* Banks may pay up to 2-3 billion euros to compensate borrowers
* Some banks may need capital boost after fresh blow, analysts say
* Measures could boost consumer demand, reduce Hungary's vulnerability
* Banks would benefit from stronger economy, but will they lend?
By Krisztina Than
BUDAPEST, July 11 After a rough four years, banks in Hungary now face another blow - government measures to help borrowers could force them swallow billions of euros in costs.
If so, some of the country's foreign-owned banks may need a capital boost from their parents and some might even decide to leave the once lucrative Hungarian market, analysts say.
But those who stick around despite the hardship may see a silver lining: strengthening domestic demand and a growing and less vulnerable economy.
It is hard to predict how the new losses will affect banks' willingness to lend and whether they will trust Prime Minister Viktor Orban's government not to confront them with more harsh policies.
Andreas Treichl, CEO of Austria's Erste Group, told CNBC earlier this week that he hoped the "ordeal" was slowly ending in Hungary after years of tough government policies. He said Budapest's approach to banks could be summed up as:
"We're going to milk the cow as much as we can, but we are not going to slaughter it."
After providing hefty profits in most of the past decade, Hungary since 2010 has become something of a nightmare for banks, which include Erste and Raiffeisen, and Italy's Intesa.
They were hit by windfall taxes and various measures to bail out Hungarian borrowers who took up expensive foreign-currency loans. Those measures have cost them at least 1,000 billion forints ($4.39 billion) under Orban's government so far.
And now they might face up to 2 billion-3 billion euros of new costs under legislation approved last week. Banks will be forced to compensate borrowers for past interest rate and fee changes on consumer loans and or some charges on foreign- currency loans that Hungary's top court ruled were unfair.
Bank stocks have tanked this week as they announced their expected hit from the measures one after the other. Raiffeisen said on Thursday it would take a charge of 120 million to 160 million euros, and Erste projected costs as high as 300 million euros.
The added costs come at a critical time. Euro zone banks are undergoing so-called asset-quality reviews (AQR), where the European Central Bank sifts through their books to check for poor-quality loans.
The new measures also include a conversion of $15 billion worth of foreign-currency mortgages into forints later this year that could result in further losses for the banks. But once they're all implemented, the landscape of Hungary's financial sector could change.
Some experts believe the sector could undergo consolidation and then see a period of relative calm, even though the health of the banking system might deteriorate in the short term.
"We view the pending resolution of Hungary's FX mortgages positively as an improvement to longer-term policy flexibility, and necessary in paving the way for longer-term consolidation and stabilization of the embattled banking sector," analyst Phoenix Kalen at Societe Generale said in a recent note.
On the positive side, eliminating the huge stock of foreign- currency loans will reduce Hungary's vulnerability, by reducing exposure to shifts in the exchange rate. Borrowers' repayments would decline, which should reduce the number of non-performing loans and improve the quality of bank loan books.
"Since there will be a capital transfer from the banking sector to the households, domestic consumption may stabilize in 2014 and 2015 which is temporarily supportive for economic growth," KBC analysts said in a note.
The one aspect that is hard to foresee is how the new burden will make banks more willing to lend money in Hungary, after sharp deleveraging and an erosion of confidence in past years. If they are forced to take big additional losses on the conversion of the forex mortgages, the credit crunch could worsen, some analysts said.
"The lending activity of the banking sector may remain weak in this year and it may accelerate only slowly from next year," KBC analysts said. ($1 = 227.6500 Hungarian forints) (Editing by Larry King)