Hungarian Guarantee Scheme

In October 2008, the government reached out to the IMF to request financial support via a Stand-By Arrangement of 17 months of special drawing rights (SDR) of SDR 10.5 billion (€12.5 billion) for a large economic assistance package that would facilitate macroeconomic policies and promote financial stability throughout Hungary. The government listed three goals under the program (IMF 2008a):

1. To reduce the government’s financing needs and improve long-term fiscal sustainability
2. To maintain adequate capitalization of the domestic banks and liquidity in domestic financial markets
3. To underpin confidence and secure adequate external financing

The Hungarian government also reached out to the ECB and the World Bank for additional funding. Under the package, the Hungarian government specifically wanted to sponsor a bank support program aimed at boosting the credibility and ensuring the soundness of all banks operating in Hungary. Another goal of the program was to increase the main domestic bank’s ability to provide for its foreign subsidiaries (IMF 2008a). The program funded the creation of two schemes, a recapitalization scheme and a guarantee scheme. The purpose of the recapitalization scheme was to strengthen the capital positions of major credit institutions, increase liquidity across the Hungarian banking sector, and encourage lending to the real economy. (European Commission 2009a). (See Appendix A and Buchholtz 2018b for more about the recapitalization scheme.).

On December 15, 2008, the Hungarian Parliament passed the Financial Stability Act aimed at “strengthening the financial intermediary system” and “limit[ing] the effects of the global financial crisis in Hungary and maintain[ing] its financial stability” (European Central Bank 2009).

After two months of analysis and deliberation over the program, the EC approved the program in February 2009 under Article 87(3)(b) of the EC Treaty, which “enables the EC to declare aid . . . if it is necessary to remedy a serious disturbance in the economy of a Member State” (European Commission 2009a). The EC believed that the program’s objectives could sufficiently address the issues of the lack of liquidity and confidence in the Hungarian banking sector, as well as provide a benefit to the overall Hungarian economy (European Commission 2009a).

Regarding the EC’s assessment of the guarantee scheme, the EC believed that guarantee schemes as a whole could help overcome global market failures that inhibited banks from accessing liquidity or constrained a healthy bank from serving as a financial intermediary. Given that the goal of the Hungarian guarantee scheme was “to provide a safety net to investors that purchase the newly issued debt of, or lend to, the participating institutions,” the EC was satisfied with the objectives of the guarantee scheme (European Commission 2009a).

As discussed in more detail below, the need to structure the guarantee scheme in such a way as to ensure EC approval significantly influenced the design of certain program features.

Program documents did not contain specific rationales for these figures.

To have been considered fundamentally sound, a credit institution was evaluated by the MNB and the Pénzügyi Szervezetek Állami Felügyelete, or the Hungarian Financial Supervisory Authority (PSZAF) (European Commission 2009a). The MNB evaluated the impact of the institution on markets, financial infrastructure, and other regulated entities, and assessed its short-term liquidity position. The PSZAF evaluated the medium-term and long-term liquidity positions of the applicant. Afterward, the MNB and PSZAF provided a recommendation to the Hungarian Minister of Finance to assess whether an institution was eligible for assistance and what the extent of assistance to that institution should be. (European Commission 2009a).

Hungary’s parliament removed these requirements following feedback from the European Commission. The regulatory capital requirement in particular would have limited participation to just three of Hungary’s largest banks. The elimination of this requirement was thus seen as promoting “non-discriminatory” practices and avoiding “threat[s] to distort competition” (European Commission 2010).

Program documents did not provide a specific rationale for the types of debt that were made eligible.

Since a major portion of the Hungarian financial market relied on the housing market and mortgage loans, whose maturities often exceeded three years, the fund guaranteed interbank loans of between three years and five years. However, the EC noted that it was in the best interest of all parties to cover loans with as short a duration as possible, defined by the EC as three months. Therefore, the guarantee scheme allowed only up to approximately a third of the RGF to be utilized to guarantee loans with maturities of between three and five years. Loans with a maturity of between three and five years could be guaranteed only to a maximum of HUF 450 billion (European Commission 2009a).

Program documents did not provide a specific rationale for limiting the guarantee scheme to these currencies.

Programs documents did not contain language restricting the amount of an individual institution’s participation in the guarantee scheme.

Based on the European Central Bank Recommendations on Government Guarantees on Bank Debt, released on October 20, 2008, any guarantee provided by the Hungarian government would include a flat fee of 50 bps for newly issued short-term loans, in addition to an add-on fee derived from CDS spreads. Because CDS spread data was generally unavailable for Hungarian banks, the ECB used the CDS spread on A-rated bonds, which was then 73.50 bps, to set the annual fee at 123.50 bps (European Commission 2009a).

Guidance issued by the European Commission in October 2008 on the creation of credit guarantee programs called for the inclusion in programs of a set of safeguards “to minimize . . . distortions and the potential abuse of the preferential situations of beneficiaries brought about by a State guarantee” and “to avoid moral hazard.” This guidance did not specify what safeguards a program should include, but required “an adequate combination” of elements, including restrictions on advertising based on the guarantee, balance sheet growth, share buybacks, and executive compensation, some of which Hungary adopted (European Commission 2008).

The state believed that to ensure that the bank support program would “not allow the credit institutions to expand their business in an unfair manner,” the government should impose behavioral conditions on any participating institution (European Commission 2009a). Those conditions included requiring that each participating institution not advertise any government assistance they received and imposing restrictions on salary, compensation, and other benefit plans of the top executive officers of the banks (European Commission 2009a).

Given that the state would provide large guarantees on interbank loans, the terms of the guarantee scheme required that the participant grant a special veto share to the government. The share provided “veto rights” that allowed the state to deter decisions “which would lead to a misuse of funds” or could have threatened financial stability at home and abroad (European Commission 2009a). Some examples of the misappropriations of funds included issuing large dividend payments, providing large executive compensation and bonus payments, or extraction of funds by management (European Commission 2009a).

Hungarian authorities intended this requirement to ensure that any institution troubled enough to default on its guaranteed debt would be restructured.

The EC approved Hungary’s request to prolong the issuance window of the guarantee scheme until the end of 2009 in spite of the fact that no institution had sought to participate. The EC believed that keeping the scheme open provided reassurance to the global economy that the state had assistance measures in place and that restoring market confidence in Hungary would lower sovereign risk, thus stimulating participation in the guarantee scheme (European Commission 2009b).