In 1987, the Hungarian government began to reform the banking system from “one-tier” bank system to a “two-tier” banking system (IMF 1995). The “one-tier” system consisted of a bank for households (Országos Takarékpénztár (OTP) and the National Bank of Hungary (NBH), which had served both central and commercial banking purposes. The Hungarian government spun out three credit departments from the NBH to form three large state-owned commercial banks: the Hungarian Credit Bank (MHB), the National Commercial Credit Bank (K&H), and the Budapest Bank (BB) (Ábel and Bonin 1993a; Nováková 2003; IMF 1995). These banks inherited loan portfolios and customers from the central bank (Ábel and Szakadát 1997).
Between 1990 and 1993, real GDP in Hungary fell by approximately 20% (Nováková 2003). This severe recession led many of the loans that were transferred from the NBH to become nonperforming. Banking problems were exacerbated by lack of clear regulation, lack of proper supervision, and insufficient experience among bank staff in risk assessment and loan evaluations (Ábel and Szakadát 1997). Furthermore, bank customers tended to be concentrated in specific sectors, because MHB, K&B, and BB were formed from the industrial, food processing, and infrastructure financing departments of the central bank, making the banks vulnerable to the economic recession (IMF 1995).
The Hungarian government passed the Banking Act, which became effective on December 1, 1991, and required banks to reach a capital adequacy ratio (CAR) of 8% by 1994 and to accumulate loan-loss reserves (Ábel and Szakadát 1997). This act also introduced three categories for rating loan portfolios. The classification of loans under the Banking Act required that banks classify assets as “bad” if the borrower was in default for more than one year or if the borrower had filed for bankruptcy; these loans required 100% provisioning by 1994. The other two categories of assets that required provisions were “substandard” loans and “doubtful” loans, which required 20% and 50% provisions, respectively. A month later, the government enacted 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 “or the responsible parties would be subject to criminal prosecution” (Ábel and Bonin 1993a).
The combination of the recession, the bankruptcy reform, and the new loan classification standards led to a rapid increase in the portion of loans that banks reported as nonperforming, from an estimated 9% in 1991 to 17% in 1992. Credit spreads increased, and viable borrowers began to seek out alternative sources of credit (IMF 1995). Total bank lending decreased, and banks did not have sufficient loan loss provisions (IMF 1995; Ábel and Szakadát 1997).
In 1992, the Hungarian government announced measures to address nonperforming loans. The first measure was the 1992–1993 bank-oriented Loan Consolidation Program (LCP) (Ábel and Szakadát 1997). Banks with a CAR of less than 7.25% were eligible to sell bad debt to the Ministry of Finance (MoF), on behalf of the government, in exchange for government bonds (IMF 1995). Only loans issued prior to October 1, 1992, and classified as “bad” were eligible for transfer to the government. In exchange for the nonperforming debt, the government issued long-term “consolidation” bonds and deducted accumulated risk reserves from the banks (Ábel and Szakadát 1997). Initially, the government issued Series A bonds in exchange for loan principal and Series B bonds for interest arrears and fees, but ultimately replaced Series B bonds with Series A bonds that paid higher interest rates (Várhegyi and Boros-Kazai 1994; Ábel and Szakadát 1997).
Fourteen banks and 69 credit cooperatives participated in the bank-oriented LCP (Ábel and Szakadát 1997). In 1992, the government purchased loans and interest claims with a total face value of HUF 102.5 billion ($1.3 billion) in exchange for a total of HUF 81.3 billion in consolidation bonds (Balassa 1996). Later, in 1993, the government acquired HUF 17.3 billion in additional bad debt at face value from three financial institutions under the LCP (Ábel and Szakadát 1997). The discount on book value for a given asset depended on when the loan was classified as bad: loans classified as bad in 1991 received 50% of face value while loans classified as bad in 1992 received 80% of face value (Ábel and Szakadát 1997). For the debt of certain companies, the government paid 100% of face value (Balassa 1996).
In 1993, the Hungarian government launched a “firm-oriented” LCP program to allow banks to sell debt of large state-owned enterprises (SOEs). The government selected 13 industrial SOEs and later added eight food processing firms, multiple state farms and agricultural cooperatives, and the Hungarian Railways company. The government purchased debt of industrial and food processing companies at a 10% discount. It purchased debt of Hungarian Railways, state farms, and agricultural cooperatives at face value (Ábel and Szakadát 1997). Similar to the bank-oriented credit consolidation, the government issued consolidation bonds in exchange for the bad loans. Under the firm-oriented LCP, the government exchanged a total of HUF 57.3 billion in consolidation bonds for bad debt with a face value of HUF 61.3 billion (Balassa 1996). (See Figure 1.)
Figure 1. Debt Purchased from Hungarian Banks under the Loan Consolidation Programs
Sources: IMF 1995; Balassa 1996; Ábel and Szakadát 1997.
Though MoF purchased the bad debt, a majority of the debt from the bank-oriented cleanup remained with the selling banks to manage until 1994; the MoF and the selling banks entered into renewable, three-month contracts for the temporary management of the transferred debt (Balassa 1996). The MoF sold approximately HUF 40 billion of debt at face value to the Hungarian Investment and Development Corporation (HIDB), a government-owned entity, and it appears that the loans were sold based on the viability of debt resolution and workout procedures (IMF 1995). The HIDB was responsible for resolving claims with the creditors of the transferred debt, and during the first half of 1993, the HIDB completed agreements with debtor firms—most of which involved reorganizations or liquidations (IMF 1995). Bad debt remaining from the bank-oriented LCP was offered for sale to businesses engaged in the management of nonperforming debt; it appears that HUF 7 billion in bad debt was sold in this manner for a price of approximately 10% of face value. In 1995, the HIDB took over the management of the remaining HUF 63 billion in bad debt and was allowed to retain 35% of the net revenues from the debt recovery (Balassa 1996; Ábel and Szakadát 1997). As of 1997, the total recovery on the bank-oriented LCP totaled approximately HUF 6 billion (Ábel and Szakadát 1997).
Under the firm-oriented LCP, the SOE-related bad debt was transferred to the Hungarian State Holding Company and the State Property Agency (IMF 1995). In 1994, the Hungarian State Holding Company forgave all of the claims it acquired, which comprised a book value of HUF 24 billion in debt from eight SOEs (IMF 1995; Balassa 1996). The State Property Agency did not have the same legal authority: it swapped HUF 16 billion in debt for equity in SOEs, and then transferred the remaining debt to a new State Privatization and Holding Company (Balassa 1996).