Development of the Hungarian banking system in 2000

After slowly overcoming the difficulties associated with the transformation to a market economy and completing the process of macro-economic transition, in the second half of the 1990s the Hungarian economy finally embarked on a path of sustainable economic growth. Through to the middle of 2000 the economy was growing at an annual rate of 4.5%, while inflation was declining for the fifth year in a row and the foreign trade financing requirement was not increasing the country's external debt. Fiscal policy was an important partner in accomplishing this, as government expenditures were growing slower than GDP. Along with an appropriate interest rate policy, household savings formed the basis for meeting the growing financing needs, in addition to the inflows of FDI.

In 2000, the course of economic policy was changed. Incentives for households to save were scaled back, the fight against inflation stalled, and domestic consumption began to grow increasingly strong.

For the banking system, 2000 produced outstanding results. Lending expanded significantly, and the sector's profitability reached the lower range of figures typical for market economies.

1. Economic policy and the banking system in 2000

In contrast to the official target of 6-7%, the rate of inflation in 2000 amounted 9.8%. The December-December figure for 2000 was 110.1%, and even less pleasing was the fact that core inflation (which excludes prices for food, pharmaceuticals and energy) stood at 9.8%, having increased each month since June 2000. Price inflation for imported goods (tradables) remained below 5%, and prices increases for government-regulated goods and services amounted to only 7.6%. The increase of 12.5% in prices for market services clearly indicated that stronger consumption, together with the dwindling propensity to save, will be a serious obstacle to the successful implementation of economic policy, the central objective of which is to reduce inflation.

Households' net financial wealth increased by a mere 14% in 2000, hence the rate of growth was slightly lower than nominal GDP growth. This raises certain issues, as over the long term net financial wealth needs to rise to the ratio typical for developed countries, i.e. approximately one and half times the amount of GDP. At the beginning of the 1990s this ratio amounted to just 10-15%, increasing to 45% by 1999, but it is now stagnating and has even declined somewhat.

Chart 1: Consumer price index April 1999 - April 2000

The decline in interest rates is clearly reflected by the fact that while the average interest rate on 3-month discount T-bills was 4-5% higher than inflation in 1998, by 2000 this difference had dropped to an average of 1-2%.

Banks' aggregate balance sheet total increased by 15% in 2000, and the monetization of the economy did not increase (in developed countries the ratio of balance sheet total to GDP is usually between 1 and 2, while in Hungary is has remained around 75% for almost a decade).

On the assets side of the banking system's balance sheet total, one positive note was that the share of receivables from the state, foreign parties and the banking sector declined, while the share of loans to large and small enterprises and households increased. The three latter groups of clients together accounted for 39% of banks' assets in 1999, rising to 44% in 2000.

In 2000, corporate lending grew by 28% (loans to small enterprises grew by 24%), and lending to households grew by 48%. At the end of 1999, total lending in forint and foreign exchange to companies amounted to less than HUF 1,200 billion, with this figure increasing to HUF 1,600 billion by end-2000 (short-term loans grew from HUF 1,140 billion to HUF 1,400 billion).

The share of various sectors in corporate lending developed as follows: 1/6 of loans went to agricultural and food industry companies, 1/6 to real estate and other business-related enterprises, 1/5 to trade, repair and maintenance companies, 1/10 to transportation, storage and communications enterprises, and 1/16 to petroleum processing and chemicals companies.

The aggregate total of corporate loans with a maturity of over one year rose by 42% (consisting of a 20% rise in forint-denominated loans and a 53% rise in foreign exchange-denominated loans). Long-term loans to companies active in agriculture, the food industry and construction grew the least, and outstanding long-term loans to these sectors decreased in real terms. Long-terms loans to enterprises in the electricity and coke production sectors and the chemicals sectors exhibited the highest rate of growth.

Claims on households amounted to HUF 532 billion, while claims on small enterprises amounted to just HUF 140 billion at the end of 2000.

On the liabilities side, one key note is that aggregate equity increased from HUF 663 billion to HUF 842 billion, resulting in an improvement in the capital adequacy rating to 15.7%. In 2000, the banking sector's aggregate equity increased in real terms as well, by a surprising degree at the most profitable banks. The share of corporate deposits in the balance sheet total increased somewhat, while that of households decreased. The share of government and foreign liabilities remained essentially unchanged.

Compared to the balance sheet total, the weighted value of off balance sheet liabilities did not change between January and September 2000, amounting to 12.7%. This figure declined slightly in the last quarter of the year. The majority of these items are contingent liabilities (e.g. lines of credit), with a small portion of them being accounted for by future liabilities (FX forwards).

At the end of 2000, the Hungarian banking sector consisted of a total of 42 banks (4 building societies, 4 specialized credit institutions, 16 small banks, 11 medium-sized banks and 7 large banks) and 198 credit cooperatives. The foreign ownership ratio in banks amounted to 66% (in terms of capital). Compared to the beginning of the year, the share of medium-sized banks in the balance sheet total increased by 1.3%, growing to 26.5%, to the detriment of the larger banks. The vast majority of medium-sized banks continued to increase their share for the fourth year running, and some of them have almost reached the category of large banks.

Concentration in the Hungarian banking system continued to grow stronger in 2000. Seven banks account for two-thirds of all corporate loans. On the other hand, bank concentration in the household lending market shows a downward trend.

Market interest rates declined again last year, both in respect of assets and liabilities, with rates on liabilities dropping somewhat more quickly. At mid-year, key rates stood as follows:

a) Assets
As of June 2000 (in descending order)
ˇ consumer loans: 23%
ˇ housing loans: 21%
ˇ long-term corporate loans: 13%
ˇ short-term corporate loans: 12%

b) Liabilities
ˇ 3-month government security yield: 11%
ˇ short-term corporate deposits: 9%
ˇ 5-year government security yield: 8%
ˇ long-term household deposits: 8%

In respect of consumer loans, typical total fees charged on loans far exceeded interest rates; for the year as a whole, the total fees for consumer loans ranged from 30-35%. State-subsidized housing loans can be considered a new form of loan. Another indicator for the household banking business is that there were 2,400 ATMs and more than 4 million bank cards in Hungary as of September 2000.

Profitability in the banking system increased considerably in 2000, with pre-tax profits exceeding HUF 100 billion. Whereas in 1999 ROE was 6.36% and ROA was 0.55%, in 2000 ROE amounted to 14.50% and ROA to 1.30%. Hence, returns on assets improved by 0.75%. On the one hand, this was the result of a reduction in the formation of provisions (0.53%), and, to a lesser extent, to a decline in operating costs (0.27%). Staff employed in the banking sector dropped by 1,660, or 6%. The decline in the interest spread (0.14%) was countered by the increase in profits on other services (0.23%).

2. Outlook for 2001 - Will the improvement seen in 2000 be lasting?

Since 1997, the Hungarian economy has been growing at an average rate of 4.8% and it continued this strong growth in 2000, posting an increase of 5.2%, but this has not been without a negative impact on external equilibrium. In order to sustain the rapid pace of growth this year, the government has promised measures to stimulate economic growth, in particular measures targeted at increasing domestic consumption.

In terms of the aggregate balance sheet for credit institutions in the first quarter of 2001, it was seen that while the balance sheet total grew slower than nominal GDP growth, lending continued to expand strongly, along with a significant shift in the balance sheet structure. In Q1 2001, corporate and household loans (especially long-term loans) grew exceptionally quickly, while banks' foreign currency reserves declined sharply (banks are holding 2/3 of the previous year's level, in real terms) and claims on the central bank dropped by nearly one-half in real terms. Total claims amounted to HUF 2,000 billion in February 2000 and have since declined to HUF 1,380 billion over the course of one year. Net outstanding lending to companies increased by 44% in nominal terms in the course of one year (March 2001 vs. March 2000), representing growth of some 30% in real terms (the expansion in corporate lending in 2000 is well illustrated by the fact that companies in the mechanical engineering, chemicals and transportation and communications sectors increased their total amount of loans by more than 70%). Total lending to households increased by almost 50%.

All of these developments are related to the significant decline in interest rates. In real terms, the NBH's leading two-week rate (calculated ex post) was 6.2% in March 1999, falling to 1.9% by March 200 and further to 0.7% by March 2001. A similarly sharp decline was also seen in ex ante real interest rates as well.

Chart 2: Corporate loans to GDP and real 6-month T-bill interest rates - 1997 to 2001

3. Bank products in 2000

We would like to illustrate the extremely wide range of bank products by presenting some of the various types of personal deposits. At the beginning of 2000 (in February), 24 banks provided information on products for the personal banking market, in a structure that made it possible for comparison. The following data are based on the results. The banks surveyed offered a total of some 500 different products on the personal deposits market, and these can be compared, as the banks provided the total interest rate charged on the products in a uniform structure (band rates for time deposits have been averaged). The following chart illustrates that interest rates were highest for term deposits of 60-90 days (10.11%), and then drop off a few tenths of a percent, in line with the inflation expectations of banks and the public.

Chart 3. Interest rates and number of personal deposits, by term

Longer deposit terms do not generally result in higher interest rates, if there is no confidence in a reduction in inflation over the short term, and this was exactly the case at the beginning of 2000. The graduated interest rate bands, which depend on the amount deposited, however, did have an impact on interest rates: deposits of over 3 million forints resulted in an increase of one percentage point, for example for fixed deposits of 0-30 days.

Chart 4. Dependence of interest rates (in %) for 1-30 day deposits on the deposit amount (in HUF `000).

In terms of the term of the deposit, the curve is not the same for all banks: many of them offer the highest interest rate on 30-60 day deposits, but not all of them. Banks which publish interest rates for all of the terms were included on the chart.
Chart 5. Interest rates on certain kinds of deposits (in %), broken down by term

During the year (from February to December), only a few new products were launched on the personal deposits market. Interest rates tended to fall by 1-1.5%. In a few cases the amount ranges were changed (generally the upper limit was increased); a few products were introduced and a few products were discontinued.

Conclusion

In 2000, the Hungarian economy grew vigorously (by more than 5%), which contributed to stronger activity in the banking business. There was a favorable change in the structure of the banking sector's aggregate balance sheet total, with loans to customers increasing, including long-term loans. The banking sector's pre-tax profits exceeded HUF 100 billion, and banks' ROE was up to 14.5%, more than doubling the previous year's figure (in real terms this figure is not particularly high, but it reaches the lower one-half to one-third of the range of returns expected by owners). Lending to households and enterprises grew briskly and this expansion continued in 2001. The almost 50% nominal growth in outstanding loans clearly reflects the strength of activity in the Hungarian economy. Nevertheless, the temporary standstill in the fight against inflation and the growing foreign trade deficit require more and more attention on the part of economic policy. The significant broadening of the exchange rate band in May of 2001 (from +2.25% to +15%) reflects a renewed effort by economic policy to further lower the rate of inflation. In order to ensure a solid basis for sustainable economic growth it is important to foster an increase in households' propensity to save, as dynamic growth in household financial wealth will provide a sound footing for a continuation of Hungary's excellent economic performance.