The Swiss central bank's decision to abandon the Swiss franc's peg to the euro is still making waves in Central and Eastern Europe. Several governments in the region have spent the past few days debating ways to prevent a more expensive franc from harming customers in the region.
Foreign-denominated loans, mostly in euros and Swiss francs, were very popular in Central and Eastern Europe during the 2000s. But during the financial crisis, many of these governments devalued their currencies to cope with the generalized economic downturn. This made it harder for households to pay back their foreign-denominated loans, most of which were mortgages. Governments reacted differently to this situation: While Hungary decided to convert most of these loans into forints, Poland chose to ban new loans in foreign currencies, expecting their share in total loans to be watered down over time.
Despite these measures, these countries are still vulnerable to external shocks. Hungary's move, which was severely criticized by banks and EU officials, is becoming a potentially attractive option for other countries in the region. Some governments have said they would not follow the Hungarian model, but others are more open to the idea.
Poland Seeks Balance
The risks are highest in Poland, where 37 percent of household loans are still denominated in Swiss francs, totaling about $36 billion in value. However, Poland has an important mitigating factor: The default rate on these loans is low because the country has stricter credit requirements for those taking out loans in foreign currencies. Still, with more than half a million households affected by the appreciation of the Swiss franc, the issue is politically sensitive and financially risky.
Polish authorities are trying to strike a balance between helping customers and protecting banks. On Jan. 20, Prime Minister Ewa Kopacz set up a commission to investigate whether banks abused their powers when issuing Swiss franc mortgages. Also, Finance Minister Mateusz Szczurek has said the banks and their customers should share any potential risks.
The Polish central bank stated that fixing the exchange rates to pre-Jan. 15 levels would be a violation of banking contracts. This was meant to dismiss the opposition Law and Justice party's demands to fix the exchange rates to the levels seen before the Swiss central bank abandoned its peg to the euro. Poland is in an election year, and the government will have to take measures to help households in order to avoid political fallout. In the coming days, Polish authorities will pressure banks to pass on the negative interest rates in Switzerland to their customers and extend maturities to make it easier for borrowers to pay back their loans. Poland is not considering the Hungarian model at this point, but the option could emerge if the issue becomes too politicized or if the Swiss franc keeps appreciating against the zloty.
Conditions Elsewhere in Central Europe
The situation is less severe in Romania, where roughly 4.3 percent of household loans are denominated in Swiss francs. However, Bucharest is also studying ways to deal with a problem that affects some 75,000 borrowers. Romanian officials held several meetings with commercial banks and the central bank, and a special parliamentary session took place on Wednesday.
The options currently under consideration include rescheduling loans, converting loans to the rate when the contract was signed, widening tax credit for borrowers and introducing a new personal bankruptcy law that could better protect borrowers. Some Romanian banks have also taken precautionary measures such as temporarily freezing the exchange rate for loans in Swiss francs and applying cuts to their franc interest rates. Although Romanian officials have not mentioned Hungary specifically, the parliament discussed the conversion of foreign currency loans into lei.
The situation is more contentious in Croatia, where some 60,000 housing loans are denominated in Swiss francs. This represents roughly 8.5 percent of the overall loan portfolio of the country's banks. The Croatian government announced plans to fix the exchange rate for a year at roughly the point where it was trading on Jan. 15, and Prime Minister Zoran Milanovic said Zagreb would consider converting loans into kunas. Croatia will hold general elections in early 2016, and Zagreb wants to prevent protests by borrowers at a time when the country is already dealing with a difficult economic situation. However, banks have rejected this proposal, arguing that they have their own plans to fix the exchange rate for three months.
Broader Concerns
Independent of the final decisions that these countries will make, the issue highlights the extent to which some countries in Central and Eastern Europe are still dealing with relatively fragile banking sectors. Data from the World Bank shows that 23 percent of Serbia's total loans are nonperforming, while that number is around 22 percent in Romania, around 17 percent in Bulgaria and around 16 percent in Croatia.
The potential conversion of foreign-denominated loans into local currencies could also affect Western European banks — mostly from Austria, Italy and Germany — which dominate Central and Eastern Europe's banking sectors. Moreover, the Hungarian model also has a political component: Prime Minister Viktor Orban's government saw the European Union's political and financial fragility and decided to expand state control of the economy. If more countries in Central Europe decide to challenge Western banks and EU authorities, the European Union's political fragmentation could be exacerbated.
While countries in Central and Eastern Europe continue discussing how to react to the Swiss central bank's decision, another central bank is expected to make even larger waves. On Jan. 22, the European Central Bank is expected to make an announcement regarding its plans to purchase debt from countries in the eurozone. This would probably lead to a weaker euro, which in turn could lead to weaker currencies in Central and Eastern Europe and a stronger Swiss franc. As a result, the debate over foreign-denominated loans in the region will not end any time soon, and it will likely continue to affect the financial sectors of a significant number of countries in Europe.
