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The following OECD assessment and recommendations summarise chapter 3 of the Economic Survey of Hungary published on 11 February 2010.
How to improve financial regulation and supervision?
A major lesson learnt from the crisis in Hungary is that the approach towards household lending needs to change: stronger protection for borrowers needs to be combined with tighter regulation of lenders. The right balance needs to be struck in both directions, as neither the over-protection of households nor the over-regulation of banks would be desirable. The former can lead to moral hazard and boost the pool of “subprime” borrowers, while the latter can hurt the efficient functioning of the financial system and hence of the whole economy.
Household debt as a percentage of GDP, at less than 40% in 2009 is much lower than that in more developed countries, but most debt is floating-rate and a large share of the debt is in foreign currency (Figure 3). This exposes borrowers to interest rate and exchange rate risks that increase their solvency risks. In view of the risks that high household debt-service ratios pose for financial stability, in accordance with the already effective Code of Conduct, the share of income that can be used for debt servicing should be capped. To ensure that the ceilings on debt-service ratios are observed, a comprehensive credit registry is needed, which goes beyond the existing negative list. Borrowers’ incomes should be better documented to ensure ability to repay. This measure would also help “whiten” the economy.
Housing loans in foreign currency have become more attractive for households1
1. Stock of housing credits.
Source: HCSO (2009), “Dwellings, public utilities”', Stadat Tables, Hungarian Central Statistical Office, December.
To mitigate solvency risks for households, the supply of mortgage insurance-type financial products, (for instance, in the case of unemployment or sickness of the borrower) should be reinforced, and the practise by banks to use these products as a loan security should be fostered. Financial education at the stage of formal studies is widespread and covers major issues. But financial education in general should be bolstered at all life stages and targeted programmes for vulnerable groups such as the elderly and the less educated should be introduced.
Major sources of risk for financial stability have been borrowing in foreign currency and inadequate liquidity management with a mismatch of maturities between assets and liabilities. Exposure of banks in foreign currency, in particular Swiss francs, is large, while the scope for the authorities to provide emergency liquidity in this currency is limited. Hence, liquidity regulation and oversight of the largest institutions needs to be given high priority to avoid a future currency crisis. Although capital requirements have so far been adequate, better preparation for a rise in non-performing loans is needed. Liquidity conditions in foreign currency should be more closely followed. Banks should be subject to higher costs for risky lending in the form of higher capital requirements, although this would be more effective if enacted at the regional (even global) level. Dynamic provisioning should be introduced once the economy recovers to provide a buffer for banks during economic downturns.
A source of risk for borrowers has been the arbitrary cost increases passed on by banks without much restriction until very recently. Inadequate disclosure of the conditions of loan products, in particular unilateral change of contract by banks, resulted in soaring instalments, payment difficulties, defaults and sometimes evictions. Unfair conditions, unilateral changes of contract and other abusive practices in the recent past call for vigilant consumer protection. All conditions of financial products should be disclosed in a transparent way before signing the contract. More recently, the instances where banks can transfer increased costs to households have been limited with the signature of banks, the regulator and the government of a “Code of Conduct” effective from December 2009. However, related clauses in lending contracts should be generally condemned and declared non-binding. As a second-best option for existing contracts, lenders should be encouraged to engage in restructuring of loans if borrowers’ defaults result from a unilateral contract change.
There are serious obstacles to effective competition. One relates to the lack of information on borrowers, which implies higher credit risk for banks and hence less likelihood for reducing margins. Another very important obstacle is high switching costs, amounting to 1 2% for housing loans and 3 5% for loans for other purposes. Increased competition should help reduce switching costs but capping of pre-payment costs by a recent legislation is a welcome step, even though the cap may somewhat be high. Also, portability for housing loan subsidies across properties and across financial institutions should be introduced, as recommended by the competition authority. Independent agents should be required to offer several options to customers for a fixed fee, which should only be paid if one of the options is chosen by the customer, and these agents should be prohibited from accepting commissions from financial institutions. Agents working for or on behalf of banks should disclose their remuneration scheme and amount to the borrower.
The crisis exposed weaknesses in the supervisory framework, such as inadequate monitoring and risk assessment of the financial system, and insufficient cooperation among institutions in charge of financial stability. The financial supervisory authority had not been entrusted with stopping unfair commercial practices and protecting consumer interests until very recently. The supervisory authority has been made independent from the Ministry of Finance and responsible directly to Parliament. To better identify and assess systemic risks, cooperation between the central bank and other institutions in charge of financial stability should be strengthened further. A more formal Financial Stability Council should play a prominent role in detecting risks and making recommendations to mitigate them. The financial market supervisor should be granted wider scope to issue regulation, although care should be taken to avoid overlap with the central bank. The supervisory authority should not be held liable for the damages its regulations may cause to regulated institutions, otherwise the new powers to charge higher fines cannot be effective.
How to obtain this publication
The complete edition of the Economic Survey of Hungary is available from:
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.
For further information please contact the Hungary Desk at the OECD Economics Department at email@example.com.
The OECD Secretariat's report was prepared by Margit Molnar and Colin Forthun under the supervision of Pierre Beynet. Research assistance was provided by Desney Erb.