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Document Type

Case Study

Abstract

Hungary implemented a number of new policies from the late 1980s to the early 1990s, shifting from a centrally planned economy to a market economy. Despite the top-down market reforms, Hungary lacked the knowledge to build a fully functional financial system. Eventually, an economic turmoil caused by the collapse of eastern markets and fragility in the financial system led to the banking crisis of 1992–1993, revealing the undercapitalization of the financial system. The government implemented the recapitalization, or “bank consolidation,” as part of a stabilization program. It injected capital into banks in three stages—in December 1993, May 1994, and December 1994—so that their capital ratios would be raised to the 8% Basel accord minimum. The government expected recapitalization to address imprudent lending behaviors (the flow problem) by tying receipt of the funds with banks’ commitment to improve their risk management and controls. The asset purchase could only improve the quality of banks’ existing portfolios (the stock problem). Banks were required to submit restructuring plans (“consolidation plans”) upon participating in the capital injection, although some banks received the capital even if they did not provide adequate plans. Along with the recapitalization program, prudential regulation and accounting standards were amended. The recapitalization was successful overall, although larger banks benefited more than smaller banks.

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