Developments in the costs of external funds of the Hungarian banking sector

The high dependency of the domestic banking sector on foreign funds and its open on-balance-sheet foreign exchange position, as well as the considerable increase in sovereign and parent bank credit risk premia due to the sovereign debt crisis, warrant a more accurate mapping of the pricing principles and costs of foreign (primarily parent bank) funds. For this reason, in the summer of 2011 we conducted a survey of the pricing practices of banks at the individual bank level and the evolution of the costs of foreign funds in recent years. Both personal interviews and historical data confirmed that since 2010 the country risks of subsidiaries have been increasingly included in the premia above the interbank reference rates, mainly on maturities of over one year. Accordingly, the price of funds obtained from abroad changed significantly, as the importance of risk-based pricing increased during the crisis. The historical data also suggest that this took place gradually at the system level. Following the onset of the subprime mortgage market crisis in 2007, premia averaged at the system level gradually approximated the credit default risk spreads of the parent banks. From the October 2008 crisis until the autumn of 2009, at the system level parent banks effectively passed their own premia on to domestic subsidiaries. From 2010 on, with the deepening of the European sovereign debt problems, sovereign CDS-based pricing corresponding to the country risk of subsidiaries (i.e. corresponding to the Hungarian sovereign risk in the case of domestic subsidiaries) became increasingly prevalent. At the system level, premia on longer-term currency swaps used for covering the on-balance-sheet open foreign exchange position were typically lower than the premia on foreign funds: the inclusion of counterparty and liquidity risks in prices started only later, and on average up to the level of parent bank CDS spreads at most. All of this has driven domestic banks in the direction of short-term financing and swap-based foreign exchange financing.