The cost of converting loans linked to the Swiss franc into euros could reach eight billion kuna

The Croatian National Bank (HNB) has estimated that the cost of converting loans linked to the Swiss franc into euros could reach approximately 8 billion kuna.

This would exceed preliminary estimates of 5.5 to 6 billion kuna, as announced on Tuesday by the central bank.

– Given that the cost of converting loans in Swiss francs involves the write-off of part of the principal, the conversion will certainly significantly reduce the capital of banks that have parts of their loan portfolio denominated in Swiss francs and are subject to the provisions of the mentioned law. From the available incomplete data, it can be assumed that the expansion of the scope of loans subject to conversion and subsequent changes in the model on which the initial estimate was made will increase the conversion cost for banks compared to preliminary estimates, so this cost could reach approximately 8 billion kuna, states the HNB report on the issue of citizens’ indebtedness with CHF loans and proposals for measures to ease the position of debtors in CHF based on the conclusion of the Finance and State Budget Committee of the Croatian Parliament.

As further stated, the current proposal for amendments to the Consumer Credit Act and the Credit Institutions Act would create significant costs for banks, which would reduce their capital adequacy and generate losses amounting to nearly three years of expected profit.

– Of the estimated impact of the legal amendments on bank earnings of 8 billion kuna, 5.8 billion relates to the cost of one-time write-offs or the equalization of the remaining principal of CHF and EUR debtors, 1.8 billion to additional reduction of annuities, and about 500 million kuna for non-housing and canceled loans, the report states.

Based on the estimate of possible costs of the proposed solution, the capital adequacy and earnings of eight banks, which account for the majority of CHF loans for the next period, can also be forecasted. Thus, a one-time cost of 8 billion kuna would lead to a decrease in the total capital ratio from 23.5% to 19.7%, a drop of 3.8 percentage points, according to the HNB. Also, assuming that banks use their earnings in the current year first to cover losses from the previous year, the cost of 8 billion kuna would mean that banks would only return to the area of positive earnings in 2017. It is also taken into account that banks currently achieve a slightly better net interest margin on loans in euros compared to CHF loans.

– Finally, the elimination of three years of bank profits has significant fiscal implications since banks will not pay corporate income tax during that period. The absence of payments based on corporate income tax will affect the increase in the budget deficit or will require compensatory measures on the side of fiscal revenues and/or expenditures if the effect of the conversion on the deficit is to be neutralized.

The conversion of CHF housing loans into euros does not automatically lead to a decline in international reserves. However, the write-off of part of the principal for converted CHF loans could lead to a decline in the international reserves of the Republic of Croatia, according to the HNB.

Namely, through the write-off of receivables in euros, banks shorten their position in that currency. If banks were to fully compensate for the shortening of their currency position (and the regulatory position motivates them to keep their open foreign currency position low) by purchasing foreign currency on the domestic market, there would be an increase in banks’ demand for foreign currency, which could cause a depreciation of the kuna against the euro. In such a situation, the HNB would be forced to intervene since there are not sufficient foreign currency funds on the domestic market to meet that demand. Consequently, the HNB would need to intervene by using international reserves. Specifically, assuming that banks would want to immediately restore their foreign currency position to balance and that they achieve this by purchasing foreign currency on the market, the HNB would need to sell foreign currency reserves to banks in the amount of 0.88 billion euros. If the reserves are reduced by the total amount of the banks’ costs due to the conversion, the loss of reserves in that case could exceed one billion euros.

Finally, the HNB emphasizes that these quantifications consider only the direct effects of the proposed package on debtors, banks, public finances, and international reserves. Its indirect effects on the potential materialization of financial risks as well as broader impacts on the financial sector and the economy as a whole are not considered, although they may manifest in the perception of greater investment risk in the Croatian economy and, particularly, greater credit risk. The HNB states that the total number of approved credit parties for CHF housing loans amounted to 73,700. If the loans repaid in the meantime are excluded, as of the end of October 2013, there were 55,800 credit parties remaining. The average approved CHF housing loan amounted to approximately 82,000 CHF with a weighted nominal interest rate (NIR) of 4.62% and an initial maturity of 22 years.