Foreign currency loans: Who’s getting punked?

| October 11, 2011 | 0 Comments

"Punked" by Perke

Hungary is proving to be quite in a pain in the you-know-where. That, at least, must be the sentiment of certain European banks who’ve been punked now for the second time in as many years by Hungary’s financial activism.

First came the decision last year to to impose a “brutal” tax of 0.5% on banks, insurance and other financial companies (foreign & domestic) in order to help Hungary make its budget deficit target. Projected to raise about €708 million, the tax caused much gnashing of teeth and was ultimately part of the reason why Hungary didn’t get a new loan last year from the decidedly unamused IMF.

Well last month Hungarian prime minister Viktor Orbán did it again…

Hungarians will be allowed to wind up their burdensome Swiss franc-denominated mortgages in a lump sum and at a preferential exchange rate of Ft180 to the Swissie (compared to the current market rate of around Ft234), with the exchange rate loss falling on the banks.
-Orban says banks will take Hungary’s Swissie hit

…and is already having a big impact on his western neighbor, Austria:

Austria’s Erste Group on Monday said it expects Erste Bank Hungary to rack up a loss of about €500m in 2011 because of the direct and indirect effects of an early FX mortgage repayment scheme as well as the adaptation of its business strategy.
-Erste Bank Hungary expected to rack up €500 million loss in 2011

This most recent bit of bad news has got us thinking about those mortgages made in foreign currency. Have a look at this graph from the Economist:

We’re not the only ones squeamish at the sight of this: outgoing ECB president Jean-Claude Trichet raised the issue just today at the European Parliament in his capacity as the chair of the European Systemic Risk Board (ESRB). He sees the increasing amounts of unhedged foreign currency loans offered to Eastern-European banking customers as an anvil hanging over the head of the European financial system. He pointed out three key issues:

  1. Loans made to unhedged borrowers are at greater risk of not being repaid because the total value of the loan would shoot up if the domestic currency falls.
  2. Since foreign currency loans usually carry a lower interest rate than domestic currency loans they may fuel excessive credit growth.
  3. The need to make payments on foreign currency loans can create greater overall liquidity and funding risks due to the reliance on short-term FX markets.

On a macro-level, if enough banks and clients are engaged in this then cross-border spillover effects could be substantial and contribute to systemic risk.
To combat this the ESRB has published recommendations and expects follow-up via the national banking supervisory authorities by the end of next year. Unfortunately, they seem to boil down to:

  1. Hey, you–banks! Educate your consumers more about their risks. We ask: does this ever work, anywhere?
  2. Hey, you–banking regulators! Monitor your banks’ risks to these type of loans and if it starts to look a bit dodgy, do something about it! (See the preceding question.)

What’s missing, though, is a deeper look on just why these loans are so widespread in the first place. Aside from the point that they’re cheaper (or, at least look so on paper and under certain favorable assumptions), could it be some external factor driving their growth? In a paper entitled Foreign-currency loans in Eastern Europe: Borrower push or bank pull? Martin Brown, Karolin Kirschenmann and Steven Ongena argue that it’s more bank-driven than one might guess. 

Brown, et al took a sample of 105,589 business loans granted to over 60,000 firms from 2003 to 2007 by one retail bank in Bulgaria and examined how the currency specified on the customer’s request form matched up with the currency in which the loan was eventually made. As shown in their figure below, they concluded that the bank was, indeed “pushing” the euro loans.

Of course this is just one bank and we have no way of knowing if its business practices are representative of the larger industry either in Bulgaria or in other Eastern European countries. But that’s just the point–wouldn’t it be good for the ESRB and national banking regulators to at least ask the question?

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Category: Eurozone