VZCZCXRO0392
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV RUEHSR
DE RUEHUP #1214/01 3540609
ZNR UUUUU ZZH
R 190609Z DEC 08
FM AMEMBASSY BUDAPEST
TO RUEHC/SECSTATE WASHDC 3714
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS SECTION 01 OF 03 BUDAPEST 001214 
 
SENSITIVE 
SIPDIS 
 
DEPARTMENT FOR EUR/CE, EB/OMA, INR/EC 
TREASURY FOR ERIC MEYER, JEFF BAKER, LARRY NORTON 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PREL HU
SUBJECT: BANKING SECTOR DEVELOPMENTS: GOV'T AND BANKS ADAPT 
TO NEW REALITY WHILE SME'S STRUGGLE FOR CREDIT 
 
REF: A. BUDAPEST 1108 
     ¶B. BUDAPEST 1139 
     ¶C. BUDAPEST 1059 
 
¶1. (SBU) Summary.  The banking industry is undergoing a rapid 
transformation as the financial crisis and global credit 
crunch impose new realities on the financial sector in 
Hungary.  Banks find themselves altering their business 
models to reduce loan deposit ratios and improve the quality 
of their loan portfolios.  The government, meanwhile, is 
rushing to pump liquidity into the system even as it tightens 
its oversight of the industry.  Small businesses, a key 
political constituency but viewed as riskier and less 
profitable than consumer borrowers, are increasingly finding 
themselves caught in the middle and without access to credit. 
 End summary. 
 
PARLIAMENT PASSES REVISED BANKING ASSISTANCE PACKAGE 
 
¶2. (U) On December 15, the Parliament passed a revised 
version of its banking sector support package, part of the 
Stand-by Arrangement with the IMF.  The package includes a 
fund to guarantee the rollover of loans and wholesale 
securities (Liquidity Fund), and a fund to increase the 
capital of banks (Capital Enhancement Fund) (ref A).  The 
revised law expands the number of banks eligible to 
participate in the program, and addresses a key concern of 
banks by limiting the possibility of the government taking 
over management and control of participating institutions. 
 
¶3. (U) Participation eligibility in the HUF 600 billion (USD 
3 billion) package has also been expanded.  Under the initial 
draft proposal, only three banks met the warranty capital 
requirements.  This has now been expanded to all credit 
institutions registered in Hungary. 
 
¶4. (U) Banks are in the process of studying the new law, and 
have not yet indicated whether they will use the support 
package.  Many observers believe that a number of banks will 
likely use the credit guarantee program, if not the Capital 
Enhancement Fund. 
 
¶5. (U) The IMF welcomed legislation implementing the banking 
assistance package in its recent review of economic and 
fiscal developments in Hungary, noting that with current 
global deleveraging and economic downturn, "it is important 
that banks in Hungary have access to the same capital 
enhancement and borrowing guarantees as other banks in the 
EU." 
 
GREATER GOVERNMENT OVERSIGHT 
 
¶6. (U) Additional support for the financial sector will be 
accompanied, however, by additional regulation and oversight. 
 As noted in its agreement with the IMF, the government is 
working on legislation to strengthen financial sector 
regulation and supervision, including expanding the role of 
the financial supervisory authority to more actively monitor 
and analyze risks to the financial sector, and to provide it 
with additional tools to intervene if necessary.  Other 
measures announced in the IMF agreement include the 
introduction of a positive credit registry for households, 
introduction of maximum loan-to-value ratio requirements for 
new mortgage loans, and close monitoring of foreign exchange 
exposures. 
 
SME LENDING HURT BY LOWER LOAN DEPOSIT RATIOS, FOCUS ON 
PROFITIBILITY 
 
¶7. (SBU) A number of bankers have told us that the financial 
crisis is rapidly transforming the banking sector in Hungary. 
 Over much of the last decade, banks enjoyed high levels of 
profitability, and were focused primarily on growth and 
increasing market share.  Today the landscape has changed 
considerably, as scarce and more expensive credit and greater 
oversight from parent banks is causing banks to focus on 
improving the quality of their loan portfolios, reducing loan 
deposit ratios, and shedding less profitable business lines. 
Unfortunately, small and medium sized enterprises (SMEs) will 
likely feel the worst effects of these changes. 
 
LOWER LOAN DEPOSIT RATIOS 
 
¶8. (SBU) Banks in Hungary maintain comparatively high loan 
deposit ratios.  In June 2008, the loan deposit ratios of 
large banks in Hungary averaged nearly 150 percent, with only 
 
BUDAPEST 00001214  002 OF 003 
 
 
one major bank having a loan deposit ratio below 100 percent. 
 When loans exceed deposits, banks must rely on parents or 
external sources of funding to cover excess liabilities. 
Because of continued scarce and expensive credit, and 
possibly instructions from parent banks, banks are reducing 
their loan deposit ratios to levels more sustainable in the 
current environment. 
 
¶9. (U) To do so, banks are working hard to increase deposits 
on one hand, and are limiting new loans and not renewing 
certain existing loans on the other.  To increase deposits, 
banks are offering high interest rates as a lure to 
depositors.  K&H Bank, for example, is currently offering 
interest rates of over 13 percent for certain deposits (the 
Central Bank benchmark is currently 10.5 percent).  Other 
banks are offering similarly high rates. 
 
¶10. (SBU) Their efforts appear to be taking affect, but 
perhaps in unanticipated ways.  The Central Bank reports that 
deposits from companies into Euro-denominated accounts rose 
over 50 percent in June - October, climbing over HUF 1.4 
billion.  By contrast, HUF-denominated deposits dropped 4 
percent to HUF 1.6 billion. 
 
¶11. (SBU) Banks are also reportedly tightening lending 
standards and reducing the number of riskier and less 
profitable loans in their portfolios in order to both reduce 
loan deposit ratios and to improve the quality of their loan 
portfolios.  Consumer lending, while experiencing some 
decline, has not been severely impacted, as it is generally 
favored over corporate lending because of higher profit 
margins and more diffuse risk.  Unicredit officials tell us 
that international institutions find these operations in 
Hungary particularly profitable compared to other European 
markets.  In the corporate sector, banks favor large 
corporate customers over smaller businesses, which are often 
viewed as riskier and which generally have lower profit 
margins. 
 
¶12. (SBU) As a result, SME's are facing difficult times 
securing financing.  Gyorgy Barcza of K&H Bank predicts that 
unless the government takes action or liquidity returns to 
the market at pre-crisis levels, we will see an increasing 
number of small businesses fail because they are unable to 
obtain new financing or renew existing loans.  Indeed, we are 
already hearing anecdotal evidence of this from business 
contacts (ref B).  SzDSz Party President Gabor Fodor, for 
example, told a group of Ambassadors yesterday that he found 
"most stores empty ... or not open at all" when he tried to 
do his Christmas shopping. 
 
PROVIDING CREDIT TO SME'S 
 
¶13. (SBU) The Hungarian government and international 
institutions recognize the problem and are working to 
increase liquidity in the banking sector, with a particular 
focus on SME's.  Central Bank Governor Andras Simor reports 
that about HUF 1,000 billion (USD 5 billion) more liquidity 
flowed into the Hungarian banking system in the last quarter 
than the previous one, as the mandatory reserve requirement 
was lowered from 5 to 2 percent, and banks found new funding 
sources.  Despite increased liquidity, however, Simor notes 
that banks remain risk averse, and are "not getting money out 
the door," particularly to SME's. 
 
¶14. (SBU) Simor believes additional measures are needed to 
incentivize banks to use resources where they are most 
useful.  He admits that this is not ordinarily the role of a 
central bank, and that banks should make loans based on their 
own business decisions, but notes that "these are not normal 
times." 
 
¶15. (U) The government has already undertaken steps to 
encourage loans to small businesses (ref C), including 
through micro-credit programs, redirecting EU development 
funds to SMEs, and providing financial incentives and loan 
guarantees to banks.  In addition, the EBRD and the EIB are 
making more money available to banks for SME's. 
 
¶16. (SBU) Comment.  Despite statements from banks and 
government officials that the banking sector in Hungary 
"isn't broken", the financial crisis and current economic 
situation is transforming several aspects of the Hungarian 
banking industry.  For banks, the order of the day is to 
improve the quality of loan portfolios, reduce 
vulnerabilities, and shed less profitable business lines.  On 
 
BUDAPEST 00001214  003 OF 003 
 
 
the government side, the trend is toward greater regulation 
and oversight of the financial sector and toward greater 
sensitivity to SME's, which represent a large political base 
depite their comparatively modest economic impact.  At the 
end of the day, these trends may result in a healthier, less 
vulnerable financial sector.  In the short term, however, 
there is a risk that it could further delay the financial 
sector "returning to normal", and could have increasing 
spillover effects on the real economy.  End comment. 
Foley