VIII. TRADE AND PROJECT FINANCING A. Description of Banking System Prior to 1987, all banking activities were monopolized by the Hungarian National Bank (MNB). Some international trade activities were provided by the Foreign Trade Bank (MKB) while the National Savings Bank (OTP) performed some limited retail banking activities. In 1987, a two-tier banking system was established. The MNB's loan portfolio was divided among three new commercial banks: Budapest Bank, Hungarian Credit Bank (MHB), the Commercial and Credit Bank (K&H). Simultaneously, the State Banking Supervision Agency (SBS) was created to oversee and supervise the banking system. The SBS administratively reports to the Ministry of Finance. The banking system has developed rapidly and currently consists of: the National Bank of Hungary; 37 commercial banks (17 are fully or partially foreign-owned); 6 specialized financial institutions; 1 off-shore bank; 260 saving cooperatives. Comprehensive banking reform removed credit and service functions from the MNB. Enterprises can maintain commercial accounts with more than one bank. Except for the ceilings on household deposits, commercial banks are free to set terms for deposits and loans. Hungary's banking system is not considered "user-friendly". Banks have failed to develop and to promote retail instruments to service the client base. Checking accounts number less than 50,000. For example, many branches are not electronically interconnected. Consequently, it is not possible to cash checks other than in the branch in which the account was opened. Bank transfers are time-consuming, with transfers often lost in the process for days and sometimes months. While human error is presumed, it also possible that the banks are playing with the floats. Given the little consumer confidence in the banking system, depositors are often skeptical of new instruments. Following the introduction of direct-deposit and debit cards, employees at the Foreign Trade Bank immediately checked their balances and withdrew the money. In short, Hungary is a cash-based economy. In terms of corporate services, the banks are not eager to lend on a long-term basis. Moreover, the cost of borrowing is prohibitively high for companies. The current nominal interest rate is nearly 28 percent (note: annualized inflation rate is 17 percent; hence, the real interest rate exceeds 10 percent). Bank privatization is proceeding slowly given the bad loan portfolios of the banks. The government has developed a "credit consolidation" scheme to clean the banks' credit portfolios. Implementation of the Bankruptcy Act (January 1992) highlighted the bad loan problem. In effect, the Bankruptcy Law precipitated a sort of "mini bang" by forcing companies to settle with creditors within 90 days. Failure to do so required the company to automatically declare bankruptcy. During a 90- day moratorium, companies were to reach unanimous agreement with all creditors. Again, failure resulted in the company automatically entering into liquidation. While banks were improving their capital/asset ratios to guard against dubious loans, the bankruptcy developments encouraged them to increase the rate of provisioning. In July 1994, the first Hungarian bank was privatized. Shares of the Foreign Trade Bank (MKB) were sold-off to the German bank Bayerische Landesbank. The European Bank for Reconstruction & Development also took a stake in MKB. The next bank rumored for privatization is Budapest Bank. B. Foreign Exchange Controls Affecting Trading The Hungarian forint is not a fully convertible currency. Currently, the forint is pegged to a currency basket consisting of the U.S. dollar (30 percent) and the ECU (70 percent). Appreciation of the forint has resulted in periodic devaluations. Exporters have been critical of the government's exchange rate policy, stating that the overvaluation of the forint has priced them out of foreign markets. The worsening current account fuelled anticipation that a sizeable devaluation would take place to correct the situation. In August 1994, the government devalued the forint by 8 percent -- the single largest devaluation to date. Although the forint continues to be a managed currency, it is in essence fully convertible for business purposes. Foreigners may freely repatriate profits and dividends in hard currency (note: MNB requires that an equivalent amount in forints be on deposit with a Hungarian bank). Steady progress has been achieved in the liberalization of foreign exchange controls. Foreigners are now permitted to maintain forint accounts which can be used to purchase goods domestically. C. General Financing Availability The cost of borrowing locally is prohibitively high. The current nominal interest rate is nearly 28 percent (note: annualized inflation rate is 17 percent; hence, the real interest rate exceeds 10 percent). Local banks are often resistant to lending on a long-term basis. Close ties to old (usually state-owned) clients, the larger and safer profits available from investing in state securities, unfamiliarity with loan application evaluations, and inadequate bank reserves have acted to constrain commercial bank credit to the private sector. D. Export Financing (Methods of Payment) Decree Number 52 (March 1990) sets forth requirements for import contracts. This law was amended in by Decree Number 35 in February 1991. All import contracts exceeding 2 million forints must be secured by a letter of credit (LC) bank guarantee or by advance payments/deposits with commercial banks. The advanced payments/deposits must be put on deposit with the MNB. Importers are restricted from making foreign currency cash payments abroad exceeding a quarter million forints. Enterprises are permitted to enter into deferred payment arrangements for imports, with the LC and advance payment/deposit requirement for contracts exceeding 10 million waived if the deferred payment is for a period exceeding 60 days. E. Available Export Financing and Insurance The U.S. Export-Import Bank has provides finance and insurance for some transactions in Hungary. The largest deal to date involved the Hungarian Airlines (MALEV) procurement of two Boeing 767s. Currently, only the Foreign Trade Bank is approved by EXIM in Hungary. First Chicago and Continental Bank which were active in Hungary many years ago are again trying to redevelop their export finance business in Hungary. F. Available Project Financing Many companies look for financing abroad. Many U.S. commercial banks will provide financing services in Hungary for long-time corporate clients. But the cost of this financing is likely to be higher. West European banks are active in project financing especially the Giro Bank (Austria), Creditanstalt (Austria) and some German banks. Other sources of credit for private investors include: the Hungarian-American Enterprise Fund, the First Hungary Fund, the European Bank for Reconstruction and Development and the International Finance Corporation. Bankers Trust and Barclays maintain offices in Budapest and specialize in structuring financing packages. G. List of Banks with Correspondent U.S. Bank All major Hungarian banks -- Budapest Bank, MKB, MHB, K&H, Posta Bank, OTP -- have correspondent banks in the United States. Additionally, there are a number of international banks that maintain rep offices in Budapest (most with offices in the United States): Citibank, ABN Amro, Creditanstalt, Credit Lyonnais, and Giro Bank. For contact information, see Appendix B (section D).