Unconventional monetary instruments in the current crisis: the case of

Hungary

Péter TabákHead of Financial Stability

Magyar Nemzeti Bank (the central bank of Hungary)

„The Modern Role of Central Banks in Small Open Economies”June 26-27, 2009

Tbilisi

Outline

• Initial conditions: the landscape in October 2008

• The immediate challenge: FX liquidity provision

• Mitigating the costs for the real economy

• Domestic currency liquidity provision

• Some lessons from the Hungarian experiences

Initial conditions: the landscape in October 2008

• Weak fundamentals – large adjustment in the fiscal deficit but still high public and external debt

• High share of foreign currency lending (CHF-based mortgages)– the primary concern for banks is foreign currency liquidity

• Bank’s strong reliance on foreign funding – but major role of parent banks

• Structural domestic liquidity surplus – there is more than sufficient HUF liquidity in the system, but unevenly distributed

• Strong pressure on the exchange rate – monetary easing (rate cut) is not an option for financial stability reasons

High public indebtedness

Source: Eurostat

Public debt in percentage of GDP, 2007

0

20

40

60

80

100

120

Est

onia

Rom

ania

Bul

garia

Luxe

mbo

urg

Lith

uani

a

Latv

ia

Slov

enia

Slov

akia

Cze

ch R

epub

lic

Den

mar

k

Finl

and

Swed

en

Spai

n

Irel

and

Pola

nd

Cyp

rus

Nor

way

UK

Net

herla

nds

EU

(27)

Aus

tria

Mal

ta

Ger

man

y

Portug

al

Fran

ce

Icel

and

Hun

gary

Bel

gium

Gre

ece

Ital

y

%

High external indebtedness

Source: Eurostat

Net foreign debt in percentage of GDP, 2007

-20

-10

0

10

20

30

40

50

Cze

ch R

epub

lic

Bul

garia

Slov

akia

Rom

ania

Pola

nd

Lith

uani

a

Est

onia

Den

mar

k

UK

Swed

en

Hun

gary

Latv

ia

%

-20

-10

0

10

20

30

40

50%

Strong reliance on foreign funds in the past - expected adjustment in the near

futureLoan-to-deposit ratio in the banking sector

80

90

100

110

120

130

140

150

160

Dec-06

Jan-07

Feb-0

7

Mar-

07

Apr-07

May-07

Jun-0

7Jul-0

7

Aug-07

Sep-0

7

Oct-07

Nov-07

Dec-07

Jan-08

Feb-0

8

Mar-

08

Apr-08

May-08

Jun-0

8Jul-0

8

Aug-08

Sep-0

8

Oct-08

Nov-08

Dec-08

Jan-09

Feb-0

9

Mar-

09

Apr-09

May-09

Jun-0

9Jul-0

9

Aug-09

Sep-0

9

Oct-09

Nov-09

Dec-09

0

2

4

6

8

10

12

14

16

18

20

Loan to deposit ratio (exchange rate adj.)

Leverage (balance sheet total/ equity, exchange rate adj.) (right scale)

Euro area - leverage (balance sheet total/ equity) (right scale)

Euro area - loan to deposti ratio

forecast

%

Source: MNB

Funding from parent banks has been important

Source: MNB

0

2 000

4 000

6 000

8 000

10 000

12 000

14 00020

03

2004

2005

2006

2007

Mar

-08

Jun-

08

Sep-

08

Dec

-08

Mar

-09

0

10

20

30

40

50

60

70%

Foreign funding - from parent bank Foreign funding - not from parent bank

Parent funding/ foreign funding (right scale) Foreign funding/ external funding (right scale)

HUF Billion

Recurring pressure on the exchange rate

Implied HUF yields from FX swaps

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

11

12

1-A

ug-0

8

15-A

ug-0

8

1-Se

p-08

15-S

ep-0

8

29-S

ep-0

8

13-O

ct-0

8

29-O

ct-0

8

12-N

ov-0

8

26-N

ov-0

8

10-D

ec-0

8

29-D

ec-0

8

14-J

an-0

9

28-J

an-0

9

11-F

eb-0

9

25-F

eb-0

9

11-M

ar-0

9

25-M

ar-0

9

8-A

pr-0

9

23-A

pr-0

9

8-M

ay-0

9

22-M

ay-0

9

%

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

11

12%

Implied HUF yield on one-day USD/ HUF transactions Implied HUF yield on one-day EUR/ HUF transactionsAverage uncovered interbank overnight interest rate

Source: MNB

The immediate challenge: FX liquidity provision I

FX back-up facilities for the banking system

• Two-way overnight EUR/HUF FX-swap– The central bank steps in as intermediary between

counterparties– Mitigates counterparty risk– No extra liquidity - saves foreign reserves– From October 2008

• One-way overnight EUR/HUF FX-swap– End-of-the-day back-up instrument at a penalty rate– Additional FX liquidity– Backed by a repo agreement between the MNB and ECB– From October 2008

The immediate challenge: FX liquidity provision II

Due to the prevalence of CHF-based mortgages: CHF liquidity is also key

• 1-week CHF/EUR FX-swap– Backed by a CHF/EUR swap agreement between the

MNB and the SNB– Provides CHF liquidity for commercial banks at a

small surcharge– Widely used by some banks– From February 2009

Mitigating the costs for the real economy

Strong decline in corporate credit: banks needed longer-term, more predictable foreign-currency liquidity to provide working capital financing to the corporate sector

• 6-month and 3-month EUR/HUF FX-swap facilities: – Backed by the IMF standby agreement– Aim is to avoid a credit crunch in the corporate sector– The 6-month swap is cheaper, but only available for

banks who agreed to maintain corporate lending, and bring in additional long-term foreign funding as well

– No bidding, each bank has an agreed swap limit– The 3-month swap is more expensive, but available to all

registered banks– Competitive bidding– Both facilities operate from March 2009

Contraction in corporate credit: potential „financial decelerator” effect

Source: MNB

-200

-150

-100

-50

0

50

100

150

200

250

Jan-

07

Feb-

07

Mar

-07

Apr

-07

May

-07

Jun-

07

Jul-0

7

Aug

-07

Sep-

07

Oct

-07

Nov

-07

Dec

-07

Jan-

08

Feb-

08

Mar

-08

Apr

-08

May

-08

Jun-

08

Jul-0

8

Aug

-08

Sep-

08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb-

09

Mar

-09

HUF Billion

Net flow, short Net flow, long Net flow, total Net flow, total, s.a.

The use of the MNB’s foreign currency liquidity instruments

0

30

60

90

120

150

180

210

240

13-O

ct-0

8

27-O

ct-0

8

10-N

ov-0

8

24-N

ov-0

8

8-D

ec-0

8

22-D

ec-0

8

5-Ja

n-09

19-J

an-0

9

2-Fe

b-09

16-F

eb-0

9

2-M

ar-0

9

16-M

ar-0

9

30-M

ar-0

9

13-A

pr-0

9

27-A

pr-0

9

11-M

ay-0

9

HUF Billion

0

100

200

300

400

500

600

700

800CHF Million

Two-way overnight EUR/ HUF facility One-way overnight EUR/ HUF facility3-month EUR/ HUF facility 6-month EUR/ HUF facility1-week CHF/ EUR faclility (right scale)

Source: MNB

Domestic currency liquidity provision

Periods of HUF liquidity shortage despite aggregate surplus

• Almost 25% HUF depreciation between July and October 2008 margin callls, extra collateral at rollovers need for extra HUF liquidity

• Uneven distribution of HUF liquidity surplus and tightened counterparty limits individual banks faced HUF liquidity problems

• HUF liquidity provision – 2-week and 6-month collateralised lending facilities– Lower reserve ratio– Outright government bond purchases– Conversion of the IMF and EU funds at the central bank– Extension of the range of eligible collateral

Large drop in foreign investors’ demand for HUF T-bonds after Lehman

Source: MNB

2 200

2 400

2 600

2 800

3 000

3 200

3 400

2-Ja

n-08

13-F

eb-0

8

27-M

ar-0

8

9-M

ay-0

8

24-J

un-0

8

5-A

ug-0

8

17-S

ep-0

8

30-O

ct-0

8

11-D

ec-0

8

28-J

an-0

9

11-M

ar-0

9

22-A

pr-0

9

HUF Billion

20

22

24

26

28

30

32

34

36

T-bonds owned by foreign investors Share of foreign investors

%

Liquidity of the government bond market improved but still not

normalised

Source: MNB

-35

-30

-25

-20

-15

-10

-5

0

5

2-Ja

n-08

23-J

an-0

8

13-F

eb-0

8

5-M

ar-0

8

26-M

ar-0

8

16-A

pr-0

8

7-M

ay-0

8

28-M

ay-0

8

18-J

un-0

8

9-Ju

l-08

30-J

ul-0

8

20-A

ug-0

8

10-S

ep-0

8

1-O

ct-0

8

22-O

ct-0

8

12-N

ov-0

8

3-D

ec-0

8

24-D

ec-0

8

14-J

an-0

9

4-Fe

b-09

25-F

eb-0

9

18-M

ar-0

9

8-A

pr-0

9

29-A

pr-0

9

20-M

ay-0

9

Bid-ask spread Price effect Average size of transactions Number of transactions Aggregate index

Some lessons from the Hungarian experiences

First lesson: beware of the latent liquidity risk in open FX positions

• Funding markets that seem very liquid for a long time can dry out completely (FX swaps)

• Local authorities' LOLR capacity in FX is limited• In case of a liquidity crisis, effective help from parent

banks' LOLR authorities (in our case the ECB) is far from guaranteed (no FX swap lines, CEE subsidiaries' assets not accepted as collateral by ECB)

• Funding from international institutions (IMF, EU) is the last resort

• Hedging by swaps requires domestic liquidity in case of the weakening of the domestic currency

• These risk should be taken into account in prudential regulation (e.g. requiring larger liquidity buffers for FX funding)

Second lesson: enhance resilience with external help

• IMF-EU-WB package of USD 25 bn– higher international reserves– bank support package of USD 2.5 bn– continued fiscal adjustment– structural measures (new indexation of pensions, higher

retirement age)

• Central banks – ECB facility of EUR 5 bn– EUR-CHF swap facility with the Swiss National Bank

Third lesson: avoid international

repercussions

• High exposure of several developed EU countries in the region

• Home countries can be negatively affected by host country problems– financial stability should be a joint responsibility– a soft landing in FX lending would be desirable– continued support by parent banks is essential– level playing field in liquidity provision in and outside the

eurozone needed– much more intensive information exchange, coordination of

liquidity management, regulation and supervision

Fourth lesson: look forward in regulation and supervision

• Intervene proactively based on micro- and macroprudential risk assessment– top-down and bottom-up stress tests based on fat-tail

assumptions– enhanced on-site inspections– earlier intervention triggers for supervisory action– power to intervene based on risk assessment– more emphasis on communicating the risks and desirable

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