in 2000, especially during the second quarter changes, important for the financial sector, continued both at macroeconomic and microeconomic levels and became noticeable. From a macroeconomic perspective the most important development was that the restructuring, which had already been typical within household assets (fading dominance of bank deposits), a rearrangement also started to emerge in the proportion of financial and real assets compared to consumption. The amount of gross household assets was stagnant in real terms, while net financial assets decreased in real terms as a result of increasing use of retail loans. The separation of the direction of changes in gross and net assets is a new phenomenon of the changes of household income. Among the business cycle sensitive, and therefore generally high risk, retail facilities, the growth of the top risk commodity and personal loans is the fastest. The increase in consumption put ever-increasing demand pressure on the slower and slower inflationary decrease. The 9.1 percent inflation projected for the year in June 2000 is higher than planned.

 

Financial assets of household (%)

Source: National Bank of Hungary

 

in addition to a quick increase in bank financing, one of the key changes that characterized corporate financing was the definite weakening of funding from domestic capital markets. Corporate bond issues practically disappeared in the first half of 2000, and there were no public stock offerings. Private stock issues became the dominant form of funding from capital markets; it amounted to HUF 60.7 billion during the first quarter and HUF 76.6 billion during the second. However, it was below the level that characterized the previous years. The marked decline of issues has a negative effect on the markets' liquidity, gives rise to pricing problems, and limits the applicability of diversified investment strategies, and the efficient distribution of risks.

 

in general macroeconomic changes had a beneficial impact on the sector's operation. The GDP increased by 5.9%, the indicators of external and internal balances improved. The current account deficit was lower by HUF 270 million euro at the end of June, this year, than a year earlier; it was HUF 860 million euros at the end of the first six months. Approximately 60% of the deficit was covered by the non-debt creating capital inflow of HUF 501 million, which amounted to two-thirds of the previous year's total. The decline was caused by a drop in portfolio investments, which is also reflected in capital markets' and investment service providers' turnover volumes. The budget deficit amounted to HUF 214 billion during six months (excluding local governments). This significant improvement can be explained by the rate of inflation, which was higher than planned, and the, even in real terms, 12% higher revenues stemming from solid economic growth. The decreasing trend of money market and bank interest rates had been continued, which eased the burdens on the central budget.

 

On the other hand money market developments were unfavorable. Although government bond yields were transitionally on the rise in the second quarter, the yield curve returned to the level where it was at the end of the first quarter after an upward shift lasting for a month and a half. For that reason the price of government securities decreased and then increased during the quarter. Nevertheless, the slope of the yield curve revealed a declining trend, and spreads at expiration narrowed, in parallel with the decrease in the level of inflation and yields. The price level increase on the stock market that characterized the first quarter was disrupted from the beginning of April, and the BUX dropped by 17% during the quarter. Simultaneously its volatility increased slightly. Although foreign investors cannot withdraw from the market because of their dominant participation, their passivity squeezed the actual daily turnover well below the former average of about HUF 15 billion, even below the HUF 10 to 12 billion 'theoretical minimum' calculated for the Budapest Stock Exchange, down to the HUF 5 to 7 billion range.

 

The above changes had a marked, though different effect on financial mediators, who channel savings into financing corporate (and budgetary) activities. The effect may be measured in part on households' financial savings, and in part on the changes in the strategies and operation of supervised institutions. in the competition for corporate growth not only individual institutions, but often different segments of the financial sector are turned against each other in such a manner, that competition is substantially influenced by statutory regulation.

 

indicators of financial mediation

 

The credit institutions' most significant risk factor lays in the impact of the expansion of lending on the sector's profitability. The amount of total assets increased in the credit institution sector slightly during the second quarter, owing to credit cooperatives that account for 6% of the sector, however, there was practically no further increase in the banks' balance sheet total (+0,1%). Although, in itself it does not mean that the banks' role in financial mediation would have decreased, the fact that the growth of deposits also stopped (a change of 0.0%) during the quarter, is a sign of warning. The banks financed their credit expansion exclusively by asset restructuring, clearly by decreasing their central bank and interbank placings. This is a temporal solution, the limits of which are set by the rate at which the central bank's reserves fall. Subsequently, competition for deposits is expected to strengthen.

 

The banks' profits and profitability were rather good similarly to the first quarter. At the end of June 2000 the HUF 54 billion pre-tax profit exceeded the previous year's profits by 40% even in real terms, while both the number of loss-making banks and the size of their losses decreased. However, it is necessary to qualify this very positive initial picture from several perspectives. The main source of profit growth was not "classical" banking, but auxiliary and other financial and investment services. Banks, just as credit institutions in general, settle most of their expenditures in the fourth quarter, and for that reason profits in the last quarter are normally negative, which will decrease the profit calculated during the year. Audited profit figures, reflecting credit institutions' actual position, are also significantly lower than the interim figures because of the supplementary specific provision requirement (amounting to about HUF 10 billion for the entire banking system on 1999 level) prescribed by auditors.

 

The composition of classifiable portfolios changed favorably during the second quarter, the proportion of problem-free facilities grew. At the same time the increase in the portfolio of high-risk placings has raised the level of provisions, and the net costs of specific provision generation, which has had, and will have a negative effect on profits. All in all the positive (slower decrease of interest margins) and negative (higher costs of provision creation) effects on the banks' profits are currently balanced. However, the expansion of lending, and therefore the quality of the loan portfolio, are rather dependent on the business cycle. Continued fast expansion of lending is likely to offset the balance through the increase of the substandard portfolio, therefore, the growth of profits is expected to slow down in the second half of the year. However, the rate of profit increase during the first half of the year was so fast, that we may definitely expect a profit level in excess of last year's profits for the entire sector (excluding the possibility of an extreme shock). The banks also try to support higher risk-taking by increasing their capital. However, the capital increases only slightly above inflation was not sufficient to halt the slow, but steady decline of the capital adequacy ratio.

 

in addition to the effects of the expansion of lending, the development of the credit institution sector was substantially influenced by a strong wave of mergers, which can be explained in part by mergers of foreign mother companies, and in part by withdrawals as companies adjust to the size of the Hungarian market. Further concentration will probably put the banks that are left out into a difficult situation. The diversification within the sector that had already been typical before remained during the past quarter as well, while the spread of profitability continued to be significant. The bank sector may be divided into three groups according to profitability, representing almost identical market shares, excluding new banks and/or banks with a very small market share, furthermore, the nine banks that do not yet extend loans. Generally, total assets and profitability moved together, however, no direct short-term connection could be established between lending activity and profitability. There are profitable and loss-making institutions as well among the most aggressively lending banks. Lending activities were primarily determined by market opportunities and not by profitability.

 

Changes in the banks* total assets and loan portfolios
First half of 2000 (%)

*Excluding HV, FHB, Fundamenta, Lakáskassza, OTP Ltp., Otthon Ltp., Cetelem, Hanwha and iC

**33 banks

 

The profits of cooperatives grew slower than the banks', but their profitability, in contrast to the banks, did not improve. The root of increased activities was the growth of lending here as well. Credit cooperatives are exposed to concentrated partner and performance risks, private individual and small businesses dominate among the borrowers. The weight of the loans extended to these sectors is much greater in the cooperatives' balance sheets, than in the banks', where the weight of retail lending remains relatively low in spite of the expansion. An additional risk is presented by the fact that the capital supply of cooperatives differ widely, and for cooperatives with poor capital adequacy even a few non-performing loans may cause serious troubles.

 

The negative effects of market developments in the second quarter determined the position of investment service providers. Turnover suffered a dramatic drop, it fell back to 56% of the first quarter's level. The profit making ability of enterprises, especially that of commission agents and traders, declined significantly. As a consequence of that, the settlement of market that had started earlier within the sector, and which had also been supported by the Supervision's measures, markedly continued even after the end of the quarter.

 

Settlement of the investment service market

 

The total assets of investment service providers, the growth rate of profits, and the profitability shrank together with the market (-3,1%). Compared to the profit of HUF 3.7 billion attained in the first quarter, the sector could only add a profit of HUF 875 million during the second quarter. in spite of the fact, that both the capital and the total asset portfolio decreased, the value of both the ROA and the ROE indicators is lower in comparison to the first quarter, although they are still somewhat above the corresponding 1999 figures. One of the favorable outcomes of market settlement was that the number of loss-making investment service providers decreased together with the total losses of the sector, while the liquidity of the firms that remained on the market improved.

 

Partly as a result of the settlement of the market, and partly because of the smaller turnover, the clients' debt portfolio related to commission deals decreased. Additional favorable changes were that the concentration of such debts also loosened, and that the dominant part of the portfolio belonged to the more stable investment service providers backed up by banks. The majority of the firms who withdrew from the market during the second quarter and later did not have much financial strength, and had a low level of liquidity. Such firms may continue to exit or be squeezed out from the market in the future as well. The fact that neither the measures taken so far, nor the market's pressure could force certain companies to settle their financial position constitutes a risk equally from the Supervision's and the clients' perspective. Several institutions are in continuous violation of the provisions of both the Securities Act and the Companies Act, indeed, there are firms that notoriously meet the capital requirement prescribed in the Companies Act on the lower limit, at which level the Supervision is only entitled to issue a warning.

 

The changes in household saving and consumption preferences, and the adverse market developments held back the growth of the assets (and numbers) of investment funds. The net assets of investment funds, that used to grow by an annual 30 to 40%, practically remained unchanged in the second quarter (+0,8%). One of its probably not so important reasons is that the households that owned 80% of the funds' assets turned to other forms of saving or to consumption. The disruption can rather be explained by the devaluation of the funds' portfolios owing to lower government security and stock prices.

 

The assets of clients purchasing investment vouchers are secured, owing to the separation of fund managers and escrow account managers, and to the extremely strict investment policy restrictions. The experiences drawn during supervision are also positive. Looking from fund managers' perspective risks arise in two aspects. This currently almost HUF 550 billion market is shared by 31 fund managers in a way, that 80% of the assets are concentrated in the three leading fund managers' funds. Precisely for that reason one of the sources of risk is presented by the expected ignition of fierce competition, or market settlement. At the same time the entire investment voucher market may start shrinking, in the event other financial players can offer similar types of constructions, which are, however, better from tax, investment strategy, or yield, etc. perspectives. From July 1, 2000 domestic investors may purchase the investment vouchers of foreign fund managers that meet certain conditions as well, nevertheless, competition is unlikely to strengthen on this side due to the regulation in place. Serious competition is much more likely to be provoked by insurance companies that are not as strictly regulated.

 

The steadily increasing role of insurance companies as financial mediators exercises a major influence over the other players of the financial sector, the source of which to a considerable degree are regulatory and tax arbitrage. The banking system is affected by the fact that policyholder may obtain loans tied to certain life insurance constructions. Unit-linked life insurance policies are attractive as long-term saving options, which offer higher yields and tax breaks than bank deposits in addition to the life insurance service. Unit-linked life insurance is the fastest growing field in the insurance business, and also the field where insurers enjoy significant regulatory advantages over competitive forms of investment, primarily over investment funds. Premiums collected from such life insurance tied investment forms are managed by the insurers themselves and deposited into the so called 'asset funds'. The main difference between this asset fund and the investment fund, which falls under the investment Funds Act, is precisely that this Act is not applicable to asset funds, nor does the insurance Act contain provisions pertaining to investment policy, or reporting obligation, etc., as opposed to the tightly regulated investment voucher market.

 

in addition to the above mentioned fields, certain insurance companies also has come out with asset management deals, though currently this is only available to members of the insurance group, or companies closely associated with insurers. in the second quarter three insurance companies created private open-end investment funds, which are responsible for high yield management the funds invested by the group's members.

 

insurance companies dominate the insurance market in comparison to insurance associations. With respect to companies both premium income (+32%), and loss settlement and services (+24%) increased noticeably compared to the corresponding period of the previous year, however, the increase of premium income was bigger. The total premium income amounted to HUF 187.2 billion in the first half of the year, 45% of which came from life insurance policies. Both the life and the non-life business lines are highly concentrated. The share of the five market leaders from premium revenue in the life business is 84%, while the three dominant companies of the non-life business disposed over 76% of the premium incomes. The HUF 496.1 billion technical reserves and 86% of the security capital continued to finance the state budget. Acquisition costs provide an ever-increasing proportion of the HUF 56.9 billion costs (57% in the fist half of this year).

 

The development of the funds' assets, which forms a steadily increasing portion of households' financial savings, has been determined by pension funds ever since the system was launched. 96% of the funds' membership, and 99% of the funds' assets are concentrated by pension funds, the remaining four percents and one percent represents mutual funds and health funds, respectively. Concentration strengthened in the funds' sector as well, in the first half of the year 5 of the 30 private pension funds at the end of 1999, 20 of the 145 voluntary pension funds decided to merge or liquidate itself. Until the end of the year further mergers can be expected following the developments taking place among the money and capital markets' players.

 

The membership of private pension funds exceeded 2.09 million at the end of the first six months, which meant a 1.5% growth compared to the end of the year. As a result of a 3% increase in the membership of voluntary pension funds, it reached more than 1.04 million at the end of the first six months. 80% of the fund members belong to the 20 to 40-year age group. Within that the greatest proportion is of those between 20 to 24 (22.7%), and the trend shows that the proportion of this age group is increasing, as membership increased only with those at the beginning of their careers during the last two quarters. The weight of employers' funds is rather small among private pension funds, the six biggest funds backed up by banks and insurance companies concentrate 855 of the membership, and 80% of the assets. The number of people returning to the system based on the pay-as-you-go principle is slowly rising, however, the 22,500 members who have returned to that system since the beginning represents merely one percent of the membership of private pension funds. The overhead costs of private funds increased by 25% during a single year. The overhead representing 5.8% of revenue from membership is only partially covered by the 5.5% deducted for overhead provision from identified membership revenue, the funds cover the rest from financial support received.

 

The funds did not suffer loss of capital, the assets of private pension funds increased to HUF 130 billion (+40%), and voluntary pension funds' assets grew to HUF 220 billion (+38%) by 2000. in spite of the merely 10% share of stock within the invested assets, both private and voluntary pension funds' assets were adversely affected by the decline of stock prices during the second quarter. The low yield realized on the week government security market was practically eliminated by the devaluation of the stock portfolio. During the second quarter the growth of assets came almost entirely from the premiums collected. in this quarter private pension funds booked HUF 700 million, and voluntary pension funds collected HUF 460 million net incomes from investment activities. This did not even reach one-forth of the first quarter's figure (HUF 3 billion) in case of private pension funds, while it was less than 10% of the previous quarter's results for voluntary pension funds. The decrease of net income from investment activities can be mainly attributed to the price loss of securities.

 

 

Annex - Statistics
Table 1 Structure of the banks assets
(in billions of forints)

 

 

Table 2 Banks' liability structure
(in billions of forints)

 

 

Table 3 Banks' foreign exchange position
(in billions of forints)

 

 

Table 4 Banks' off-balance sheet activities
(in billions of forints)

 

 

Table 5 Credit cooperatives' asset structure
(in billions of forints)

 

 

Table 6 Credit cooperatives' liability structure
(in billions of forints)

 

 

Table 7 Key ROA components for the year
(percentage)

 

 

Table 8 Components of the profit
(in billions of forints)

 

 

Table 9 The banks' classifiable portfolio as of
June 30, 2000
(in billions of forints)

 

 

Table 10 Changes in the banks' classifiable portfolios from
June 30, 2000 to December 31, 1999
(percentage)

 

 

Table 11 Credit cooperatives' classifiable portfolio as of June 30, 2000
(in millions of forints)

 

 

Table 12 Changes in the credit cooperatives' classifiable portfolios from
June 30, 2000 to December 31, 1999
(percentage)

 

 

Table 13 investment service providers' asset structure
(in millions of forints)

 

 

Table 14 investment service providers' liability structure
(in millions of forints)

 

 

Table 15 investment service providers' profits

 

 

Table 16 investment service providers financial position

 

 

 

Table 17 Market concentration based on H-H indices of revenues

*Excluding interest revenue built into sales price.

 

 

Table 18 issues
(in billions of forints)

 

 

Table 19 Portfolio of open-end securities' investment funds, as of June 30, 2000
(percentage)

 

 

Table 20 Portfolios of insurance lines
(number)

 

 

Table 21 Total premium by insurance lines
(in thousands of forints)

 

 

Table 22 insurers' premium income by insurance lines
(in thousands of forints)

 

 

Table 23 Premium incomes
(in thousands of forints)

 

 

Table 24 Loss payments
(in thousands of forints)

 

 

Table 25 Loss payments by insurance lines
(in thousands of forints)

 

 

Table 26 insurers' technical reserves and investments into security capital as of June 30, 2000
(in thousands of forints)

 

 

Table 27 Technical reserve and security capital investments of the insurance sector
(in thousands of forints)

 

 

Table 28 Private pension fund membership
(number of persons; percentage)

 

 

Table 29 Breakdown of private pension fund membership by age groups as of June 30, 2000
(number of persons; percentage)

 

 

Table 30 Membership concentration of private pension funds
(number of persons; percentage)

 

 

Table 31 Concentration of premiums credited to private pension funds' personal accounts
(in thousands of forints; percentage)

 

 

Table 32 Assets of private pension funds
(at book value; in thousands of forints; percentage)

 

 

Table 33 Assets of private pension funds
(at book value; percentage)

 

 

34. Table Breakdown of private pension funds' overheads
(in thousands of forints; percentage)

 

 

Table 35 Membership of voluntary funds
(number of persons; percentage)

 

 

Table 36 Assets of voluntary funds
(book value; in thousands of forints; percentage)

 

 

Breakdown of voluntary fund investments as of June 30, 2000
(book value; percentage)