Banking reform started much earlier in Hungary than in other socialist countries and Hungary now has by far the most advanced system among transitional socialist economies. The authors discuss recent trends in competition and efficiency in Hungarian banking. They assess the performance of Hungarian banks and note the tremendous progress that has been made in expanding the number of competing banks, strengthening the legal and regulatory framework, increasing the banks'managerial autonomy, and promoting development of the private sector. But the authors also note that effective competition is constrained by the continuing segmentation of the market. In addition to the segmentation of corporate and household banking inherited from the old regime, a new segmentation appears to have emerged, between large and small banks, or between old and new banks. The entry of new banks - especially joint-venture banks - has a clear impact on market shares, but competition appears to be more effective in increasing the range of services than in lowering bank spreads. The impact of foreign banks would be greater if they were allowed to open branches or at least to establish fully owned subsidiaries. During the period under review, there was a collapse of long-term lending, reflecting both conservative lending practices and a subdued demand for investment finance. But the use of short-term credits has picked up considerably since 1988, in line with the ongoing restructuring of the Hungarian economy and the growth of services. Reported nominal spreads and profit ratios appear to be high by international standards. For small banks, these reflect the high level of inflation and the low level of leverage. But for the large banks, the high nominal spreads may be more apparent than real because of the existence of nonperforming loans. There is considerable uncertainty about the size of nonperforming loans, following the collapse of CMEA trade and its adverse impact on corporate profitability. Tackling the problem of nonperforming loans is important both for enhancing the efficiency of banks and for lowering nominal spreads, the high level of which appears to hinder the financing of new firms.