Limit setting practices of banks in Hungary: Focus on counterparty limits

During the financial and economic crisis, non-price type restrictive factors came to the fore in financial markets as well; these mainly consist of limits and margin requirements. Specific relevant signs were observed in the domestic financial markets in late 2011 and early 2012: following the downgrade of Hungarian sovereign debt to the non-investment grade category, the average interest rate on overnight unsecured interbank forint money market transactions (HUFONIA) left the interest rate corridor for a short time as a result of the constraints on limits among participants and their limits set to the MNB, and recourse to central bank swap facilities surged. This article presents the findings of a survey examining the limit setting practices of the most important banks in the Hungarian financial markets and an analysis of market data relevant from the aspect of limits. All of this is important in terms of the analysis of the efficiency of the interest rate transmission mechanism and of central bank instruments as well. Limit amounts are mainly influenced by the counterparty’s (or its country’s) external credit rating, financial indicators and CDS spreads. The banks surveyed perceive counterparty limits to be the most restrictive. In recent years, however, maturity limits have also appeared, in addition to limit amounts. In the interbank unsecured money market, the tightening of limits was reflected in a decline in daily turnover and a shortening of maturity, while in the currency swap market the shortening of maturities was observed only in the more turbulent period, as a result of the increasingly widespread use of margin requirements and the introduction of the foreign exchange funding adequacy ratio (FFAR).