REPORT

on Activities of the Hungarian Banking Association

2^st Quarter 2004

Budapest, August 2004

CONTENTS

I. PROFESSIONAL ACTIVITIES *

II. LOAN SCHEMES *

III. INTERNATIONAL COOPERATION *

IV. ASSOCIATION EVENTS *

I. PROFESSIONAL ACTIVITIES

1.1 Companies Act

The codification committee appointed by the Minister of Finance has finalised the concept for the review of the Companies Act (Act CXLIV of 1997) and the Company Registration Act (Act CXLV of 1997) scheduled to be presented to Parliament following a review process in the autumn.

The new Companies Act will maintain the current mandatory forms of association. Invariably, general and limited partnerships will have no legal entity. As a main rule, the nature of legislation will be permissive for limited liability companies, cogent for joint stock companies. Both forms of company may be operated as a one-man company. The institution of quotas in limited liability companies will remain; the memorandum of association of limited liability companies may not be terminated; for quitting the company, the quota must be transferred. For joint stock companies, the regulations on both public and private founding will be retained, given that public foundation is allowed under the Capital Market Act. Here, however the separation of open vs. closed forms of operation will be more consistent: only those joint stock companies that are stock exchange members will be recognised as public joint-stock companies.

The conclusion of memorandums of association will be simplified: lawyer's countersignature or incorporation of the memorandum in a deed will not be compulsory if the memorandum is concluded based on the sample provided in the Schedule to the Companies Act; notwithstanding, legal representation will continue to be required for company registration.

The regulations on scope of activities will be simplified: activities will no longer have to be listed by TEÁOR number (Statistical Classification of Activities) companies may undertake any activities that are not prohibited or restricted by law. The rules for in-kind contribution for the various forms of companies will be standardised.

As for the various bodies of a company, the general meeting will continue to be the supreme body of a company. Under the concept of corporate governance, the conditions for exercising shareholder rights would be improved and activities of the Board of Directors would be regulated in more details. The regulations on joint stock companies founded from public funds would be revised (this, however, within the framework of the Public Finance Act, not the Companies Act). The minimum capital requirements for joint stock companies and limited liability companies will not be increased.

Under the proposed revision to the Company Registration Act, the legal supervisory role of Courts of Registration would be increased through stronger sanctions. To ensure the authenticity of the Companies Register, a company will be deemed as formed upon registration in the Companies Register and terminated upon cancellation from the Companies Register. Where a sample Memorandum of Association have been used for foundation, registration will be carried out under a simplified process.

In our comments on the concept and answers to the Justice Ministry's questionnaire we indicated our agreement with the concept of a separate law and more permissive legislation. We agreed with the concept that public joint stock companies should be introduced on the stock exchange or regulated capital market; at the same time, the shareholders of private limited companies should be charged with the obligation to report their acquisition of shares in the company. We also supported relaxing the regulations in respect of the operation of private limited companies and proposed that general meeting resolutions be allowed to adopted by using telecommunication means. In relation to the rules for representation we pointed out that the relation between company representation and representation provided under the Civil Code and should be clarified in the Companies Act.

In our comments we also indicated that it would be desirable to reconcile the provisions of other laws interrelated with the Companies Act: the Capital Market Act, the Credit Institutions Act and the Accounting Act. Our detailed comments were copied to our member banks.

1.2 Insolvency Act

The codification committee drafting the new insolvency law held two meetings in the second quarter, on April 29 and June 24.

On the April 29 meeting, three new sub-working groups were set up: the financial sub-group will draft special rules to be applied to credit institutions, investment firms and insurance companies under the Insolvency Act. At it's first meeting on May 26, 2004, the group identified the types of financial organisation where special rules will be required. The group revealed that special attention should be given to those organisations whose members are also customers of the organisation, for example: voluntary and private pension funds.

The sub-working groups on self-employed entrepreneurs and social organisations are charged with studying whether these personal entities can be involved in the scope of the Insolvency Act.

A number of studies were prepared by the sub-working groups: the sub-group on civil laws and civil procedural laws compiled a document on the relation between the insolvency law and the civil procedural law, the challenging of contracts and legal transactions and contracts resulting in the deprival of collateral. The Taxation sub-working group prepared a report on the possibility to include certain taxation provisions in the Insolvency Act. The Criminal Law sub-working group developed a report on bankruptcy crimes, adjudication practices and the fraudulent alienation of companies with unpaid public dues, and drafted a proposal for a reform of the penal norm.

The sub-working groups on agricultural issues and archiving also submitted their own professional concepts. The general working group presented the codification committee with a discussion paper on the concept of the proposed new legislation. The paper was reviewed by the committee's meeting of June 24. The revised discussion paper and reports of the sub-working groups are available on the Prime Minister's Office's website.

(http://www.meh.hu/szolgaltatasok/kodifikacio/fizeteskeptelenseg).

The concept for the new legislation is expected to be completed by the autumn at the earliest.

1.3 Supplementary supervision of financial conglomerates

The Ministry of Finance submitted for professional review and subsequent administrative review the proposed law amendments related to financial conglomerates. These amendments are primarily required for law harmonisation. In addition to consolidated supervision, EU Directive 2002/87/EC on the supplementary supervision of credit institutions, insurance undertakings and investment firms in financial conglomerates provides for the supplementary supervision of such groups which are headed by a credit institution, insurance company or investment firm and at least one of the entities of the group is in the insurance sector and the aggregated activities of such entities within the group and the aggregated activities of the entities within the banking and investment services sectors are both significant. Cross-sectoral activities are presumed to be significant if the balance sheet total of the smallest financial sector in the group exceeds HUF 1,600 billion. Credit institutions, insurance undertakings and investment firms must meet the capital adequacy requirements at the financial conglomerate level and have adequate capital adequacy policies in place at the conglomerate level. Entities in a financial conglomerate are required to have special risk management processes and internal control mechanisms in place at the conglomerate level.

The proposed amendment will affect the Credit Institutions Act, the Capital Market Act and the Insurance Act. Although all those banks which have ownership in any insurance company were invited to participate in the reviews, OTP Bank will probably be the only bank that will be affected by the regulation. In our comments, sent to the Ministry of Finance, we proposed that the regulation on capital adequacy requirements be issued simultaneously with the regulation on financial conglomerates and a detailed explanation be provided to give guidance in the application of the regulations. In our detailed comments we drew attention to the importance of ensuring consistency with the various secrecy and data protection rules and providing detailed procedures for the provision of information. Further, we submitted specific wording proposals and requested that the provisions concerning the Hungarian Financial Supervisory Authority be made more specific.

1.4 Data protection

A consultation on the implementation of the data protection Act and other issues was held at the beginning of May with the participation of legal counsels and compliance and data protection officers from member banks. Dr András Jóri, data protection expert, gave a presentation on general issues related to data protection regulations, difficulties in implementing the latest data protection articles and problems related to the transfer of data to third countries. The presenter confirmed banks' opinion that the sanctions related to the Data protection Act are inadequate; the procedures launched by the Data Protection Ombudsman are not accompanied by any guarantees and the regulations on the Ombudsman's powers are rather superficial.

The Association's representative attended the meeting held by the legal section of the Association of Hungarian Insurance Companies in May, where common data protection issues affecting banks and insurance companies were reviewed. Participants showed particular interest in the operation and regulation of the inter-bank information system.

1.5 Ombudsman's criticism of mortgage lending practices; consequent regulatory measures

1.5.1 Ombudsman's report

Upon citizen complaints, the Ombudsman for Citizen Rights compiled a report on banks' mortgage lending practices. The Ombudsman's Office informed the press first on their findings, which were seriously detrimental to banks. The Ombudsman's report along with his recommendations for actions were subsequently sent to the competent authorities (the Ministry of Finance, the Hungarian Financial Supervisory Authority, the Competition Office) and the Banking Association. While the Ombudsman may only recommend actions to state organs, not to the business sphere (and thus, neither to banks), his recommendations clearly expected actions from banks and their regulatory authorities.

The Association did not wish to engage in a public dispute with the Ombudsman over his findings and criticism. Instead, it informed the Ombudsman in writing on banks' opinion, disproving his critical statements.

We expressed our objection to the way the report was compiled and made public as well to the contents of the report, based on the following:

- a responsible organisation should not draw general conclusions for the entire banking profession based a few complaints (five in number!),

- banks and the competent authorities first learned about the report from the press: under the principles of professional correctness the report should have been furnished to the parties affected, to enable them to comment on the report before making going public with it (whereby several professional mistakes could have also been avoided),

- the report accused banks of unconstitutional, unilateral and customer-unfriendly conduct pursued in a cartel, thereby fundamentally questioning the operations performed by banks up until now.

As for the specific statements:

• We refused the criticism that banks are artificially underrating the real estate collateral provided: the methods for collateral rating are provided for by statute; consequently, the fact that banks follow similar practices is not due to a cartel but to a law abiding behaviour;
• Contrary to the report, on the one hand: the stipulation of a buying option is not unconstitutional, as also pronounced by the Supreme Court; on the other hand, not all banks require this type of collateral, so, there is no grounds for claiming a cartel in this case, either. We drew attention to the fact that the reason for some banks using this instrument (tough, but fully legal) is rooted in the extremely low efficiency of execution procedures (that would be the normal way of enforcing claims);
• We agreed with the Ombudsman that the stipulation of a buying option for undervalued collateral is customer-unfriendly; however, banks confirmed that before using a buying option, the collateral is re-rated by an independent appraiser and then sold at a new and fair price.

1.5.2 Amendment to the Credit Institutions Act.

In compliance with the Ombudsman's recommendation, the Ministry of Finance drafted an amendment to the Credit Institutions Act, aimed at better customer information.

According to the proposal, in case of mortgage loans with a buying option the bank would be obliged to provide a risk statement, which should be countersigned by the customer. Also, in contracts with a buying option the bank should give the customer 90 days to try to sell the real estate collateral on his own (to avoid the - in the legislator's opinion - imposed and undervalued prices).

In our opinion, provided based on banks' comments, we acknowledged that in their comments to the Ombudsman banks did find customer information inadequate and were not against the idea of a risk statement; however, they found it problematic due to the unspecified contents and unclear relation of the statement to the loan contract. We emphatically objected to adding to the provisions on a buying option the right of the customer to sell the collateral on his own, on the grounds that this is alien to the legal instrument in question.

Some of our comments were accepted: the risk statement will only be applied to retail loan contracts; it will not be mandatory to provide for the option for the customer to sell the collateral in case of buying options; the Ministry did not insist on providing for additional obligations in respect of collateral in the banks' business terms and conditions, and agreed to provide sufficient time for banks to prepare themselves for implementing the new provisions. Nevertheless, the risk statement itself was retained in the proposal and despite our request, the requirement that the risk statements should be provided with uniform contents was not included in the proposal.

1.6 Proposed amendment to the Decree on housing subsidies

During the drafting and review process of the proposed amendment to the Decree on housing subsidies, the bad practice of sending the various versions of the draft unexpectedly and at an unrealistically short notice (sometimes just hours), with inconsistent contents and changes continued.

In some versions, the tenement reform programme was highlighted, EU law harmonisation in some others, new construction and engineering definitions in the third version and the latest modifications to bank financing in some other versions: it was impossible to follow why certain topics appear in some versions and then disappear in others and whether our comments had been taken into account (some provisions challenged were not included at all in the next version).

Due to technical reasons and the extremely short notice given, we were only able to review the versions briefly with a few colleagues. The draft versions and our comments were passed on to member banks for their information.

Naturally we indicated this problems several times to the Housing Department at the Ministry of Interior (one of the main parties in responsible for the topic) .

1.7 Proposed modifications to currency exchange regulations

The Association of Hungarian Travel Agents and Tour Operators (MUISZ) requested the Association to provide assistance in easing the regulations on currency exchange operations. Namely: pursuant to the anti-money laundering laws, currency exchange operations may only be performed by bank agents; however, banks refuse to conclude agency agreements with many of their members. Being aware of the Association's support of existing regulations, in their letter they presented the arguments they felt could convince banks on the need to change the regulation. MUISZ requested us to solicit our member banks' opinion and to also inform the Ministry of Finance, as the regulating authority.

Banks took quite different positions depending on whether they do work with exchange agents or do not.

Those working with agents were against changing the regulation, for the following reasons:

• in their opinion there are no uncovered areas in the currency exchange market,
• a more permissive legislation would compromise the quality of services,
• they pointed out the fact that the supervisory authority relies on banks' control (the authority does not have the resources to check on hundreds of exchange agents).
• it would be unfair and damaging to those banks, who have put in substantial investments and efforts in developing their agency networks over the past two years based on the new and tightened regulations.

Banks who currently do not work with no agents did support easing the regulation (allowing currency exchange to also be performed by businesses other than bank agents) arguing that that would:

• allow more players to engage in the market,
• stimulate business,
• make services cheaper for the customer
• allow banks to work with exchange agents without any administrative constraints (banks in this group admitted that it was the extra administrative burdens and responsibility imposed by the tightened regulations why they stopped operations with currency exchange agents and they would be happy to be engage in this area once again).

Notwithstanding the differences in opinions all banks agreed that the current achievements of the regulation should be preserved and the strict personal and material requirements and anti-money-laundering measures should not be relaxed.

The Association did not want to take sides in this debate between member banks; therefore, it forwarded both arguments to the Ministry of Finance. The Ministry informed the Association on the fact that in the meantime, the Ministry of Economy has, primarily for tourism considerations, taken up the matter and proposed the Ministry of Finance to modify (relax) the regulation. (According to our information, the decision was postponed to the autumn, as the Ministry would like to wait until the end of the tourist season and then analyse the situation before it decides on the issue).

1.8 Customs bank guarantees

Although the regulation on bank guarantees serving as customs guarantees had been finalised (with a slight delay) by the time of Hungary's accession to the EU, problems in the application of the regulation could be expected at the Customs Authority, which had to cope with serious administrative problems in the immediate period after Hungary's accession to the EU.

a.) First, the Customs Director of the National Customs and Excise Guard (VPOP) wrote a letter to the Association, practically trying to override the expiry provisions of the effective regulation on bank guarantees. In the wake of this letter we turned to the Customs Department of the Ministry of Finance asking for urgent action to ensure that bank guarantees, as effective customs guarantees, can be retained. The Head of the Ministry's Customs Department sent a strong letter to the Commander of the Customs and Excise Guard, calling his attention to observing and implementing the effective regulations.

b.) Although the Customs Act stipulates that upon Hungary's accession to the EU as of May 1, 2004, all previously issued customs licences are null and void and all guarantees provided as collateral should be accounted for and released within one month, problems were encountered in the application of the law in practice. During the discussion held with the heads of VPOP to resolve the problems, preliminary agreement was reached on documentation requirements and on a mutually acceptable schedule of proceeding. To have this agreement confirmed, we requested the approval of the Ministry of Finance, as the supervisory authority of VPOP. This has not been received to date.

c.) Banks' clients became entangled in disputes with the Customs Authority, as their bank guarantees, issued in accordance with the relevant regulations, were refused by the Authority for the varied reasons. This was rather embarrassing for banks, as it might have suggested that banks did not understand the regulation. In our letter to the Ministry of Finance we repeated our, previously ignored, proposal that the parties involved (the Ministry of Finance, VPOP and banks) jointly draft a sample bank guarantee to be published at soon as possible. The Ministry requested the Association to draft the guarantee. After a broad review with member banks the sample guarantee was sent to the Ministry and was published within a week time on VPOP's website as a recommended sample guarantee. The sample guarantee contains a specific expiry date and allows bank to set up successive guarantees to provide for continuous backing for regular customs transactions. Thereby, the issue was practically resolved.

d.) To resolve a set of issues that have arisen since Hungary's accession to the EU, the Ministry of Finance drafted a proposal aimed at modifying the Ministry's implementation decrees for customs procedures. The proposal was acceptable from banking points of view; however, banks raised two issues, which were forwarded later to the drafters of the regulation.

One of the issues was that the regulation extended the definition of "customs debt" to include "non-community taxes and fees" (thus practically overriding the definition provided in the EU Customs Code). Bank guarantees serve as a security for customs debts and therefore, no requirement can be imposed on them to cover other items (the sample guarantee on the VPOP website will also have to be adjusted accordingly).

Also, we proposed that in accordance with international practice, the law of Hungary as the governing law and the exclusive jurisdiction of Hungarian Courts should be stipulated in the sample guarantee.

1.9 Bank security

The FBE's annual statistical report on physical bank robberies was published in the second quarter. According to the report, the number robberies against banks in Hungary decreased by 20% and damages halved over the previous year. 22 out of a total 2,760 branches were attacked, with total damages accounting for HUF 22 million. Bank robberies and the damages incurred have decreased for the third consecutive year now. The rate of decrease in 2003 was in accordance with the European trend.

A phenomenon that deserves special mention though is the outstandingly high, and increasing, number of attacks on cash delivery vans in Hungary, which primarily affects cash delivery companies but its effects will obviously appear in delivery fees. The number of attacks on ATMs is also increasing.

Notwithstanding the favourable statistics, to further strengthen prevention the Bank Security Working Group initiated with the National Police Headquarters to intensify the cooperation between banks and the Police. The National Police Headquarters responded positively to the proposal. The main areas of cooperation were specified as alarms to the police, prevention and training. A working group was scheduled to be set up at the end of August to identify the possible ways and further areas of cooperation. The Association is represented in the working group through the bank security officers of OTP Bank, K&H Bank, Erste Bank and Budapest Bank.

1.10 Fight against terrorism and money laundering

Tasks related to the fight against terrorism and money laundering continue to be given special attention in the banks' operations. Most legal questions and uncertainties encountered last year have been resolved in the meantime in the relevant legislation.

An unresolved issue yet is the item of "careless involvement in money laundering" and its sanction. As far as we know, the Ministry of Finance, the Ministry of Interior and the National Police Headquarters all agree with the need to modify this item, especially in view of the fact that the vast volume of reports filed by bank employees out of fear makes it impossible to identify and investigate the actually dangerous cases. The Ministry of Justice and the Hungarian Financial Supervisory Authority are at present opposed to modifying the law.

Most anti-terrrorism and money laundering regulations have been in conformance with the relevant EU regulations since Hungary's accession to the EU. The Third Money-Laundering Directive is currently under drafting. The Ministry of Finance and the FBE have both asked for our contributions. However, not all of our members have the awareness that these are the forums where we can express our opinions on legislation and it is much more difficult to change the legislation once adopted. The new Directive will extend to cash payment orders in excess of EU 15,000 and issues related to terrorist financing and would provide for a reporting obligation for banks on customers denying identification.

A favourable development is that from June this year the FBE has published a Terrorist List on its home page, including names and organisation details. Banks should monitor this list. A presentation on how the system is used was provided by the Association in June.

1.11 National Qualifications Register (OKJ) certified training courses

The Association provided its comments on the proposed Decree on certification and examination requirements for persons acting as salespersons, sales representatives and investment advisors within investment firms (see detailed comments in our first quarter report).

The proposed decree would provide unreasonably strict conditions for obtaining the required certificates, which would pose extremely difficult requirements for those employees engaged in the sale of banking, investment and insurance products and would imply substantial extra costs for employers as well. Given that the proposed new training and certification system would affect all employees engaged in sales within banks and savings cooperatives, the Association and the National Association of Savings Cooperatives (OTSZ) jointly turned to the Minister of Finance to seek compromise. In our reasons we pointed out that the proposed vocational training system would be much more stringent than those in other EU member states and would therefore lead to a competitive disadvantage, especially in relation to the new member states. Accordingly, it might happen that if the registration of agents is easier in a neighbouring country, then some providers may decide to transfer operations to that country.

1.12 Local trade tax

Discussions aimed at achieving that expenses are recognised in the trade tax base continued with the competent staff at the Ministry of Finance. To assess our request, the Ministry requested a voluntary data supply from member banks on two occasions, based on which the magnitude of the loss (difference) in tax revenues at the municipalities can be established.

The proposal for amendments to the laws on taxes, contributions and other fiscal dues provides the following definition for net revenues:

"b) for credit institutions and financial enterprises: interest and interest-type revenues received, as reduced by interest and interest-type expenses paid, and increased by revenues from other financial services, revenues from investment services and net revenues from non-financial and non-investment services. For hedging transactions, net revenues shall include the profit obtained as the difference between the gain/loss on the basic transaction (the hedged item) and the gain/loss on the hedging transaction."

Although this proposal is a significant improvement compared to the current regulation and also allows the recognition of a certain portion of trade tax in corporate tax, the Association and banks continue to consistently argue for the reasonable solution that net revenues are computed on a real net basis for all investment and other financial services.

1.13 Hungarian version of the European Master Agreement

After a review with member banks, the Hungarian version of the European Master Agreement (EMA) providing a standard framework for repo and securities lending transaction was sent the Hungarian Financial Supervisory Authority with a request for the Authority's comments. The Supervisory Authority asked for some modifications. Once these are carried out the Authority is expected to give a positive opinion on the Master Agreement.

1.14 Income certificates for taxpayers subject to Simplified Corporate Tax

The income certificates provided by the Tax Office for private entrepreneurs subject to Simplified Corporate Tax had only contained a statement to the effect that the taxpayer was subject to Simplified Corporate Tax (EVA), in accordance with the relevant Act. Banks indicated that this caused a problem in credit rating. We proposed the Ministry of Finance to add a provision to the Act on Simplified Corporate Tax within the framework of the proposed law package on amendments to the laws on taxes, contributions and other fiscal dues for 2005, to say that in the income certificates the tax authority shall state the fact that the taxpayer is subject to Simplified Corporate Tax and indicate the taxpayer's annual income and tax liability for the taxation year. Certificates on income acquired by private individuals (not subject to Simplified Corporate Tax) will be issued in accordance with the rules otherwise applicable.

II. LOAN SCHEMES

1. Public Private Partnership

The Minister of Education invited bank leaders to discuss the question why banks have reservations about providing finance for companies seeking to participate in new types of public development project schemes.

Bank leaders indicated that PPP project are new in Hungary and thus, it is quite understandable that financing is an issue that should be addressed. Namely, under PPP projects, bidders are not only expected to implement the project but to also run the facilities in question (e.g.,: dormitories, prisons, etc.), against a reimbursement fee (to be paid by the state) that is not exactly known in advance; this is a major uncertainty in terms of a 15 to 20-year bank finance. Bank leaders promised to give their answers to the Minister's questions and to provide banks' requirements in connection with PPP projects through the Association.

Based on this, the Association invited a consultations with the involvement of specialists from the banks involved. During this consultation, the main elements of a common position were agreed on. After a second consultation, our answer was sent in a letter to the Minister of Finance.

In the letter, banks provided the following requirements:

• Banks consider the repayment of the loans as a first priority. Therefore, they must insist that the contracts be signed by the field ministry (in the present case, the Ministry of Education) and countersigned by the Ministry of Finance.

• The reimbursement/rental fees to be paid by the state should be carefully planned as must cover operating and maintenance costs, debt services and a fair profit.
• The investor (and through it, the bank) assumes implementation and operation risks, given that the state's payment obligations are conditional and will onset only in case the investor delivers according to the contract.
• Since neither the state nor the business community has experience in PPP projects, the involvement of internationally experienced financial/legal consultants to assist the tender inviter during the preparatory stage and the entire public procurement period would largely contribute to the success of the projects.
• The tender invitation should not provide any requirement for banks to assume irrevocable and unconditional payment obligations: determining the full set of conditions between the public institution and the private investor is a long and meticulous process and banks should be involved in this process from the very beginning, as they are the ones who take the highest risk. Only when all conditions are known may banks be expected to undertake irrevocable obligations.

Upon receipt of our letter, the Ministry's associates requested a meeting where they expressed their opinion that most of the points made by banks were legitimate and promised that the proposal for the regulation of PPP projects, to be drafted jointly by the Ministry of Education and the Ministry of Finance, will contain the banking requirements indicated in our letter.

2. Agricultural loan schemes

The disbursement of loans under the Europe Plan Agricultural Loan Scheme was concluded at the end of April. Close to HUF 240 billion in loans were placed under this scheme, mostly from bank resources.

Under a government decision, registered agricultural producers were given access to a part of the 2005 development subsidies already this year. Bank specialists had been involved in developing the facility for the HUF 46 million advance subsidies. The facility basically implies the factoring by banks and factoring companies of the subsidy deed.

With the high number of producers expected to participate in the scheme over a short time (150,000 to 250,000), setting up a fast, simple and secure management procedure was a key priority.

As regards secure lending, after consultation with bank specialists the Association took the position that, in view of the factoring scheme, the subsidy should be transmitted from the Hungarian State Treasury to the managing bank rather than to the client, and any fiscal dues incurred after submission of the loan application should be ignored. Taking note of the fact that this is an important condition for the fast and smooth management of the scheme, the Ministry of Finance submitted an amendment to the tax laws, which was promptly passed by Parliament.

Ultimately, four banks have decided to undertake the conditions of the advance loan scheme and are currently managing scheme.

In 2003, agricultural producers in adverse areas we given the opportunity to convert their previous loan debts into a three-year loan under a government subsidy scheme. If the applicant meets the business plan, the annual loan instalment is paid from government subsidies by the Tax and financial Control Administration (APEH).

Self assessments on meeting the business plan were due this year for the first time. Financing banks had to comment on the self-assessments by June 30 (banker's opinion on meeting the business plan is an important condition for granting the subsidy).

At the request of the Ministry of Agriculture and Regional Development, the Association assisted in the disbursement of a HUF 2.8 billion credit line through an application scheme aimed at bridging liquidity problems due to the winding up and unpaid debts of Hajdú-Bét Rt. and Parmalat Hungária Rt.

3. SME loan schemes

The Ministry of Economy and Transport plans to modify the Government Decree providing for SME loan reporting requirements.

Upon the Ministry's request the Association submitted a proposal for improving and simplifying the loan reporting requirements. Consultations on the proposal are now underway.

Since, under an authorisation from the Government, the reporting obligation is ordered by the President of the Hungarian Financial Supervisory Authority, we initiated consultations with the Supervisory Authority to review the proposal and acquire their support.

III. INTERNATIONAL COOPERATION

European Banking Federation

1. Banking Supervision Committee - Capital Adequacy Working Group

The Committee and the Working Group made all efforts in the past quarter to ensure that a capital accord meeting the interests of the European banking industry is adopted. With the regulatory process drawing to conclusion, events have sped up. Here is a brief summary:

The FBE's April letter to the European Commission

This letter touches upon those key issues whose treatment is not acceptable for the FBE under the current information available. Accordingly, the letter addresses issues related securitisation, consolidation requirements and approval of the use of the AMA in the home and host countries.

The FBE disagrees with the proposed method for determining home and host country capital requirements for operational risk under the AMA, as it contradicts the business line approach to operational risk and the setting up of common data bases and would generate substantial extra costs. The FBE's standpoint is that capital requirements for operational risk in the AMA, should be determined on group level and the use of the model should only be approved by the supervisory college headed by the home country supervisor (single validation). Should the European Commission adopt the Basel Committee's approach, European banks will consider whether at all to use the AMA.

According to the FBE, the supervisory formula for securitisation is still too conservative. The proposed rules do not reflect the nature of securitisation business and would set back the development of the market. The objective of the regulation should be to ensure correlation between risk and capital, without intervening into market processes and penalising operations.

As to the levels of consolidation, the FBE is of the opinion that capital requirements should be applied to the highest group level, the highest group levels in member states and individually. Exemption from an individual application should be given if capital allocation within the group is adequate, risks are controlled and managed within the group in an integrated manner, the parent company has a financial intervention policy in place for helping out the group members and the parent company and its subsidiary are subject to the same national/consolidated supervision.

PriceWaterhouseCoopers report on the financial and macroeconomic impacts of the new capital accord

At the request of the European Commission, PriceWaterhouseCoopers made a study on the financial and macroeconomic impacts of the new capital requirements on the European market. The findings of the study were published in April. (In respect of quantitative impacts PriceWaterhouseCoopers relied on the results of QIS3). The report envisages a slightly positive overall impact. Capital requirement is expected to decrease by 5% across Europe, while the impact of the accord on the GDP will be negligible even in the long-term, around 0.07 per cent. The capital requirements for retail and SME portfolios are expected to decrease, with a minimum change for corporate portfolios. The new capital directive will only have a limited impact on pricing practices - and not necessarily in those lines where capital is freed up.

The most fundamental impact is observable in the behaviour of the institutions. Basel II will change banks' risk management practices, with a substantial improvement in rating and information systems and databases. Banks' risk awareness and risk sensitivity will increase, which, however, does not imply that the risk appetite of EU banks will be diminished but rather, a better orientation. Banks will have access to better and more frequent customer information.

PriceWaterhouseCoopers do not confirm the fears concerning the negative impact on competition. The consultants see no evidence for the claims that the new regulation will favour large banks and will result in the exclusion and merging of small banks. A large size and international-scale operations will be make the use of advanced approaches difficult, while smaller institution may cooperate and use the advanced approaches, although at higher unit costs. According to PriceWaterhouseCoopers the fact that the new capital accord will be applied to all banks and investment firms in Europe will not cause any significant competitive disadvantage. (Neither advantage for US banks, given that the Directive will be mandatory for all banks active in Europe). At the same time, concerns over allowing too wide national discretions and the non-uniform application of Pillar 2 may be legitimate.

Capital requirements for large investment service providers (E730k firms) may increase substantially; for them, capital requirements for operational risk will clearly be a competitive disadvantage. Although their current capital requirements may well be below the necessary level, envisaged sudden regulatory measures are not necessarily desirable, and probably not risk-rated. For a level playing field regulation, the capital requirements for trading book items will have to be revised.

PriceWaterhouseCoopers do not expect any major procyclical impact of the new capital directive (in its opinion, such impact would be lower than in the case of Basel I); however, the regulation's potential impact of deepening the cycles should be minded. The introduction of stress tests and flattening of the risk weight curves have reduced the procyclical nature of the regulation substantially.

The report estimates the implementation costs of Basel II to be EUR 20 billion to 30 billion (EUR 80 million to 150 million per large bank) between 2002 and 2006. To be added to this are the costs arising at the supervisors. However, the report also emphasises that part of these costs would arise anyway, irrespective of the new capital directive and the new Basel capital accord will only speed up the application of advanced measurement approaches.

Interestingly: banks think the supervisory authorities will not be able to live up to the requirements set for them, while supervisors think banks are not as much prepared as they believe to be. All in all, through enforcing a risk sensitive behaviour, the new directive is expected to contribute to increased financial stability. Of course, on the individual level the change will be difficult and existing uncertainties will not make the preparations any easier, either.

CEBS April 29 document on consultative process

According to the document CEBS has the following responsibilities:

• advising the European Commission on banking regulation issues,
• promoting the consistent application of EU directives and the convergence of supervisory practices,
• strengthening cooperation between supervisors.

To be able to efficiently perform its duties, the CEBS is organising a broad consultation with market players, consumers and end-users of banking services. The CEBS would like to conduct the consultation in an open and transparent manner and seeking consensus. Decisions adopted during the consultations will be published.

The CEBS will publish its annual work programme, indicating whom it would like to consult with for each topic. Additional requests for consultation, if found legitimate and where possible, will be accommodated in the programme.

The CEBS will:

• familiarise the parties interested with its assignments and authorisations from the European Commission,
• prepare consultative proposals,
• where possible, indicate in the proposals the expected impacts,
• prepare working documents in the various stages of the consultation, if so required,
• set up specialist groups, where necessary,
• use a wide variety of consultation tools (Internet, written consultation, open hearings, roundtables, bilateral discussions, etc.)

The CEBS will share all information as available and will allow sufficient consultative time for forming an opinion. For key issues, the CEBS proposes a three-month consultative period. The comments will be duly considered answered and published. Further consultations will be invited where essential issues are revealed from the comments or if the new proposal to be developed based on the comments received substantially differs from the original. Final proposals will be published.

The CEBS will give the reasons should it depart from the above practice. If necessary, the CEBS may revise its position concerning consultations.

Comments on the proposed consultation practice were to be provided latest by July 31.

In its response, the FBE welcomed the proposal, pointing out that it has always supported the extension of the Lámfalussy process to banking. In the FBE's opinion, rulemaking at Level 2 and Level 3 may only begin after the rules have been set with sufficient certainty at Level 1. The FBE finds it desirable to explicitly state that the professional associations affected will be involved by the CEBS in the consultation process. The FBE thinks a minimum three-month consultative period is necessary for key issues; also, after agreeing on the principles, a second round of consultations would be necessary (except where the proposal has received a stable support in the first round or where the topic is not of major importance).

May Decisions of the Basel Committee

In its May 11 press release, the Basel Committee on Banking Supervision announced that it has achieved consensus on the remaining issues regarding the proposals for a new international capital standard and the text of the new framework will be published at the end of June 2004 (www.bis.org). The standardised and the foundation IRB approaches will be implemented from year-end 2006, the advanced IRB approach from year-end 2007.

Parallel running for banks adopting the foundation IRB approach will apply for one year, during 2006. Banks adopting the advanced approaches will have two years of parallel running (2006 and 2007). The floors on both foundation and advanced approaches in 2008 and 2009 would be 90% and 80%, respectively. The floor on the foundation IRB approach will be 95% in 2007.

Agreement was reached that the required capital charges for qualifying revolving retail exposures (QRRE) will be aligned to the results of recent empirical studies. The asset correlation for revolving retail exposures will be fixed at 4%. With regard to securitised portfolios of QRRE, the capital framework will reflect more closely the economics of such transactions. Undrawn credit lines related to securitised exposures will be allocated between the seller’s and investor’s interests.

The Committee has given guidance on assessing loss-given-default (LGD) for "economic downturns" but has for the time being not provided for the calculation of LGD for stress situations. The Committee believes that the framework should retain the concept of a single assigned LGD that should reflect "economic downturn" conditions where necessary to capture the relevant risk. The Committee considers one possibility would be for banks' internal LGD processes to focus on assessing an expected LGD. Meanwhile, the Committee seeks to develop a broad consensus on how to achieve appropriate "economic downturn" LGDs for the various exposure categories. The Committee is looking forward to receiving further industry input and is open to further dialogue on the issue.

The Committee believes it is important to maintain the overall level of minimum capital requirements, while also providing incentives to adopt the more advanced risk-sensitive approaches of the new framework. The Committee will further review the calibration of the new framework prior to its implementation. Should such review reveal that the objectives on overall capital would not be achieved, the Committee will take actions necessary to address the situation. (In practice, this would entail the application of a single scaling factor - which could be either greater than or less than one - to the results of the new framework. The current best estimate of the scaling factor using QIS 3 data adjusted for the EL-UL decisions is 1.06. The final determination of any scaling factor will be based on the parallel running results).

The Committee emphasises the importance of closer coordination between supervisors. It has provided further high-level principles for the cross-border implementation of the new framework, in addition to those published in August 2003. According these home and host supervisors should consider practical ways to coordinate requests for information. Host supervisors needing detailed information about Basel II implementation and roll-out plans from foreign subsidiaries operating in their jurisdictions will have to ask for the information from the home country supervisors before addressing the bank. (This will not preclude host countries from discussing prudential matters with their banks directly, but will strengthen and rationalise the communication efforts among supervisory authorities). The Committee reiterates the principle that, wherever possible, supervisors should avoid performing redundant and uncoordinated approval and validation work for Basel II in order to reduce the implementation burden on the banks and to conserve supervisory resources. The home jurisdiction should play a leading role in the approval and validation of advanced techniques with appropriate input from the host country supervisor and material reliance by host countries on the work of the home country supervisor.

The Committee has received informal comments and questions from various industry participants on its recent publication of a paper on home-host supervisory principles for the advanced measurement approaches (AMA) for operational risk (AMA home-host paper). The Committee chose not to define "significance" in determining which internationally active banking subsidiaries are ineligible to make use of an approved allocation mechanism (according to that proposal, in that case stand alone AMAs should also be used). However, the Committee made it clear that in its proposal only internationally active banking subsidiaries would be deemed as significant. Setting stand alone capital requirements for banking subsidiaries not active internationally will be the discretion of the host country. Home and host supervisors should work together in determining which subsidiaries can be deemed as significant. In those cases where the AMA is to be used at both group and subsidiary levels, the supervisory assessment of the AMA models should be coordinated by the home country supervisor.

While a banking group may choose to adopt a group-wide AMA, significant internationally active banking subsidiaries of such banking groups will not be required to adopt an AMA for determining its capital requirement for operational risk. Likewise, a significant internationally active banking subsidiary may choose to adopt a stand-alone AMA, while the parent adopts a simpler approach on a group-wide basis. The parent of such a subsidiary would not be in violation of the partial use rules if it chose to adopt a simpler approach on a group-wide basis, even if it did so permanently. The Basel Committee expects that supervisors will have some flexibility in applying the partial use provisions of the New Accord, providing incentives for the adoption of advanced approaches but not allowing "cherry-picking" for favourable capital treatment.

Subsidiaries implementing a stand-alone AMA will be permitted to leverage the resources of the group in determining their operational risk capital requirements. The subsidiary’s process for leveraging group resources within its stand-alone AMA would have to be transparent to its board and host supervisor. The Committee does not share the view that banks that manage themselves on a business line basis will be unable to satisfy the use test at the level of a significant internationally active subsidiary that implements a stand-alone AMA.

The Committee will be working to ensure that the New Accord is implemented in a consistent manner and to identify key implementation issues and concerns. The Committee is committed to maintaining a dialogue with banking organisations in order to identify and address implementation-related issues.

CEBS consultation paper on Pillar 2 and on outsourcing

On 24 May 2004 the CEBS released a consultation paper on the application of the supervisory review process under Pillar 2. A key element of the new framework is the Internal Capital Adequacy Assessment Process (ICAAP) with the relevant approaches to be developed by the institutions themselves. The consultation paper sets out 11 High Level Principles for the assessment process:

• Every institution must have a process for assessing its capital adequacy in relation to its risk profile.
• The ICAAP is the responsibility of the institution, to fit its circumstances and needs, and using its own inputs and definitions.
• The ICAAP should be proportionate to the nature, size, risk profile and complexity of the institution.
• The ICAAP should be formal, the capital policy fully documented and the management body's responsibility.
• The ICAAP should form an integral part of the management process and decision-making culture of the institution.
• The ICAAP should be reviewed regularly
• The ICAAP should be risk-based.
• The ICAAP should be comprehensive and should consider all risks.
• The ICAAP should be forward-looking.
• The ICAAP should be based on adequate measurement and assessment processes. There is no one "correct" process.
• The ICAAP should produce a reasonable outcome.

Another key element of the new framework is the Supervisory Review and Evaluation Process (SREP), with the following 11 High Level Principles:

• The SREP should be an integrated part of the authority's overall risk-based approach to supervision.
• The SREP should apply to all authorised institutions (and thus, all credit institutions).
• The SREP should cover all activities of the institution or group.
• The SREP should cover all material risks and risk management/internal controls.
• The SREP shall assess and review the institution's ICAAP.
• The SREP shall assess and review the institution's compliance with minimum standards laid down in the Directive.
• The SREP should result in the identification of existing or potential problems and key risks faced by the institution; deficiencies in the control and risk management frameworks; and assess the degree of reliance that can be placed on the outputs of the institution's ICAAP.
• The SREP should lead to prompt measures to address any deficiencies identified.
• The results of the SREP will be communicated to the institution at the appropriate level (usually senior executive/management body), together with the action that is required of the institution and any significant action planned by the authority.
• The supervisory evaluation should be formally reviewed at least on an annual basis, in order to ensure that it is up to date and remains accurate.
• The depth of the SREP can be varied according to the systemic importance and either the nature and scale (size, risk profile and complexity) of the institution or the overall assessment of the quality of governance, management and systems and controls, or both.

The CEBS document on supervisory review process in several points refers to the consultation paper on outsourcing released in April. In relation to outsourcing the CEBS has set the following 11 high-level supervisory principles:

• Strategic and core management responsibility and functions cannot be outsourced.
• The ultimate responsibility for proper management of the risks associated with outsourcing lies with an outsourcing institution's senior executive management.
• The institution should take particular care when outsourcing material activities, i.e. activities of such importance that any weakness or failure in the provision of these activities could have a significant affect on its ability to meet its regulatory responsibilities and/or to continue in business.
• There should be no restrictions on the outsourcing of non-material activities of an outsourcing institution.
• The outsourcing institution should have a policy on its approach to outsourcing, including contingency plans and exit strategies.
• An outsourcing institution's policies should require it to manage the risks associated with its outsourcing arrangements.
• All outsourcing arrangements should be subject to a formal (written) and comprehensive contract, clearly defining the operational area to be outsourced, performance requirements in both quantitative and qualitative and the respective responsibilities.
• In managing its relationship with an outsourcing service provider an outsourcing institution should ensure that a service level agreement (SLA) is put in place.
• Supervisory authorities should aim to establish a right to information, and to conduct, or order, on-site inspections in an outsourcing service provider's premises.
• Supervisory authorities should take account of concentration risk, where one outsourcing service provider provides outsourcing services to several authorised outsourcing institutions.
• Supervisory authorities should take account of the risks associated with "chain" outsourcing (whereby the outsourcing service provider sub-contracts elements of the service to other providers).

(Comments on the consultation papers were invited to be received latest by July 31, 2004).

Review of capital requirements for trading book items

A review of the regulatory framework on trading book items before implementation of the new capital accord is a must. To ensure this, the Basel Committee and IOSCO set up a joint working group. The group met with industry representatives, including the FBE, for the first time in May. The FBE recommended that the working group complete the review and publish the results by March 2005 so that they can be taken into account in the new capital adequacy directive. The working group did not commit to this deadline overall but accepted it for some of the topics. The industry considers the appropriate management of counterparty credit risk and the credit risk mitigation as the most important issues to be addressed. It was emphasised that the various topics should be reviewed in correlation with each other. Each of the broad headings of "counterparty risk" and "credit risk mitigation" included a number of sub-issues. The counterparty risk for instance encompassed the counterparty risk treatment of OTC derivatives and repos, short term credit risk and the suitability of applying a capital charge to unsettled transactions. Credit risk mitigation included the treatment of double default risk, as well as the need for improved recognition of commodity collateral in the trading book.

June paper of the Basel Committee and July paper of the European Commission

The final text of the new capital accord was published in June as planned, under the title "International Convergence of Capital Measurement and Capital Standards: a Revised Framework". The accord was revised compared to CP3 in accordance with the Committee's announcements of October 2003 and January and May 2004.

The Committee expressed that additional work of a long-term nature will be needed in the definition of eligible capital and this work will not be finished before the introduction of the new capital accord. The Committee also made clear that it would continue to monitor the performance of the credit risk models of banks and their comparability across banks. The advanced IRB approach is regarded as a transition between a purely regulatory measurement of credit risk and an approach that builds more fully on internal credit risk models.

With the new capital accord adopted, the European Commission also met its own schedule and released the draft of the new Capital Adequacy Directive in July. The Directive will be enacted in the form of amendments to the Banking Consolidation Directive (Directive 2000/12/EC) and the Directive on the Capital Adequacy of Credit Institutions and Investment Firms (Directive 93/6/EC)

2. Accounts Committee

IAS 39- Interest rate hedging

Dissatisfied with the Exposure Draft titled "Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk", the FBE developed an alternative proposal to address the issue. The Interest Rate Margin Hedge (IRMH) Proposal is a significant step forward in that it

• is in full conformity with banks' risk management practices,
• provides satisfactory solutions for the treatment of core deposits,
• would reduced capital volatility.

Although not rejecting it in principle, the IASB does not support the proposal and purely regards it as a version of cash-flow hedging, rather than a third hedging model. The IASB would only be prepared to consider the proposal if gains or losses entail capital adjustment. It is unclear whether the IASB accepts the recognition of core deposits and there is concern that the efficiency criteria would be set incorrectly, as was the case with macro hedging. In summary, the IASB's objections could offset the advantages of IRMH.

At their June 8 meeting the FBE and the IASB expressed willingness to engage in a dialogue on the IRMH proposal and decided to set up a working party to address the issue. The following schedule was envisaged:

June - September Working party meetings

October Board discussion

November/December Exposure Draft

Mid-2005 Revised standard

A comprehensive review of IAS 39 should be completed in the medium-term. Also, it should be assessed whether the different approaches to hedging have become institutionalised and whether rationalisation could be achieved.

IAS 39 - Fair value option

Under revisions to IAS 39 the IASB proposed the introduction of an option that permits any financial instrument to be measuredat fair value (Fair Value Option - FVO). The majority of the respondents who commented on the proposed fair value option agreed with it. However, some, mainly authorities and supervisors expressed concerns that the fair value option might be used inappropriately, arguing that entities might apply the fair value option to financial assets or financial liabilities whose fair value is not verifiable, their valuation is subjective, and may therefore inappropriately affect profit and loss. The option might increase, rather than decrease, volatility in profit and loss. If an entity applied the fair value option to financial liabilities, it might result in the entity recognising gains or losses in profit and loss for changes in its own creditworthiness.

In light of the above, the IASB decided to propose that the fair value option be amended so as to limit its use whilst preserving the key benefits of the option. This proposal is to be achieved by requiring that the option may be applied only to financial assets and financial liabilities whose fair value is verifiable.

The IASB issued a new Exposure Draft for the use of FVO under IAS 39 in April, with six questions concerning the revised proposal. Comments had to be received until July 21.

In their comments to the Exposure Draft, FBE and EFRAG pointed out that contrary to regulators' opinion, European banks have always supported the wide application of the Fair Value Option, for both theoretical and practical reasons. The concerns raised by regulators can be addressed in other ways rather than by restricting the option. The Exposure draft is not effective in meeting the stated objectives. It does not address the legitimate requirement that the devaluation of an institution's debt (deterioration of creditworthiness) should not lead to reporting a profit. For instance, where a debt instrument contains an embedded derivative, it would still be possible to apply the fair value option (and thus, report a profit). Restricting the fair value option will in fact contribute to the volatility in profit and loss in certain cases and maintain the asymmetry where some financial assets are measured at fair value and the related financial liabilities at amortised cost. The introduction of "verifiability" as a condition for the FVO is difficult to interpret and is not consistent with other IAS standards. It is unclear how it would result in a stricter test than "reliability" notion. The introduction of the "verifiability" requirement will substantially reduce the scope of those instruments eligible for the fair value option. The basic principle should be that the fair value option can be applied to those components of a financial instrument that result in inconsistency within the profit and loss account or equity due to the mixed accounting model approach of IAS 39 or to those that, according to the risk management policies of the entity, are managed on a fair value basis.

The current option to use fair value accounting for all financial instruments that meet the conditions is useful for banks, as it helps measure hedging transactions according to their economic contents. Therefore, contrary to the IASB's revision proposal the FBE supports retaining the current regulation and is opposed to any further restricting of the FVO compared to the current proposal.

Application of IAS 39 in Europe

Despite serious reservations about IAS 39, in its initial comments EFRAG recommended the adoption by the European Commission of both IAS 32 and IAS 39. In case of IAS 39, six out of eleven members of the Technical Experts Committee voted against adopting the standard, a ratio less than a two-thirds majority that would have been required for rejecting the proposal. Thus, EFRAG finally did not make a recommendation for the adoption of IAS 39. Those rejecting the proposal agreed with the urgent need to adopt a European standard for the reporting and valuation of financial instruments. However, they think the current IAS 39 is not satisfactory, as it would lead to a significant deterioration of the financial statements of those banks with major hedging volumes. The standard fails to meet the criteria of understandability, relevance and comparability, and doesn’t satisfy the "true and fair view principle".

The FBE's position is that IAS 39 should be revised before it is adopted in Europe. In its letter to EU Commissioner Frits Bolkenstein the FBE stressed its commitment to the application of IAS to listed companies in Europe. However, it should be ensured that the standards developed by the IASB are suited to European market conditions. The hedging rules in IAS 39 are unnecessarily complex and fail to provide a model that is consistent with the underlying objectives of risk management (constituting the basis for hedging transactions). The revising of hedging rules is a prerequisite for the endorsement of IAS 39, the model proposed by FBE could serve as a basis in this regard. Improvements to the hedging rules would also ease the concerns about the limitations of the Fair Value Option. Other issues identified by banks should also be considered during the review of the standard. A last concerted effort on IAS 39 is needed to improve the standard and the understanding of its consequences. This implies the redefinition of the relationship between the IASB and the European banking industry.

A letter with similar contents was sent by the FBE to the Chairmen of IASB, the Basel Committee, the European Central Bank, EFRAG and CESR-Fin. The FBE made its position on the need for revising IAS 39 public under its press release of June 11.

Based on the comments received, the European Commission is inclined to making a proposal for the partial endorsement of IAS 39 in Europe. Accordingly, the hedge accounting rules and the Fair Value Option (both expected to be revised) has been carved out from the standard. The Commission expects that agreement will be reached on the revised rules and the new standards can be adopted during 2005.

The FBE does not support the application of the standard in its present form. The lack of resolution to the hedge accounting rules and the limitation of the use of the FVO is not acceptable for the industry. Member states are divided on the risks and benefits of a postponement and partial endorsement; however, there is consensus that both solutions can contribute to achieving that the concerns raised are properly addressed by the IASB.

The Basel Committee on the relationship of the IFRS and regulatory capital

In its June and July press releases the Basel Committee called upon national supervisors not to allow certain changes, ensuing from the application of the IFRS, to be recognised in regulatory capital. Accordingly, the cumulative fair value gains and losses on cash flow hedges of financial instruments and gains and losses arising from changes in an institution’s own credit risk should not be recognised in regulatory capital. The Committee for the time being does not encourage supervisors to make adjustments to the current capital adequacy framework due to the IFRS treatment of trading book items, equity/liability classification, intangible assets, including goodwill, deferred tax assets, pension costs, stock option costs and leasing.

IASC Foundation Constitution Review

In the context of the IASC Foundation Constitution Review Process, the FBE wrote a criticising letter to the Foundation's Chairman on the ineffective consultation process of IAS 39. The following are seen by the FBE as the most critical issues:

• The definition of a shared vision and agreed objectives is missing before the drafting of IASB technical proposals. Other than compatibility with the IAS framework, the economic and business implications of the proposed standards are not assessed and efforts are missing to ensure consistency between accounting and regulatory aspects. Coherence between accounting and regulatory aspects is of fundamental importance and ideally, their information needs should be satisfied from a single database and a single integrated information system. The FBE would like projects to start with a broad open discussion, where business impacts and comprehension of the standards are given more attention.
• The consultative process of IASB proposals is not satisfactory. There should be more room for public consultations that would help IASB to better understand the aspects of the respondents. It would be important to ensure that legitimate and well-founded arguments are duly taken into account in the revised proposals.
• The IASB places convergence to the US GAAP before the quality of standards. Starting out from US conditions it assumes deep and liquid markets, where financial assets can be easily sold or securitised, whereas this is not the case.

Revision to IAS 30

The Exposure Draft on a revision to IAS 30 is expected to be completed soon. The revised standard will only be applied to the disclosure of financial risks, other disclosure criteria will be transferred to IAS 32. IAS 30 allows institutions to explain what items they treat as capital.

3. European Payment Council

The largest pan-European banking organisation, the European Payment Council (EPC), held its general meeting in June. The event included a series of formal acts (finalisation of the Constitution, elections, organisational changes) that will basically affect the pan-European payment system. In this context, the adoption of the new working group structure and the definition of their tasks and the EPC's annual work plan were of particular importance from the point of view of setting priorities.

In the future, activities will resume in six working groups:

• A main task for the Electronic Payments Working Group is to maintain and enhance CREDEURO and ICP (EPC's two main standards, ensuring fast and automated cross-border payments). Enhancing mobile payments is a new task for the group.
• A separate working group has been set up to implement a pan-European direct debit system. The most important decisions required have been adopted; accordingly, the system, called the Pan-European Direct Debit scheme (PEDD), should be operable within two years. Initially, PEDD would run parallel with the domestic systems. Then, it would gradually take over their functions, according to the decisions of the national banking communities.
• The Cards Working Group has the task to gradually phase out domestic card system and to represent European aspects vis-á-vis Europay and VISA.
• The Cash Working Group has the task to oversee and coordinate the developing of national cash management strategies, including the reduction of cash payments.

The above four main groups will be assisted by two support groups:

• The Infrastructure Working Group, tasked to develop pan-European standards for the main groups (here, important contribution will be provided by the ECBS, which will be integrated into the EPC).
• The Legal Working Group, to address legal issues raised in the other working groups.

With the exceptional importance of the EPC and in view of Hungary's EU membership, the Association sought to use its right to represented itself through a delegate in the EPC.

The Hungarian representative was duly elected by the EPC's Hungarian "mirror organisation", the Payment System Forum. The nomination was sent by the Association to the competent unit of the EPC with a request for the Hungarian delegate to be allowed to attend the EPC's general meeting as a full-fledged member. Probably due to an administrative error, the admission process did not take place. Our president protested to this fact in a letter to the EPC's President. In his prompt response the EPC's President offered apologies and promised to rectify the situation during the EPC's next general meeting in the autumn.

Our Austrian colleagues also took keen interest in membership in the EPC. Under the ECP's Constitution, every four members may nominate one representative to the EPC's second most important body, the Coordination Committee. Our Austrian colleagues invited the Hungarian representative to a meeting in Vienna to agree on a cooperation framework and to nominate Austria to represent Hungary, the Czech Republic, Slovakia and of course, itself, in the EPC's Coordination Committee.

The meeting took place before the June general meeting of the EPC, that is, before our failed admission. The participants approved that Austria represent the four countries during the next 2-year election cycle and agreed on the cooperation and information procedures.

The Austrian party (otherwise a founding member of the EPC and chairing one of the working groups) provided an extensive briefing on the internal mechanisms of the EPC and roles of the various stakeholders. He pointed out that the EPC is working closely with the European Central Bank and the ECB's experts may attend all professional forums of the EPC as observers.; notwithstanding, the Coordination Committee is the one forum where commercial banks can decide on key issues by themselves. The Austrian colleague promised to duly inform us and solicit our opinions before taking decisions.

The Austrian colleague drew attention to the fact that although we are not yet members of the the Euro-Zone, all important projects of the ECP (Pan-European Automated Clearing House, Pan-European Direct Debit Scheme) will materially affect us: although these systems are about Euro payments, every country will have to develop at least one entry point to receive and forward these payments to the designated account. Also, it would not be wise for an EU member state to opt out of the review process of the new legal framework for European payments. He emphasised the importance of preparations for handling euro money on account and euro cash, a major planning, development, IT and logistics effort that, in his opinion, will require at least four years of preparations.

Although nominated by member states, working group members are not country-representatives; they are highly qualified, hard-working professionals, who often spend thirty to forty per cent of their working time on these areas. There is no observer status in the working groups. Countries not represented in the working groups may obtain information through their banking association. With the high importance of the work, members of the working group are selected by the chairman of the working group based on strict professional requirements. The chairman may also reject nominations on professional grounds.

Although at present we are not members of the EPC, the FBE, as our interest representation organisation provides us with regular information on work performed in the EPC. What is new for us here is that the EPC encourages national banking communities to try to represent the industry's positions (sought to be enforced on EU level) on the national level by convincing their national authorities (in our case the National Bank of Hungary, the Ministry of Finance and the Hungarian Financial Supervisory Authority) to take similar positions in the various EU Committees where the relevant proposals are reviewed.

This approach was tested at the meeting invited by the Ministry of Finance to review the proposed EU payments directive, where the Association, after consultations with banking experts, sought to convince the participants on the standpoint of the pan-European banking industry. The current Hungarian payment regulations are basically in conformance with the relevant EU legislation, and the problems raised by the European banking community are shared by the Hungarian banking community (e.g., banks' excessive liability in electronic payments, and particularly, in card payments; lack of clarity on definitions and therefore on the rules for certain payments).

Participants in the meeting found the consultation useful and promised to consider the proposal that in the future the EU draft regulations are reviewed by the parties review jointly, possibly within the framework of the Payment System Forum.

4. ECBS (European Committee for Banking Standards)

In light of the close cooperation between the EPC (European Payment Council) the ECBS it became necessary to adjust the ECBS's organisation to the organisation of the EPC. The planned restructuring will result in significant changes in the ECBS's mechanisms. The ECBS Technical Steering Committee (TSC) would be replaced by the Operation Infrastructure & Technology Standards Support Group (OITS), this plan is still to be elaborated. This change will require the definition of the relationship between the OITS and ECBS. The working relationship between the EPC's working committees and the ECBS's technical committees will also have to be defined. The ECBS will resume its work under the current rules until year-end. The Secretaries General of the EPC and the ECBS shall submit proposals for their respective organisational structures and operations. The proposals will be discussed by the TSC meeting of September 16. The Secretary General of the ECBS sent his proposal for the organisational structure and operation of the ECBS to all TSC member on July 15. The proposal will be reviewed at the TSC's September meeting.

5. FBE Financial Markets Committee

The FBE Financial Markets Committee (FMC) held its plenary meeting on April 23 in Brussels, with the following agenda:

• The FMC addressed the European Commission's work plan for the review of the Financial Services Action Plan (FSAP).
• The FBE's opinion concerning the review of FSAP was published in March 2004. An important organisational change will be that in preparing its relevant proposals the Commission will consult with and rely on the support of specialist groups in four areas: banking, insurance, securities and asset management.

In connection with the FSAP review and an assessment of experiences of the Lámfalussy process, at the request of the FBE the Dutch-based Rabobank compiled a report outlining still existing legal obstacles and constraints to cross-border and direct banking services. The report was shared with the FMC.

The FMC reviewed the status of proposed regulations: the Prospectus Directive, the Transparency Directive, the regulation on accounting for securities transactions, the new regulations on market abuse, implementation rules for the Investment Services Directive, the standardisation of investment and pension fund regulations, and a standard corporate governance legislation.

The next plenary meeting, where the new member states will also be introduced, is scheduled for October.

6. ISO TC68 plenary meeting

The ISO Financial Services Technical Committee 68 (ISO TC68) held its two-day plenary meeting on July 15, 2004 at the SWIFT Headquarters in La Hulpe.

The meeting was attended by delegates of the standardisation organisation of countries with full voting rights (P members) and representatives of observer organisations (O members).

The Hungarian Standardisation Board requested the Association to delegate a representative to this important event, given that the ECBS invited a meeting for July 14 (a day before the plenary) for European ISO members with a full voting right to obtain support for its proposal for the restructuring of ISO TC68.

The plenary meeting took place duly according to the agenda planned, 17 unanimous resolutions were adopted. One of the most important of these was the decision (endorsed with the vote of five P members) on the restructuring of TC 68. Accordingly, in addition to the current

SC2 - Financial Services - Security and Operations,

SC4 - Securities and Related Finantial Instruments and

SC6 - Financial Services - Retail sub-committees,

a new sub-committee, the SC7 - Financial Services - Core Banking Sub-Committee will be set up.

The new sub-committee will address standardisation issues related to the management of core banking functions: deposit taking, lending, account keeping and payment transactions. Lending functions related to credit cards and securities lending will continue to be addressed sub-committees SC4 and SC6.

SC6 will also address standardisation issues related to cards and new payment techniques. Hungary is currently not involved in the work of SC6. However, both areas, cards and small-value payments, are growth areas and valuable information could be obtained through participation in the standardisation work in these areas.

Certain new standardisation works will be transferred to the newly set up SC7 sub-committee. Participants adopted the proposal for the TC68 Secretariat to take action to revoke the following standards, if no indication is received during the next five years on any problem envisaged upon such revocation:

1. ISO 10043, Banking and related financial services - information interchange - collection form
2. ISO 10044, Documentary credit form
3. ISO 6234, Authorized Signature Lists and their representation on Microfiche
4. ISO 6260, Mail payment orders
5. ISO 7746, Banking - Telex formats for inter-bank messages
6. ISO 7982, Bank telecommunication - Funds Transfer Messages Part 1- Vocabulary and universal set of data elements for electronic funds transfer messages
7. ISO 9778, Banking - Forms for confirming loan contracts

In its contribution, the Belgian delegate indicated that IBAN and BIC are now generally used in customer orders. Customer orders are received centrally: customers send their orders to a central location (not to their principal bank), from where the orders are directly forwarded to the beneficiary's bank. This is a customer-friendly solution (account holders only need to remember one address to send the order), and a cost-saving solution for banks. All system enhancements are carried out centrally, sparing banks any development procedures.

Among the reports of committee heads, Mr. Michael Versace gave a presentation on a new and spreading type of fraud: getting hold of the account holder's details from different sources (Phishing), the fraudster starts acting on behalf of the account holder: opens accounts, borrows, concludes deals, etc. Mr Versace pointed out the need for joining forces in combating this type of fraud internationally.

IV. ASSOCIATION EVENTS

1. Payment System Forum

The supreme body of Payment System Forum, the Payment System Council held its first ordinary meeting on May 5, 2004.

Following the opening addresses by the Co-Chairs Henrik Auth and Tamás Erdei, István Prágay gave a presentation on the European Payment Council (EPC), followed by the election of a delegate to the EPC. The Council discussed the proposal for a revision to the Forum's Organisational and Operational Rules and voted on the representation of small banks and on the launching of projects through remote voting. Finally, "Recommendations" prepared by the working groups were presented by heads of groups, followed by respective decisions.

In accordance with the resolutions adopted by the Payment System Council, the following issues wee addressed by Payment System Forum's technical committees and working groups in the recent period:

At the RTGS/VIBER and KELER Technical Committee's first meeting, held on July 9, 2004, participants received an update on the following issues:

• The EU Commission's Communication on the Commission’s Strategy and Priorities for Clearing and Settlement, adopted on April 28, with comments expected by July 30, 2004,
• Announcement of Second Hearing ESCB-CESR standards for Securities Clearing and Settlement Systems in the European Union,
• TARGET2 progress.

Representatives from the Ministry of Finance, the Hungarian Financial Supervisory Authority, and the Budapest Stock and Commodity Exchanges are to be involved in the working groups to be formed within the framework of the RTGS/VIBER and KELER Technical Committee.

The Council unanimously adopted the Guide for the migration of chip cards, prepared by the Cards Technical Committee's Chip Cards Working Group. With this, accomplishing its objective, the Chip Cards working group concluded its work and dissolved. The Council approved the setting up of two new working groups under the Cards Technical Committee: the Statistics Working Group and the Card Holders Working Groups. The Statistics Working Group will address modifications to statistical reports requested by the National Bank of Hungary. The Card Holders Working Group will draft recommendations for the safe use of bank cards and make proposals for the financing and dissemination of the relevant information documents.

A Mobile Payments Working Group was set up, as the third active group of the Cashless Payment Methods Development Technical Committee. (Active groups are: the OCR, Direct Debit and Mobile Working Groups). The work of the fourth group, the Report Payments Working Group, has been suspended until enactment of the relevant regulations.

The Payment System Council, at the Association's initiative, endorsed the setting up of a Legal Working Group to analyse current liability and remedy obligations and to compile a report on its findings. The Association undertook the task of organising the group. The Legal Working Group held its first meeting on June 25, 2004. A short-term objective of the group is to adjust the definitions in current payment regulations and in their proposed amendments so that the definitions provided in Hungarian legislation are in conformance with the definitions provided in EU legislation and international standards. As a long-term objective, the group shall study the New Legal Framework (NLF) and Pan-European Automated Clearing House (PE-ACH) documents and, in the knowledge of the definitions provided in these documents, provide assistance in the drafting of legislation on payments. Members of the Working Group supported the proposal to involve in the work a representative from the Ministry of Finance.

The Standardisation Technical Committee of the Payment System Forum has still not been set up, while documents continue to arrive from the ECBS for review. On May 28 the Association held a meeting with those banks who have indicated their intention to participate in the working group and requested their assistance in developing an opinion on the proposal for setting up a working group to develop a standard for devices ensuring the secure issue of PIN codes and the "DEBS 100: Keyboard Layout for ATM and POS PIN Entry Services" standard. Issues related to standardisation work were also addressed at this meeting.

The Association became a member of the Hungarian Standardisation Board in 2004. It is our objective to familiarise banks with the financial standards developed by the ECBS and European and international organisations (CEN, CENELEC, ISO, IEC). The Association is going to take up contact with bank specialists seeking to participate in the work of the four technical committees of the ECBS (TC1-Plastic Cards & Related Devices, TC2-automated Cross Border Payments, TC4-Security, TC6-Electronic Services).

2. Information Society Inter-Ministerial Coordination Committee

The Electronic Administration Sub-Committee of the Information Society Inter-Ministerial Coordination Committee (ITKTB) held a meeting on June 14, with the participation of members of the IT Security Committee, including the Association. The opening presentation was offered by István Piróth on eMunicipality. In the contributions following the presentation it was proposed that a centralised solution should be developed for the payment of eAdministration service charges. In connection with the working document on the Hungarian eAdministration Interoperability Framework, Zsolt Sikolya offered a presentation about a project set up to identify interoperability requirements. Dr Márton Csapody presented a project for developing the requirements for the use of electronic identification, electronic signatures and smart cards in public administrations. The document summarising achievements was sharply criticised by participants contributing to the topic, including representatives from the Smart Card Forum, who said the document was a good summary of the tasks but did not answer the questions concerning the feasibility of the objectives set in the tender.

At the IT Security Sub-Committee's meeting of July 6, Lajos Muha presented the ITKTB draft recommendation for the Hungarian IT Security and Evaluation Scheme prepared based on ISO 17799/BS and 7799. This was followed by presentations by István Szabó and Imre Szeberényi on the MIBÉTS training system and on information and IT security education within the Ministry of Defence and the Budapest University of Technology.

3. Smart Card Forum Open Day

A presentations day, organised under a cooperation between the Association and the John von Neumann Computer Sciences Society Smart Card Forum was held for commercial banks in the Farkas Kempelen Student Information Center on July 24. During the open day Oberthur Card Systems presented Omex, a smart card and biometry-based security solution developed for the Swedish Ministry of Defence. László Ágos and András Vilmos of Bull Hungary presented SEMOPS (Secure Mobile Payment Service), a system model developed within the framework of a European project.

ST Microelectronics SA provided a presentation on electronic identification solutions used in Italy. Márton Hegyi and Péter Szőke of Diákbónusz Kht, Compuworx Rt. gave account of integrated applications and results of the student certificate system implemented at the Student Information Center and results of the higher education program. Jan Mooijweer (Business Manager, EMEA) of ACI Worldwide spoke about the main features and operation of the government electronic ID card system implemented in Hong Kong.

4. Information Security Working Group

The Information Security Working group, set up on March 26, held its second meeting on June 2. The meeting addressed the Integrated Hungarian Labour Data Base (EMMA), set up by HP Hungary, as a main contractor at the Employment Office. The organisational setup and plans of the Smart Card Forum and potential areas of cooperation were presented by Gabriella Beliszky. Zoltán Lengyel of MKB reviewed the obligations imposed by information security regulations. Participants agreed that solutions and alternatives meeting the requirements and should be identified and developed jointly.

5. Conference at the Budapest Municipal Court

At the initiative of the Chairman of the Budapest Municipal Court, a conference programme was launched in cooperation with the Hungarian Banking Association. The first event under this program was on May 3 and 4 in the Jury Hall of the Budapest Municipality Court. The objective of the conference is for judges to know more about certain money and capital market transactions through acquiring first-hand information from financial specialists. Capital market institutions and transactions we the main topics of the two-day conference, with presentations offered by prominent banking and stock exchange specialists. The objectives and contents of the initiative were presented at a news conference held for business journalists after the event.

The following presentations were provided at the event: following the opening address offered by Dr László Gatter, Chairman of the Budapest Municipal Court, Tamás Erdei, President of the Hungarian Banking Association and President and CEO of the Hungarian Foreign Trade Bank (MKB) spoke gave an overview of economic outlooks, interest rates, and the economic environment affecting banks. Gábor Bataki, Director of MKB and Dr Attila Tajthy, Chief Legal Counsel of Raiffeisen Bank gave a joint presentation on portfolio management, investment fund management and pension fund asset management. Investment fund operations were presented by Sándor Vízkeleti, CEO of a CA IB Securities Investment Fund Management Ltd. and Dr János Krizsai, Legal Director of K&H Securities Investment Ltd.

On the second day, a presentation on the stock exchange and its future was offered by György Jaksity, President of the Budapest Stock Exchange (BSE), followed by a presentation by Zolt Horváth, CEO of the BSE, on stock exchange transactions and settlement processes.

Concluding the program, dr. Adrienne Kraudi, Chief Legal Counsel and Managing Director of MKB, gave a summary of the regulatory framework on insider trade and the unfair manipulation of prices. Here, four criminal cases were presented by Dr Erzsébet Diósi, Judge of the Budapest Municipal Court.

6. Presentation on EU capital market legislation

Within the framework of a technical consultation held at the Association, competent senior associates from the Ministry of Finance and the Hungarian Financial Supervisory Authority gave an overview of those European Institutions and legislative processes where Hungarian authorities are represented. In turn, the Association presented the role of the European Banking Federation in the European lawmaking process, its review role and interest enforcing ability. (The Association has been a full-fledged member of the FBE since January 2004).

The creation of a single European financial market and the criteria of effective movement of capital prompted European lawmakers to review the EU's slow, inefficient and untransparent decision-making mechanisms.

The Lámfalussy Process, currently applied to capital market legislation and planned to be extended to banking, insurance and investment funds, is aimed at speeding up the legislative process, allowing the drafting of efficient and practicable legislation that can keep pace with market developments.

The Lámfalussy process is a four level legislative process. A key principle is that market players should be consulted with right at the start of the legislative process. This should take place on two scenes: one, when Hungarian regulatory authorities present their views in the various institutions based consultations with players in the Hungarian market and, second, when the position of the Hungarian banking industry (not necessarily the same as that of the authorities) is represented on the FBE's committees and working groups.

The Lámfalussy process is a four-level legislative and control process:

• The European Commission (the Commission) presents the regulation or directive to the Council and Parliament after broad consultation with market players.

• The Commission consults with the European Securities Committee (ESC) and orders CESR (Committee of European Securities Regulators) to draft the technical implementation measures.
• CESR consults with market players and submits its legislative proposals to the Commission.
• the Commission drafts the legislation and sends it to ESC. ESC has three months to endorse or reject the proposal.
• In function of ESC's decision, the Commission adopts the implementation measures.
• Parliament is kept informed; there are two formal opportunities to adopt resolutions.

• CESR recommendations, guides and standards,
• Assessing national supervisory practices

• Commission checks on conformance of national legislation with EU legislation; as an ultimate resort may turn to the Court of Justice.

The FBE's legislative work is adjusted to this process, the consultative committee for capital market issues is the Financial Markets Committee /FMC/, which has various sub-committees and working groups. The FMC's position is solicited on all subsequent issues belonging to other consultative committees (for example, payments and securities settlements).

Currently, the following legislative work is in process (all forums open are for the Association to join and participate):

National Implementation

The Directive on Market Abuse was adopted in December 2002. Its two implementation directives were adopted by the Commission on April 30, 2004 and should be transposed into national legislation by October 2004. (Directive 2003/6/EC; Implementation Directive: 2004/72/EC)

Subject of the Directive: the Directive updates the regulations on insider trade and market manipulation (together: market abuse).

The Prospectus Directive

Subject of the Directive: issuers to have a Single European Passport ensuring that if the issue has been authorised in one member state, the issuer does not need to apply for authorisation in another member state once certain conditions are met.

Directive 2003/71/EC, promulgated in the OJ on December 31, 2003.

Secondary legislation adopted by the Commission on April 30, 2004. (Commission Regulation 809/2004).

The deadline for transposition of the Directive into Hungarian legislation is July 1, 2005 (being also the effective date for the direct application of the Regulation).

Regular reporting obligation of companies listed in regulated markets

The proposed Directive is aimed to ensure that investors have access to detailed information and the information asymmetry between member states is eliminated. The Directive provides for quarterly reporting obligations for issuers (to a limited scope relative to the original version).

The drafting of the relevant implementation decrees is underway.

Directive on Financial Instruments (ISD2)

The directive is aimed at removing the remaining barriers to a single investment services market in order to ensure efficient capital markets and increased investor protection. (This Directive annuls Directive 93/22 EC)

The Directive was adopted under No. 2004/39/EC on April 27, 20004. Implementation deadline: April 30, 2006.

Drafting of implementation measures: the Commission would like to either reduce the preparatory period or to issue the implementation measures under a Regulation, contrary to CESR, who envisages a preparatory period of at least one year. The FBE is expected to be actively involved in the drafting process, working groups commence work in July.

Pension and investment funds

Tasks provided by the FSAP for the next two years include the creation of consistency between operations and capital, the implementation of transparency requirements for better investor information, preserving the value of concentrated assets, determining custodian liabilities, etc.

The Companies Act and regulations on acquisitions

Economic concentration, mergers, acquisitions, holding companies. Promoting shareholder interests, limiting the right of target company managements to take protective measures, employee protection.

Clearing and settlements

The Commission's communication on clearing and settlement was published on April 28. This may serve as a basis for a legislative proposal.

Objective: to remove the remaining barriers to cross-border individual payments and settlements.

In consultation with banks, the European Banking Federation challenged the proposal developed by a joint ESCB/CESR working group. The relevant position paper is available on the FBE's website.

Financial analysts

Developing recommendations aimed to set out the best regulatory and market practice framework for financial analysts. The Commission set up a working group of financial analysts to develop a preferred code of conduct. An FBE specialist is a member of this group. The group is charged with analysing and evaluating business activities, behaviours and the current regulatory framework. The recommendations put forward by the group were well-received by the financial industry. CESR is to draft a regulatory proposal within the ISD implementation measures.

Monitoring the legislative process and its implementation (Inter-Institutional Monitoring Group). The European Commission, Council and Parliament set up an independent expert group to monitor, analyse and identify potential weaknesses of the Lámfalussy process. Results are published semi-annually. The report on processes closing the final phase will be concluded at the end of 2004.

top of page