It all started innocuously enough in the late 1980s. Many of Vorarlberg’s residents worked in neighbouring Switzerland and earned Swiss francs. So it seemed sensible enough to borrow in the same currency; Swiss interest rates were, after all, lower than those in Austria. Once the idea took off it spread fast and far. By the end of 2007 almost one-third of Austrian household borrowing was denominated in foreign currencies with low rates.
This rapid take-up was repeated and exceeded as Austrian and other Western banks moved into central and eastern Europe. The IMF reckons that Polish households took on mortgages denominated in Swiss francs that were worth about 12% of GDP in 2008. In Estonia foreign-currency mortgages accounted for about 80% of household borrowing last year (see chart); in Hungary almost 85% of new mortgages were in Swiss francs in recent years.
This borrowing primed a bomb that still threatens some emerging-market economies and their bankers. The most exposed of all is Latvia, where more than 80% of all household borrowing is denominated in foreign currencies, mainly euros. That seemed to pose little danger as long as Latvia could credibly keep its currency pegged to the euro. But with its economy mired in a deep recession and the country dependent on outside lenders’ money, there are increasing doubts about Latvia’s ability to maintain the peg. Devaluation might help exports but would also make it harder for households to pay back their foreign loans. On October 6th the Latvian government said it was drafting a law limiting the liability of mortgage borrowers to the (reduced) value of their homes, not the value of the original loan, a move that would make devaluation less painful and that would saddle banks such as Swedbank and SEB of Sweden with big losses.
The Economist
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