection with Hungary's joining the EMU were also addressed.

3. Payment Systems Forum

At the initiative of the National Bank of Hungary, a Payment Systems Forum was set up on June 11 with the participation of the National Bank of Hungary, the Hungarian Banking Association, the top ten banks in terms of payment turnover and the Hungarian State Treasury. The objective of the Forum is to promote the development of the payments and settlements system with special regard to the challenges posed by Hungary's accession to the EU. By setting up the Forum, the National Bank of Hungary, as the organisation responsible for ensuring the efficient operation of the payments and settlements system has created an institutional framework for reviewing the most important strategic issues affecting the entire community of actors in the payments and settlements system and preparing professional proposals. Savings co-operatives will engage in the work through the National Interest Representation Association of Savings Co-Operatives (TÉSZ) and the National Federation of Savings Co-Operatives (OTSZ). The Forum is a consultative nature; it formulates recommendations, developed based on a consensus of the professional community, aimed at providing best practices in specific issues related to the payments and settlements system. Recommendations are not compulsory but can be implemented in practice and incorporated in future regulations.

The organisation of the Forum has three levels, its top body is the Payments System Council, which has 15 members and meets twice a year. The institutional and personal composition of the Council was determined by the founding meeting.

The second level consists of professional committees. Following the European pattern, these are as follow:

VIBER/RTGS-KELER Committee,

Cash Processing and Transport Committee

Cards Committee,

GIRO Committee,

Standardisation Committee,

Non-cash Payment Committee

The third level comprises working groups, whose task is to develop specific projects for resolving issues adopted by the Council.

Activities of the Council are assisted by a secretariat staffed by the National Bank of Hungary. Activities of the Forum are supported by a coordination group made up of the professional associations involved (The Hungarian Banking Association, TÉSZ and OTSZ).

4. Discussion of the study titled The Almost Operating Market

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

Júlia Király, the coordinator of the study, explained the purpose and structure of the study, pointing out that the preparers gave particular attention to using a standard terminology and analysing the evolution and future development of the derivatives market by customer segments and market players.

Zoltán Kuráli, member of the authors' group, added that although some new processes are seen, the Hungarian derivatives market is still lagging behind Poland and the Czech Republic in terms of products and maturities, one of the reasons being that the questions whether these products are really needed by the end users and what are obstacles hindering the use of these products are have not yet been answered in Hungary. As for banks, there are no legal obstacles in the way of using the products; however, there seem to be some accounting constraints in terms of certain transactions. Balance sheets are not managed properly, and with no communication between the assets and liabilities sides, only few banks know the real risks in their operations; with abundant liquidity, banks are not induced to change the situation.

Proper accounting and financial regulations are prerequisites but not sufficient conditions for the wide-spread use of derivatives. It will take companies a paradigm change; namely, thus far companies have been encouraged to increase exports even at the cost of losses. Companies are not adequately informed; exporters in many cases think in terms of expected exchange rate changes rather than using derivatives products. Those responsible for asset management at the companies are not motivated (or rather: counter-motivated) to hedge risks: if the deal results in a loss, it would have to be explained, whereas if just doing nothing, any exchange rate or interest rate loss on a particular deal would remain invisible and merge into other operations of the company.

5. Discussion of the study titled Competition and Profitability in the Banking Sector (by Éva Várhegyi)

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

In her brief introduction Éva Várhegyi presented the study, which was aimed to assess the specific features of competition in Hungary and the competitive situation in the banking sector and to see whether the welfare impacts of competition in this sector are different from those in other sectors.

To answer these questions, the author looked into the correlation between competition and market stability and the applicability of the various generally known models and international examples. An analysis of the concentration indices revealed that concentration in the Hungarian banking market - and in particular, in the retail market - decreased perceivably in the nineties. The early appearance of foreign banks in the market was a decisive move from the point of view of a structural levelling and increased competition in the banking market.

The restructuring of the banking market created the conditions for the evolution of competition and vulnerability. The study showed an apparent interest rate flexibility in the market, indicating that competition in the corporate banking sector is satisfactory; in other words, banks are forced to adjust their interest rates to their marginal costs and returns. In the retail market, the correlation between interest rates and changes in the money market is much looser and therefore, banks can still realise monopolistic gains in the current market structure.

As for pricing behaviour, a downward flexibility is apparent. The corporate lending market is more balanced than the retail market: here, competitive conditions are present, most banks active in corporate lending are able to flexibly respond to changes in marginal costs and competitive interest rates.

Pricing behaviour largely impacts profitability in the banking sector. Interest margins and operating costs are double those in the EU. At a low return on assets, profitability in the banking sector was relatively high due to the extra high income from interests and commissions realised amidst a limited competition. Efficiency is still low in the Hungarian banking sector by international comparison, while profitability is relatively high due to the monopolistic feature of certain market segments.

Participants added their own experiences to the conclusions of the study. The representative from the Supervisory Authority noted that product range, quality and prices play a key role in the benefits of competition for the consumer; Hungarian banks should increase their volume efficiency; impact on competition should be a criterion during bank privatisations. Mismatch is growing (long-term placements financed by short-term funds). A scarcity of resources is expected in the near future, retail resources will become increasingly important. While central bank interest rates are reduced, banks' gross interest margins remain constant, since the only way banks can manage the situation is by restructuring their portfolios. Maturity transformation should also be taken into account when analysing flexibility.

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

6. Meeting of the TC1 Committee

At the invitation of the Hungarian Banking Association, the Bank Cards Working Group of the FBE Technical Committee held its meeting in Budapest. The meeting addressed technical issues related to bank cards.

top of page