ADDRESS ISSUES CONNECTED WITH FOREIGN CURRENCY-BASED CONSUMER LOANS
1. The Economic and Social Background of Foreign Currency Lending
1. 1. The Role of Real Estate Property in Hungarian Society
Over the last hundred and fifty years, Hungarian society witnessed the radical transformation of ownership structures on three occasions. One of the main achievements of the Revolution and Freedom Fight of 1848-1849 was the liquidation of feudal ownership.
After 1945 nationalisation affected society as a whole with central planning introduced in the economy. As a result, private ownership had dropped to a minimal level and was virtually restricted to housing property. In the wake of the political changeover of 1989-1990 an opposite process unfolded: state property was dismantled, privatisation and restitution began. Private property expanded rapidly and the number of privately-owned businesses (business associations) increased from 45.770 in 1990 to over 280.000 in 1997.1 These developments have determined both the attitude of the Hungarian population to property and the development of areas of law that are closely associated with economy, like civil law.2
Due to historical upheavals, real estate ownership has gained special significance in Hungarian society. As a vestige of archaic rural society, this includes the ownership of both arable land and the house. Real estate ownership which should be preserved and extended is also characteristic of the bourgeois mindset.3
One of the features of residential property is that it either requires total renovation by each generation or it should be replaced by an entirely new home. In view of the number of inhabitants and the size of families, around 40.000 new homes should be constructed in Hungary each year. This target was met by the first Orbán government (1998-2002) for the first time since the 1980s. The subsidized forint-based home loan scheme of the first Orbán government was the first successful attempt that besides increasing the number of housing constructions, also encourage newlyweds to move into modern homes of their own.4 Consequently, the number of residential constructions increased steadily from 1999.5
1 At the same time the number of state corporations decreased drastically: whereas in 1990 there were 1859 such companies, their number dropped to 3 by 1997. The number of businesses owned by the state, however, was much higher than that. The increased number of business associations implied more insolvency procedures.
See.: HARMATHY, Attila: Das Recht der Mobiliarsicherheiten – Kontinuität und Entwicklung in Ungarn. In:
KREUZER, Karl F. (Hrsg.): Mobiliarsicherheiten – Vielfalt oder Einheit?, Nomos, Baden-Baden, 1999. p. 78-83.
2 On the impact of the last 150 years on civil law see: HARMATHY, Attila: Jogpolitika – polgári jog. Magyar Jog, 12/2010. p. 705-719.
3 KOVÁCS Levente: A devizahitelek háttere. Hitelintézeti Szemle, 3/2013. p. 183., See also: KATZENBACH Zoltán – OSVÁTH Piroska: Lakhatás és befektetés – egy új lakásfinanszírozási modell. Hitelintézeti Szemle, 4/2012. p. 289-297.
4 KOVÁCS: i.m. 183.
5 In 1999 19.287 new apartments were built; in 2000 the number was 21.583 and in 2001 it was 28.054 and in 2002 31.511. Source: Central Statistical Office (KSH)
1. 2. Switching to Foreign Currency-based Residential Mortgage Loans
Following the general elections of 2002, the new government discontinued the interest-rate subsidization of mortgages denominated in forints for budgetary reasons. People, however, continued to yearn for owning a home. Forint-based residential lending became unsustainable in the absence of subsidies due to the fact that while the base-rate of the forint ranged between 8-12%, the market interest rate was 14-18%.6
Extremely high forint interest rates triggered the (seemingly good) idea of switching residential mortgage landing to foreign currencies as these were available at lower interest rates.
Inflation as well as the high base-rate directed households towards foreign currency loans due to significant interest rate differentials.7 This was the time when loans denominated in foreign currency, in particular Swiss francs, which were offered at a low interest rate, appeared on the Hungarian market. These foreign currency-based housing loans were associated with a reduced payment obligation owing to lower interest rates. The repayment curve of the foreign currency-based loans was also more attractive as the debt service started from a low level, therefore initial payment burdens were lower than in the case of forint-based loans.
Nevertheless, this lower interest burden was offset by the ever-fluctuating exchange rate of the principal debt. At first the issue of the exchange rate risk was completely set aside. The stable interest rate of foreign currencies which was much lower than that of the forint was taken into consideration instead. A classic bubble phenomenon could be observed on the market. Debtors and creditors both appeared to nearly totally ignore risks in the hope of huge profits. The majority of borrowing households only took the monthly payment instalment into account when making the decision.
As for the lending banks, they made their assessment and took decisions on the basis of real estate collateral rather than by examining the future life situation and the payment capacity of prospective debtors.8 With hindsight, it can also be established that banks failed to act in a in good faith when they accepted properties that had no chance to be sold on the market (for instance residential real estate properties taken over by the National Asset Management Program) as collateral.9
The proliferation of foreign currency-based loans can also be attributed to the fact that judging from political declarations, in 2003 the financial sector could reasonably expect the introduction of the euro as legal tender in Hungary within a few years. It seemed to be a logical choice to offer long-term loans spanning several decades in euros or Swiss francs anchored to it rather than in the constantly appreciating forint with its high interest rates.
This solution enabled wider segments of the Hungarian population to upgrade their home or acquire a new home despite the relatively low level of wages in the country.10
6 KOVÁCS: i.m. p. 184. During this period the base rate of the central bank and the inflation rate were both rather high: In 2002 5,2 %, in 2003 4,7 %, in 2004 6,8 %. Source: KSH. Rising inflation was mostly linked to budgetary adjustments.
7 NYESTE, Orsolya – ÁROKSZÁLLÁSI, Zoltán: Devizahitelezés Magyarországon – régiós makrogazdasági, fiskális és monetáris politikai megközelítésben. In: KOVÁCS, Levente (szerk.): Negyed százados a magyar bankrendszer. Magyar Bankszövetség. Budapest, 2012. pp. 149., 153.
8 NYESTE – ÁROKSZÁLLÁSI: i.m. p. 150.
9 The National Asset Management Program was launched pursuant to Act CLXX of 2011 on the housing provisions of natural persons incapable of meeting their payment obligations under their loan
10 KOVÁCS: i.m. p. 185.
As a consequence, housing constructions continued to pick up, then peaked in 2004.11 During this year over 43,000 new homes were built in Hungary. Subsequently the number of constructions showed a slight downturn before and stagnation until 2008, then fell rapidly.12
1. 3. Impacts of the 2008 Crisis
In the wake of the 2008 financial and economic crisis, whereas the Hungarian forint depreciated substantially, the euro and even to a greater degree, the Swiss franc appreciated significantly.
In the very year of 2008, 90% of new residential loans were denominated in foreign currency.
The first signs of the storm, however, had emerged as early as in 2006. This is when the interest rate of the Swiss francs and of the euros moved apart due to the fact that the European Central Bank started to raise interest rates in 2006. As a result, between 2006 and 2008 the average interest rate of loans denominated in euros first exceeded 10 %, then after a slight decrease stabilized around 10 % from 2009 onward. In the meantime, the average interest rate of Swiss franc-based mortgage loans was 5-6% and exceeded 6% only from 2009 onward.13
Since the Hungarian financial supervisory authority failed to take measures, foreign currency lending became particularly widespread between 2006 and 2009. The foreign currency loan portfolio of households grew from 2,000 billion forints (approximately EUR 6,2 billion) at the end of 200614 to 6.000 billion forints (approximately EUR 19 billion) by early 2009. It is perplexing that the foreign currency loan portfolio of the Hungarian population should have increased with a further amount of 1.000 billion forints (approximately EUR 3 billion) even after the onset of the financial crisis.15
Foreign currency lending was initially dominated by housing loans, however, free-to-use mortgage loans became increasingly popular later on and were free-to-used by hofree-to-useholds for consumption purposes.
The Hungarian financial supervisory authority first reacted in substance to the risks associated with foreign currency-based lending immediately before the outbreak of the crisis, on 15 February 2008. The Chairman of the National Bank of Hungary (MNB) and the Chairman of the Supervisory Council of the Hungarian Financial Supervisory Authority (PSZÁF)16 issued a joint recommendation on the systemic risks involved in foreign currency lending. Apart from the fact that it was several years overdue, the recommendation identified an interestingly increased risk with regard to Japanese
11 In 2003 35.543 new homes were built. Source: KSH
12 In 2005 41.084, in 2006 33.864, in 2007 36.159, and in 2008 36.755 homes were built. The number of housing constructions subsequently dropped sharply: in 2009 31.994, in 2010 20.823, in 2011 12.655, in 2012 10.560 and in 2013 only 7.293 new homes were constructed. Source: KSH
13 The interest rate of free-to-use Swiss franc-based loans was higher by around one percent. For more details see: PITZ, Mónika: A svájcifrank-alapú jelzáloghitelek kamatait alakító tényezők. Hitelintézeti Szemle, 2012.
augusztus, Különszám, pp. 62-69.
14 In the present study the 320 HUF/EUR exchange rate was used
15 In addition, foreign currency loans were granted to the corporate sector as well, the expansion of which was the most spectacular in 2007 (cca. HUF 800 billion/EUR 2,5 billion) and in 2008 (cca. HUF 900 billion/ EUR 2.8 Billion). See: NYESTE – ÁROKSZÁLLÁSI: i.m. p. 150.
16 The MNB and the PSZÁF used to be separate organisations at the time.
yen-based lending.17 Since then it has become apparent that debtors of yen-based loans suffered the least in the crisis owing to the decrease of the interest rate of the yen as well as its weakening.
The reaction was delayed. In fact, by this date the phenomenon that was to distress Hungarian debtors was in full swing: namely that not only the forint, but the euro also depreciated considerably against the Swiss franc. During the crisis the Swiss franc became a reserve currency (safe haven currency) and as a result, strengthened by around 25 % against the euro. Meanwhile, the forint weakened by around 10 % against the euro. As an overall outcome, while in early 2008 one Swiss franc was worth ca. 150 forints, in 2010 it stood at 200 forints, and in 2012 it reached 250 forints.
The depreciation of the forint against the euro was less marked, but still impressive: whereas at the beginning of 2008 one euro was worth around 250 forints, it stood at 280 in 2010 and at 300 in 2012.
The rapidly deteriorating forint, especially against the Swiss franc, affected the situation of indebted households drastically. As far as banks are concerned, the quality of their mortgage loan portfolio declined, as the share of non-performing loans within the portfolio rose consistently.18
In response to the 2008 crisis, Hungary’s country risk rating (the so-called CDS spread) increased considerably.19 While in September 2008 the spread of the five-year Hungarian foreign currency bond yields fluctuated around 100 basis points, two months later it reached 700 basis points. Simultaneously, the refinancing costs of the Hungarian banks increased, too. However, the further increase of refinancing costs was halted by the fact that both the European Central Bank and the Swiss central bank introduced interest rate cuts.20 As the financial authority failed to take measures and no limits had been set by national legislation, Hungarian banks, that are regularly abusing their statutory right to amend contracts unilaterally, embarked upon interest raising. Acting contrary to the original purpose of their unilateral right to modify the contracts, the Hungarian banks started to use this tool to augment their profit.
1. 4. Other Reasons for the Prevalence of Foreign Currency Lending
The wide-spread use of foreign currency lending stemmed from other factors as well, including competition between the banks based increasingly on risk, considerable information asymmetry between creditors and debtors, the instability of the financial
17 The Austrian financial authority issued a Communication as early as on 30 June 2006 to highlight the risks associated with foreign currency-based loans. One of its key statements is that all foreign-currency-based loans are ultimately forein currency speculation transactions. See: https://www.fma.gv.at/de/ueber-die- fma/presse/pressemitteilungen/pressemitteilungen-detail/article/fma-und-oenb-praesentieren-einen-informationsfolder-zu-den-risiken-von-fremdwaehrungskrediten.html Later, in October 2008 the Austrian financial authority practically prohibited the granting of new foreign currency-based loans. In 2008 yet 270.000 Austrian households had a foreign currency (in particular Swiss franc)-based loan agreement, this number fell by 45% by 2018, i.e. to 150.000 due to the prohibition.
18 NYESTE – ÁROKSZÁLLÁSI: i.m. p. 150.
19 The value that shows how risky it is for a foreign bank to lend in a given country.
20 As a result, LIBOR rate decreased to 0 %. In the meantime, the CHF LIBOR turned negative. On 27 February 2015 its three month LIBOR was -0,73 %. This trend affected the euro as well: the one-week EUR LIBOR stood at -0,06 % on the same day. Hence it was necessary for the Hungarian legislature to take action and to clearly state in connection with the negative interest rate that in accordance with Hungarian civil law negative inte-rest rates cannot be charged in the case of loan agreements. See: Sections 2(5) and Section 3 of Act II of 2015 amending Act on the Consumer Loan Agreements of Financial Institutions and other private law related acts.
intermediaries, financial illiteracy as well as failure to introduce lending rates pegged to the reference interest rate. These issues were addressed in the Report of the Parliamentary Committee for Constitutional, Justice and Procedural Matters of February 2012.21
In economics literature it is held that the spread of foreign currency lending in a catching-up, small, open, liberalized and under-capitalized economy is a natural phenomenon associated with an open foreign currency position. In the case of Hungary, however, open foreign currency positions appeared on the balance sheet of the retail sector with higher amounts than in other countries of the region, which led to systemic problems when the crisis broke out in 2008. The indebtedness of the sector in foreign currencies, that subsequently turned out to be unsustainable, should be seen as a symptom that reflected mostly the so-called crowding out effect of the unruly fiscal policy, the conflicts between the monetary and the fiscal policies as well as the fundamental structural issues of the Hungarian economy.22
1. 5. Belated Legislative Measures
Due to its size and the associated risks, by the early 2010s the retail foreign exchange loan portfolio had become an obstacle to economic growth. The following data serve to illustrate the burden weighing on society as a whole: at the end of June 2014 the retail foreign exchange loan portfolio was still above 4,147 billion forints (EUR 13 billion), of which 3,607 billion forints (EUR 11 billion) represented mortgage loans. In the same period the forint denominated retail loan portfolio amounted to 3.792 billion forints (EUR 12 billion) (of which 2.122 billion forints – i.e. EUR 6,6 billion constituted mortgage loans). In aggregate there were approximately 872.000 existing retail foreign currency loan contracts at the end of the first half of 2014.23
The legislature was therefore constrained to take steps. As a first major result, foreign currency retail lending was virtually banned in 2010. This was followed by further legislative measures that are of outstanding relevance both economically and legally. In 2014 retail mortgage loans were converted into forints then in 2015 the same was done to personal loans and car loans.
However, before going into the details of the provisions, it is necessary to provide an overview of the legal nature of foreign currency-based loans as special banking products.