What tips the European banking system over the edge may in the first instance be Central and Eastern Europe, rather than the PIIGS. Reckless lending there by Austrian, Swiss, German, and Swedish banks in euros and Swiss francs, has left foreign exchange debt at horrific levels in Hungary (mostly CHF loans) and Bulgaria (Euro loans). And Romania (Euros), Poland (CHF), and the Baltics also have substantial foreign debt exposures.
As the Swiss franc surges to record levels against the forint on safe haven flows, the consequences of being burdened by debt denominated in the one of the world’s two strongest currencies are becoming clear. And a tsunami of bad debt now threatens to engulf Europe’s banks.
Because Swiss franc loans make up about 44% of Hungary’s entire household debt stock and 55% of all mortgages the ECB and the IMF have had to put in place support mechanisms, but Hungary stands out in terms of its vulnerability to any future growth shock or lack of foreign funding because its foreign debt to GDP ratio is already 136%.
So desperate is the situation that Hungary’s ruling Fidesz party has drafted proposals to help troubled foreign exchange loan holders, which would force banks to use more favourable exchange rates, ban arbitrary rises in interest rates, and automatically extend he maturity of loans by five years at the borrowers request, and accept that the outstanding mortgage must not exceed the current market value of the real estate used as collateral! The new centre-right government, which took office in May, has already banned further foreign currency mortgage lending to households.
But prudent fiscal management may not be enough. The potential for a debt spiral is very real, as any deterioration in the economy causes the HUF to weaken further, creating a negative feedback loop with Swiss Franc loans and further deterioration in non-performing loans. With another peak in gross government re-financing coming next year amounting to about 20% of Hungarian GDP, and the foreign debt burden denominated in HUF worsening, the markets are watching closely.
Interestingly, the Swiss themselves weren’t foolish enough to do any of this lending. Austrian banks provided about 40% of CHF loans in the euro-zone. And between 15-25% of the balance sheets of the top four Greek banks are exposed to SE Europe, including almost 40% and 30% of loans to the private sector in Bulgaria and Romania respectively, according to Macquarie Bank. In turn, German, French and other northern European banks are heavily exposed to Greece. No wonder then, that the EU fears the chain reaction which would ensue from a Greek default.