CBH introduces fixed reserve ratio

UniCredit Bank Hungary Zrt.
Thu, 05/11/2015

The Central Bank of Hungary presents further actions of its “Self-financing Programme” and steps towards harmonising with ECB practices.

The goal of the “Self-financing Programme”, announced by The Central Bank of Hungary (CBH) in April 2014, is to reshape the structure of government debt by increasing Hungarian securities holdings of domestic banks and to reduce the country’s external vulnerability.

The intention was to increase participation of the local banking system in government debt financing by boosting their investments in government bonds. By reforming its monetary policy instruments the CBH wanted to encourage local banks to restructure their receivables from the Central Bank, i.e. to convert the two-week sterilisation bonds into government securities.

In the frame of the programme, the CBH already introduced a number of reforms to its instruments during the course of 2014:

  •  The format of the CBH’s policy instrument changed: the two-week CBH bill was replaced by a two-week time deposit as of August
  • A forint-denominated interest rate swap instrument was introduced in June
  • A three-year secured forint loan became part of the potential central bank instruments in June (has not yet been activated)
  • An asset swap transaction also became one of the potential CBH instruments as of June (has not been activated either)

Debt reduction

In addition to the programme, the following economic policy measures contributed primarily to the reduction of the national economy’s external debt of and of external government debt:

  • A shift towards retail government securities in government debt financing
  • A series of base rate cuts (the base rate of the CBH is currently staying at 1.35% compared to 7% in early 2012)
  • A Pillar III of the Funding for Growth Scheme (in the frame of Pillar III of the Scheme banks had to reduce their short-term external debt)
  • FX conversion programmes

This summer, by carrying-on with the Self-financing Programme, the CBH announced further measures to restructure its monetary policy instruments in order to support the refinancing of government debt from domestic forint funding. One of the key elements of the new measures was that the two-week facility, which had served as the main monetary policy instrument, was replaced with a new three-month fixed interest rate deposit starting on 23 September 2015.

The two-week deposit remained part of the central bank instruments; however the Central Bank imposes a quantity limit by using the auction method. As a result of the quantity restriction, holdings of the two-week deposits are expected to decrease gradually week by week to a HUF 1,000 billion level by the end of the year from HUF 5,000-5,500 billion.

The aim of this measure is clearly to encourage banks to purchase government securities, which are expected to be more attractive than the three-month deposit, which is not accepted by the Central Bank as a liquid instrument.

Further decisions regarding FFAR and FECR

As a next step the Financial Stability Board of the CBH adopted two decrees on the changes to the foreign exchange funding adequacy ratio (FFAR) and on the introduction of the foreign exchange coverage ratio (FECR) on 7 July 2015. Both decrees will enter into effect on 1 January 2016.

By tightening the FFAR and by introducing the FECR to the market, the reliance of the domestic banking sector on external funding is being reduced.

After 1 January 2016 outstanding swaps can no longer be included in the FFAR and the required level of the FFAR will be raised to 100%. The new FECR regulation will limit the on-balance sheet currency mismatch at 15% of the balance sheet total, thereby reducing banks’ reliance on the swap market.

As a result of the new regulations, the short-term external debt of the banking sector is expected to fall by EUR 2–3 billion to EUR 6–7 billion by the end of 2016.

Interest rate swap tenders

The Central Bank also decided to continue to announce interest rate swap tenders which help banks to manage their interest rate risks, thereby encouraging their demand for longer-term government securities.

Regulation No 575/2013/EU of the European Parliament and the European Commission’s prudential requirements for credit institutions and investment firms and Commission Delegated Regulation No 2015/61 require credit institutions to comply with the Liquidity Coverage Requirement (LCR). The purpose of the LCR is to ensure that banks have liquid assets of adequate quality and quantity over the short term (30 days) to withstand a liquidity shock. Under EU legislation, the minimum requirement for meeting the LCR is set at 60% by 1 October 2015 and is being raised gradually to reach 100% on 1 January 2018. However, the national authorities may choose to overcome this schedule and accelerate the implementation of the LCR.

In its capacity the CBH accepted a decree on the increase of the liquidity coverage ratio in order to already reach 100% in 2016.

In October the Monetary Council of the Central Bank of Hungary decided to reform the Bank’s minimum reserve framework as well. Since 2010 banks have been allowed to choose a reserve ratio between 2% and 5%. With the latest decision the current optional reserve calculation system will be replaced with a uniform reserve ratio set at 2% for all domestic banks in Hungary as of 1 December 2015.

Gabriella Kopházi-Tóth
Senior Relationship Manager
Global Securities Services Hungary