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Walking away: anti-bank politics in eastern Europe

In the aftermath of the global financial crisis, populist politicians in central and eastern Europe realised that struggling homeowners could be their new powerbase. Lenders are facing a potential onslaught of unwelcome government intervention in the banking sector, though there could be a silver lining. Stefanie Linhardt reports.
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Imagine taking out a mortgage and buying a house, but being able simply to return your property to the bank with all liabilities taken care of if you cannot sustain your mortgage payments. Sounds utopian? Surely lenders would never agree to such a deal. True – unless the government passes legislation forcing it through, as has happened in Romania.

Regardless of the asset’s market value, borrowers can now hand over their keys and leave. Thousands are expected to take advantage of the new law, but banks have drawn the short straw. Lenders are likely to turn into unwilling property owners, and ratings agency Fitch warns that the legislation threatens to “disrupt the Romanian banking sector’s improving performance”.

Influenced by growing populist movements, political interference such as that seen in Romania is on the rise across central and eastern Europe (CEE) and banks are being forced to fight their corners.

“We are operating in a region where politicians have made very skilful use of the bad image of banks in order to extract some value from them through banking levies and forced conversions,” says Erste Group chief executive Andreas Treichl. “Unfortunately, we also have to acknowledge that banks made mistakes that have made it very easy for politicians to attack us.”

Hungary's intervention

The downturn in the world economy following the global financial crisis caused difficulties for businesses and individuals throughout the CEE region, but the then-widespread practice of lending in Swiss francs rather than in the local currency added to the burden of many households struggling to keep up with their interest payments, making this a prime platform for populist campaigning.

Under prime minister Viktor Orbán, who returned to office in 2010, the Hungarian government was one of the first in the region to start political intervention. In April 2014, Mr Orbán’s government was re-elected for a four-year term on a ticket promising to force banks to compensate borrowers for past lending practices deemed 'unfair', including unilateral interest rate increases on loans, as well as an end to foreign currency denominated mortgages, which caused such trouble for homeowners when the forint weakened after the global financial crisis.

The measures have cost financial institutions in Hungary dearly: some €3bn for “unfair” practices alone. Hungary further operates a bank levy, calculated as a percentage of a bank’s assets exceeding 50bn forint ($170m) as of fiscal 2009, which at 0.53% when it was introduced in 2010 was the highest banking levy in Europe. Other countries are following suit, giving the region’s most senior bankers plenty of reasons to worry.

“I am afraid of every new election in CEE after all the presents that have been handed out to the electorate at the expense of the banking sector,” says Karl Sevelda, chairman of the managing board and chief executive at Raiffeisen Bank International, the second largest bank in the CEE region by country presence.

Croatia's challenge

In some cases, bankers’ fears are justified. In September 2015, the centre-left coalition government in Croatia passed a similar set of legislation. Those concessions coincided with an election campaign, though they were no help in prime minister Zoran Milanović’s bid for re-election.

But for the banks, the damage was done. The laws allow citizens to convert their Swiss franc-denominated loans into euros at an exchange rate predating the franc’s appreciation, which was a result of the Swiss National Bank’s decision to unpeg the currency from the euro in January 2015. Croatia’s banks must make up for the difference in exchange rate, a decision that provoked strong opposition from financial institutions. The conversion law cost banks some €1.1bn in 2015, but lenders are not going down without a fight.

Local banks have contested the law’s legitimacy before the Croatian Constitutional Court. Moreover, they have given notices of dispute to the government in preparation for arbitration proceedings against Croatia at the World Bank’s International Centre for the Settlement of Investment Disputes in Washington, DC.

“We expect our chances of success to be high,” says Raiffeisen’s Mr Sevelda, who adds that the Croatian state might have to reimburse banks for their losses should Washington rule in their favour.

EU involvement

During a session in the European Parliament on May 12, Lord Jonathan Hill, then EU commissioner for financial stability, financial services and capital markets union, declared: “Allowing borrowers to exchange their loans from Swiss francs into euros at an artificially low exchange rate, and placing the cost almost exclusively on lenders, goes beyond what is needed to avoid a crisis and protect borrowers.”

Croatia’s government does not have an easy task on its hands. The legislation was passed under previous leaders, which leaves the new government dealing with the fallout as well as its own coalition struggles. Prime minister Tihomir Orešković lost a no-confidence vote in June and the country will have new elections in September.

Finance minister Zdravko Marić told The Banker at the annual meeting of the European Bank for Reconstruction and Development (EBRD) that the government is in talks with the country’s lenders.

“Almost 94% of total individual loans have been converted from Swiss franc base to euros – we are a highly euroised economy – and some individuals went even further, to kuna,” says Mr Marić, who adds that the conversions are widely concluded. “Generally, all these effects have already been put in the [banks’] profits and losses and financial reports for 2015. We continue our discussions [with the banks] on further implications of this law but we are also having a constructive dialogue with them because one of the key challenges for us is also how to stimulate overall lending activity.”

Talks are moving forward. In May, Mr Hill was urging the Croatian government to make progress “or we will have to take appropriate action”. He called for a solution that is consistent with EU legislation while protecting consumers, investment and the single market.

He added that the European Commission was “monitoring the situation carefully in Croatia, but also in other countries” and was “keeping all options open”, including an “infringement procedure”, which was subsequently begun in July.

The infringement procedure allows the European Commission to refer a case in which a member state violates or fails to implement an EU law to the European Court of Justice, which can impose penalty payments and decides whether a member state breached the law. In Croatia’s case, the European Commission has sent a formal notice to the government, which now has two months to respond.

Romania under scrutiny

Romania has also come under the European Commission’s scrutiny, even before the passing of the so called “datio in solutum” law. The European Commission’s 2016 country report on Romania released in February warned that the law “may generate a systemic risk for the entire banking sector, with risks for financial sector stability and implications for the whole economy” if passed by parliament in its original form.

Mr Hill and Pierre Moscovici, EU commissioner for economic and financial affairs, taxation and customs, followed this up with a letter to Romania’s finance minister, Anca Dana Dragu, in mid-April, voicing concerns over compliance with the general principle of EU law of legal certainty, and reminding her: “Whereas member states are allowed to take measures to pursue overriding reasons of public interest, they must do so in compliance with the general principles of EU law, in particular proportionality.”

On April 28, Romania’s president, Klaus Iohannis, ended up signing into law a revised version of the bill allowing mortgage borrowers to walk away from their loan commitments by returning their properties to the banks after he asked for the initial bill to be revised. However, the main change in the new version of the law is minor: a cap on the size of the loan at the equivalent of €250,000. The law applies to any mortgage loans, irrespective of currency and whether or not the creditor is able to keep up repayments, apart from those signed under the state-subsidised ‘prima casa’ programme.

Romania’s banks have welcomed the interventions by the European Commission because many believe the law is unconstitutional.

“One-sided, after-the-fact changes of the legal framework, under which business is done, are always critical,” says Carlo Vivaldi, head of UniCredit’s CEE division. “Being prudent businessmen, UniCredit Bank Romania has decided – like other local banks – to file an appeal to the constitutional court and to have the constitutionality of the ‘giving-in payment’ law reviewed. Although we cannot anticipate the verdict to come, we certainly hope that the constitutional court will confirm our legal viewpoint.”

Rising risks

Across institutions, the deposit requirements for new mortgage applications have risen because the law means that lenders no longer grant a loan to an individual but finance an asset, according to Steven van Groningen, CEO of Raiffeisen Bank Romania. This means that “the main risk is not the individual borrower and his or her financial situation, but the value of the asset”, he has written on his blog. “This is a totally different risk and it would be naive to think that this would not be expressed in the terms and conditions of mortgage loans.”

This is why Raiffeisen Bank has been forced to increase the standard downpayment for mortgage loans in local currency from 15% to 35%, meaning that new mortgage applicants need higher deposits. By mid-May, 13 Romanian banks had followed suit. “If the risk is increased, the prudent thing is to take measures to limit the risk to acceptable levels,” says Mr van Groningen.

There are concerns that lawmakers could pass further legislation detrimental to the banking sector. “Every day we hear different news from Romania,” says Mr Sevelda, who fears legislators could be looking into mandatory conversion of Swiss franc loans as they did in Croatia.

Nevertheless Romania’s finance minister Ms Dragu tells The Banker: “There are several discussions here and there but I think there is some quiet in this area of Swiss francs as the initial exposure was very small [at about 2% of total loans]. Banks individually got into some rescheduling programmes with their clients, so this issue, for Romania, was not significant and was approached step by step and solved by the banks.”

Poland’s perspective

In Poland, the conservative government of the Law and Justice Party signed into law a bank tax demanding payment of 4.4bn zlotys ($1.1bn) in 2016 after winning the elections in October 2015. The tax is equivalent to about 32% of banks’ annualised earnings for the first 10 months of 2015, according to rating agency Moody’s.

The tax is expected to reduce banks’ return on assets (ROA) and return on equity (ROE) by one-third. In 2015, Polish banks generated average ROA of 0.72% and ROE of 8.03%, according to The Banker Database.

As well as the banking tax, the Polish government is also looking to implement legislation regarding the conversion of foreign exchange (FX) loans.

The outgoing president of the Polish National Bank, Marek Belka, warns that “adventurous internal policies” could derail Poland’s economic growth prospects, adding that a close watch must be kept on developments with regard to the banking sector. “There are some measures already introduced, like the banking tax, which have vastly reduced the prospects for profitability of the banking sector, and there is a looming problem of FX mortgage loans which, if tackled in a whimsical way, could undermine the stability of the banking sector,” he told The Banker at the EBRD meeting.

Under the auspices of the Polish president, a group of experts has worked on an FX loan conversion plan, one that is rumoured could hit banks heavily. According to local press speculation, a partial redenomination of FX mortgage loans could ask banks to convert loans at the historical rate from the date the loan was originated. Any loss would be covered by banks, while customers would gain on lower interest rates compared with zloty-denominated loans. This could be accompanied by share sales and repurchase agreements with the central bank to prop up the banks, although this might “raise questions whether the support for banks is not a kind of public help”, says Marta Petka-Zagajewska, chief economist at Raiffeisen Bank Polska. The use of public funds is restricted under EU regulation.

Battles to come

Poland’s Ministry of Finance told The Banker that it was “not consulted” on the latest proposal and that the proposed solutions require additional work and analysis, particularly in relation to financial consequences for public finances, and consultation with other institutions responsible for financial stability”.

It adds: “However, the Ministry of Finance supports all initiatives aimed at resolving the foreign currency loans issue.”

Prospective legislative measures on Swiss franc lending in Poland and elsewhere are proving to be hard-fought battles between politics on one side and banks and regulators on the other.

“[Central bank governor Mugur] Isarescu in Romania massively opposed measures introduced, [Marek] Belka [in Poland] has strongly criticised this, and also in Croatia the governor was no supporter of the mandatory conversion legislation,” says Raiffeisen’s Mr Sevelda. “We have almost always had good experiences with central bank governors but, unfortunately, central banks are often losing to politics.”

Banks in the Balkans

Outside the EU, in Montenegro, a country with some 622,000 inhabitants and gross domestic product (GDP) estimated at $4.04bn in 2015, according to the International Monetary Fund (IMF), only one institution was involved in Swiss franc lending: the former Hypo Alpe Adria, which hit trouble after the global financial crisis. Its successor, Addiko Bank, had to deal with the Montenegrin government’s decision to convert Swiss franc loans into euros at the exchange rate valid on the day of signing the loan with a fixed interest rate of 8.2% within less than two months.

Meanwhile, Montenegro’s larger but regionally fragmented northerly neighbour, Bosnia-Herzegovina, is still debating a conversion law. The country, said to have the world’s most complicated system of government, comprises two entities – the Federation of Bosnia and Herzegovina and Republika Srpska – each of which has its own assembly, prime minister and 16 ministries, alongside a parliament for the entire country and three presidents.

While in Republika Srpska a Swiss franc loan conversion law is off the table and banks such as Addiko are working on individual solutions, the final view of the Federation of Bosnia and Herzegovina is not yet clear.

Addiko Bank chief executive Ulrich Kissing explains that his bank has already reduced its Swiss franc loans in Bosnia-Herzegovina, from a peak of more than 10,000 to fewer than 2000 as of July.

“Since March, we are offering a voluntary solution consisting of a cut by 30% for all private individual Swiss franc creditors across Bosnia-Herzegovina,” he says. “For those on the lowest income, the lowest 25%, we are even offering a 50% haircut because we are of the opinion that we have to work out this legacy. Due to increasing interest we have prolonged our offer until July 31.”

The bank is in talks to refinance more than 84% of its creditors in Republika Srpska under these conditions, although the share in the Federation of Bosnia and Herzegovina only reaches 60%.

“The problem here is that in the Federation, the in our view unconstitutional Swiss franc legislation is still up in the air,” says Mr Kissing. “I hope that we will come to a solution which will not damage the EU accession negotiations for Bosnia-Herzegovina and that the government realises our voluntary solution is also best for the customers.”

So far, there are no clear signals regarding which route the government plans to take, although Bosnia-Herzegovina’s agreement over an economic programme loan from the IMF would have come with some conditions. According to Bosnian media reports, the IMF probably linked its Km443.04m (€550m) 36-month extended fund facility to a requirement for the government to withdraw from a law to convert loans in foreign currency to loans in Bosnian marks. However, that agreement has not yet been signed.

The good news

Despite legislative uncertainty in some CEE countries, the deputy governor of the Austrian national bank, Andreas Ittner, believes that banks’ CEE endeavours have been “a success story”, hinting at why banks are prepared to endure such policies.

“Although the road is likely to stay bumpy, CEE has stronger growth rates than western Europe – up to 150 basis points more – and many markets are still under-banked, so there is still more to gain,” he says. “Subsidiaries of the Austrian banks in the region have made €2bn of profits in 2015. The overall profits after tax will be about €5bn.”

Economic growth and potential exert a strong attraction. Romania’s GDP growth rate in 2015 was the highest out of EU members from the CEE region, with 3.7% at constant prices. UniCredit expects the Romanian economy to grow by more than 4% in 2016, one of the highest increases in the region. Small wonder then that both UniCredit and Raiffeisen are looking to expand their operations in the country.

In fact, according to UniCredit research, the economies of all its CEE countries of operations apart from Russia are set to grow in 2016. With real growth rates of more than 3% forecast for Romania, Poland, Bulgaria, Turkey, Slovakia and Bosnia-Herzegovina, expansion is set to significantly outperform the IMF’s forecast for average growth in the EU of 1.6%.

And there could be another bonus: in some countries, legislation is moving in the opposite direction. Hungary’s government has reduced the banking tax to 0.24% on 2009 total assets over Ft50bn in 2016 and has committed to a further reduction to 0.21% in 2017, calculated on 2015 total assets. So there is scope for change.

“Given the post-Brexit turmoil, politicians realise more than ever how important it is for their countries to be an appealing and stable investment destination,” says Erste’s Mr Treichl, adding that the first effects of this improved climate can already be seen. “Confidence is coming back in CEE. We [and other banks] have been lending more and are expecting to be profitable this year.”

It is timely that governments are realising that the long-lasting benefits of a sound judicial system and stable management significantly outweigh short-term advantages such as one-off tax gains.

“It can’t be that there is no consideration as to what impact a Swiss franc law might have on the respective local banking systems and that the expectation prevails that international investors will always keep pouring fresh money into the system,” says Addiko’s Mr Kissing. “This could at some point turn out to be a fallacy.”

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