as the lower interest rates induced by the state-subsidized housing loan system, also contributed to the pickup in lending. As a result of the latter, in the early 2000s new loan disbursements were dominated by state-subsidized forint loans. Retail foreign currency lending also appeared in Hungarian financial intermediation, although financial enterprises<sup>5</sup> were the sole providers of this product at the time. Indeed, typically the financial enterprises of foreign-owned banks offered foreign-currency-denominated loans to households, mainly to finance vehicle purchases. Thanks to parent bank relations, the owner bank was able to provide them with the required foreign currency funds (Banai et al., 2010a).

**Box 1: The identification methodology of equilibrium credit-to-GDP levels based on Kiss et al.**

The identification of the equilibrium credit-to-GDP levels is based on a two-step out-of-sample method. In the first step, eurozone data was employed for panel estimation using the pooled mean group (PMG) estimator. In the second step, the estimated long-run parameters (structural relationship) were used for the calculation of the equilibrium level of Hungary‘s credit-to-GDP.

The underlying assumptions for the estimation are that the long-term relationship is the same in every examined country, but the short-term dynamics and the constant can differ across countries. Specifically, it means that in the estimation of the equilibrium credit-to-GDP, the estimated parameters of the explanatory variables are assumed to be the same; however, the dynamics around the equilibrium, hence the constant in the equation, are allowed to differ. The explanatory variables for the estimation of equilibrium credit-to-GDP were the short-term real interest rate, the GDP and inflation.

Finally, for Hungary we used the common long-term parameters on the Hungarian data. Choosing the countryspecific constant was less straightforward. Therefore, we decided to plot out-of-sample equilibrium credit estimates using all country-specific effects.

It was only in 2004 that foreign currency lending rose noticeably in banks‘ mortgage lending. In response to news about a drastic tightening of the subsidy scheme on forint-denominated mortgage loans, 2003 saw a substantial surge in demand for this product. In 2004, however, a new product type—foreign-currency-denominated mortgage loans—played an essential role in maintaining the previous level of lending. Net credit flow in 2004 still fell short of the level observed in the previous year, and its structure changed as well: the share of foreign currency loans gained ground (Chart 4). The change in 2004 did not increase the vulnerability of the banking sector substantially in itself; however, it was apparent that its potential evolution into a trend could pose significantly increased risks to financial stability (MNB, 2004).

As was the case with the analysis of corporate lending, we use the results of Kiss et al. (2006) to determine the occurrence of a credit boom in the household sector. Again, we supplemented the equilibrium paths based on country constants with a median path. Chart 5 reveals that in the case of households, the actual credit/GDP ratio exceeded the equilibrium level toward the end of the period, which can be attributed to two factors. On the one hand, as shown above, the announced tightening of the state subsidy scheme and the resulting borrowings brought forward to 2003 led to a surge in household indebtedness. On the other hand, while the growth rate of the loan

> 5 Financial intermediaries that do not accept deposits but their main business is raising funds to lend (e.g. leasing companies)

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