Thomas Escritt in Budapest -

Banks with interests in Hungary have warned that a proposed windfall tax on financial institutions would lead to a sharp rise in offshore lending, in what can be considered an ill-disguised threat to move their lending elsewhere in order to minimise their tax liability if the government goes ahead with the plan.

Hungary's new government said it wanted to raise HUF200bn (€707m) a year for three years from the tax, which was announced after Viktor Orban, the new prime minister, failed to persuade the International Monetary Fund and European Commission to loosen the strict 3.8% budget deficit target the country accepted under the terms of the bailout deal it signed up to 18 months ago.

In a background briefing document, seen by bne, the banks warn that the plan, "may have a result that contradicts the tax's aim by encouraging offshore lending and financial activity, thereby reducing the base of the planned tax and leading to unplanned structural impacts."

Every major player in the Hungairan banking market is part of an extensive regional network, including OTP, the largest player, which is an independent Hungarian company with around one-third of the market by some measures. It has extensive interests in the region, including Romania, Russia, Serbia, Slovakia and Ukraine. Other major players, including Austria's Erste Bank and Raiffeisen International, and Italy's Unicredit Grup and Italy's Intesa Sanpaolo, have major investments in subsidiaries across the region.

After the financial chaos in early 2009, when wild currency swings across the region placed holders of euro and Swiss franc-denominated mortgages under huge pressure, leading to sharp deteriorations of banks' loan portfolio qualities, regional banks were able to stabilise their positions. Hungary's banks closed 2009 with healthy profits, making them look a ripe target for a cash-strapped government. But few believe the region's banks are out of the woods yet: OTP in May reported that its non-performing loan ratio had almost doubled compared with the same period last year, and the June 25 sharp falls in currencies across the region following a Romanian court ruling that a planned austerity package is unconstitutional are a reminder that nervous markets will react strongly to unexpected shocks.

Details to come

The government has provided no details concerning the final shape of the tax, which it says it will unveil on June 30.

Most recently, local media reported that the tax will now only be levied for two years. One option under consideration is a tax of half of 1% on a bank's total assets. It has also been widely reported that the tax will be levied on banks' balance sheets as at the end of 2009, in order to prevent bank's from minimsing their exposure before the introduction of the tax. However, experts have suggested that an attempt to levy tax retrospectively could be unconsitutional.

The tax has been widely criticised by experts who say its likely impact will be to slow banks' lending activity. In a letter to the PM, Alessandro Profumo, chariman of the European Banking Federation, wrote of his "deep concerns" regarding the tax. "The aggregation of the planned bank tax with the current corporate tax and the existing solidarity tax will result in banks being subjected to an effective tax rate that is estimated to exceed 60%," he wrote, adding that the tax would "impact negatively the banks' capacity to finance households and businesses in Hungary and place downward pressure on your economic growth expectations, depriving the Hungarian treasury of a far greater source of fiscal income."