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With Budapest continuing to strong arm the banking sector despite apparent agreements to work with the banks, the Hungarian Bankers' Association (BSZ) on November 13 reported the resignation of its chairman, Mihaly Patai.

The announcement came a day after the Hungarian parliament approved a budgetary package prepared by the economy ministry that includes a provision wiping out a pledge to cut the country's extraordinary bank tax in half in 2013. According to MTI, BSZ said that the move undermines an agreed pact in which the government had agreed to first consult with the banks before taking decisions affecting the sector.

Patai, who heads the local unit of UniCredit Group, was reported to have told an extraordinary presidium meeting of BSZ shortly after the budgetary package was announced in late October that he would resign if the government broke the agreement he had spent weeks hammering out. He told the association he had "tried to consolidate relations between banks and the cabinet," but after the government unilaterally threw out the previous agreement this was no longer possible.

The same budget package that was passed on November 12 includes a doubling of the new financial transaction tax that starts next year, piling extra pressure on banking profitability. The association notes that the government had earlier promised in talks to uphold a plan to cut what the banks have said is the highest banking tax in Europe.

The 50% cut in the windfall levy in 2013 was the original plan when it was introduced by the Fidesz government shortly after it entered office in 2010. The tax was then planned to finish by the end of the year. However, officials have also recently indicated that it is set to persist in 2014 - by claiming it will be cut in half in that year.

Since then, the banks have expressed outrage at what they say is rough handling by the government of PM Viktor Orban. They were forced to shoulder hefty losses in late 2011 under a government scheme allowing borrowers with foreign currency mortgages to repay their loans early, at exchange rates well below the market. That helped push the sector to its first consolidated loss in 13 years, the association revealed earlier this year.

The pressure has continued with the windfall and financial transactions tax issues. The bitter standoff has helped make the decisions faced by the capital-hungry Eurozone banking groups that dominate over where in the region to pullback investment that much easier.

Recent reports on bank deleveraging all note Hungary as an outlier. It was one of only two CEE states (alongside Slovenia) to see a pullback by parent banks of over 10% of GDP in the second quarter, according to a recent report from the Vienna Initiative. By way of contrast, its Visegrad peers are suffering little adverse affect. That has seen reports that bank lending has all but dried up in Hungary, helping push an already sluggish economy into recession.

Budapest's reaction appears to be cutting off its nose to spite its face. PM Orban said in late October that the latest plan, breaking the agreement with BSZ, would not hurt the economy as "the banks aren't lending anyway."

Instead, the sector is bracing itself for another hit after the central government announced recently a plan to consolidate HUF612bn (€2.15bn) in municipal debt. Orban sprinkled the statement with a couple of the cryptic threats he so favours, and reports since suggest Budapest intends to push the lenders to take a haircut of up to 25% on the debt, although there has been no confirmation.

Analysts at Capital Economics write in a report: "As it happens, we suspect that a restructuring of local government debt would result in smaller losses being imposed on banks than was the case under the mortgage repayment scheme. After all, local government debt is much smaller than FX mortgage debt."

Assuming the media reports are accurate, they suggest losses for the banks could amount to HUF150bn at most. That, they say, would reduce the aggregate tier 1 capital ratio of Hungarian banks by just 50 basis points to 12%. "By contrast," they note, "banks faced much larger losses of around HUF260bn under the mortgage repayment scheme."

"[T]he fact that any restructuring of local authority debt would probably constitute a sovereign default in the eyes of the ratings agencies means that the government is likely to think twice before pursuing such a course of action," the analysts add. However, Orban already said at the weekend that it is "obvious" that any such haircut would constitute a default.

"[T]he very fact that the government appears to be considering such a course of action illustrates a point we've been making for some time," Capital Economics concludes; "namely that austerity alone is unlikely to resolve Hungary's debt problems, and default (or "restructuring") will continue to form part of the solution."