Sigrún Davíðsdóttir's Icelog

Back in the 1980s Australians, many of them farmers, were offered low-interest loans, appealing in a high-interest environment. With changes in currency rates the loans in Swiss francs and Japanese yen quickly became much beyond the means of the borrowers to service with ensuing pain and suffering. The same story has since played out in country after country with the obvious lesson reiterated: for people with income only in their domestic currency FX borrowing is too high-risk to be wise. Icelanders felt the FX loans’ pain as the Icelandic króna depreciated 2008 as did many Eastern-European countries. – All these loans, often the result of predatory lending, follow the same pattern and it is no coincidence where they hit. There is now ample case for countries to take action: banks should be forbidden to lend in FX to private individuals with all their income in the domestic currency.

Australia in the 1980s, New Zealand in the 1990s, Iceland and a whole raft of other European countries in the 2000s saw liberalised markets but inflation was high and so were interest rates. By taking an FX loan or even just a loan pegged to FX the high domestic interest rates could be avoided – it seemed too good to be true.

Sadly it was indeed too good to be true: currency fluctuations changed the circumstances and servicing FX loans for those with income in the domestic currency became unsustainable. For loans running over many years this was, statistically seen, almost unavoidable. FX loans have turned into a huge problem in countries such Croatia, Bosnia, Bulgaria, Montenegro, Poland and Ukraine but politicians and banks have ignored the problem. These cases were spelled out at a conference on CHF/FX loans in Cyprus in December. Organised by Katherine Alexander-Theodotou president of the UK Anglo-Hellenic and Cypriot Law Association and various representatives of organisations fighting FX loans, the organisers have recently set up European Legal Committee for Consumer Rights to co-ordinate their work in the various countries marred by FX loans.

The recent shock of the CHF appreciation is now forcing the problem into the foreground in these countries. But more should be done: this problem should be solved once and for all because as long as banks and investors see profits in these loans this sorry saga will continue in new countries.

Australia in the 1980s

In Australia banks started offering customers, many of them farmers, yen and CHF loans in the 1980s. With Australian interest rates at around 10-16% the 7% rates of the yen and the CHF was attractive. When the Australian dollar started depreciating in 1986 the difference in interest rates was by far not enough to compensate for the new ratio between the Aussie dollar and other currencies.

As always, the borrowers first tried to keep on paying, then to negotiate new terms with the banks followed by court cases, mostly based on the banks’ negligence of warning the borrowers of the inherent risk of FX loans. To begin with, the borrowers were fighting on their own, not realising that there were so many others in the same situation.

The banks had the upper hand in court: people should have understood the risk and it was neigh impossible for the borrowers to prove what the bankers had said or not said, promised or not several years earlier. The banks claimed the loans had been issued in good faith and foreseeing the Aussie dollar depreciation had been impossible.

Westpac had been particularly successful in the FX loan market. In 1991 a former Westpac executive, John McLennan, leaked two letters from 1986 showing that the bank was well aware of the risk. What ensued was an investigation, which exposed that not only had Westpac been aware of the risk but a law firm had helped it covering its track. This turned into a classic whistle-blower case: Westpac sued McLennan but later settled.

The letters set the story straight, politicians finally turned against the banks and thus the borrowers got the upper hand and some compensation. But all of this only happened five years after the depreciation, leaving many borrowers bankrupt with all the tragedies such events bring on.

The Australian saga entails the same elements later seen in country after country: banks lend in FX to people who neither have an FX income nor are particularly well-placed to gauge the risk; politicians side with the banks – and only after much struggle and long time are borrowers able to get a write-down or other assistance. But by then, tragedies such as divorce or homes lost have already happened and things can never be the same or compensated.

Iceland: where politicians sided with borrowers

High inflation and consequently high interest rates characterised booming Iceland after the privatisation of the financial system in 2003. Banks were eager to grow by issuing loans and lend funds they borrowed internationally. With credit boom in Iceland savings were insufficient to satisfy the credit demand. Icelandic borrowers were offered so called “currency basket loans”: FX indexed loans usually based on a mixture of currency, usually US$, euro, CHF and yen.

As in Australia, things changed and fairly quickly. From October 2007 to October 2008 the króna had been depreciating drastically: €1 cost ISK85 at the beginning of this period but ISK150 in the end; by October 2009 the €1 stood at ISK185.

Borrowers complained, turned to their banks and some individual solutions were found. However, quickly borrowers were not only turning to the banks but to courts. There were no class actions but individuals sought to court, the cases were well publicised and others in the same situation followed them intently.

Already in June 2010 the first Supreme Court judgment fell regarding two such cases. According to the ruling it was against Icelandic law to tie interest rates on Icelandic loans, loans in Icelandic króna, to foreign currency but perfectly legal to lend in FX.

The result was huge uncertainty: first of all, which loans were legal and which were not, i.e. which loans were real FX loans and which were only FX indexed loans – and if some of these loans were illegal what should the interest rates be?

The banks distinguished between loans to private individuals and to companies where company loans have mostly been regarded as legal FX loans, i.e. the companies did indeed receive FX whereas loans to individuals have all been treated as illegal, i.e. not proper FX loans but only with interest rates tied to FX, no matter the form. The Supreme Court ruled that instead of the FX currency interest rates the lowest CBI rates should be used causing substantial losses to the banks.

The Supreme Court has by now ruled in around thirty FX loans’ cases. There are however still on-going FX loan cases in the courts, some of them related to consumer information such as Directive 87/102/EEC The Consumer Credit Directive, Directive 93/13/EEC The Unfair Terms Directive and Directive 2005/29/EC The Unfair Commercial Practices Directive

The peculiarity of the Icelandic FX loans saga is that from the first borrowers had political support, very much contrary to other countries where FX loans have been common. This is partly due to the fact the Icelandic households have long been highly indebted, which has to a certain degree tilted sympathy towards debtors rather than towards those who are trying to save money.

Croatia, Hungary and Poland

The fight of Croatian FX borrowers have their own organisation, the Franc Association but their fight has been arduous, as covered earlier on Icelog. Already last year, Franc won a case against eight banks, all foreign or foreign-owned subsidiaries: UniCredit – Zagrebačka Banka, Intesa SanPaolo – Privredna Banka Zagreb, Erste & Steiermärkische Bank, Raiffeisenbank Austria, Hypo Alpe-Adria-Bank, OTP Bank, Société Générale – Splitska banka and Sberbenk.

The banks were found to have violated customer protection law by not informing clients properly. Further, the Croatian government has now decided to freeze interest rates for one year while further solutions will be sought, with banks forced to take a write-down on these loans.

In Hungary, where FX loans were among the most widespread in Eastern Europe before the 2008 crash, the government ordered banks last year to fix conversion of euro and CHF loans into Hungarian florints to a rate well below market levels. Following the recent CHF deprivation the government has said that no further action will be taken.

Polish FX loans have not been issued since the financial crisis of 2008 but the number of loans before that had been high, which means that many are still suffering their effect. Last year, governor of the Polish Central Bank Marek Belka said these loans were a ticking time-bomb. It certainly has blown up now with the CHF appreciation. The Polish government is now seeking a solution and regulators are investigating collusion on lending terms among the banks issuing the FX loans.

The underlying mechanism of FX loans

Although FX loan sagas vary in details from country to country the general mechanism is everywhere the same, always with four actors involved: international financial institutions looking for interest margins; investors, often called “Belgian dentists,” i.e. wealthy individuals looking for moderate-risk long-term investments; domestic financial institutions (often foreign subsidiaries) selling domestic currency, looking to lend in FX; domestic borrowers looking for low-interest loans.

The FX loans are normally marketed to middle or low-income earners in small or transition economies, recently been liberalised, with unstable currency or where the currency lacks credibility – and/or where interest rates are high. The banks issuing the loans are often, but not always, foreign banks, operating in a weak legal environment with weak or no customer protection.

There are certainly FX loans in other countries, such as the UK but there they have mostly been issued to wealthy borrowers often financing property deals abroad. The situation can certainly be painful for those individuals but these loans are anomalous, hitting only a very limited part of borrowers. In France, many local councils are struggling with CHF loans and fighting financial institutions in court, again clearly a major problem for the councils but now following the general pattern of FX loans listed above.

The general description above fits Australia, New Zealand, Iceland – and the countries where many borrowers have been sorely struggling with FX/CHF loans since 2008, i.a. Poland, Croatia, Hungary and other countries. With the exception of Iceland these countries have been fighting the banks for years, often with limited or only very late success. Only the recent CHF appreciation has finally managed to clearly demonstrate the calamity these loans are for normal borrowers with income only in their domestic currency.

The only sensible solution to FX (predatory) lending

For more than thirty years FX loans have periodically been causing huge harm and personal tragedy in country after country. The pattern is always the same. Banks continue this type of lending, every time minimising or ignoring the risk to unenlightened borrowers. The only new elements are a new country and new people to suffer the consequences.

Since this story has been repeating itself for decades, bankers issuing these loans cannot reasonably claim to be unaware of the risk. Instead, FX lending to private individuals with no FX hedge increasingly looks like predatory lending: the banks must have been aware of the risk and known that the risk had indeed materialised earlier in other countries.

Bankers have so far shown little aptitude of learning anything at all from the past few decades. National and international organisations working in the field of financial regulation and consumer protection should work towards making FX lending to private individuals with no FX hedge illegal. Until that happens the FX loans will continue to find new countries to wreck havoc in.

*Another side to the FX lending is whether the banks issuing the loans have properly hedged their FX exposure of their liabilities. There is indication that banks in i.a. Austria, Croatia and Hungary have held more CHF assets than liabilities. This is another interesting aspect, which I hope to cover later.

If any Icelog reader has documents showing that banks were aware of the risk of FX borrowing to clients but did wilfully not inform them I would be interested in hearing from them.

Update 15.11.22 – obs: some of the links are now out of date. 

Follow me on Twitter for running updates.