The high inflation environment in Hungary is a big headache for the country’s bankers and is putting profits under pressure. And to make matters worse the authorities have raised taxes on the sector.

Hungary’s inflation is the  highest in the European Union but recently has begun to fall. Analysts say rate cuts are just around the corner in many markets. Hungary, however, was still struggling with 19.9% inflation in June. It’s at the lowest point since October 2022, but still significantly higher than other European countries; Slovakia is second with a mere 11.3% and Poland is third with 11.2%. The eurozone area average is only 5.5% as inflation falls across the region.

Hungary’s inflation has been caused not only by the COVID-19 supply chain disruptions and the war in Ukraine, but also by the fiscal stimulus ahead of the April 2022 elections. Another reason is “a widening external deficit led by high energy prices and sustained demand, tightening global financial conditions, and disputes with the European Union that added to risk perceptions intensified pressure on the exchange rate and imported inflation,” according to the IMF. On top of that, agriculture production in Hungary was hit by a drought in 2022.

Inflation “remains the public enemy”, Gyorgy Matolcsy, Hungary’s central bank governor, has said repeatedly. But it will slow down to 7-8% by December, Finance Minister Mihaly Varga believes (food deflation already helps that). In October 2022, the Hungarian central bank introduced a one-day deposit rate, an emergency monetary indicator which in fact replaced the base interest rate (13% at that time), and set it at 18%. By July, the central bank already cut the rate three times, to a total of 15%.

High interest rates should help local financial institutions but in Hungary, banks faced a double whammy thanks to a windfall tax introduced as part of budget consolidation measures and tightening regulation.

“A significant rise in central bank policy rates in Hungary has fuelled banks' revenue generation by driving up their net interest income (NII). High inflation could have also positively affected banks’ fee and commission income. However, this has been counterbalanced by a windfall tax that banks are obliged to pay since last year. Moreover, the high inflation environment puts pressure on banks’ other operating costs,” Agata Gryglewicz, director of financial institutions at Fitch Ratings, told bne IntelliNews.

NII increased by about 63% y/y in 2022 and 82% in the first quarter of 2023, “despite a significant share of fixed-rate loans in banks' portfolios and the regulatory loan interest rate caps applicable to eligible retail mortgage and SME loans,” Gryglewicz explained. It was significantly generated by excess liquidity placements at the central bank and even helped to recover sector return on average assets (ROA, non-consolidated) from 0.7% in 2022 to around 1.3% in 1Q23.

But nevertheless, the sector’s after-tax profit went down 5% in 2022, to HUF485bn (€1.24bn at the average exchange rate for 2022). It’s the “result of changes in opposite directions”, the Hungarian central bank wrote in its financial stability report. With net interest income at HUF779bn in 2022, loss provisioning reduced profit by HUF285bn, and the bank levy subtracted HUF264bn more, including HUF212bn of windfall tax.

The biggest Hungarian banks and Hungarian banking association didn’t provide comments on bne IntelliNews’ requests.

Despite all the problems, Hungary’s banking sector is in the black, but not completely. For example, OTP Bank, the biggest in the country, has reported record quarter profit in 1Q23 of HUF194,7bn, but the main reason is a paper profit of HUF85bn, thanks to the acquisition of the Slovenian NKBM, and the 77% of consolidated adjusted profit (after tax) it earned from its foreign subsidiaries. Domestic profit fell by 55% y/y. However, ROE is at 24%, and stocks are rising – one share of OTP costs HUF13.1 compared to HUF10.1 in the beginning of the year (but far from the HUF18-19 in October 2021).

K&H Bank's profit after tax reached HUF12.8bn in the first quarter of 2023, 23% higher y/y. The bank has been largely resilient to various shocks and benefited from high market interest rates “but was pressured by extraordinary policy measures (including windfall tax and loan interest rate caps),” Fitch states. All the big banks were profitable last year despite the tax, thanks to the increase in interest income received from the central bank, Portfolio reported.

What’s next?

The market consensus is the central bank will continue monetary easing. The 100 bps rate cuts may last till March 2024, and by the end-2024 the key rate in Hungary rate could be around 5.5%, OTP analysts predict.

“While credit growth is muted in 2023, high interest rates should support profitability at similar levels compared to 2022,” Lukas Freund, an associate director at S&P Global, told bne IntelliNews.

He expects NII to decrease from very high levels as interest rates come down, and net interest margins to come down to about 3.5-4% by late 2023/2024 from about 5-5.5% in 2022/2023. Since April 2023, the minimum reserves ratio increased from 5% to 10%. Also, the central bank only pays interest on 75% of reserves.

Interest rate cuts “will inevitably lead to lowering of banks’ net interest margins (and therefore revenue generation), however, the impact will vary by bank, and we expect the monetary policy easing to be gradual,” Gryglewicz said.

She forecasts margins to stay relatively high this year, and in 2024 margin contraction could be mitigated by higher lending volumes and lower regulatory burden. Banks will still have to pay the windfall tax in 2023, but they could cut such payments in 2024 if they’ll increase the purchases of forint-denominated government debt.

Banks won’t ease their lending standards, Gryglewicz thinks, but new lending will “fall significantly this year due to economic stagnation and reduced domestic demand and still high borrowing costs.” But the lending volumes may be contributed by state-sponsored subsidised lending schemes.

Government subsidised schemes in SMEs and corporate lending “keep the market alive,” Freund from S&P confirms. Generally, he believes that credit growth will slow down to about 5-6% this year, in contrast to strong double-digit growth in the past, and may return to double-digits only in late 2024/2025.