A Counterfactual Analysis of Regulatory Changes in Hungary: Could the Crisis Have Been Avoided?

The main purpose of this paper is twofold. First, it aims to estimate the effect of the tightening of regulatory capital requirements on the real economy in periods of credit upswing. Second, it intends to show whether applying a countercyclical capital buffer measure as it is in Basel III rules could have helped reduce the pace of FX lending growth in Hungary, mitigating the build-up of vulnerabilities in the run-up to the global financial crisis. In order to answer these questions, we use a Vector Autoregression based approach with the aim of understanding the impact of shocks to capital adequacy in the pre-crisis period. Our results suggest that although regulatory authorities could have slowed down the increase in lending temporarily, they would not have been able to avoid the upswing of FX lending by requiring countercyclical capital buffers even if such a tool had been available and they had reacted quickly to accelerating credit growth. Our results also suggest that a more pronounced tightening might have reduced FX lending substantially, but at the expense of real GDP growth. The reason is that unsustainable fiscal policy led to a trade-off between economic growth and the build-up of new vulnerabilities in the form of FX lending