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An end to foreign currency loans

Author: Sándor Péter Kovács

An end to foreign currency loans?

Contributed by Gárdos Füredi Mosonyi Tomori
October 01 2010

Foreign currency loans in Hungary could all but vanish due to a recently adopted act.
However, the new rules may violate EU law.

With effect from August 14 2010 real estate can no longer be pledged as collateral for a
foreign currency loan borrowed by individuals according to Act 90/2010, which amended
the Civil Code. The prohibition in the new act primarily affects residential mortgage
loans; it does not apply to loans borrowed by enterprises or other legal persons.
Foreign currency loans, especially loans denominated in Swiss francs, dominated the
retail banking sector a few years ago, as their interest rates were significantly lower
than those of Hungarian forint loans. However, early in 2009, due to the weakening of
the forint, the instalments to be paid on foreign currency loans rose significantly. During
2009 the government made every effort to increase the country's economic credibility,
which had a positive effect on the forint exchange rate and thus eased the burden on
debtors. However, in the past few months the forint has sunk to historic lows, owing
partly to international currency movements and partly to uncertainties about the new
government's economic policy. As a result, an increasing number of bank clients have
struggled to pay the sharply increased monthly instalments. In a recent article, Reuters
noted that:

"franc loans make up about half of Hungary's household debt stock and the Swiss
currency's appreciation means borrowers are being pushed to their limits to meet
payments, driving up non-performing loan rates."

The previous government also adopted measures that aimed to restrict the marketing
of foreign currency loans to individuals in order to limit the financial risks taken by
private borrowers. For example, since March 2010, a higher loan-to-value ratio has
been prescribed for foreign currency loans than for loans denominated in forints.
In June 2010, shortly after taking power, the new government announced further steps
to cut the provision of foreign currency loans. Uncertainties about future legislation
resulted in a significant reduction in the number of new foreign currency loans for
individuals, even before the new act was adopted.

However, from a legal point of view, the act is problematic because it violates the
prohibition against restraints on free movement of capital, a cornerstone of EU law. In
1999 the European Court of Justice found that an Austrian law which prohibited the
taking of mortgages on real estate as collateral for foreign currency loans constituted a
restriction of the free movement of capital. In addition, the court stated that it would not
recognise extraordinary circumstances that would justify such restrictions. In July 2010
a delegation from the European Commission, which came to discuss the government's
future economic policies, also expressed concerns about the act's possible noncompliance
with EU law.

However, even if the act were found to be in contradiction with the EU Treaty, it would
probably take the European institutions a long time to persuade the Hungarian
government to repeal it. Thus, the new rule is likely to remain in force for the next few
years at least, and financial institutions will have to comply with it.
For further information on this topic please contact Sándor Kovács at Gárdos, Füredi,
Mosonyi, Tomori by telephone (+36 1 327 7561), fax (+36 1 327 7561) or email (kovacs.sandor@gfmt.hu).

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