Hungarian Bank Recapitalization Program (1993–1994)

The recapitalization of Hungarian banks in early 1990s was part of “consolidation” that began in mid-1992. The consolidation took three forms (Neale and Bozski 2001):

Asset purchases—Asset purchases through the Loan Consolidation Program involved substituting bad debt for long-dated (20-year) Treasury bonds with a variable interest rate, linked to the Treasury bill yield of the previous quarter (see Dreyer 2021).

Recapitalization—The government recapitalized banks by purchasing common stock or subordinated loans.

Debtor restructuring—This process endowed capital directly to banks’ debtors to improve their financial conditions preparatory to their own privatizations.

Each process took several stages. The recapitalization was implemented over three stages: in December 1993, May 1994, and December 1994 (IMF 1995). Balassa (1996) argues that the step-by-step approach taken by the government had negative consequences. The author argues that uncertainty, combined with the slowness of the legislation process, may have led to technical complications and a decline in efficiency. Balassa further argues that the slow and politically turbulent legislative process hindered public understanding of the details of the program and the importance of the consolidation processes. The author laments that “it might have been more expedient to implement the consolidation of the banking sector on the basis of one or more laws . . . Perhaps, had that been the case, less mistakes would have been made during its implementation” (Balassa, 1996).

The recapitalization process was authorized by the Bank Consolidation Act (Neale and Bozski 2001). Yet, Neale and Bozski (2001) argue that the legality of early consolidation processes was “flimsy.” The budget law of 1993 authorized the government to issue credit consolidation bonds (CCBs) to fund its interventions. The law did not specify the limits of issuance and other details; the government took care of such details through executive orders.

The Ministry of Finance took the initiative in the consolidation process, as well as in the development of the supervisory and regulatory system (Neale and Bozski 2001).

Capital was injected in financial institutions that did not meet capital ratio regulatory requirements (Balassa 1996). The threshold of the targeted capital adequacy ratio and the targeted banks evolved over time. Larger banks and state banks were more likely to receive capital. Furthermore, after the second capital injection, in May 1994, participating financial institutions were required to submit “consolidation plans,” detailing the modernization of business policies, management, and risk management (see the Restructuring Plan section for further details) (IMF 1995).

Prior to the first capital injection, in December 1993, the Ministry of Finance identified 10 significant financial institutions (Magyar Hitel Bank [MHB], Kereskedelmi és Hitelbank [K&H], Budapest Bank [BB], Mezobank, Takarekbank, Agrobank, Dunabank, Iparbankhaz, Konzumbank, and Realbank) and further determined whether to inject capital to those banks whose capital adequacy ratios were negative (Bonin and Schaffer 1995).^FFurthermore, some savings cooperatives and other smaller-scale banks from the consolidation program and the “sour sixteen,” selected large state-owned institutions employing in excess of 7% of the industrial labor force, were also included (Bonin and Schaffer 1995). Realbank underwent a management buyout and was privatized, and it became apparent that the capital adequacy ratio of Konzumbank was above 8%. Ultimately, the other eight banks (MHB, K&H, BB, Mezobank, Takarekbank, Agrobank, Dunabank, and Iparbankhaz) received the first round of capital injections, in December 1993 (Bonin and Schaffer 1995) (See Figure 3).

Figure 3: Banks’ Capital Adequacy Ratios (CARs) below Zero after the Capital Injection in December 1993

Source: Bonin and Schaffer 1995, 69; note that A=Agrobank, BB=Budapest Bank, D=Dunabank, I=Iparbankhaz, K&H=Kereskedelmi és Hitelbank, M=Mezobank, MHB=Magyar Hitel Bank, and T=Takarekbank.

In the second injection, in May 1994, banks with capital adequacy ratios below 4% were eligible. The Ministry of Finance injected capital so that banks’ capital adequacy ratios would reach 4%. Finally, in the third injection, in December 1994, four large state-owned banks received capital so that their capital adequacy ratios would reach 8%, the ratio required by Bank for International Settlements rules (Balassa 1996). The Basel accord called for a minimum ratio of capital to risk-weighted assets of 8% to be implemented by the end of 1992. This framework was introduced not only in Group of Ten countries but also in virtually all countries. Hungarian banks were required to reach a capital adequacy ratio of 8% by 1994.

There were a few exceptions to the eligibility rule. For instance, in May 1994, the National Savings and Commercial Bank (Országos Takarék Pénztár, or OTP), one of the largest commercial banks, received a HUF 5 billion capital injection twice in 1993 and 1994, even though its capital adequacy ratio had already exceeded 4% and even though it was not designated as one of 10 banks nominated by the government in December 1993 (IMF 1995). Furthermore, smaller banks did not participate in the last round of capital injections, in December 1994, as it was assumed the smaller banks would be able to raise their capital ratios through privatization and partnerships with larger banks (Ábel and Szakadát 1997). The deviation in implementation varied with discretionary governmental judgments.

While estimations vary, approximately HUF 165 billion to HUF 180 billion was injected throughout the recapitalization process. It was approximately 5% of Hungarian GDP in 1993 (IMF 1995; Nováková 2003). The first capital injection, in December 1993, was the largest in terms of size, totaling more than HUF 100 billion (see Figure 2 in the “At a Glance” section above).

The budget law of 1993 authorized the government to issue credit consolidation bonds. The CCBs issued under the budget law of 1993 had a maturity of 20 years, and interest was to be paid twice yearly, compared to the formerly issued CCBs, which paid interest once a year (Ábel and Bonin 1992; IMF 1995). CCBs were deployed both in the loan consolidation program (see Dreyer 2021) and the recapitalization program (IMF 1995). In the recapitalization, the government acquired the equity in the banks by purchasing newly issued shares with CCBs (IMF 1995).

Until the end of 1994, approximately HUF 330 billion worth of CCBs were issued by the government, and by mid-1996, the number reached HUF 360 billion (Balassa 1996). The CCBs were also used (1) to purchase HUF 1.9 billion in equity from existing commercial bank shareholders; (2) to grant the savings cooperatives HUF 5.9 billion in subordinated loans and to increase their capital by HUF 2.7 billion; and (3) to grant the OTP a HUF 5 billion subordinated loan (IMF 1995.

While the state later sold some of the banks above their book values after the recovery, the cost of the consolidation (including other nonrecapitalization measures) was expensive, burdening the state budget. As Figure 4 shows, despite the successful privatizations, the total proceeds (HUF 98.9 billion) from selling the privatized banks covered only 35% of the consolidation costs (Neale and Bozski 2001).

Figure 4: Privatization Revenue Relative to Consolidation Cost

Source: Neale and Bozski 2001, 166; Postabank was privatized in 2003.

There seem to have been no fixed participation limits.

The first capital injection, in December 1993, took the form of voting shares. The government recapitalized eight banks by purchasing newly issued banks’ common stocks with CCBs (IMF 1995). The second capital injection, in May 1994, took a mixed form. For the three large banks, capital was injected by acquiring additional common stocks with voting shares so that their capital ratios would reach 4%. For the four smaller banks, the Ministry of Finance acquired voting shares to increase capital to a 2% capital ratio level; the remaining 2% was filled with subordinated loans (Balassa 1996).

The third capital injection, in December 1994, took the form of a 30-year subordinated loan. In order to offset the budgetary impact of the lending, interest payments on CCBs and on the subordinated loans were adjusted (IMF 1995).

Figure 5: Expenditure on Consolidation 1992–1994 (HUF millions)

Source: Neale and Bozski 2001, 155.

As a precondition of the May 1994 recapitalization, banks were required to submit “consolidation plans.” The consolidation plans prescribed management strategies for bank reorganization and required the banks to participate actively in enterprise debt resolution programs (Balassa, 1996; IMF 1995). The enterprise debt resolution program involved determining the circle of clients to be dealt with in the course of debtor conciliation, another program run by the government (Balassa 1996). The agreements based on the consolidation plans also detailed certain bank restructuring procedures on an individual (bank-by-bank) basis (Bonin and Schaffer 1995).

Amongst three banks that received capital in December 1994, only BB had submitted a consolidation program acceptable to the government by the end of 1994. The government rejected the plans submitted by MHB and K&H. These two banks submitted revised consolidation plans and eventually replaced top management in late 1994 and early 1995, in order to obtain the government’s approval. With some delay, all banks, including MHB and K&H, received the capital (IMF 1995; Neale and Bozski 2001).

The majority of banks created a separate internal or external workout unit to deal with the nonperforming loans. Separating the liquidation process from normal bank business not only avoided unintended disruptions in the financial system but also prepared banks for privatization by separating “good banks” from “bad banks.” Some banks sold their nonperforming loans to private liquidation organizations (Nováková 2003). For instance, in order to deal with their nonperforming loans, Budapest Bank formed 2B Ltd., K&H and Mezobank jointly set up Kvantumbank, and MHB established Risk Ltd. (Neale and Bozski 2001).

No further detail was found for this Key Design Decision.

In the 1990s, Hungary adopted new banking sector reform policies, including updated banking, accounting, and bankruptcy laws, overhauling the entire Hungarian financial system. In December 1991, the Hungarian government introduced the Banking Act, which required banks to reach a capital adequacy ratio of 8% by 1994 and accumulate loan-loss reserves (Ábel and Szakadát 1997; Dreyer 2021). This act also introduced three categories for rating loan portfolios (Ábel and Bonin 1993) and established the State Banking Supervisory Agency (Borish et al. 1996). The establishment of the Banking Act was followed by the enactment of a new bankruptcy law, which became effective on January 1, 1992, requiring any company with any outstanding debt that was more than 90 days in arrears to initiate bankruptcy proceedings (Ábel and Bonin 1993).