* To make financial watchdog PSZAF independent agency
* To give regulatory powers to central bank
(Adds more detail, comments, background)
By Krisztina Than and Marton Dunai
BUDAPEST, Oct 2 (Reuters) - Hungary will finalise new legislation in a few weeks to strengthen financial markets watchdog PSZAF as an independent regulator and boost the central bank's powers to address systemic risks, an IMF official said.
Iryna Ivaschenko, the International Monetary Fund (IMF)'s representative, told Reuters in an interview on Friday that the new legislation would be fully in line with the recommendations of the Fund's technical mission.
Hungary, which had to resort to a $25.1 billion financial package from the IMF, EU and World Bank last year, must improve its supervisory authority's independence and strengthen its institutional framework for financial regulation to meet the requirements of its programme agreed with the IMF.
"The legislation that is underway strengthens the supervisory system, using the current institutional set-up ... in line with the technical recommendations of the IMF," Ivaschenko said.
"But it's not really a small tinkering around the margins -- it is significant strengthening (of supervision)," she added.
Ivaschenko said the strengthening of Hungary's financial supervision was in line with a similar EU-wide process.
Under the new system PSZAF will gain the most muscle.
It will no longer belong under the Finance Ministry, but will have true operational independence, and a change in the corporate governance of the watchdog will streamline and speed up decision making, Ivaschenko said.
This will make PSZAF more efficient, adaptable and responsive to risks in the financial system, she said.
Currently PSZAF only has the power to impose fines and issue recommendations, but these measures are mostly backward-looking.
Under the planned legislation PSZAF would be given the powers to issue binding regulations. This will require changing Hungary's constitution, which could be politically difficult as it needs two-thirds of votes in parliament to pass.
"I hope it will not be a politically contentious issue because it is good for the country going forward to have a strong and efficient supervisory system," Ivaschenko said.
The central bank, which is responsible for safeguarding financial stability, will have the right to issue temporary regulations and to ask the supervisor or the Ministry of Finance (MoF) to follow up with permanent regulation, she said.
"The process will be ... transparent so that the agencies that are responsible, namely MoF and the PSZAF, they will have to either comply or explain why they don't do it," she said.
AVERTING RISKS
Hungary's banking sector has escaped crisis and its banks are adequately capitalised to absorb loan losses, but their non-performing loan rate is expected to jump early next year amid a deep recession, the central bank said.
Hungary's consumption boom in recent years was fuelled by rapidly rising debt, particularly foreign currency loans, which remain a major risk in the financial system.
Ivaschenko said a new financial stability board or committee, with equal representation from the Finance Ministry, PSZAF and the central bank, would be set up to enhance and institutionalise cooperation among the three agencies.
"It will also enhance the transparency and hence accountability to the public of the strategic decision-making in the area of financial regulation," she said.
Adam Farkas, who took over as PSZAF chief in July, has told Reuters the immediate capital side risks to the banking system had likely been averted, but a deterioration of portfolio quality would pose the next big challenge for the sector. (Reporting by Krisztina Than and Marton Dunai, editing by Will Waterman)