Hungary's banks stable, profits and lending to fall - central bank

© Reuters. FILE PHOTO: The Hungarian national flag flies on the building of the National Bank of Hungary in Budapest January 10, 2013. REUTERS/Laszlo Balogh//File Photo

BUDAPEST (Reuters) - Hungary's banking system is stable and has significant reserves to manage risks, the National Bank of Hungary said on Thursday, adding that banks faced weaker profitability due to government measures, while high interest rates were set to crimp lending.

The NBH left its base rate unchanged at 13% on Tuesday and pledged to maintain tight monetary conditions for a "prolonged period", with inflation only set to decrease more significantly from mid-2023.

The bank said the deteriorating economic environment amid the war in neighbouring Ukraine had hit the Hungarian economy and posed a considerable risk to portfolio quality.

Economists polled by Reuters expect average inflation to reach a 26-year-high of 16% next year, with economic growth stalling amid high interest rates, slowing global growth and falling demand due to the surging cost of living.

"The shock resiliency of the sector is adequate, its liquidity and capital position is robust even in the case of a crisis much more severe than the current forecasts," the bank said in its financial stability report.

"We expect a decline in credit expansion in both the corporate sector and the household sector, due to the rising interest rate environment and uncertainty caused by the war."

The NBH said the median probability of default for small businesses with loans had increased to 4.7% from 2.9%, while the non-performing loan ratio among mortgage loans could rise by 2 percentage points by the end of next year as households grapple with soaring utility costs.

Return on equity in the banking sector fell by three percentage points to 7% in the first half, hit by government tax increases to rein in the budget deficit, with the stabilisation measures continuing to weigh on banking profits next year.

"Falling profitability and the narrowing of funding opportunities may lead to the deterioration in lending capacities over the medium term," the bank said.

"Although banks' liquidity buffers fell slightly, ample reserves are still available," it said, adding that there would only be a "temporary and manageable" capital shortfall even in a more severe, protracted stress scenario at the sector level.