The two-tier banking system
After centuries of “evolution”, nowadays we have a two-tier banking system. The “lower tier” is made up of a network of commercial banks and financial service providers that satisfy the needs of economic operators (households, companies) for financial services, i.e. to keep accounts, collect deposits, provide loans, and perform various financial transactions. The “upper tier” is the central bank, which is not directly engaged with households and companies, but keeps the accounts of commercial banks (including the Treasury in Hungary), provides loans and supervises, regulates and even acts as a mediator in disputes if needed.
However, the two tiers do not simply entail a different client base; both the central bank and commercial banks are involved in supplying money to the economy. The central bank produces the lawful means of payment, the so-called central bank money, while commercial banks produce commercial bank account money through loans. We all have bank account money if we have a retail bank account with any bank.
However, the two-tier banking system is not a rule set in stone. After World War II, the two-tier banking system was terminated in Hungary, based on the Soviet model, and was restored only after more than four decades, in 1987.
Two-tier banking system
The issue of the national banking system was seriously reconsidered in the 1980s. After Hungary joined the IMF and World Bank in 1982, the banking system and its operation on a market basis had to be obviously contemplated. The new economic reform has once again set the objective of a full-scale two-tier banking system along with the convertibility of the forint.
Three major commercial banks were established by the state in 1987 to take over the deposit and loan accounts of companies from Magyar Nemzeti Bank. The first ones included Budapest Bank, Országos Kereskedelmi és Hitelbank and Magyar Hitelbank. OTP also set off to a great start: it became less dependent on Magyar Nemzeti Bank and was transformed from a retail savings bank to an actual commercial bank. By the second half of the 1980s, foreign and Hungarian private banks also appeared in the market. Some of them didn’t last long and could not defeat their competitors, others are still available to clients.
Act LXIX of 1991 on Financial Institutions and their Activities reflected the establishment of new commercial banks, just like the more detailed Act CXII of 1996 on Credit Institutions and Financial Enterprises. These laws laid down the legal status, duties and responsibilities of financial institutions, and were designed to guarantee the safety of depositors and other clients of the bank. The law adopted in 1996 is already integrated into the European law approximation process, in preparation for our future membership of the EU. A crucial element of this process was to allow credit institutions to enter the market for state bonds and private corporate securities, and subsequently to participate in the market for public corporate securities. This made the domestic banking system universal.
Magyar Nemzeti Bank had to face new tasks and, in particular, new responsibilities in a two-tier banking system after the regime change. Act LX of 1991 on the Magyar Nemzeti Bank already provided for the independence of the central bank from the law enforcement authorities (the MNB is accountable only to the Parliament, while its managers are independent of the government, not elected but appointed on the basis of their merits). Furthermore, priority has been given to ensuring the stability of the national currency, the functioning of the domestic payment system, the internal and external financial balance of the national economy, and the promotion of sustainable development and international integration. Since it took the forint almost a decade to become fully convertible (16 June 2001), Magyar Nemzeti Bank was given a prominent role in foreign currency management; MNB became the central body for foreign currency management, endowed with the power of a foreign currency authority.
However, as accession to the EU was approaching, rules on the central bank had to be reconsidered.
Since the primary objective of the European System of Central Banks (OSCB) is to preserve price stability, it had to be laid down in Act LVIII of 2001 on Magyar Nemzeti Bank. Taking into consideration that the Hungarian economy had double-digit inflation at the turn of the millennium, i.e. the economy was not marked by price stability, this constitutes the primary and only objective of the central bank’s functions. Approximation also required the law to stipulate that MNB may only support the implementation of the government’s economic policy programme if it does not jeopardise the achievement of its primary objective.
Our banking system, i.e. the central bank and commercial banks saw substantial changes in the course of the economic crisis that emerged in 2008 and the adoption of the Fundamental Law in 2011. Legal regulation was placed on a new basis (e.g. the MNB took over the tasks of the Hungarian Financial Supervisory Authority (PSZÁF)), and the use of unconventional central bank instruments became typical.