WATCHING THE WATCHDOG: REFORMING HUNGARY'S

C O N F I D E N T I A L SECTION 01 OF 03 BUDAPEST 000477

SIPDIS

DEPARTMENT FOR EUR/CE, EB/OMA, INR/EC, TREASURY FOR ERIC
MEYER, JEFF BAKER, LARRY NORTON

E.O. 12958: DECL: 07/01/2014
TAGS: EFIN ECON PREL HU
SUBJECT: WATCHING THE WATCHDOG: REFORMING HUNGARY'S
FINANCIAL SUPERVISORY SYSTEM

REF: 08 BUDAPEST 1027

Classified By: Acting P/E Counselor Jon Martinson, reasons 1.4 (b,d)


1. (C) Summary. Amidst a sea of criticism and disagreement
over the restructuring of the Hungarian Financial Supervisory
Authority (HFSA),HFSA Supervisory Council Chairman Istvan
Farkas resigned on June 18. Ministry of Finance officials
and National Bank Governor Andras Simor favor the National
Bank taking on some of the responsibilities of the HFSA, a
move the HFSA strongly opposes. On June 29, Parliament
approved the appointment of Adam Farkas as the new HFSA
Chairman, and it appears that no changes will likely be made
to the organizational structure of the HFSA until the autumn
at the earliest. The IMF and EU are leading the call for
strengthening the HFSA, and Chairman Adam Farkas expressed
commitment to improving the HFSA's ability to identify
potential risks to the financial system and preventing them
from developing.


2. (C) Controversy has also reached National Bank Governor
Andras Simor following press reports that he transferred
millions of forints out of Hungary into his Cyprus-based
firm. Analysts believe calls for Simor's resignation are
politically motivated by both the opposition, as well as by
some Socialist Party MPs possibly seeking to deflect blame
for the economic crisis. Excessive criticism of the HFSA and
the national bank leadership could reduce confidence in
Hungary's still vulnerable financial system. End summary.

CRITICISM OF THE HFSA


3. (SBU) In recent months, the HFSA (also known by the
Hungarian acronym PSZAF) has faced increasing criticism for
being ineffective and insufficiently independent of
government and lobby group influence. Complaints include
criticism that the HFSA should have taken greater steps to
curb the explosion in recent years of foreign currency
lending by banks (reftel),and that it should impose stricter
penalties on financial service providers not complying with
HFSA rules. In addition, the HFSA was faulted in March for
failing to initially join a statement by financial
supervisory authorities of other Central and Eastern European
(CEE) countries warning against making overly broad and
potentially misleading statements on the economic and
financial health of the region.


4. (SBU) Finally, last November, the HFSA suspended trading
by real estate funds that were facing severe liquidity issues
due to large capital withdrawals. HFSA's decision to suspend
trading was criticized as both unnecessary as well as
contributing to the liquidity problem by fueling further
flight from the funds.

REFORM, RESIGNATION, REORGANIZATION


5. (SBU) Both the EU and IMF emphasized the need to
strengthen and provide additional regulatory authority to the
HFSA. In particular, in its review of Hungary's financial
stabilization package implementation, the IMF notes that the
HFSA is constrained by its lack of authority to issue
regulations, as well as by its status as a semi-autonomous
agency subordinated to the Ministry of Finance. It also
notes the need for stronger supervision of large financial
groups, as well as the need to improve its capabilities in
the area of on-site bank inspections. Hungarian National
Bank (MNB) Deputy Governor Ferenc Karvalics noted that
Hungary will receive a technical assistance team to help with
institutional strengthening in the area of banking
supervision. HFSA's newly approved Supervisory Council
Chairman Adam Farkas (note: no relation to former Chairman
Istvan Farkas. End note) also announced that he intends "to
create a new financial regulatory and control framework for
the HFSA," in order to ensure the HFSA devotes more attention
to identifying potential risks to the financial system and
preventing them from developing.


6. (C) There is strong internal debate, however, as to how
HFSA's organizational structure will be impacted by these
changes. Press and analyst sources indicate that Ministry of
Finance officials and National Bank Governor Andras Simor
favor incorporating HFSA responsibilities into the MNB. The
HFSA opposes this approach, maintaining that the HFSA should
remain a separate independent entity. HFSA Director General
Csaba Varga argues that the focus of the two entities is
different, with the MNB focused primarily on price stability,
while the HFSA's mandate is broader, and includes issues of

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competition and consumer protection, and that only as
separate entities can all interests be properly safeguarded.
HFSA Director General Csaba Varga recently complained to
Embassy officials that discussions about the possible merger
of the HFSA into the national bank have been carried out
without input from HFSA.


7. (SBU) The issue came to a head in mid-June when current
HFSA Supervisory Council Chairman Istvan Farkas announced his
resignation. In a letter posted on the HFSA website, Farkas
noted he is resigning because there is no hope of finding a
common position between the HFSA and "government branches
responsible for shaping financial regulations" on
organizational and management changes to the HFSA. Farkas'
resignation appears to have at least temporarily postponed
any major changes; the daily newspaper Nepszabadsag goes even
further, suggesting that Farkas' resignation may have been
the price for HFSA to maintain its current organizational
structure. Krisztian Szabados of the research firm Political
Capital notes, however, that the government still plans to
revisit the organizational structure of HFSA in the next
parliamentary session.

MNB GOVERNOR SIMOR ALSO UNDER ATTACK


8. (SBU) The MNB has not been without its share of drama as
well. National Bank Governor Andras Simor has recently been
accused by the opposition FIDESZ Party as well as by several
Socialist Party MPs of tax evasion by "concealing millions of
forints from Hungarian tax authorities" through the use of an
"offshore company." Simor responded to these accusations by
noting that his foreign-registered company is registered in
an EU Member State (Cyprus),and pays taxes based on local
regulations. He notes that there is no tax liability on the
after-tax assets moved into the company. Analysts generally
believe this is not a case of tax evasion, although some note
the case raises ethical issues given the MNB Governor's
failure to list these foreign assets in his property
declaration. Although accusations of Simor's "offshore
dealings" have subsided somewhat lately, FIDESZ continues to
call for him to step down.


9. (SBU) Analysts note that the Socialists and FIDESZ have
different motivations for attacking Simor. Some socialists
may be trying to use Simor as a scapegoat for Hungary's
economic situation and the austerity measures the government
recently enacted. They may also be concerned that Simor's
tight monetary policy is making problems worse for Hungarians
by stifling economic growth. The opposition, although also
arguing that the MNB should be more aggressive in rolling
back last October's emergency 300 basis point rate increase,
continues to associate Simor with many of the failed policies
of the previous Gyurscany government, and believes he should
resign.


10. (C) There is likely to be little practical effect,
however, of demands for Simor's resignation. Removal of the
National Bank Governor requires proposal by the Prime
Minister and approval by the President. Given the close
relationship between the Prime Minister and the National Bank
Governor (Note: Simor was formerly PM Bajnai's boss. End
note),as long as Prime Minister Bajnai remains in power, MNB
Governor Simor is unlikely to be forced out of his position.
Some analysts speculate, however, that the Socialists may
find it in their interests to appoint a new central bank
governor, who would remain in place well beyond the 2012
expiration of Simor's current tenure.

COMMENT: IMPLICATIONS FOR FINANCIAL REGULATORY SYSTEM


11. (C) Although criticism of the HFSA and attacks on MNB
Governor Simor are not directly related, together they serve
the interests of both Socialist Party MPs looking for a
scapegoat for Hungary's financial problems, as well as the
opposition hoping to tarnish the government's image in the
run-up to national elections. They may become victims of
their own success, however, should attacks on the credibility
of financial regulation (and regulators) reduce confidence in
Hungary's financial system and continue to keep investors
away.


12. (C) The increased focus on strengthening the HFSA, led
primarily by pressure from the IMF and the EU, will help
Hungary improve its system of financial supervision. It is
unclear whether what will emerge will be a stronger
independent HFSA, or whether the responsibilities of the HFSA
will be folded into a national bank with an expanded mandate.

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As we have already seen, however, as is often the case in
Hungary, the process is unlikely to be smooth and
unpoliticized. End comment.
Levine