Financial Stability Report – November 2017 Magyar Nemzeti Bank Budapest 29 November 2017

Agenda Existing external risks have moderately eased, but have not disappeared completely. The shock absorbing capacity of the domestic banking sector remained strong over the past period. In 2017, a broad-based expansion was observed in domestic lending and housing market as well. Housing prices do not show excessive level of increase compared to economic fundamentals. Special attention is devoted to household’s financial vulnerability and financial literacy as well. The report focuses on mitigating interest rate risks on housing loans. In 2017, domestic banks are characterized by high profitability, mainly due to one-off and unsustainable items. Long-term sustainability of bank’s profitability can be ensured by digitalisation and automatisation. Similarly to the previous years, portfolio cleaning has been continued, which contributes to an improvement in lending capacity. Social implications of debt settlement, however, should be monitored with increased attention. Magyar Nemzeti Bank

Macroeconomic outlook has improved and risks have moderated in Europe Changes in VSTOXX volatility indices and the European political uncertainty index from 2007 Source: PolicyUncertainty.com, Datastream Magyar Nemzeti Bank

Due to unresolved issues, complete lending turnaround has not occurred in some countries yet Annual growth rate of the private sector’s outstanding loans in Europe Source: ECB Magyar Nemzeti Bank

Outstanding non-performing loans are still high in many countries Problem loans compared to gross loans outstanding in European countries (2010–2016) Source: SNL Magyar Nemzeti Bank

High level of indebtedness can result in an increasing vulnerability Gross government debt and household indebtedness to GDP (2013-2016) Source: Eurostat Magyar Nemzeti Bank

In many countries, house price growth is coupled with increasing indebtedness Changes in house prices and the share of housing loans to GDP in European comparison Source: ECB, BIS Magyar Nemzeti Bank

Gradually growing investor demand can be identified in the commercial real estate market of the CEE region Vacancy rates and prime yields on the regional capital cities' office markets Source: Based on data published by CBRE, Colliers, Cushman&Wakefield and JLL Magyar Nemzeti Bank

Agenda Existing external risks have moderately eased, but have not disappeared completely. The shock absorbing capacity of the domestic banking sector remained strong over the past period. In 2017, a broad-based expansion was observed in domestic lending and housing market as well. Housing prices do not show excessive level of increase compared to economic fundamentals. Special attention is devoted to household’s financial vulnerability and financial literacy as well. The report focuses on mitigating interest rate risks on housing loans. In 2017, domestic banks are characterized by high profitability, mainly due to one-off and unsustainable items. Long-term sustainability of bank’s profitability can be ensured by digitalisation and automatisation. Similarly to the previous years, portfolio cleaning has been continued, which contributes to an improvement in lending capacity. Social implications of debt settlement, however, should be monitored with increased attention. Magyar Nemzeti Bank

The upswing of the housing market has continued with the previously observed heterogeneity of regions MNB house price index for the whole country and for Budapest, and the annual number of housing market transactions Magyar Nemzeti Bank Source: HCSO, MNB

A revival has been experienced in the number of building permits issued and home completions Granted building permissions for homes and newly built homes Source: HCSO Magyar Nemzeti Bank

Housing prices are under the level justified macroeconomic fundamentals House prices' deviation from the estimated equilibrium level in the whole country and in Budapest in percentages Magyar Nemzeti Bank Source: MNB

The affordability of newly built dwellings in Hungary are similar to that of other CEE countries How many years of gross income is needed for the purchase of an average, 70 sq. metre new dwelling? Source: European statistical offices, Deloitte Magyar Nemzeti Bank

The affordability of houses did not deteriorate significantly despite the price increase Housing Affordability Index (HAI) and its decomposition The HAI (Housing Affordability Index) shows how many times the income of a household with two average wages covers the income necessary for the purchase of an average (65 m2) dwelling with a loan. Parameters of the loan product, except for the interest rate, are constant until maturity. LTV = 70%, PTI = 30%, maturity = 15 years. Magyar Nemzeti Bank Source: MNB

Household borrowing continued to improve both in the segment of housing and in the consumer credit New household loans in the entire credit institution sector Source: MNB Magyar Nemzeti Bank

The upswing in lending is primarily driven by the increase of demand Changes in credit conditions and in credit demand in the household segment Source: MNB, based on the answers of respondent banks Magyar Nemzeti Bank

No major increase in risk taking was observed among borrowing households Distribution of PTI values of new loans by number of units Source: MNB Magyar Nemzeti Bank

In addition to the SME segment, corporate lending has also reached the desired level Annual changes in lending to non-financial corporates and SMEs Source: MNB Magyar Nemzeti Bank

The phase-out of the FGS did not cause a setback in long-term financing Maturity distribution of new SME loan contracts Source: MNB Magyar Nemzeti Bank

Agenda Existing external risks have moderately eased, but have not disappeared completely. The shock absorbing capacity of the domestic banking sector remained strong over the past period. In 2017, a broad-based expansion was observed in domestic lending and housing market as well. Housing prices do not show excessive level of increase compared to economic fundamentals. Special attention is devoted to household’s financial vulnerability and financial literacy as well. The report focuses on mitigating interest rate risks on housing loans. In 2017, domestic banks are characterized by high profitability, mainly due to one-off and unsustainable items. Long-term sustainability of bank’s profitability can be ensured by digitalisation and automatisation. Similarly to the previous years, portfolio cleaning has been continued, which contributes to an improvement in lending capacity. Social implications of debt settlement, however, should be monitored with increased attention. Magyar Nemzeti Bank

Financial vulnerability can be mitigated by increasing financial literacy Dimensions of financial fragility and financial awareness within Hungarian households repaying loans Source: MNB - Századvég survey Magyar Nemzeti Bank

Fixed-rate housing loans are more expensive than variable-rate products Interest rate spreads on new household loans Source: MNB Magyar Nemzeti Bank

Variable-rate and over 5 year initial rate fixation loans represent a significant proportion Distribution of new housing loans by initial rate fixation in selected countries (2017 Q1) Source: European Mortgage Federation Magyar Nemzeti Bank

Low interest rates can be ensured by a solid covered bond market Components of the difference between interest rates of housing loans fixed for 1-5 years and loans with a floating rate Source: National central banks, ECB Magyar Nemzeti Bank

Looking ahead, variable-rates may impose significant risks Change in instalments in the case of a loan with a floating rate, assuming different risk shocks Source: MNB Magyar Nemzeti Bank

Agenda Existing external risks have moderately eased, but have not disappeared completely. The shock absorbing capacity of the domestic banking sector remained strong over the past period. In 2017, a broad-based expansion was observed in domestic lending and housing market as well. Housing prices do not show excessive level of increase compared to economic fundamentals. Special attention is devoted to household’s financial vulnerability and financial literacy as well. The report focuses on mitigating interest rate risks on housing loans. In 2017, domestic banks are characterized by high profitability, mainly due to one-off and unsustainable items. Long-term sustainability of bank’s profitability can be ensured by digitalisation and automatisation. Similarly to the previous years, portfolio cleaning has been continued, which contributes to an improvement in lending capacity. Social implications of debt settlement, however, should be monitored with increased attention. Magyar Nemzeti Bank

As a result of the loan loss reversals, banking sector has achieved outstanding earnings similarly to the previous year Actual RoE of credit institutions and its value adjusted by cyclical provisioning Source: MNB Magyar Nemzeti Bank

Real profitability can be treated satisfactory compared to 2006-2007 Nominal and real RoE of credit institutions and the return above the 3M BUBOR Source: MNB Magyar Nemzeti Bank

Strategies for credit institutions to increase profitability over the long term Magyar Nemzeti Bank

How open customers are to innovation? Consumer openness towards e-banking If every banking service was available on a smartphone… Source: MNB survey Magyar Nemzeti Bank

How open institutions are to try new solutions? Planned / already in use innovations by banks and fintech companies Source: MNB survey Magyar Nemzeti Bank

Agenda Existing external risks have moderately eased, but have not disappeared completely. The shock absorbing capacity of the domestic banking sector remained strong over the past period. In 2017, a broad-based expansion was observed in domestic lending and housing market as well. Housing prices do not show excessive level of increase compared to economic fundamentals. Special attention is devoted to household’s financial vulnerability and financial literacy as well. The report focuses on mitigating interest rate risks on housing loans. In 2017, domestic banks are characterized by high profitability, mainly due to one-off and unsustainable items. Long-term sustainability of bank’s profitability can be ensured by digitalisation and automatisation. Similarly to the previous years, portfolio cleaning has been continued, which contributes to an improvement in lending capacity. Social implications of debt settlement, however, should be monitored with increased attention. Magyar Nemzeti Bank

In recent years, risks have significantly reduced in banks’ balance sheets Net non-performing loans as a proportion of regulatory capital at major banks Source: MNB Magyar Nemzeti Bank

All institutions fulfil regulatory requirements in both the baseline and the stress scenario Distribution of the capital adequacy ratio based on number of banks Source: MNB Magyar Nemzeti Bank

Portfolio cleaning has mitigated risks, but the social implications should be monitored Number of non-performing mortgage loans and real estates acquired by NAMA Source: MNB. Magyar Nemzeti Bank

Agenda Existing external risks have moderately eased, but have not disappeared completely. The shock absorbing capacity of the domestic banking sector remained strong over the past period. In 2017, a broad-based expansion was observed in domestic lending and housing market as well. Housing prices do not show excessive level of increase compared to economic fundamentals. Special attention is devoted to household’s financial vulnerability and financial literacy as well. The report focuses on mitigating interest rate risks on housing loans. In 2017, domestic banks are characterized by high profitability, mainly due to one-off and unsustainable items. Long-term sustainability of bank’s profitability can be ensured by digitalisation and automatisation. Similarly to the previous years, portfolio cleaning has been continued, which contributes to an improvement in lending capacity. Social implications of debt settlement, however, should be monitored with increased attention. Magyar Nemzeti Bank

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