The effects of US subprime crisis

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The effects of US subprime crisis a Hungarian
perspective Márton Nagy (nagymar_at_mnb.hu) Magyar
Nemzeti Bank Brunnel University, West London May
20, 2008 Co-authors of the background paper
Júlia Király, Lóránt Varga
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Hungarian risk map





Internal environment

Domestic financial institutions
External environment
Significant slowdown
Deceleration
in
credit
Lower economic growth
in
US and Euro

growth

zone
economic

growth

Deterioration in credit
portfolio


U.S. subprime crisis


Lower profitability (i.e. shock-absorbing
capacity)
Repricing of the
investment portfolio

Shocks to investors
Increase in risk premia

risk appetite

Higher market and
Turbulence on the fixed
funding liquidity risks

income market
and
higher
cost of funding

Lower margins between
credit and funding rates

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Channels of contagion and main effects

• Portfolio allocation
• Increasing risk premium (differentiation among
  countries)
• Trade
• Weakening economic growth
• Parent banks
• Deteriorating funding liquidity conditions
• Risk-based competition (search for yield
  strategy)
• Possible cross-boarder solvency problem

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4
Monetary and fiscal policy (portfolio allocation
and trade channels)

• Effect Increasing risk premium
• Higher interest rates
• Higher foreign funding cost
• Deteriorating financial market liquidity
• Monetary policy
• Rate hikes due to
• strong IT commitment
• external price shocks
• more focus on the increasing risk premium and
  capital inflow
• less fear from economic growth
• Fiscal policy
• Fiscal discipline in order to
• keep CA on a sustainable level
• achieve Maastricht criteria

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Financial stability policy crisis prevention
(I)(parent bank channels)

• Effect Deteriorating funding liquidity in
  foreign currency
• No disorder in the market of domestic currency
  liquidity
• Shorter maturity of available external funds
• Higher funding costs
• Monetary operations
• Unchanged monetary operation and LoLR framework
• But task-forces on
• Operation of FX-swap market
• Possible modification of reserve requirement
• Extension of collateral on individual and
  systemic level
• Cross-boarder cooperation
• Prudential policy
• Close investigation of stress tests and
  contingency plans
• All banks has stress tests and CP, but do they
  work?

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Financial stability policy crisis prevention
(II) (parent bank channels)

• Effect strong risk-based competition
• No subprime and securitization process, but risky
  product innovation and easing lending standards
• FX lending (CHF and EUR, but Yen credit in
  Hungary), complex unit-linked products
• Higher LTV, longer maturity, teaser rates
• Prudential policy
• Mass media campaign aiming consumer protection
• Common recommendation of HSA and MNB
• Creating full-information credit register
• Banks self-regulation
• Possible additional capital requirement after FX
  lending under Piller II

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Financial stability policy crisis management
(parent bank channels)

• Possible cross-boarder solvency crisis
• Only few parent banks have subprime exposure.
• But CB, FSA and MoF must be prepared.
• Required reactions CB, FSA and MoF
• Regional arrangements
• Organization of regional exercises
• Set-up of networks for crisis management
• Organization of workshops
• Burden sharing
• Common methodology
• Identifying systematically relevant bank
• Defining insolvent entities

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Thank you for your attention!
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Chart 1/1 Higher CA deficit higher risk premium
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Note CA deficit data for 2007, change in
exchange rate between Augustus 2007 and March
2008. Source ECB.
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Chart 1/2 Risk premium manifested in CDS in
countries with fixed exchange rate and high CA
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Source ECB.
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Chart 2/1 High foreign holdings (USD 1,500
billion) of long-term U.S. asset-backed
securities in Europe
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Note June 30, 2007 Source U.S. Treasury.
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Chart 2/2 Strong foreign presence in the banking
systems of EU10 countries (2007)
Source ECB.
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Chart 2/3 High market share of foreign-owned
banks in host-countries (2007)
Source ECB.
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Chart 3/1 Aggregated domestic financial market
liquidity index has decreased in Hungary

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Trends in the liquidity of domestic financial
markets can be measured by means of an aggregate
liquidity index which related to the four
domestic financial markets which are critical to
the operation of financial institutions (i.e. the
HUF/EUR spot FX market, the HUF/USD FX swap
market, the secondary market of Hungarian
government bonds and the interbank unsecured
money market). The index is generated through
aggregating (applying un-weighted averaging) of
the normalised daily time series of four
indicators captured with the various dimensions
of liquidity. Source MNB.
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Chart 3/2 Sharp fall in the liquidity index
bid-ask spreads are widening in Hungary

Source MNB.
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Chart 4/1 Higher credit growth higher loan to
deposit ratio

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Source ECB, MNB.
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Chart 4/2 Domestic banking sector has been
relying on a great extent on foreign funding

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Note Foreign funds of the banking systems as per
cent of total external funds Source ECB, MNB.
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Chart 4/3 Foreign funds are becoming shorter

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Note 12-month change in short- and long-term
funds Source ECB, MNB.
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Chart 4/4 and more expensive

Note The TED spread is the difference between
3-month interbank and of 3-month treasury bill
yields. Source Datastream.
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Chart 5/1 Fast FX lending and the appearance of
yen credit in Hungary
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Source MNB.
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Chart 5/2 Increasing LTVs in Hungary
Source MNB.
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