Hungary Recapitalization Scheme

In the midst of the global financial crisis in October 2008, the Magyar Namzeti Bank (MNB), the Hungarian national bank, noticed a selloff of government securities by foreign banks and a large depreciation in the exchange rate of the Hungarian forint (HUF) in FX markets. Hungarian banks experienced liquidity pressure due to margin calls on FX swap contracts, prompting the MNB and Minister of Finance to seek assistance from the International Monetary Fund (IMF), European Central Bank (ECB) and the World Bank. The IMF and ECB approved the Hungarian government’s (the State) requests in late 2008 to create a €19 billion facility, with HUF 600 billion (€2.2 billion) intended to back a bank support program (the Program). The Program would involve the creation of two schemes, one of which, the recapitalization scheme, would be financed by a Capital Base Enhancement Fund (CBEF), aimed at shoring up the capital ratio of large banks operating in Hungary and maintaining financial stability in Hungary. Only one institution, FHB Mortgage Bank plc, participated in the scheme, having drawn down HUF 30 billion in March 2009, which was fully repaid by February 2010. Nonetheless, some analyses of the recapitalization scheme deemed it relatively successful since its operation reassured banks and investors that financial institutions would have a capital buffer in the event of a sudden economic decline or to backstop the ongoing risks in long-term funding. However, due to the low usage of the overall Program, the State created a new liquidity scheme to provide direct on-lending measures to three of its largest domestic financial institutions in March 2009. The recapitalization scheme was repeatedly approved for extension by the European Commission, until it was finally allowed to expire in June 2013.

In the years leading up to the global financial crisis, the Hungarian banking sector depended largely on foreign investment and foreign exchange loans. In the wake of Lehman Brothers’ bankruptcy and the ensuing credit crunch, investors began exiting investments from Hungary, leading to a selloff of Hungarian government bonds. The floating Hungarian forint depreciated drastically, motivating foreign investors to exit investments in FX (foreign currency) swap contracts with Hungarian banks. Margin calls placed severe liquidity pressure on banks, straining the stability of Hungary’s banking sector. In October 2008, Hungary’s national bank, the Magyar Nemzeti Bank (MNB), reached out to the International Monetary Fund (IMF), European Central Bank (ECB), and World Bank for assistance. The IMF and ECB granted Hungary €19 billion to support a national economic package that sought to address Hungary’s fiscal needs and improve financial stability with the hope of reducing the risk of contagion in Central and Eastern Europe.

As part of the multilateral package, a HUF 600 billion (€2.2 billion) bank support program (the Program) was split between a guarantee scheme and a recapitalization scheme. The recapitalization scheme was financed by a fund called the Capital Base Enhancement Fund of HUF 300 billion (€1.1 billion) that intended to inject capital into banks to increase their capital adequacy ratio to 14% and boost market confidence in the strength of the Hungarian financial system. In return for their investment, the Hungarian government (the State) received non-cumulative, non-voting preferred stock. The preferred stock paid dividends equal to the yield of a five-year government bond, plus an add-on fee of 2%. The add-on fee would annually increase by 1% after 2011. The State also received a special veto share that granted the State the ability to veto major corporate decisions and sit on the participating institution’s board of directors, while imposing behavioral conditions on the participating bank. Any use of acquired funds would have had to be approved by the Ministry of Finance, the HFSA, and the MNB, in compliance with systemic risk conditions.

On December 15, 2008, the Hungarian Parliament passed Law CIV 2008, the Act on the Reinforcement of the Stability of the Financial Intermediary System, which granted the authority to inject capital into banks via the recapitalization scheme. The European Commission (EC) approved the scheme on February 12, 2009.

The IMF claims that the Program’s announcement, which signaled that the IMF was prepared to aid Hungary and its banking sector, boosted market confidence. Only one institution ever utilized the recapitalization scheme, accepting a HUF 30 billion capital injection, which it fully repaid to the State within a year. Due to the under-subscription of the overall Program, the State created a new liquidity scheme in March 2009 to finance loans to all credit institutions in Hungary, including subsidiaries of foreign banks. The recapitalization scheme was continuously approved for extension every six months until it was allowed to expire in June 2013.

The IMF stated that the “timeliness and size” of the overall Program was crucial to avoiding a systemic banking crisis, as well as contagion across central and southern Europe. The announcement of the Program signaled to the market the IMF’s readiness and willingness to provide immediate assistance to Hungary during the crisis (IMF June 2011). Specifically, however, the EC continued to extend the recapitalization scheme repeatedly with the belief that its operation contributed to elevated market confidence in Hungary and the ability for Hungarian credit institutions to lend to the broader economy (EC SA.36088).

Appendix: Hungary Requests International Assistance

By 2008, Hungary had become an especially integrated investment and trade center in Europe. Specifically, Hungary’s integration into international banking markets left it extremely vulnerable to external credit shocks. The Hungarian banking sector mostly consisted of foreign bank subsidiaries and of a few domestic banks that depended largely on international bank flows (IMF June 2011).

Prior to the global credit crunch in 2008, Hungary’s high debt levels had lingered since the early-2000s, causing concern that Hungary was susceptible to exchange rate and maturity risks. Due to the risks Hungary presented at the time and a weakened FX market, many foreign investors began to sell off Hungarian government bonds. Consequently, the Hungarian forint (HUF) depreciated drastically, which consequently devalued the collateral of FX swap contracts (denominated in HUF) with domestic Hungarian banks. This only furthered the concerns of foreign banks, who accelerated margin calls on FX swap contracts creating liquidity pressures on Hungarian banks (IMF June 2011).

A major concern for Europe was that a Hungarian financial crisis could spread contagion into other European financial systems, such as in Austria, Belgium, and Ireland all of whom had considerable bank claims and investments in Hungarian bonds. With only enough cash to relieve pressures on its banking system for about two months, the Hungarian government (the State) and the Hungarian central bank, the Magyar Nemzeti Bank (MNB) reached out to the European Central Bank (ECB) for assistance. On October 16, 2008, the Swiss National Bank and ECB each extended their own €5 billion FX swap and repo facility to the MNB “to support MNB’s newly introduced euro-liquidity operations” (Gardos 2008). Although Hungary was part of the European Union (EU), it was not part of the Eurozone, thus marking this as “the first instance of the ECB providing financing to a central bank outside the Eurozone”. Unfortunately, since the ECB’s facility required Hungary to provide collateral with a credit rating of at least A-, for which Hungarian bonds did not suffice, Hungary was unable to draw upon the facility (IMF June 2011).

Hungary’s growing economic problems motivated the State to request greater support from the IMF, EU, and World Bank. First, on November 6, 2008, the IMF approved a seventeen-month stand-by arrangement for Hungary with special drawing rights (SDR) up to 10.5 billion (€12.5 billion), with SDR 4.2 billion (approx. €4.9 billion) available upfront (IMF PR 11/06/2008). The EU soon followed in December 2009 by providing a two-year €6.5 billion balance of payments loan to Hungary that would transfer in three installments.^FNThe EU loan transferred to Hungary via three installments: the first €2 billion on December 9, 2008; the next €2 billion on March 26, 2009; and the final €1.5 billion on July 6, 2009 (Kerényi 2011). Although the World Bank approved assistance to Hungary in September 2009, the World Bank’s contribution was never drawn upon by the State (Kerényi 2011).

The IMF-EU package was intended to support a variety of different Hungarian economic initiatives, including a bank support program (the Program) aimed to promote the stability of the Hungarian financial sector and its domestic banks. The Program included HUF 600 billion to be split evenly between two separate schemes. The recapitalization scheme was financed by a newly created Capital Base Enhancement Fund (CBEF) and was intended to help raise the capital adequacy ratio of eligible domestic banks to 14% via capital injections. It was determined that any remainder of the CBEF’s HUF 300 billion not utilized by banks by the expiration of the recapitalization scheme on March 31, 2009 would transfer over to the second scheme’s fund, the Refinancing Guarantee Fund (RGF). The RGF financed a guarantee scheme, under which the State could guarantee the wholesale loans received and debt securities issued by domestic banks, up to a maximum of HUF 1500 billion (IMF November 2008).

The Hungarian Parliament passed the Reinforcement of the Stability of the Financial Intermediary System Act (the Financial Stability Act) on December 15, 2008, which became effective on December 23. The Financial Stability Act granted the State the authority to recapitalize any banks operating in Hungary and guarantee the interbank loans of domestic banks using the two schemes formed under the Program. On February 12, 2009, the EC approved the Program, effectively starting the schemes (EC N664/2009).