Studies in International Economics, August 2015, Vol. 1, No. 1 (pp. 3–33.)
Macroprudential Paradigm Shift in Hungarian Bank Regulation KATALIN MÉRŐ – DÓRA PIROSKA Within the framework of the global macroprudential paradigm shift, which directs regulators’ attention on systemic risks, governments that had to intervene during the financial crisis to maintain financial stability now require banks to comply with more and stricter rules. The new paradigm significantly increases the powers of state institutions over the banking industry. This article analyses the distinctive aspects of the international paradigm shift in bank regulation as observed in Hungary in light of the changes in bank regulation and the institutional framework of bank supervision between 2008 and 2013. Its main findings are as follows: (1) the 2008 agreement between the Hungarian government and the IMF played an important role in the paradigm shift, (2) regulations enacted within the framework of the new paradigm strengthened Hungarian state institutions vis-à-vis the banking sector, (3) the opposition of the banks to the changes in Hungary is attributable to the inherent quality of the new paradigm: it raises the cost of banking. The analysis does not provide a conclusive answer to the theoretical question of whether the banking sector gains in stability with the implementation of the macroprudential paradigm.* Journal of Economic Literature (JEL) code: G 280, G 010, F 590.
* The authors wish to express their gratitude to Júlia Király, Mihály Laki, Erika Marsi and Mária Móra, and to all interviewees, for the support and valuable comments given for this article. The authors naturally assume all responsibility for any possible errors. The Hungarian version of the article was published in Külgazdaság, Vol. LVIII, 2014, No. 3–4, pp. 47–76. Translated by András Hopp. Translation checked by Robert Young.
Dóra Piroska, Associate Professor of the International Business School. E-mail:
[email protected] Katalin Mérő, Associate Professor of the International Business School. E-mail:
[email protected]
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Katalin Mérő – Dóra Piroska Introduction In our article (Mérő-Piroska, 2013) published in Hitelintézeti Szemle in August 2013 (Credit Institutes’ Review), we identified a paradigm shift in international bank regulation in response to the 2007-2008 financial crisis. Advancing Andrew Baker’s analysis of the ideational shift in bank regulation (Baker, 2013), we argued that changes were observable not only in the assessment of the banking sector’s efficiency (ideas), but also at the level of practice (bank regulation). Baker argued that confidence in efficiency suffered a blow, and a new macroprudential approach for the interpretation of trends gained ground. According to the turn identified by Baker, banking carries risks not only on a micro level (on the level of individual banks), but also on a macro level (for all participants of the banking market). Under the new approach, an actively regulating and supervising state is necessary for the management of macro-level risks, that is, for establishing and sustaining the stability of the financial market. In our previous article we supplemented Baker’s concept – pertaining solely to ideas – by noting several global regulatory and supervisory instruments introduced after the crisis in the spirit of the new macroprudential approach. Therefore, we argued that while ideas and perception underwent change, the regulatory and supervisory arsenal did also. Following Baker and relying on the analysis of Peter Hall of policy paradigm shifts (Hall, 1993), we argued that all three levels of banking policy (calibration of rules, enactment of new meso-level regulation, new regulatory concepts) underwent change, and hence a paradigm shift has occurred since 2008.1 The current wave of regulation evolving in response to the crisis is not unprecedented, as all major financial crises have brought about regulatory changes. Some of these had a profound impact on the development of the banking sector as a whole. Such changes include the Glass-Steagall Act following the Great Depression of 1929-1933, or the set-up of the Basel Committee on Banking Supervision after the banking crises of the 1970s. Other changes focused on the resolution of individual problems, such as the adoption of rules relating to consolidated supervision after the bankruptcy of the BCCI in 1995, or the introduction of capital requirements for market risk in the 1990s following the first bank bankruptcies caused by speculative proprietary trading. But as we stated in our previous article, the changes in regulation evolving in response to the current crisis show fundamental differences 1 It was Baker who turned Hall’s analysis upside down and argued for the possibility of conceptual changes in a policy (third level of policy change) without changes in the first two levels of a policy.
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Macroprudential Paradigm Shift in Hungarian Bank Regulation to earlier changes. These changes not only modify the existing rules, but also result in a paradigm shift; former regulation – essentially based on a microprudential approach – is replaced by the paradigm of macroprudential regulation. Although the earlier microprudential rules are conserved by the new paradigm, their reach is now determined according to the new paradigm (essentially expressed by higher regulatory expectations). In addition, many new rules are introduced, which reflect the new paradigm. We identified two important properties of the macroprudential regulatory paradigm. Firstly, since rules are introduced not only for the avoidance of individual risks, but also for systemic risks, the new indicators and rates generally result in higher costs for banks than indicators calibrated in the past for individual levels. Secondly, confidence in the efficiency of the banking market, measured before the crisis, wavered as a result of the crisis. Thus, according to the new paradigm, state institutions are required to supervise banks more closely than before. To this end, in the spirit of the new paradigm, governments strengthen the powers of supervisory and regulatory authorities over banking market participants. Upon the review of trends identified on an international level, a line of questions arise in connection with the changes on the Hungarian banking market. Can a macroprudential paradigm shift actually be observed in Hungarian banking regulation and supervision since 2008? Which instruments of Hungarian banking regulation qualify as macroprudential instruments and why? Why was there a change in Hungary? To what extent has the new regulatory system strengthened the powers of state institutions over banks? How did banks respond to the regulatory changes? And finally, is banking becoming more stable, or does the macroprudential shift carry new risks? Our article attempts to answer these questions. We focus our attention on regulatory and institutional changes initiated by domestic stakeholders in the spirit of the macroprudential paradigm. We will therefore, not analyse all changes in Hungary associated with the macroprudential shift. We will not look at the Hungarian implementation of macroprudential rules adopted in the European Union, nor will we discuss rules simultaneously serving macroprudential, economic stimulus or monetary policy objectives. For example, we will not examine the bank tax. Finally, we will also ignore macroprudential measures implemented on the microsociological level of legislation, such as warnings, changes affecting information and data provision systems of banks, etc.
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Katalin Mérő – Dóra Piroska In the course of our research, we conducted semi-structured anonymous expert interviews with representatives of the public and private sectors. We addressed questions to the current and former colleagues of the Hungarian Banking Association, National Bank of Hungary (MNB), Hungarian Financial Supervisory Authority (HFSA), Ministry of Finance, as well as foreign and Hungarian banks. Most of the interviews were conducted in the autumn of 2013. We asked the interviewees about regulatory and institutional changes on the banking market in chronological order, but with different points of emphasis for each interviewee. The subsequent section of the article discusses analyses relating to the effects of the financial crisis on Hungary. We then identify the main characteristics of the macroprudential paradigm shift and its specific manifestation in Hungary. This is followed by an analysis of Hungarian regulatory and institutional changes adopted within the framework of the macroprudential paradigm shift. In this analysis, we deal separately with the effects of the IMF Agreement, the strengthened role of the state, and examine the banking sector’s reaction to the changes. In the final section, we draw our conclusions, formulate questions and discuss uncertainties concerning the future stability of the banking system, which follow from the analysis of our findings relating to the macroprudential paradigm shift in Hungary.
The 2007 crisis and Hungary: Review of Hungarian analyses Hungarian analysts examining the consequences of the 2007 financial crisis for the Hungarian banking sector formulated important conclusions pertaining to the spread and causes and effects of the crisis in Hungary. It is worth highlighting that neither the Hungarian market participants, nor the National Bank of Hungary or the HFSA expected the crisis to severely affect the Hungarian banking market at the time of its eruption. This is attributable to the fact that the Hungarian macro indicators were not particularly worse in comparison to previous years – in fact, they showed moderate improvement in 2007. In addition, in contrast to many countries, the rise in the volume of Hungarian mortgage loans was not accompanied by rising real estate prices, that is, there was no build-up of a real estate price bubble (Király– Nagy–Szabó, 2008, p. 609). Furthermore, Hungarian banks did not hold foreign mortgage-backed or structured securities that posed specific risks for them. Banks in Hungary significantly increased lending in the years leading up to the crisis. Growth in lending was financed not by domestic savings, but predominantly by foreign 6
Macroprudential Paradigm Shift in Hungarian Bank Regulation (mainly parent bank) funds, resulting in the sharp rise of the loan-to-deposit ratio in the banking sector and its exposure on the money market. Swiss franc denominated loans made up the bulk of new loans, which, geared for higher profitability, were financed by banks with short-term FX-swaps on the international money markets. Credit standards were simultaneously loosened.2 According to the analysis of Király et al. published in 2008, participants of the Hungarian market did not expect Hungary’s risk premium to surge in reaction to the crisis. When it did increase, the value of the forint depreciated temporarily and domestic yields increased. Simultaneously, the Hungarian government securities market was hit by liquidity problems and extreme price fluctuations (Király–Nagy– Szabó, 2008). Due to depleted liquidity on the international money markets, liquidity came at a higher price for the parent banks of Hungarian banks, contributing to the rising cost of credit financing. Király–Nagy–Szabó [2008] thus argue that the crisis arrived at Hungary, at the periphery of Europe, through two channels of contagion: the surge in risk premium and declining liquidity. In other words, the crisis reached Hungary notwithstanding the fact that structured securitisation was not characteristic of Hungarian banks, unlike core countries. In her analysis, Neményi [2009] agrees with Király that Hungary was hit much harder by the crisis than was to be expected (Neményi, 2009, p. 401). In her article, analysing the manoeuvring room of fiscal and monetary policies, she notes that Hungary suffered the crisis in the middle of a severe domestic political crisis. She expands on Király by arguing that the rise in the Hungarian risk premium is attributable not only to changes on the international money markets, but also to the growing country risk. The tense internal political situation led to a change of government in March 2009. Neményi [2009] also points out that the declining demand in Germany and generally in Europe as a result of the crisis caused the Hungarian real economy to face increasing problems from 2008 on. The high level of debt and worsening GDP data significantly limited the new government’s options for crisis management; fiscal stimulus was out of the question. Meanwhile, the quality of the money market deteriorated rapidly; parent bank funds became uncertain, the withdrawal of liquidity and escape to safe havens strengthened in early 2009. After the collapse of Lehman Brothers, demand for Hungarian government securities on the government securities market plummeted dramatically. Neményi [2009] observes 2 The profitability of Hungarian banks improved prior to the crisis. The profitability of the Hungarian banking system surpassed performance measured in the countries of the parent banks by 50 per cent, and in many cases by 100 per cent (Banai–Király–Nagy, 2010, p. 114).
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Katalin Mérő – Dóra Piroska several other external causes leading to the escalation of the crisis: speculative attacks launched against OTP and devaluation expectations. These factors jointly led to the Hungarian government’s application for assistance from the IMF, the European Union and the World Bank at the end of 2008 and its agreement on a credit line of approximately 20 billion EUR (MNB, 2009, p. 19.). Among the three international agreements, the one concluded with the IMF played the most important role in managing the crisis. Within the framework of this agreement, the IMF made available a credit line of 10.5 billion SDR (12.5 billion EUR) to the Hungarian government. Under the agreement, pursuant to Act CIV of 2008 (on strengthening the stability of the financial intermediary system), the Hungarian government designated approximately 2 billion EUR (HUF 600 billion) of the above credit line to strengthening the stability of banks (IMF Agreement, 2008, p. 1). Within the context of our argument, it is of even greater relevance that the Hungarian government committed itself to a series of macroprudential measures within the framework of the IMF Agreement (IMF Agreement, 2008). As demonstrated below, the key changes in domestic regulation were prepared by the IMF Agreement. Another agreement was concluded in 2009, which was very important in terms of the stability of the Hungarian banking system.3 Éva Várhegyi was first to describe in detail the circumstances surrounding the so-called Vienna Initiative4 (Várhegyi, 2012). The agreement was concluded by nine banking groups5 and the international financial institutions (IMF, European Commission, EBRD, European Investment Bank, World Bank) with the aim of guaranteeing the stability and liquidity of banks in the Central Eastern European region. The agreement was necessary because in response to government measures and the liquidity-providing measures of the ECB, Western European banks in the eurozone had no interest in funding their banks outside of the eurozone. Within the framework of the agreement, the banks pledged to maintain their financial assets (net exposure) at levels of late September 2008 and to recapitalize their banks in countries that conclude an agreement with the IMF and the EU on joint crisis management plans and crisis management (EBRD, 2012). The commitments undertaken in the Vienna Initiative became void upon termination of 3 Here we somewhat disagree with Rachel Epstein’s argument on the importance of the Vienna Initiative (Epstein 2014). 4 European Bank Coordination Initiative. 5 Erste and Raiffeisen of Austria, Intesa Sanpaolo and UniCredit of Italy, Bayerische Landesbank of Germany, KBC of Belgium, Société Générale of France, Swedbank of Sweden and EFG Eurobank of Greece.
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Macroprudential Paradigm Shift in Hungarian Bank Regulation the IMF credit agreements (as early as the autumn of 2010 in Hungary) (Várhegyi, 2012, p. 219). Several authors have analysed the Hungarian banking system after the crisis. These analyses commonly examined the sector in terms of competitiveness, and focused less on changes in regulatory measures (Várhegyi, 2010; Banai–Király– Nagy, 2010). Várhegyi [2010] distinguished three groups of crisis management measures introduced by the Hungarian state: (1) regulatory modifications that are competition neutral, (2) bailouts that are also intended to be competition neutral and (3) special measures, such as capital injections, asset buyouts and guarantees, which clearly distort competition. In her article analysing state regulation published in the 2012 issue of Verseny és Szabályozás (Competition and Regulation), Várhegyi draws a distinction between the crisis management strategy of core countries – which meant state capital injections in the first stage – and regulatory measures implemented in periphery countries, where state capital injections did not occur. Várhegyi mentions two reasons for the omission of substantial capital injection in Hungary. Firstly, the losses suffered by Hungarian banks were smaller than those of Western European banks, as the former held smaller portfolios of structured securities. Secondly, the majority of Hungarian banks are owned by Western European parent banks, which pledged to supplement capital, albeit they could use capital injections received from their own respective states for this purpose (Várhegyi, 2012, p. 217). Várhegyi, therefore, maintains the view that the monetary policy measures of the central bank played the key role in managing the crisis in Hungary. Várhegyi notes that in response to changes in the Western European regulatory environment and in reaction to the tighter capital requirements of the Basel III package, banks in Hungary are unable to raise capital at their subsidiary banks and could even be contemplating an exit from the market (Várhegyi, 2012, p. 221). When analysing the crisis management measures introduced after the change of government in 2010, both Várhegyi [2012] and Mérő [2014] observe the significant change in banking policy. Both authors emphasise that the banking policy of the Orbán government clearly strengthens the power of the state over market participants. Also, both authors make note of the new international regulatory solutions drawn up in Hungarian regulation in response to the crisis, at the same time as the change of government. Várhegyi analyses the effect of the unconventional management of household FX loans (solution involving the transfer of most costs to banks) and the bank tax (fiscally motivated) on competition in the banking market. In her analysis she concludes that the Hungarian regulatory measures amplify the 9
Katalin Mérő – Dóra Piroska already tightening effect of international regulations on banking activity. Várhegyi argues that the measures of the government that weaken the income positions of banks and, in some instances, undermine their legal certainty, also diminish the ability of the Hungarian banking sector to draw in funds (Várhegyi, 2012, p. 235). Mérő draws a similar conclusion in her analysis: The role of the Hungarian state as bank regulator and supervisor since 2010 has strengthened well beyond the already high levels warranted by the intensifying regulatory period after the crisis and the macroprudential paradigm shift. Mérő also observes the strengthening role of the state as expressing the ideology of the government. As an example, she notes the bank tax, which is very high in international comparison and effectively distorts competition, and the transaction tax levied on bank transactions (Mérő, 2014). In other words, both authors agree that components of the Orbán government’s banking policy point in one direction: the strengthening of the state’s role, while these changes are implemented simultaneously with the macroprudential paradigm shift in Hungary. However, certain critical components of Orbán’s government bank policy, such as the bank tax and the transaction tax, were introduced not in the spirit of the new paradigm, but as part of the statist ideology of the Orbán government. As discussed below, this has significantly hampered the analysis of the spread of the macroprudential paradigm in Hungary after 2010; it is increasingly difficult to analytically distinguish measures that qualify as macroprudential regulatory measures and statist measures of the Orbán government, or a combination of both. We reviewed above the most important studies of Hungarian analysts that assess the effects of the international financial crisis on the Hungarian banking system. We wish to complete these analyses with the description and analysis of changes affecting banking regulation.
Main characteristics of the macroprudential paradigm and its appearance in Hungary As noted in the introduction, after the crisis the governments of Western Europe and the United States sought regulatory solutions that were to ensure the mitigation of the risk of a banking crisis in the future on a systemic level, and hence reduce the probability of having to bail out banks with taxpayer money. The macroprudential paradigm serves the fulfilment of these two objectives. Table 1 contains a comparison of the macroprudential and the earlier microprudential perspectives. 10
Macroprudential Paradigm Shift in Hungarian Bank Regulation Table 1 The macro and micro perspectives compared Macroprudential
Microprudential
1. Proximate objective
limit financial system-wide distress
limit distress of individual institutions
2. Ultimate objective
avoid output (GDP) costs
consumer (investor/depositor) protection
3. Model of risk
(in part) endogenous
exogenous
4. Correlations and common exposures across institutions
important
irrelevant
5. Calibration of prudential controls
in terms of system-wide distress; top-down
in terms of risk of individual institutions; bottom-up
Source: Borio [2003], p. 2.
As shown in Table 1, the key difference between the macroprudential and microprudential perspective lies in the objective of regulation and the calibration of regulatory instruments, and not in the type of instruments applied. Depending on the objective and scope of a specific regulatory instrument, it may be either of a macroprudential or microprudential nature. If, for example, the capital requirements for market risk applicable to banks are calibrated to match the bank’s risk appetite and best risk management practices, then these are defined from a microprudential perspective. If, however, the results of macroeconomic stress tests – which account for significant market declines – are also taken into consideration, these are qualified among macroprudential regulatory instruments, which serve to protect not single institutions, but the system as a whole. Accordingly, we will classify specific regulatory instruments under macroprudential or microprudential instruments depending on the purpose defined by the regulator and the approach applied to their calibration. In Hungary, the macroprudential paradigm shift evolving in response to the crisis was and is driven by two factors. Firstly, as a member of the European Union, Hungary implements the macroprudential rules enacted by the EU. Secondly, the macroprudential model is increasingly applied in the crisis management and financial stability practices of Hungarian regulatory and supervisory authorities. Table 2 indicates changes in Hungarian banking regulation implemented in response to the crisis. The table lists regulatory measures that satisfy the 11
Katalin Mérő – Dóra Piroska requirements of macroprudential regulation listed in Table 1. Table 2 does not contain those Hungarian rules that are clearly of a macroprudential nature, but do not constitute the special responses of Hungarian authorities to the crisis, but rather express the mandatory implementation of European Union regulations in Hungary. Some of these have become an integral part of national regulation in recent years,6 while others must be applied only from 2014, in some cases on a gradual basis. In accordance with Table 1, the table similarly ignores consumer protection rules (e.g. banks’ Code of Conduct, its legislative codification, or various regulatory packages serving the rescue of FX debtors), or rules of a fiscal nature (bank tax, transaction tax). In addition, Table 3 indicates those institutional changes relating to the institutional framework of regulation and supervision, which, by nature, may support the spread of the macroprudential paradigm. Table 2 Macroprudential regulations enacted after the financial crisis Date
Regulation
Description
1. 7 November 2008
HFSA resolutions on individual real estate mutual funds
HFSA suspended for max 10 days the operation of real estate funds and the trading of units of real estate funds.
2. December 2008
Act CIV of 2008 on promoting the In relation to the 2008 IMF stability of the financial intermediary Agreement: 600 billion HUF fund system created to strengthen banks, which may happened through guarantee, capital increase based on the request of a bank, capital increase based on the decision of the state.
3. 30 December 2009 Government Decree on 361/2009 (XII.30.) on the terms of prudent retail lending and the assessment of creditworthiness
Introduced maximum requirements on loan-to-value (LTV) ratio on household mortgage lending. The limits were set in euro and forint, and other currencies. Payment-toincome (PTI) in forint, euro and other currencies was also introduced (effective from the 11th of June).
6 These include, for example, the addition of stress testing on VaR to capital requirements for market risk, or the regulation of bank manager remuneration subject to the mandatory application of long-term incentives.
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Macroprudential Paradigm Shift in Hungarian Bank Regulation Date
Regulation
Description
4. August 2010
Act XC of 2010 on ban of FX mortgage lending.
The ban was significantly eased in July 2011. Since then mortgage loans can be granted in foreign currency if the borrower has regular income in the same currency.
5. September 2011
Act CXXII. of 2011 on the central loan information system
Established the Credit Bureau in relation to retail lending.
6. January 2012
Government Decree No. 366/2011(XII. 30.) on liquidity coverage requirements for credit institutions and on the maturity mismatch of foreign currency positions of credit institutions.
Out of two new liquidity ratios at least one must be fulfilled in addition to fulfilling the requirements of foreign currency coverage ratio.
Table 3 Changes in the institutional framework of bank regulation and supervision Date
Institutional change
Description
1. January 2009
Amendment of the HFSA Act
Additional legal tools to react to the threats to the stability of the financial intermediary sector (exceptional data request, lengthening the duration of monitoring)
2. January 2010
Act CXLVIII of 2009 on some amendments of acts making financial supervision of the financial intermediary system more efficient amending the Act CXXXV of 2007 on the HFSA.
It establishes the Financial Stability Council. Its members are the Minister of Finance, Governor of Central Bank, and the President of HFSA. The same law modifies the Law on the Central Bank so that in case the stability of the financial intermediary sector requires it, the Governor has the initiative to recommend the creation of a new law to the government, which must react to the initiative by either making a new law or explaining why not.
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Katalin Mérő – Dóra Piroska Date
Institutional change
Description
3. December 2010
Act CLVIII of 2010 on HFSA.
Empowers the HFSA with the power to issue decrees on certain issues. In order to preserve the stability of the financial intermediary sector the HFSA may suspend activities and trading with certain products for max. 90 days or may make them conditional.
4. December 2011
Act CCVIII of 2011 on the Magyar Nemzeti Bank
With the modification of the Law on the Central Bank, the central bank received a number of rights to intervene in macroprudential regulation and supervision. (e.g. decree power in the area of systemic liquidity risk and development of new tools that may curb extensive credit outflow)
5. October 2013
Act CXXXIX of 2013 on Magyar Nemzeti Bank (MNB) with effect as of 1 October
The HFSA was integrated into the central bank.
The large number of listed regulatory and institutional changes indicates that the Hungarian authorities have indeed actively applied the macroprudential paradigm identified in international trends since the 2008 crisis. Our next analysis aims to determine whether the listed measures are only of individual importance or if they compose a uniform paradigm together.
Analysis of the macroprudential regulatory measures Effects of the IMF Agreement On 4 November 2008, the Hungarian government turned to the IMF with the aim of securing financial support for the financing of the comprehensive money market strategy jointly drawn up with the National Bank of Hungary, which was to also express and strengthen the international community’s confidence. The lending policy of the IMF in 2008 was fundamentally different from the policy commonly applied in the 1990s. Earlier, governments seeking support from the IMF were required to commit themselves to the full implementation of the economic policy 14
Macroprudential Paradigm Shift in Hungarian Bank Regulation measures drawn up by the IMF experts as a condition for the disbursement of the IMF credit (conditionality). From the 2000s, in reaction to intense criticism, the IMF radically modified this strategy and increasingly expects the credit applicant governments to draw up their own economic policy programmes that ensure the repayment of the credit (Barnett-Finnemore, 2004). In other words, in 2008 the Hungarian government turned to an IMF that expected the government to draw up its own proposals relating to fiscal and monetary policy and changes relating to the financial sector. In November 2008, the Hungarian minister of finance and the governor of the National Bank of Hungary sent a letter of intent to the managing director of the IMF (Dominique Strauss-Khan), in which they list in 19 points the monetary policy, fiscal policy and bank regulation measures they deem to be important for implementation (IMF Agreement, 2008). Upon review of this letter of intent, it becomes clear that it contained a surprisingly large number of measures from Tables 2 and 3. As noted above, we compiled the list of macroprudential regulatory and institutional changes in Hungary on the basis of the set of criteria drawn up by Borio [2003], and highlighted the changes based on those. Therefore, we compiled our list according to the main characteristics of the macroprudential paradigm and not on the basis of the IMF Agreement. Similarities are possible, as the IMF Agreement played a key role in the shift in macroprudential regulation in Hungary. We provide proof of this assertion in the following. The initial banking crisis management package of the Hungarian government entered into force in December 2008. This package was partly a result of and also supported by the IMF Agreement. According to point 15 of the letter of intent, “We have developed, in consultation with IMF staff, a comprehensive package of support measures available to all qualified domestic banks, to buttress their credibility and confirm our commitment to preserving their key role in the Hungarian economy.” (IMF Agreement, 2008, p. 5). This intent was fulfilled by the Act CIV of 2008 – marked No 2 in Table 2. Pursuant to the act, HUF 600 billion of the IMF credit line was appropriated to strengthen, if necessary, the banks’ position either through the undertaking of guarantees, the provision of capital if applied for by the banks, or a provision of capital by unilateral decision of the state. Under EU competition law, any Hungarian bank could have been eligible to receive funds from the credit line, but, in practice, it allowed the support of banks owned by the state and those without controlling foreign ownership.
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Katalin Mérő – Dóra Piroska After 2008, FHB, MFB and OTP banks received funds from this credit line (for details see Várhegyi, 2012, p. 217–218). The state guarantee provided to OTP is of a macroprudential quality because OTP – owing to the size of its portfolio – is regarded as a domestically systemically important bank. The provision of state funds to FHB has a macroprudential quality because FHB is also regarded as a domestically systemically important bank owing not to its size, but to its being the most important bank within the limited context of its area of operation –issuing mortgage bonds. The complete set of measures may be qualified as macroprudential for an additional reason: At the time of its adoption, the government focused on the stability of the entire economy, that is, it aimed at achieving economic stability and not at assisting individual banks. This is further supported by the fact that in 2009, after the amendment of the Budget Act, the government disbursed credit to non-foreign owned resident banks (OTP received 1.4 billion EUR, FHB received 400 million EUR in credit) on the condition that the banks expand their household and corporate credit portfolios to offset the effects of the financial crisis. Thus, the objective was the avoidance of macroeconomic losses caused by stalled lending and not the assistance of individual banks. Under point 14 of the IMF Agreement, the government made a commitment to “step up [...] efforts to strengthen the HFSA’s and MNB’s capacity to assess and address solvency and liquidity concerns in banks in a timely manner.” (IMF Agreement, 2008, p. 5). In other words, the Hungarian government was to expand the systemic risk management options of the two institutions. The HFSA Act was first amended in 2009 in response to this, which granted additional powers to the institution to identify stability and risk factors of the financial intermediary system (extraordinary data provision, option to extend monitoring). Act CXLVIII of 2009 on the amendment of the HFSA Act entered into force on 1 January 2010, which set up the Financial Stability Board in the capacity of money market coordinating organisation. By amendment of the Central Bank Act, this same law allowed the governor of MNB to initiate the enactment of legislation that served the stability of the financial intermediary system. Thus, the amendment of the HFSA Act in December 2010, which grants decree enactment rights to the HFSA, and the amendment of the Central Bank Act in 2011, which grants regulatory and intervention powers to the MNB, fulfils the commitment made to the IMF. Finally, the merger of the MNB and HFSA can also be added to this category, although the bolstering of state institutions by the Hungarian government after 2010 was not principally motivated by commitments toward the IMF or the promotion of the macroprudential paradigm. 16
Macroprudential Paradigm Shift in Hungarian Bank Regulation According to point 16 of the IMF Agreement, the government makes a commitment to the “introduction of maximum loan-to-value ratio requirements for new mortgage loans” (IMF Agreement, 2008). This ratio was specified in the government decree adopted in December 2009 [361/2009. (XII. 30.)], which, however, only entered into force on 1 March. The maximum loan-to-value (LTV) ratios were introduced at this time for household mortgage and vehicle financing loans. The limits were determined in forints, euro and other foreign currency. This same government decree determined payment-to-income (PTI) limits in forints, euro and other foreign currency, which entered into force on 11 June 2009. Both indicators were introduced for macroprudential reasons. Point 16 of the IMF Agreement also established the commitment to introduce a positive credit registry for households. This was adopted in the form of regulation in September 2011; after creating an adequately sized initial database necessary for operation. The banks began using the registry from April 2012. The introduction of a positive credit registry had been on the agenda in Hungary since the early 2000s. Its implementation was primarily hindered by strong opposition from the privacy ombudsman, even though many Hungarian banks and the MNB had been lobbying for its introduction since the early 2000s, with continuous lobbying efforts from the HFSA since the summer of 2004. At the time the government, specifically the Ministry of Finance, as regulatory authority, judged the data-protection concerns relating to the positive credit registry to be well founded. The positive credit registry was included in the IMF Agreement upon the initiative of the MNB. However, the government’s views were so divergent (in relation to the interpretation of privacy, legal protection and democracy, for example), that this became one of the few points of the agreement that were not implemented by 2010. The new government enacted regulation relating to the operation of the positive credit registry only after the rejection of the IMF Agreement. One of our interviewees maintains that this was motivated less by the need for more effective management of systemic risks (although it is obviously strengthened) than the government’s intention to make some kind of concession to the banks and weaken opposition after introducing legislation allowing the full repayment of loans. It is noteworthy that point 13 of the IMF Agreement was not implemented in the form set out in the agreement. This point outlined a three-step debt resolution strategy proposed by the government. According to our source at the Ministry of Finance, the Bajnai government chose not to enact the fully drafted piece of legislation because
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Katalin Mérő – Dóra Piroska it was unnecessary due to continuously assessed bank data. The Orbán government, as we may recall, chose a different strategy to resolve the issue of defaulted loans. Finally, we need to emphasise that the IMF Agreement was concluded in 2008, immediately after the crisis had encircled Hungary. The agreement set out a large number of new regulatory and institutional changes. Their formulation was possible only because such regulatory changes had been proposed earlier on a conceptual level. Therefore, the macroprudential changes defined in the IMF Agreement – though previously existent– became clearly desirable only within the framework of the paradigm shift evolving in response to the crisis.7 In other words, the crisis led to the introduction of the macroprudential rules; the IMF Agreement only organises these into a single programme and bolsters the state’s willingness to introduce them.
The expanding role of the state – unique developments in Hungary One of our key observations relating to the growing role of the macroprudential paradigm was that it favours the state in a state vs. market context, as it increases the state’s influence over market processes. National regulation in Hungary was essentially adapted to international best practices before the crisis, although it was more lenient in some important cases. As previously noted, there was no Credit Bureau for households, no income coverage requirements or mandatory liquidity requirements were in place, loan-to-value limits were only applicable to mortgage banks, with relatively limited intervention options available to the bank supervisory authority. After the crisis, Hungarian banking regulation underwent change in response to the international macroprudential paradigm shift. This entailed several things. Firstly, Hungarian regulation was adjusted to the shift in mandatory international regulation, that is, Hungary has been continuously introducing rules prescribed for banks by the international regulatory authorities and the European Union as part of the regulatory wave following the crisis. This wave of regulation – not analysed here – has many effects, which contributed to the strengthening of the state. Secondly, the regulatory components that had been omitted earlier were introduced within the framework of the local macroprudential paradigm shift, which is analysed here, in 7 It is noteworthy that upon reviews of the IMF Agreement, the government commits itself to implementing other measures that may be regarded as macroprudential. These measures, however, are not discussed in this article, as our aim is to document the changes in 2008.
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Macroprudential Paradigm Shift in Hungarian Bank Regulation some cases more stringently than applied by the international best practices. This is because, according to the new paradigm, these rules were drawn up and calibrated not for the risks of individual banks, but in view of the requirement of ensuring the stability of the banking system. Three things should be noted in connection with the series of measures that strengthen the power of the state. Firstly, many of these measures had been considered before the crisis as a source of desirable change, but they were either not urgent, or there was insufficient political will to implement them. Secondly, before the crisis, the banking supervision model of Hungary split the supervision of banks between two state institutions: the HFSA was mainly responsible for the oversight of microprudential risks, while the MNB (the central bank) was responsible for the supervision of systemic risks. In the spirit of the macroprudential paradigm, the government alternated between strengthening the powers of the HFSA or those of the MNB, which inevitably generated conflict. The central question of the debate surrounding the role of central banks as banking supervisor is whether the central bank’s function as banking supervisory authority produces more advantages or disadvantages. It is an advantage that by carrying out supervisory functions, central banks can access more information faster in connection with financial stability issues, which is important, in particular, with respect to the central banks’ general responsibility for financial stability, the operation of monetary policy’s credit channel and the exercise of the central bank’s Lender of Last Resort function. It is a disadvantage that the fundamental conflict of interest between monetary policy and banking supervision cannot be articulated. A conflict of interest essentially means that in a period of economic decline, for example, monetary policy should be tighter in its own right, and a looser policy in terms of financial stability. The balanced weighing of varying interests is more effective if the conflict is managed by independent institutions that apply checks and balances to each other. It is no coincidence that after the creation of the eurozone in the European Union, several countries integrated supervisory functions with the central bank, once the conflict of interest between monetary policy and financial stability policy ceased as a result of terminated national monetary policy. Thus, the independent system of supervision integrates checks and balances in the system in terms of banking regulation by virtue of the institutional division of functions. The abolition of this model and the introduction of the institutional model of merged banking supervision clearly served the supervisory function and strengthened the
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Katalin Mérő – Dóra Piroska state vis-á-vis the market. This also entailed the elimination of conflicts, i.e. checks and balances, existing under the earlier model. Lastly, it is important to emphasise that from the change of government in 2010, the expanding role of the state as banking regulator and supervisor well exceeds the level warranted by the macroprudential paradigm shift. Keeping in mind these three points, we look at regulatory changes that strengthened the role of the state in Hungary. The Stability Act, enacted in 2008, provided the first macroprudential response to the crisis; all three possible functions of the state (undertaking of guarantees upon banks’ request, raising of capital upon banks’ initiative, raising of capital by unilateral initiative of the state) resulted in strengthening the influence of the state. Among these functions, the right to raise capital clearly provided the most powerful licenses for the state. The amendment of the HFSA Act, enacted in January 2009, demonstrates the widening powers of state authorities; granting additional powers to identify any risks to the stability of the financial intermediary system. The setup of the new state institution also bolstered the state. The subsequent amendment of the HFSA Act (Act CXLVIII of 2009), entering into force on 1 January 2010, set up the Financial Stability Board, whose members are the minister of finance, the governor of MNB and the president of HFSA. The Financial Stability Board was responsible for the exchange of information and coordination in macroprudential matters. By amendment of the Central Bank Act, this same law allowed the governor of the MNB to initiate the enactment of legislation serving the stability of the financial intermediary system. The government was required to respond within 15 business days either with measures serving the enactment of legislation or with the justification for omitted legislation. The aim was to allow the state to manage risks not only on the level of individual banks, but also on a systemic level through the expanded powers of state authorities and the new state organisation. The result is stronger state power vis-á-vis the banks. At the end of 2010, parliament enacted another law that widened the powers of the HFSA: Act CLVIII of 2010, i.e. a further amendment of the HFSA Act. Under the law, the HFSA was granted the right to enact decrees in certain matters and was also granted the licence to provisionally suspend certain activities and products. The latter right was in harmony with similar licenses of financial supervisory authorities in the EU. It is, however, very much open to debate (and was questioned by the MNB) whether such a right should have been granted to the HFSA, which essentially exercises microprudential powers, or to the central 20
Macroprudential Paradigm Shift in Hungarian Bank Regulation bank of Hungary, which exercises macroprudential powers. The question was only resolved with the merger of the HFSA and the MNB. Prior to the merger, the MNB was granted macroprudential regulatory and intervention powers by amendment of the Central Bank Act in December 2011. Finally, the integration of the HFSA within the MNB in October 2013 can be identified as part of the process of concentrating the powers of the state. The strengthened role of the Hungarian state stands in contrast with trends in Western Europe. To avoid an escalation of the financial crisis in Western Europe, governments had no choice but to provide substantial state assistance to banks. The political legitimisation of the bailout was only possible if taxpayers were simultaneously reassured through bolstered state regulatory authorities that there would be less reliance on their money in the future. Some analysts argue that the spread of the macroprudential paradigm (the point of which is partly to handle systemic risk with microprudential tools calibrated beyond the level of individual risk, and also to strengthen the supervision and control of state institutions) is attributable to state capital supplied to banks earlier (Baker, 2013). A bailout in Hungary, however, was essentially unnecessary in response to the crisis.8 Therefore, the growing relevance of the macroprudential paradigm must be attributable to other factors. The paradigm shift observed in the operation of the Hungarian regulatory authorities is essentially the result of conformity to regulatory trends in Western Europe. As noted above, the regulatory measures listed in the IMF Agreement fit into this trend, although these can be interpreted as internally motivated. The money market policies of the Orbán government – aimed at strengthening the state – are also domestically, ideologically motivated. However, as noted above in the review of literature, it is important to emphasise that the steps taken by the Orbán government run parallel with the macroprudential paradigm, but they are not motivated by the paradigm shift. The banks’ response to macroprudential rules If we observe the rules contained in Table 2 from the banks’ point of view, with the exception of the Stability Act, these may even qualify as microprudential rules in terms of their ultimate and proximate objectives, as the rules also reduce the probability and/or the effects of problems affecting individual institutions, and thus 8 Under the Stability Act, only FHB received capital, which was of a negligible amount from a taxpayer point of view.
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Katalin Mérő – Dóra Piroska protect depositors. From a microprudential perspective, however, the calibration of prudential controls serving macroprudential objectives may seem unreasonably excessive because, in terms of the stability of individual banks, significantly looser rules (higher LTV ratios, lower PTI, looser liquidity rules etc.) would be sufficient for the protection of the given institution, if we ignore the endogenous nature of risks and correlations between the institutions. Compliance with macroprudential rules raises the cost of banking, as it results in more capital, higher liquidity and less lending activity. It follows that banks hold a conflicting interest in macroprudential regulation. A stable financial system is also essential for profitable banking. In the short term the macroprudential rules seem unreasonable and too costly, and their correlation with the objectives they represent do not appear to be obvious. We wish to illustrate such conflicting interest with a fictitious example. Let us imagine that after 2002, when FX lending rapidly picked up pace, the Hungarian authorities would have introduced LTV and PTI regulation similar to that introduced in 2010. We can say without exaggerating that the banks would have strongly opposed such a proposal. From a microprudential perspective, namely, when the foreign exchange markets are liquid, and the HUF permanently strengthens or at least remains stable, there is no rational need to introduce prudential controls that significantly vary for different foreign currencies. Furthermore, the large interest rate spread between foreign currency and forint funds created the illusion for creditors that lending at the cheap FX lending is possible in large volumes and at low risk levels, which also has positive effects on public welfare and economic growth. The drafting of restrictive rules would have necessitated a macroprudential perspective that focuses on systemic problems and applies a top-down approach. It, therefore, would have taken into account that in the event of an excessively large exchange rate shock the risks would become endogenous, and as a result of correlations among institutions and the exposure of several institutions to the same risks the financial system would face severe problems. Actual growth in lending contributed to vulnerability also from a microprudential point of view (on the level of individual banks), particularly as a result of ignoring consumer protection criteria, and investor protection criteria in relation to securitisation. The above example also illustrates the fact that banks inherently manage their risks on a microprudential basis. It follows that the risk-based regulatory approach evolving within the framework of the Basel consensus and implemented within the Basel II framework, which builds on the best risk management practices of banks, 22
Macroprudential Paradigm Shift in Hungarian Bank Regulation could only have been microprudentially driven. It is no coincidence that prior to its introduction, the regulation faced intense criticism for its procyclical nature, i.e. for not focusing on systemic risks, in other words not being macroprudential (Danielsson et al., 2001). Thus, macroprudential risk management and regulation based thereon can only be manifested as external requirements from banks; and the strengthening regulatory function of the state, which may be interpreted by banks as exceeding the requirements they fulfil for effective risk management, and may therefore be seen as unreasonable under normal market conditions. The introduction of macroprudential regulation is possible only after a severe crisis, as the additional requirements applied to banks legitimise the losses suffered and the burdens placed on taxpayers, even though their adequacy and efficacy in achieving stability in the financial system is unproven. We analyse below the measures contained in Table 2 from the banks’ point of view. In 2008, the suspension of real estate funds with individual decisions of the HFSA clearly served macroprudential purposes. There were concerns that if customers redeemed their units in open-ended real estate funds on a massive scale, the fund managers would conduct forced sales of the funds’ real estate portfolios, which would lead to the rapid collapse of the real estate market. The HFSA obliged fund managers to revise their fund management policies during the period of suspension so as to set out t + 90 days permitted by law for the repayment of units, instead of the commonly applied t + 3 days. The response of banks to this measure was mixed. Banks whose real estate funds suffered a substantial decline in net asset values due to mass redemptions witnessed after the Lehman bankruptcy, and who’s portfolios contained a relatively low ratio of liquid assets and a high ratio of real estate, supported the measure, as they were relieved of the obligation to carry out mass forced sales with the suspension of payments. In contrast, the Erste Group – which controlled the largest real estate fund – judged the measure to be unnecessary; it even issued a notice to the effect that the measure of the HFSA is unreasonable and unnecessary with respect to the funds it managed. As early as the drafting phase of the Stability Act, one of the most contested issues was the definition of cases, in which the state has the authority to unilaterally require banks to raise capital. The debate surrounding this issue was particularly intense in the case of OTP Bank, as OTP is Hungary’s largest bank that has no financially strong strategic owner and carries systemic risks. Concurrently, foreign bank owners 23
Katalin Mérő – Dóra Piroska were similarly unsupportive of the Hungarian state gaining the opportunity to possibly increase their powers of intervention. With regard to the raising of capital by regulation, the positions of the state and the banks were obviously in conflict; with a view to maintaining financial stability, the state supported the facilitation of raising capital, while the banks would have preferred to restrain the state’s power in order to retain their independence. The approved law reflects the strong bargaining position of OTP and the banking sector, as the very stringent rules defined for a unilateral raising of capital permitted the raising of capital by the state only under conditions of a severe bankruptcy, and not for the avoidance of a possible bankruptcy under nearbankruptcy conditions. This is how an interviewee working in the banking sector recalled the events: “The banks essentially interpreted this as aggressive efforts at nationalisation and firmly rejected them. They did so because the situation was different than in member states of Western Europe ... there was no need for the state to bailout any of the banks because there were no bankruptcies at the time ... We were aware of Hungary’s fragile position. The dominant narrative within the entire sector was that the banking sector would easily survive this whole crisis because we believed that the main cause of the crisis were toxic assets. ” The maximum LTV and minimum PTI related requirements were introduced on 1 March 2010 and on 11 June 2010, when, in reaction to the crisis, household FX lending had completely stalled and HUF lending almost completely. Therefore, it comes as no surprise that, as shown in Figure 1, not only the LTV and PTI limits, but the introduction of the other rules limiting banking operations did not result in the decline of lending, as all of these were introduced at a time when banking activity was on a minimal level even without these. Accordingly, the banks considered the introduction of these measures as unnecessary and late, and not as tools preventing excessive risk taking. The banks nevertheless aimed to retain their potential freedom of movement in the debate leading up to the drafting of legislation, lobbying in favour of the codification of looser limits.
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Macroprudential Paradigm Shift in Hungarian Bank Regulation Figure 1 Amount of newly granted mortgage loans (in billion HUF) and the macroprudential measures 500 450
FX coverage ratio
400 350
New liquidity ratios
LTV maximum
300
PTI maximum and ban on Fx lending
250 200
Credit Bureau
150 100 50
2008. I. II. III. IV. 2009. I. II. III. IV. 2010. I. II. III. IV. 2011. I. II. III. IV. 2012. I. II. III. IV. 2013 I.
0
Mortgage (HUF)
Mortgage (FX)
Source: MNB.
The MNB drew up the quantified proposals on LTV limits (MNB, 2009). The original proposal targeted a maximum 70 per cent LTV, which was considered much too low by the banks, particularly in view of the falling value of real estate and the fact that relatively low LTV limits may impede the recovery of lending in the future. They argued in favour of an 80 per cent LTV limit, which was applied in many countries. The regulation ultimately established a 75 per cent LTV limit. This is regarded as a compromise not only by virtue of setting an LTV ratio halfway between the proposal of the banks and that of the MNB, but it also significantly reduced the banks’ cost of capital within the 70-75 per cent LTV range.9 9 While the 35 per cent preferential risk weight could be applied earlier in relation to household mortgage loans if the LTV did not exceed 70 per cent under the standard method of Basel II, the LTV
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Katalin Mérő – Dóra Piroska The introduction of the PTI limits was also implemented with a compromise. The original proposal of the MNB set out a 30, 40 and 50 per cent payment-toincome ratio, depending on the income levels of households. This was opposed by the banks firstly due to the high ratio of the shadow and grey economy in Hungary, and secondly because of the availability of credit products (typically card credit), where the usual credit lines equalled 1-2 months wages. The withdrawal of such products would have caused major problems for both the banks and their customers. As a compromise, the rule does not prescribe a mandatory maximum ratio, but each bank is required to apply its own PTI limit with respect to HUF credit products. The stricter limit applied to FX loans, and variation between limits applied to the euro and other foreign currencies with the obviously limited availability of foreign currency funds did not face strong opposition from banks either in relation to the LTV or the PTI. The de facto prohibition of FX lending10 in August 2010 came at a time when banks had only been offering FX loans in negligible amounts. Obviously, the prohibition can be abolished by simple amendment to the regulation if this is necessitated by the market.11 The LTV and PTI ratios applicable to FX lending, which are stricter than in the case of HUF lending, will again be effective after the lifting of the prohibition of FX mortgage lending. Our interviewee commented on this regulatory measure as follows: “The regulation came late. This rule was introduced at a time when lending practically came to a halt. We argued that the state is aiming to further limit the manoeuvring room of banks at a time when lending is very sluggish. We particularly opposed the payment-to-income rules. Statistical income in Hungary was very low at the time and banking practices were not in conformity with these standards. The state was an accomplice in a way, because had either government intended to consciously “whiten” the economy during the credit boom, it could have simply required banks to only lend to customers with official incomes. Our position echoed existing practices.”
limit relating to the preferential risk weight was also increased to 75 percent simultaneously with the introduction of the 75 percent LTV limit. 10 The regulation did not prohibit FX lending per se, but prohibited the registration of mortgages relating to FX loans. 11 Regulation relating to the prohibition of registration has been significantly eased since then as a result of compliance with EU regulations and the relevant position taken by the EU. Pursuant to Government Decree 110/2011, the mortgage related to an FX loan may be registered if the income of the borrower is paid in foreign currency and exceeds fifteen times the amount of the minimum wage.
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Macroprudential Paradigm Shift in Hungarian Bank Regulation As noted in the section discussing the role of the IMF, the Credit Bureau stands out among the macroprudential rules as a measure that was also supported by the banks. This is attributable to the fact that the Credit Bureau not only improves the security of lending on a macroeconomic level, but also improves the risk management of banks. Liquidity regulation was introduced only in 2012. With depleted money markets, the tightening of liquidity regulation and the requirement of mandatory indicators may further stoke liquidity tensions. The introduction of the indicators after the liquidity crisis, therefore, seems to have been well-timed. Moreover, the form12 and calibration of the indicator requirement was drawn up so that compliance at any given time would not cause major problems and adjustment constraints for banks, but serve as a forward looking instrument against liquidity tensions. It follows that the banks did not make strong lobbying efforts against the introduction of the indicators. Our interviewee summed up the strengthening of the state’s regulatory power as follows: “I think it was very unfortunate for the banks to be under political assault and financial exhaustion at the same time. The regulatory authorities may have had the best intentions; they nevertheless contributed to this process and were completely insensitive to the barrage of rules imposed on a depleted banking sector.” A few consequences of the macroprudential paradigm shift – new problems and risks related to banks’ incentives Looking back from 2014, the paradigm of banking regulation in Hungary also experienced a major shift after the financial crisis. Firstly, the rules and institutional changes adopted in the spirit of the macroprudential paradigm evolved from a new interpretation of banking risks, which also focused on systemic risks, and resulted in more rules, and buffers calibrated to higher levels in relation to numerous existing rules. Secondly, the new rules and institutions changed the relationship between the state and participants of the banking market. The state gained new powers and strengthened its ability to control banking processes. As a unique aspect of Hungarian developments, from the change of government in 2010, the function of the state was strengthened not only on account of the macroprudential paradigm applied 12
ratio.
Banks were required to comply with either the deposit coverage ratio or balance sheet coverage
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Katalin Mérő – Dóra Piroska within an international context, but also as a result of the unorthodox ideology of the Hungarian government in power. The question arises as to whether the regulatory paradigm that leads to more costly and greater state control does indeed reduce risks on the banking market. Our answer does not explore the changes in Hungary, discussed above with Hungarian examples, but examines the risks inherent to the nature of the macroprudential paradigm. We are of the view that although the macroprudential paradigm shift in regulation manages a series of risks that have arisen in the past, it also generates new incentive related problems and risks. We have yet to witness these, of course, as the new regulatory scheme evolving from the paradigm shift has only recently been put in place or will be in effect in the near future. The risks and incentive related problems analysed below, however, logically follow from the above observations and will likely also play an important role in the future development of the Hungarian banking market. As the most important incentives related problem identified by us, the motivation of banks will be greater to withdraw their activity from the scope of regulation. Macroprudential regulation focuses on banks and consolidated bank groups. Since the cost of risks calibrated under the macroprudential paradigm is significantly higher than under the earlier microprudential paradigm, market participants are motivated to attempt to maximise the number of activities conducted outside of the scope of regulation. There are two ways to achieve this: a significant upturn in the activity of non-bank financial intermediaries or other innovation aiming at regulatory arbitrage. The role of non-bank financial intermediaries was growing even before the current crisis, as effectively illustrated by the development of the shadow banking system that contributed to a rise in lending and an enormous leverage. Macroprudential regulation can block channels that caused the growth of non-bank financial intermediaries in the past, but encourage banks to develop innovative methods that allow them to transfer financial intermediation to organisations falling outside of the scope of macroprudential regulation. Regulatory arbitrage of this type was commonplace even before the crisis; changing the product structure of banks in the direction of lower capital costs through, for example, a boost in securitisation and re-securitisation, or a preference for trading book risks. These options of regulatory arbitrage may have ceased, but incentives to develop new – yet unknown – forms have significantly increased as a result of more costly regulation because, as noted above, macroprudential regulation puts a higher price on banking activity than microprudential regulation did. 28
Macroprudential Paradigm Shift in Hungarian Bank Regulation A stronger motivation for regulatory arbitrage may result in the banks’ larger exposure to previously unknown risks not identified by regulators. It is unique to financial innovation aimed at regulatory arbitrage that in the period of its development, spread and mass presence, risks resulting from the given innovation are yet to be identified. The banks are developing innovative products that function as market alternatives to products regulated in the past. However, since neither the market, nor regulators understand the specific operating mechanism and risks of the product, the new product can be produced at a lower regulatory cost. Once the innovative product is applied on a mass scale, it may generate new risks, the nature of which is unknown, and may thus undermine the stability of the financial system. Furthermore, since the spread of the macroprudential paradigm entails change not only in individual countries, but in many countries simultaneously, this gives rise to the international dimension of regulatory arbitrage. In their article, Csajbók and Király [2011] note that unless states harmonise their macroprudential measures, owing to the high level of capital mobility, the potential for arbitrage that exploits the different regulatory systems of countries will increase. In other words, if, for example, capital and liquidity indicators are calibrated to a higher level to maintain the stability of money markets in certain countries, capital can be simply diverted to other countries that offer similar investment opportunities. Due to high capital mobility, non-coordinating countries may easily find themselves in regulatory competition that is incompatible with macroprudential principles, where uncoordinated, looser regulation provides a competitive advantage to banks that are subject to looser macroprudential regulatory standards. Since countries having already approved macroprudential rules would be forced to take part in regulatory competition, it is a paradox that with lacking coordination the macroprudential rules would induce systemic risks not only domestically, but in other countries as well. In this article we have not analysed, but only made references to the various changes in international regulation prompted by the macroprudential paradigm, the most important of which are several provisions of the BCBS Accord published in 2009, known as the Basel III package, which has also been published in the form of a European Union directive (so-called CRD IV Directive) and regulation (socalled CRR Regulation). For the avoidance of such risks, the most important banking market reform of the European Union, the European Banking Union, should extend not only to single supervisory mechanism, but also to a uniform regulation (Single
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Katalin Mérő – Dóra Piroska Rulebook) and to a single crisis resolution mechanism. The simultaneous enactment of these rules may reduce the risk identified by Csajbók and Király. The boosting effect of macroprudential regulation on cross-border activity and higher risks is similarly attributable to the mobility of capital. Since the macroprudential provisions prescribe higher capital and liquidity requirements, it is possible (as was the case in 2008, before the Vienna Initiative) that international bank groups will be forced to withdraw capital or liquidity from their subsidiaries in order to fulfil the higher capital or liquidity requirements in the parent country. In other words, systemic risks may arise in response to macroprudential rules adopted in the parent country in small, open economies, where international banks play a prominent role. The Vienna Initiative of 2008 – also affecting Hungary – was implemented with the support of the IMF-EU-EBRD precisely to manage this risk. At the same time, the management of this risk was also relevant from an additional macroprudential perspective, which was applied by Slovakia, for example. The liquidity ratio was initially raised in 2008 for banks operating in Slovakia with predominantly Western European parent banks to ensure that these are not in the position to easily move high Slovakian liquidity out of the country. The central bank issued a recommendation in 2012 serving the prevention of capital withdrawal, which was observed by banks on a mandatory basis, and led to the limited payment of bank dividends. It is noteworthy that the two measures were not aimed at the regulation of specific Slovakian banks, but to maintain the stability of the system. Therefore, these are regarded as having a macroprudential function. The two measures, however, may also be interpreted as protectionist measures, as they aimed to protect the stability of the national banking sector against international influences. Conclusions This article analyses the appearance, characteristics and consequences of the macroprudential paradigm shift taking place in Hungarian banking regulation. We established that the paradigm shift evolving in international banking regulation in response to the financial crisis was also implemented in Hungarian regulation. It is unique to Hungary that the regulatory paradigm shift was triggered not in reaction to budgetary funds allocated to bank consolidation, but amounted to a local response adjusted to international trends set off by the crisis. This shift was first shaped into a programme by the IMF Agreement.
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Macroprudential Paradigm Shift in Hungarian Bank Regulation The two key characteristics of macroprudential regulation, that regulation focus not only on risks threatening individual banks, but also on those arising on the level of the whole banking system, can also be observed in Hungary. Firstly, compliance with regulation comes at a higher cost for banks, as the rules defined on a systemic level are higher in number and calibrated with greater stringency than microprudential rules. Secondly, the strengthening role of the state with respect to banking regulation and supervision is also noticeable in Hungary. It follows that the banks generally find the macroprudential regulatory measures and institutional changes discussed here to be excessive, which may throttle the development of banks in a future period of recovery. Moreover, the Hungarian banking sector belongs to typically Central Eastern European banking systems, where macroprudential regulation in the parent country of the banks’ owners may work against the macroprudential stability of the local banking system. The Vienna Initiative was taken to manage this risk, with the need for macroprudential regulation of uniform strength expressed by numerous components of the Basel III regulation package and in the composition of the European Banking Union. It is necessary to be aware that macroprudential regulation also gives rise to new incentive related problems and risks. The macroprudential paradigm shift observed in banking regulation is adequate to manage risks within the banking system, which played a key role in the eruption of the current financial crisis. By defining and calibrating the defensive lines necessary to contain risks within the financial sector as a whole, it strengthens the stability of the financial sector. If the macroprudential rules recently introduced, or to be introduced in the near future, had been in place before the current crisis, the crisis would probably not have occurred, or would have done so with a less severe impact. However, the fact that macroprudential regulation is irrationally expensive from the perspective of banks, they become significantly more inclined to apply regulatory arbitrage, which in turn generates new, unknown risks for both banks and regulators. The new, unknown risks may even undermine the stability of the financial system. Thus, on the basis of the knowledge currently available, we are unable to answer the basic question of whether the macroprudential paradigm shift strengthens the stability of the financial system.
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