The huge yield difference between retail bonds and those sold to institutional investors has helped banks and some wealthy individuals to make a profit without any risk, local media reported on September 6. 

Holding bonds issued for retail investors by banks was a lucrative business for years until the state debt manager closed the loopholes, Index reported. 

The government allowed Hungarian banks to distribute local bonds for retail investors, offering them a 1% fee.

This was part of the plan to increase the share of retail bonds and to raise the maturity of papers held by households in a bid to decrease Hungary’s exposure to foreign-currency denominated loans.

As result, the stock of government bonds held by retail investors increased to HUF7.35 trillion (€20.27bn), around a quarter of the gross debt, a huge upswing from HUF400bn at the end of 2010 to HUF1 trillion by the end of 2012.

The sharp reduction of the non-forint debt and debt held by non-residents was a major reason for the upgrade of Hungary’s credit rating by Fitch, Moody’s and S&P in 2016 to an investment-grade category.

The state debt manager sold the bonds to households at hefty premiums. Whereas the 12-month T-bills purchased by institutional investors yielded 0.5%, the same maturity instrument could be subscribed by households for 2.5%.

This huge gap in the yields has lead to a scheme used by some banks and wealthy individuals. The most creditworthy clients of banks could attain loans for as low as 1-1.5%, which meant a guaranteed return of 1-1.5% on a one-year investment. 

In the current low-interest environment, some banks also made use of the opportunity, which promised a secure return without running any risks, other than a rebuke from the state debt manager at a later stage.  

The scheme worked like this. The bank would team up with a friendly foundation, in some case one founded by the bank to which it would lend at low rates. Foundations, which were allowed to buy retail bonds at the time, would sell the bonds to the bank, which would hold on to them until they matured, pocketing the 2.5% return and in addition the 1% fee for selling the bonds. The two parties would share the gains, people familiar with the scheme said. 

Although this was not a widespread practice, bank managers talking to Index acknowledged they knew what was going on at some financial institutions. 

As banks were not allowed to buy retail bonds but could buy them before maturity has led to the accumulation of retail bonds in their books, to the tune of HUF200bn at some banks. Overall, the scheme cost the state debt manager some HUF30bn

More than a year ago, as AKK decided to the party and cut bank's commission from 1% to 0.8%. The official explanation was to slow the rate of new subscriptions, which according to AKK has reached “optimal levels”, but it also served to strike down at the business. 

The state debt manager has also called on banks to scale back their stocks of retail bonds and initiated talks with the heads of financial institutions and banks' treasury leaders privately, people familiar with the situation said. Banks, which are also primary dealers on the fixed-income market, would not risk further tensions with the AKK and agree to play by the rules, according to the report.

The AKK has recently announced the introduction of a new bond aimed exclusively targeting domestic municipalities from September. The bonds will be available for purchase through the offices of the Hungarian State Treasury. 

The AKK said the bonds would offer "attractive and safe investment options" and would decrease the expense of financing government debt as the bonds carry lower interest than the similar 3-year government bonds available on the wholesale market.