In the banking sector, the transformation has been carried out through two main channels: creating new institutions and privatising existing state-owned banks. Foreign strategic investors have played a crucial role in both cases. The Hungarian authorities have pursued a conscious strategy of attracting foreign banks to set up business in Hungary. As a consequence of this, many well-known international banks have set up subsidiaries in Hungary, such as ABN-AMRO Bank, BNP-Dresdner Bank, Citibank, Commerzbank, Creditanstalt, Credit Lyonnais, Deutsche Bank, Hypo-bank, ING Bank, Nomura, and Volksbank. These foreign-owned banks have brought in capital, new technology, banking experience and new management practices which have all contributed to the development of banking services in Hungary and made the other banks follow them in the quality of services. As a result of strong competition and the rapid expansion of activities, significant developments have taken place in the settlement system, in bank IT and control systems, as well as in the training of bankers.

As a result of economic laws passed in 1991 and the overall performance of the economy, state-owned banks have faced a deteriorating business environment. The position of the group has been stabilised upon the implementation of the consolidation exercise. The consolidation of the banking system took place between 1992 and 1994. Although the methods applied were not always the best, the consolidation process has achieved its objective.

In 1995 the operation of the banking sector showed a relative stability and improved performance. The stabilisation package introduced in March 1995 has created a sounder macroeconomic environment for financial institutions through establishing a crawling peg exchange rate system and decreasing the crowding out effect of budget deficit.

As the credibility of monetary policy evolved, investor interest in Hungary increased significantly. Bank consolidation, stronger competition and the more favourable economic environment resulted in improved performance in the banking sector. For the banking sector as a whole, balance sheet totals grew by 20 per cent during 1995, while the number of foreign-owned banks grew by over 50 per cent. ROE was 17.9 per cent for the banking sector as a whole, while consumer inflation was 28.2 per cent. Foreign and joint venture banks reached a ROE of 47.9 per cent. On average, ROA was 1.2 per cent, while for foreign and joint venture banks it was 4.18 per cent.

Capital adequacy ratios have been improving for the last two years. For the banking sector as a whole it reached 19 per cent in 1995. For the major banks, capital adequacy ratios ranged from ten to 30 per cent.

The privatisation process has accelerated, so state ownership in the banking sector has been reduced significantly. By the end of 1995, direct ownership of the State fell below 40 per cent of the total registered share capital and foreign ownership increased to almost 36 per cent. Looking at the total assets of the banking sector, the share of state-owned banks fell from about 85 per cent in 1989 to about 20 per cent in 1995. The share of privately owned banks is 80 per cent in the corporate loan market and 94 per cent in the household credit market. At present, there are 39 banks in Hungary, 27 of them wholly or partly foreign-owned.

Organisational changes at the consolidated large banks have also been accelerated: several banks have reduced their staff, and while following the guidelines of the new management, some new restructuring programmes have also been developed. The stock of qualified loans, as well as the proportion of bad loans in the total stock of qualified loans, declined significantly, mainly due to portfolio cleaning.

The area of corporate finance is characterised by strong competition for the most credit-worthy clients, mostly the joint venture companies and utilities. This is reflected in the fact that banks, in general, have reduced their interest rates charged for the best clients (prime rate) significantly. Through such an interest rate policy, banks try to encourage their basic clientele to develop long-term business relations with them, as well as to provide the full range of banking services. Banks with good performance - especially medium-sized private banks - achieved notable expansion in corporate finance at the expense of others. In the market of corporate finance almost all of the products provided in developed countries can be found in Hungary. The capital markets and the banking sector are connected through a lot of channels, and the banks and their subsidiaries offer several capital market products to their customers. The off-balance sheet activities of banks are also increasing in common with international tendencies.

In the area of retail banking the dominant role of certain banks - though somewhat diminished - has still remained overwhelming. However, in 1995 and 1996 several foreign-owned banks have also made apparent progress in developing their retail banking business as well. Despite the rapid development in retail banking (the number of debit cards has doubled since 1995), some retail banking services are not appropriately represented by the banks. Such areas include mortgage lending, credit card service, home banking, etc. The technological basis for modern retail banking has been developing: a retail boom is expected in the near future.