Blog Post

Foreign loan hangovers and macro-prudential measures in Central Eastern Europe

The Swiss’ national banks’ decision to end the peg to the Euro in January 2015 put again spotlights on the foreign currency loan overhang in CEE. This blog describes the extent of the foreign exchange borrowing and the respective macro-prudential provisions adopted in recent years.

By: and Date: October 14, 2015 Topic: Macroeconomic policy

The recent decision in Poland and Croatia to limit the adverse consequences of Swiss franc denominated loans for households, has put a spotlight on foreign loan hangovers in Central and Eastern Europe. This came after the Swiss national bank’s decision to end the peg to the Euro in January 2015 (Hungary already set steps in November 2014). This blog describes (i) the extent of the foreign exchange borrowing (and the prominent role of the Swiss Franc) and (ii) the respective macro-prudential provisions adopted.

Borrowing in foreign currency increased substantially in the mid-2000s, supported by a carry trade motive, as households (as well as corporations and local authorities) borrowed in lower-yielding foreign currencies to finance the purchase of domestic assets such as housing. As Figure 1 shows, interest rates on mortgage loans in CHF in Hungary amounted to 5.1% in January 2005, less than half the domestic rate of 13.8%. A similar picture can be observed in Poland, but with a somewhat lower spread between domestic and Swiss-franc loan interest rates. The risk of foreign currency loans was perceived as low, even for unhedged customers, as expectations of further currency appreciation supported demand for foreign currency loans in countries with a floating exchange rate regime such as Hungary and Poland.

However, with the start of the financial crisis in 2008/2009, households’ perception of exchange rate risk changed dramatically, as domestic currencies devalued greatly and the Swiss franc appreciated on the back of safe haven inflows. At the same time, interest rates on mortgage loans for households fell in Poland (Figure 1), relieving pressure on foreign and domestic loan owners somewhat . In Hungary, interest rates for domestic loans increased throughout 2009 (peaking at 12.3% in July of the same year), while rates on loans in CHF continued to increase slightly up to beginning of 2013.

Figure 1: Swiss franc and domestic currency mortgage loans rates for households in Hungary and Poland and 3-month CHF LIBOR (%)

ph-131015-3

Source: National central banks and ThomsonReuters Datastream; Note: interest rates refer to monthly average agreed interest rates on outstanding amounts.

As shown in Figure 2, by end-2009 foreign currency loans in Hungary amounted to 47% of GDP (30.6 % of GDP in CHF) and to 16 % of GDP in Poland (11.6 % of GDP in CHF). In end-2011, Croatia reports foreign currency loans of 67% of GDP (9.6 % of GDP in CHF) in end-2011. Hence, the Swiss franc played a prominent role in Hungary and Poland.

Figure 2: Currency composition of loans to the non-financial sector (% of GDP)

ph-131015-2

Source: ECB and AMECO; Note: latest data available 2015 Q2, end of year data.

Macro-prudential measures in the context of foreign currency lending

Excessive foreign-currency lending can endanger financial stability; domestic currency depreciation, an increase in foreign interest rates or a deterioration of macroeconomic conditions could put under pressure the debt repayment capacity of unhedged households. This would increase the share of non-performing loans on bank balance sheets and might eventually hit banks’ profits and tighten lending to the real economy. Moreover, ECB research shows that foreign lending makes the job of the central bank harder: on the one hand, restrictive monetary policy leads to a decrease in domestic currency lending, accelerating on the other hand the growth of foreign currency denominated loans. Poland, Hungary and Croatia have set in place macro-prudential tools to deal with the risks stemming from foreign currency lending.

Poland issued ‘Recommendation S’ in 2006, which included the creation of depreciation buffers for banks and the obligation to inform customers of the related risks. In 2007, the risk weight for foreign currency mortgage loans to households was increased. Moreover, to tackle an eventual currency mismatch in bank funding, liquidity limits were introduced in 2007. Further tightening happened in 2010 and 2011, as more stringent tools which targeted borrowers were introduced, limiting debt-to-income ratios for foreign currency-denominated loans to unhedged borrowers, and raising again risks weights.

Given the substantial amount of foreign currency lending in Croatia in the 2000s, it was also one of the most active countries when it comes to macro-prudential policies, introducing among others limits on banks’ funding currency mismatch, an increase in risk weighting, adjustments to reserve requirements and a creation of liquidity buffers linked to foreign currency loans.

Hungary introduced measures starting in 2010, which encompassed lower loan-to-value and debt-to-income ratios for foreign currency loans. In 2011, the government adopted repayment schemes, which allowed early repayment of foreign currency mortgages with an artificially strong exchange rate, forcing banks to take massive losses (see ECB opinion). Foreign currency lending was still possible, but only under very tight credit conditions. In February 2015, Hungary’s banks converted most foreign currency loans into Hungarian forints,  at the market rates prevailing at that time, based on a decision made in November 2014. Thanks to this the substantial appreciation of the Swiss franc in January 2015 did not have an impact on household mortgage borrowers.

Figure 3: growth rate of foreign-currency and domestic-currency loans to the non-financial sector (year-on-year % change)

ph-131015-4

Source: ECB; Note: latest data available 2015 Q2.

As Figure 3 shows, before the financial crisis in 2008, Swiss-franc loans grew substantially more than the domestic-currency denominated loans in both Hungary and Poland. With the start of the financial turmoil, growth rates of Swiss-franc denominated loans fell both in Hungary and Poland from around 40% to around zero over 2008. By the end of 2009, growth rates of foreign-currency loans fell below their domestic-currency counterparts in both countries, and stayed below thereafter. By the second quarter of 2015, the share of foreign currency loans decreased in all three countries (Figure 1), and especially in Hungary the share of foreign loans dropped to only 2.5% of GDP after the conversion into Hungarian forints (which explains the sharp drop in Swiss franc loan growth rate, and a sharp rise in domestic loans in Hungary as reported in Figure 3).

This development might reflect on the one hand a drop in supply, due to macro-prudential measures. In this context, ECB research highlights that such measures appear to have been effective in curbing foreign currency lending, but weaken shortly after the policies are implemented. On the other hand, it might reflect a drop in demand, as consumers’ perception of the exchange rate risk changed.

Both governments in Poland and Croatia have put the foreign loan overhang high on the agenda, as elections are around the corner, and policies on how to convert Swiss foreign currency loans are being unveiled (see ECB opinion on the Croatian and Polish law).These policies, more than being macro-prudential, are dealing with the burden-sharing aspect, once the foreign-currency hangover has turned out to be problematic in the aftermath of the Swiss franc appreciation. Looking ahead, macro-prudential policy measures will continue to be key in order to avoid waking up from yet another foreign loan hangover.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Past Event

Past Event

The need for market-based finance after COVID-19

How do COVID-19-caused financial dislocations inform policy responses?

Speakers: Maria Demertzis, Gabriel Makhlouf and Guntram B. Wolff Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 29, 2020
Read article More on this topic
 

Opinion

A letter to Santa, the G7

The G7 should set an example of international cooperation and come out with a strong signal of unity and support for the euro-area. Only then will the cost of the crisis be temporary and manageable. This is our letter to Santa. I hope at least some -if not all -of these wishes can be fulfilled.

By: Alicia García-Herrero and Guntram B. Wolff Topic: Global economy and trade Date: March 17, 2020
Read article Download PDF
 

Policy Contribution

European Parliament

From climate change to cyber attacks: Incipient financial-stability risks for the euro area

The European Central Bank’s November 2019 Financial Stability Review highlighted the risks to growth in an environment of global uncertainty. On the whole, the ECB report is comprehensive and covers the main risks to euro-area financial stability, we highlight issues that deserve more attention.

By: Zsolt Darvas, Marta Domínguez-Jiménez and Guntram B. Wolff Topic: Banking and capital markets, European Parliament, Macroeconomic policy, Testimonies Date: February 6, 2020
Read article More on this topic
 

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou and Bruegel Topic: Banking and capital markets Date: July 1, 2019
Read article Download PDF More on this topic
 

External Publication

Soaring house prices in major cities: how to spot and moderate them

This article examines whether there are regional differences in house price growth within European countries and find a stronger cyclical pattern in capital cities compared to other regions, indicating a clear rationale for regional-level tools. The authors recommend using macro-prudential measures at a regional level, in particular loan-to-value and debt-to-income limits, to dampen the housing boom-bust cycle.

By: Grégory Claeys, Konstantinos Efstathiou, Dirk Schoenmaker and Bruegel Topic: Macroeconomic policy Date: June 19, 2019
Read article More on this topic More by this author
 

Podcast

Podcast

Director's Cut: The case for a legislative remedy for recessions

Bruegel's Maria Demertzis welcomes Yale Law School professor Yair Listokin to this Director's Cut of 'The Sound of Economics', to discuss how law might be deployed as a macroeconomic tool to counter financial crisis.

By: The Sound of Economics Topic: Macroeconomic policy Date: March 12, 2019
Read article Download PDF More on this topic
 

Working Paper

Will macroprudential policy counteract monetary policy’s effects on financial stability?

How does monetary policy impact upon macroprudential regulation? What are the effects on financial stability? This working paper models monetary policy’s transmission to bank risk taking, and its interaction with a regulator’s optimization problem.

By: Itai Agur and Maria Demertzis Topic: Banking and capital markets Date: January 24, 2018
Read article More on this topic
 

Blog Post

Macroprudential policy: The Maginot line of financial stability

The ability of macroprudential policies to assure financial stability and thus leave central banks free to assign the interest rate tool exclusively to price stability is unproven. As the Maginot line did not protect France from a German invasion in WWII, so macroprudential policy may not be sufficient to counter financial instability. Central banks should prepare to deal with dilemmas in the use of the interest rate.

By: Francesco Papadia and Bruegel Topic: Macroeconomic policy Date: January 17, 2018
Read article More on this topic
 

Blog Post

The political economy of macroprudential policy

What’s at stake: the emergence of renewed interest in macroprudential policy has characterised the aftermath of the great recession. There is not yet full agreement on what the tasks of macroprudential policy is or how it should be carried out, but there is a clear understanding that there is an important political economy dimension to it. We review some of the recent contribution on this.

By: Silvia Merler and Bruegel Topic: Macroeconomic policy Date: December 12, 2016
Read article More on this topic
 

Blog Post

Brexit and the UK’s Euro-denominated market: the role of clearing houses

Clearing houses in the UK operate an extremely sizable market in euro-denominated transactions. However, even though the numbers are big in value terms, in substance, clearing houses shifting to the continent will not make a big difference to the UK economy and employment. Arguably, there is a case for the ECB to claim that euro area business of clearing houses be relocated.

By: Uuriintuya Batsaikhan and Bruegel Topic: Macroeconomic policy Date: June 7, 2016
Read article More on this topic
 

Blog Post

A financial side to a macroeconomic story: macro imbalances and financial integration in the euro area

In a recent paper, I looked at the evolution of financial cycles in the euro area and at their link with capital flows. Here, I focus on how those findings inform our understanding of euro-area macroeconomic imbalances, revisiting the analysis of national savings and investment correlation.

By: Silvia Merler and Bruegel Topic: Macroeconomic policy Date: January 18, 2016
Read about event More on this topic
 

Past Event

Past Event

Central banking after the great recession

Have Central Banks lost their ability to control domestic inflation? Are macroprudential tools sufficient to ensure financial stability? Do new monetary tools, a closer relationship with fiscal policy and the renewed financial stability mandate require a new central banking paradigm?

Speakers: Ignazio Angeloni, Markus K. Brunnermeier, Claudia M. Buch, Grégory Claeys, Charles Goodhart, Dirk Schoenmaker, Andrzej Rzońca, Cecilia Skingsley and Guntram B. Wolff Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 18, 2016
Load more posts