The Journal of Financial Crises Volume 2 Issue 3 2020 The Hungarian Guarantee Scheme (Hungary GFC) Alec Buchholtz Yale University Follow this and additional works at: https://elischolar.library.yale.edu/journal-of-financial-crises Part of the Economic History Commons, Economic Policy Commons, Finance Commons, International Economics Commons, Macroeconomics Commons, and the Public Administration Commons Recommended Citation Buchholtz, Alec (2020) "The Hungarian Guarantee Scheme (Hungary GFC)," The Journal of Financial Crises: Vol. 2 : Iss. 3, 739-756. Available at: https://elischolar.library.yale.edu/journal-of-financial-crises/vol2/iss3/38 This Case Study is brought to you for free and open access by the Journal of Financial Crises and EliScholar – A Digital Platform for Scholarly Publishing at Yale. For more information, please contact [email protected]. Hungarian Guarantee Scheme1 Alec Buchholtz2 Yale Program on Financial Stability Case Study January 16, 2019, Revised Date: October 10, 2020 Abstract In the midst of the global financial crisis, in October 2008, the Magyar Nemzeti 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 foreign exchange (FX) markets. Hungarian banks experienced liquidity pressures due to margin calls on FX swap contracts, prompting the MNB and Minister of Finance to seek assistance from the International Monetary Fund (IMF), the European Central Bank (ECB) and the World Bank. The IMF and ECB approved Hungary’s requests in late 2008 to create a €20 billion facility, with €2.3 billion intended to back a bank support package. The program involved the creation of two schemes, one of which, the guarantee scheme, was funded by a Refinancing Guarantee Fund (RGF) and aimed to provide domestic banks with guarantees on newly issued interbank loans and wholesale debt contracts with foreign counterparties. Some analyses deemed the guarantee scheme unsuccessful, since no banks ever participated in the scheme, in large part due to Hungary’s own low sovereign debt rating. This prompted the Hungarian government to use a portion of the bank support program to extend direct on- lending measures under a liquidity scheme to three of its largest domestic financial institutions in March 2009. Keywords: Hungary, European Union, guarantee scheme, IMF, World Bank, stand-by arrangement 1 This case study is part of the Yale Program on Financial Stability (YPFS) selection of New Bagehot Project modules considering the responses to the global financial crisis that pertain to bank debt guarantee programs. Cases are available from the Journal of Financial Crises at https://elischolar.library.yale.edu/journal-of- financial-crises/. 2 Alec Buchholtz – Research Associate, YPFS, Yale School of Management. 739 The Journal of Financial Crises Vol. 2 Iss. 3 Hungarian Guarantee Scheme At a Glance In October 2008, in the midst of the global financial crisis, the Magyar Nemzeti Bank Summary of Key Terms (MNB), the Hungarian national bank, noticed Purpose: To “secure the refinancing of the eligible a selloff of government securities by foreign banks and to strengthen the banks’ position in an banks and a large depreciation in the international market where their competitors exchange rate of the Hungarian forint (HUF) already have access to similar guarantees.” in foreign exchange (FX) markets. Due to high Announcement Date December 22, 2008 domestic interest rates, financial institutions Operational Date February 6, 2009 had engaged in significant lending in Hungary in foreign currencies, which Hungarian banks Date of First N/A Guaranteed Issuance had funded via short-term FX swap contracts. The termination of these swaps together with Issuance Window Originally June 30, 2009; margin calls placed severe liquidity pressure Expiration Date later extended to December 31, 2009 on banks, straining the stability of Hungary’s banking sector. That month, MNB, reached Program Size HUF 300 billion; out to the International Monetary Fund (IMF), guarantee up to HUF 1.5 trillion the European Central Bank (ECB), and the World Bank for assistance. The IMF and the Usage N/A ECB granted Hungary €20 billion in aid. Outcomes N/A As part of the multilateral package, a HUF 600 Notable Features High fees relative to billion bank support program established two value of guarantee given schemes, funded individually by a HUF 300 low sovereign credit rating billion Capital Base Enhancement Fund (CBEF) and a HUF 300 billion Refinancing Guarantee Fund (RGF). The guarantee scheme was designed to provide guarantees to Hungarian bank counterparties for any newly issued interbank wholesale loans and debt securities. Using the RGF, the Hungarian government could guarantee interbank lending up to HUF 1.5 trillion. Debt guaranteed under the scheme would be subject to a fee that the ECB calculated to be 123.50 basis points (bps). The scheme covered maturities between three months and five years. Although the issuance window for the MNB to guarantee debt under the guarantee scheme was originally set to expire on June 30, 2009, and was later extended to December 31, 2009, no banks ever utilized the government guarantees. Summary Evaluation Many bank executives and international organizations questioned the usefulness of the guarantee scheme, often citing Hungary’s low sovereign credit rating as the cause. Ultimately, the state created a separate liquidity scheme to finance state loans to Hungary’s three largest financial institutions in March 2009. 740 Hungarian Guarantee Scheme Buchholtz Hungarian Guarantee Scheme: Hungary Context $140.2 billion in 2007 GDP $159.6 billion in 2008 (SAAR, Nominal GDP in LCU converted to Source: Bloomberg USD) $13,919 in 2007 GDP per capita $15,753 in 2008 (SAAR, Nominal GDP in LCU converted to Source: Bloomberg USD) As of Q4 2007: Sovereign credit Fitch: A- rating (5-year senior Moody’s: A2 debt) S&P: BBB+ As of Q4 2008: Fitch: BBB+ Moody’s: A3 S&P: BBB Source: Bloomberg $97.7 billion in total assets in 2007 Size of banking $125.0 billion in total assets in 2008 system Source: Bloomberg 69.7% in 2007 Size of banking 78.3% in 2008 system as a percentage of GDP Source: Bloomberg Size of banking system as a Data not available percentage of financial system 69.4% of total banking assets in 2007 5-bank concentration 68.9% of total banking assets in 2008 of banking system Source: World Bank Global Financial Development Database 741 The Journal of Financial Crises Vol. 2 Iss. 3 64% of total banking assets in 2007 Foreign involvement 67% of total banking assets in 2008 in banking system Source: World Bank Global Financial Development Database 0% of banks owned by the state in 2007 Government 3.4% of banks owned by the state in 2008 ownership of banking system Source: World Bank Regulation & Supervision Survey Existence of deposit 100% of insurance on deposits up to $32,884 insurance in 2007 100% insurance on deposits up to $63,725 in 2008 Source: OECD, “Financial Crisis: Deposit Insurance and Related Financial Safety Net Aspects” 742 Hungarian Guarantee Scheme Buchholtz I. Overview Background In October 2008, in the midst of the global financial crisis and the credit crunch that ensued, investors began pulling out investments from Hungary and selling off Hungarian government bonds. Due to high domestic interest rates, financial institutions had engaged in significant lending in Hungary in foreign currencies, which Hungarian banks had funded via short-term foreign exchange (FX) swap contracts. With the floating Hungarian forint depreciating drastically, foreign investors began to exit investments in FX swap contracts with Hungarian banks. Additionally, margin calls placed severe liquidity pressure on banks, straining the stability of Hungary’s banking sector. In early October, with demand for Hungarian government debt drying up and amidst low levels of foreign exchange reserves at the Magyar Nemzeti Bank (MNB), the Hungarian government requested financial assistance from the International Monetary Fund (IMF), the European Central Bank (ECB), and the World Bank. During the first week of November, the IMF and ECB authorized a €20 billion assistance package to Hungary, HUF 600 billion (€2.3 billion)3 of which was devoted to a bank support program to create two schemes funded with HUF 300 billion each—a guarantee scheme and a recapitalization scheme—designed to alleviate liquidity pressures and increase financial stability in domestic banks (IMF November 2008a). The bank support program included the creation of a Refinancing Guarantee Fund (RGF), also referred to as the Debt Guarantee Fund by the World Bank, that financed the guarantee scheme. The scheme would provide government-backed guarantees to participating financial institutions for interbank loans and wholesale debt securities (IMF November 2008a). On December 15, 2008, the Hungarian Parliament passed the Act on the Reinforcement of the Stability of the Financial Intermediary System of 2008 (the Financial Stability Act), which, under Article 1(1), authorized the government to implement the guarantee scheme using the funds provided through the RGF. The recapitalization scheme under the bank support program was also enabled, funded by a Capital Base Enhancement Fund (European Commission 2009a). (Also see Appendix A for an overview of the request for international assistance from the three institutions and for other details on the bank support package; see Buchholtz 2018b for more information on the Hungarian recapitalization scheme.) Program Description On February 12, 2009, the European Commission (EC) approved the guarantee scheme, thereby making it operational (European Commission 2009a). The guarantee scheme intended to provide guarantees on new interbank loans and any wholesale securities issued 3 The exchange rate of October 31, 2008, was $1 = HUF 204 and €1 = HUF 261. 743 The Journal of Financial Crises Vol. 2 Iss. 3 by domestic banks. Subordinated loans and capital investments were not eligible for guarantee under the scheme (IMF November 2008a).