Moody's has changed Hungary's banking system outlook to stable from negative, reflecting its expectation that the operating environment will stabilise over the next 12-18 months.

Moody's report, entitled "Banking System Outlook: Hungary," is available on www.moodys.com. Moody's subscribers can access this report via the link provided at the end of this press release.

"We expect that the operating conditions for Hungarian banks will improve in 2015-16, amid relatively strong economic growth and a shift in the government's policy stance towards banks," says Armen Dallakyan, a senior analyst at Moody's.

The improvements in the operating environment will likely help the banks return to profitability and stabilise their credit fundamentals, albeit at weak levels. The rating agency forecasts real GDP growth of 2.8% in 2015 and 2.2% in 2016, owing to an increase in government spending, as well as stronger exports and private consumption. The latter is supported by lower unemployment and growing real wages as inflation slows.

Asset quality should show an improving trend this year and next. A government measure, which took effect in late 2014, mandated the conversion, at market rates, of banks' FX-denominated mortgages into Hungarian forints - thereby removing significant asset quality risks stemming from possible local currency depreciation. Furthermore, Moody's expects that the compensation payment scheme under a separate government initiative, which were expensed by the banks last year but to a large extent being paid to retail borrowers this year, will bolster the ability of those borrowers to service their bank loans and likely shave 2-3 percentage points off the retail NPL ratio of 22.4% posted at year-end 20141. Finally, leading indicators of asset quality that the rating agency tracks suggest that the volume of new non-performing problem loans (NPLs) should continue to abate during the outlook period.

Following an average 2 percentage points decline in their Tier 1 capital ratios in 2014, due to the large provisioning taken for the compensation payments owed to retail borrowers, Moody's expect Hungarian banks' capitalisation to improve moderately over the outlook horizon. This will be driven by banks' return to profitability this year and modest growth in their Risk Weighted Assets (RWAs).

The deleveraging of the banking system since 2009 has considerably improved banks' funding structures, says Moody's. It has reduced the risks stemming from past reliance on wholesale funding, especially in foreign currency.