Swiss Franc Loans: A Real Case Study of Currency Risk

Recently, an old issue of Swiss franc loans has come to the fore again. I, as a younger person, was not aware of the specific case, however as an economist and financial analyst, I was asked by many to comment on the specific current issue and answer their questions, after information provided to me and personal research. The Swiss franc loans refer to loans, mainly of a housing nature, that Greek citizens entered into and received with Greek banks in order to buy a residence in Greece. These loans were obtained mainly during the period 2005 – 2008 with the special feature that they were granted in a foreign currency of Swiss francs and their repayment will also be made in Swiss francs. Then, after issuing the loan in Swiss currency, the entire amount was converted into Euros, at the given Euro/Franc exchange rate at the time, as the borrowers needed local currency in Greece to conduct transactions and purchase the property they intended.

Why, then, when someone needs to have the euro for transactions in his country, does borrow in Swiss francs? The answer lies in lending interest rates. In the period 2005 - 2008, the basic lending rate for the Eurozone ranged between 2% - 4%, while for Switzerland, the Swiss franc, ranged around 1% - 2%. Thus, borrowing in Swiss francs was cheaper with lower loan servicing costs, motivating borrowers to borrow more cheaply. In this way, by pegging the loans to the Swiss franc the Greek banks could attract more customers and grant them a loan, offering them the choice of the Swiss franc, as the cost of money for the banks was lower compared to the euro. Together, therefore, with a margin that the bank would charge in order to make a profit, the total cost of the loan in Swiss francs would burden the borrower with a final issuing loan interest rate of 3% to 6%. This possibility of issuing in Swiss francs made the loan 2% cheaper than the same loan that could be issued in euros, favoring borrowers and reducing servicing costs. However, at what cost? This is where there is a catch and things get difficult...

The Problem

The problem that arose in the following years lies in the repayment clause in Swiss francs. You see, the money used from the loan may have been converted into euros when the loan was received, so that it could be used in Greece for purchases, as well as the bank issuing the loan being Greek, however, the loan has been issued in Swiss franc with monthly installments required in that currency. This was initially not a problem as at the exchange rates at the time the euro was stronger than the Swiss franc and Greek citizens could buy more Swiss francs with fewer euros to repay their installments, a situation that benefited them quite a bit. Thus, they were doubly favored both by the low cost of borrowing, due to low-interest rates, and by the low franc/euro exchange rate which made installments manageable.

Then over the years, the Swiss franc/euro exchange rate steadily increased as the Swiss franc strengthened against the euro. This fact made it more difficult to repay the loan, as every month the Greeks had to commit more and more euros to buy foreign exchange in Swiss francs and repay the installment of the loan in francs. This has continued to happen continuously from 2005 until today, as the Swiss Franc is more in demand than the Euro and is constantly increasing in value, as a safe currency of a very stable and robust economy. Thus, borrowers experienced an increasing cost of servicing their loan, requiring more and more money each month in euros to pay their installments and stay current on the loan, without late payments. A period of relief was the period 2012 – 2015 when the Swiss National Bank decided to implement a bold monetary policy, setting a ceiling on its exchange rate. In doing so, it held back and devalued its currency internally to make domestically produced goods more competitive for exports, giving a boost to the local economy and averting deflationary risks, due to the financial crisis of 2007-2008. This prevented investors from seeking a safe haven for their money in the Swiss franc, with the Swiss National Bank buying foreign currency at the locked rate en masse, in large quantities, absorbing the massive appreciations of the national currency, which made domestic Swiss products more expensive abroad.

However, from 2015 onwards the exchange rate was free again, which rebounded and continued its upward trend. This fact made it more difficult for borrowers to repay, as the monthly installment increased to unimaginable levels compared to the income level of the average household, which could not keep up with the rate of increase in the exchange rate. Thus, despite the initial apparent benefit of reduced borrowing costs due to interest rates, borrowers were exposed to what we in finance call currency risk. Currency risk refers to losses that can be incurred in a transaction due to fluctuations in different currencies. In the event that the Swiss Franc was depreciating Swiss Franc borrowers would have been greatly favored, which did not happen, with the upward trends of the Franc being so strong as to make the monthly installments very difficult to meet. Although initially the exchange rate of the Swiss franc was low and it was possible to easily buy foreign exchange, it has now exceeded €1, making the position of borrowers difficult.

Loan Features and Amortization Repayment Table Evolution

To better understand the situation, I have created a detailed practical example with numbers, of a possible loan that could have been issued in 2006. Let's assume that this loan has a 20-year repayment period, with a monthly repayment frequency of its installments, and is of a fixed installment, i.e. it requires a fixed amount of payments every month. The amount of loan amounts to 200,000 Swiss francs (CHF) and has been issued with a fixed interest rate, which amounts to a total of 5% per annum. Taking into account the above characteristics of the loan as well as the fixed installment calculation method, the monthly installment of our hypothetical loan will amount to 1,320 Swiss francs, i.e. 240 installments will be required in total for the full repayment of both the capital of 200,000 CHF and the calculated interest. The fixed amortization method is the most common method of calculating loans, in which the interest of each period is calculated each time based on the remaining outstanding principal, each month, converting the annual interest rate of 5% to a monthly rate of 0.4167%. Thus, the payment table of the loan in Swiss francs is formed.

As we see in the table above with a monthly installment of 1,320 CHF the loan is repaid in 20 years or 240 months, where finally the borrower is required to repay the bank a total of 316,779 CHF, of which 200,000 CHF is the capital borrowed in 2006, while the remaining 116,779 CHF is the interest the bank will earn. Of course, the capital of 200,000 CHF has no meaning in the currency it is in, as it cannot be used in Greece, where the currency is the euro. That is why the loan is automatically converted into euros on the day it is issued, with the exchange rate that was in January 2006, at 0.6437 CHF/EUR. This means that the borrower had in his possession €128,734 (this corresponds to CHF 200,000) to use for transactions in the country and specifically for the purchase of a house, as most Swiss franc borrowers did. Of course, there is a repayment clause in Swiss francs, so every month they will have to convert part of their income from euros to Swiss francs to repay their installment. In this case, if we calculate the corresponding installments in euros, we have the following repayment table.

We notice that from a certain point the monthly installment started to increase, due to the upward trend of the exchange rate. Thus, an installment that once required €850 to be paid, reached today in 2022 needs €1,341, i.e. within 15 years it increased by approximately 58%! Watching the repayment charts below, we find that at some points in Euros in addition to the installment increase, the remaining outstanding repayment amount in Euros also increases. The strong rise observed in 2015 is due to the fact of the uncapping of the exchange rate by the Swiss Central Bank, which we explained above, and the upward trend of the exchange rate shown in the above diagram. We note that in the first years of repayment the amount of the installment that goes to interest is greater than that which goes to principal repayment. This is perfectly reasonable and is due to the method of calculating the repayment of fixed installments, where initially the remaining outstanding amount used as the basis for calculating the interest is greater.

Finally, we observe the sharp fluctuations of the installment in euros and the uncertainty it entails for a borrower, who works and earns his income in euros but does not know how much money will be required at the end of the month to satisfy his installment in Swiss francs. This is precisely the currency risk and the main reason it should be avoided. A lack of knowledge and understanding of this risk leads to undue risk-taking, creating additional problems such as this. Borrowers in Swiss francs made a wrong decision in taking out a loan in Swiss francs, as the money needed for buying a house and other transactions in Greece are in euros, and they can only make payments with them. Taking out a loan in a foreign currency and then converting it to local currency for use but obviously repaying in the currency of the loan is an irrational financial choice, as additional unnecessary risk is taken for no benefit.

At that time, it was better for borrowers to incur higher borrowing costs due to higher interest rates than to take unnecessary risks. In the above example, if he borrowed this €128,734 in euros, he might be charged an additional 2% interest rate, i.e. the annual interest rate of 5% would be around 7%, but then the installment would be fixed at around €1,000 per month. It may initially seem increased compared to the €850 required for the Swiss franc but the benefit is that it remains constant over time until the end of the loan repayment, with the guarantee that it will never rise above €1000, which unfortunately happened with the loan in Swiss franc of the example, derailing payments from 2021 onwards.

The above example was built on the assumption that the loan interest rate is fixed. In the case of a floating interest rate, things change dramatically and a separate analysis is required, as a second variable is added that changes, exposing borrowers to interest rate risk in addition to exchange rate risk. Such a case would increase the fluctuations even more and I consider it almost certain that the loan will not be able to be serviced and be sustainable. Unfortunately, there were also such loans that we may analyze in a future article.

Appropriate cases of loans in foreign currency

Currency risk should be avoided, like any other risk, whenever possible. The only case where such a risk necessarily needs to be taken that I know of is in international trade. Companies of import and export nature need either to make payments in foreign currency for the acquisition of raw materials and goods or accept payments in foreign currency from sales of products if they operate in other countries with a different currency than that of their country of operation. In this case, they are exposed to exchange risk. In particular, companies avoid borrowing in a foreign currency, different from the currency of their operation, when they do not need it. A company will take out a loan in foreign currency only if it needs to buy goods or raw materials from other countries in a different currency and does not have the necessary foreign exchange reserves nor the money in local currency to convert them into a foreign exchange market. Thus, it takes out a loan in a currency that it is going to use and buy the goods or services. Thus, for mortgage loans in Greece, it is rational to take out a loan in euros, since euros are needed to buy a house. What to do with Swiss francs...? You do not live in Switzerland!

Protection against exchange rate fluctuations

Both companies that operate internationally and banks that have various foreign exchange reserves in various currencies try to protect themselves from exchange risk. One of the ways they achieve this is by using derivative contracts to hedge risk. Also, businesses enter into foreign exchange purchase agreements before they need them to be sure of both the price and the quantity of currency reserves they may need for a future transaction. At the same time, they choose to have double reverse cash flows, that is, in a country that purchases raw materials in a foreign currency and spends money, they try to earn money from revenue due to sales in that currency to reduce the exchange gap. Hedging against exchange rate fluctuations is an ongoing process that requires knowledge of both the markets and monitoring of developments, which Greek borrowers in Swiss francs were never able to do. In the decision to take out a loan, it is crucial that there are logical considerations and not opportunistic ones (e.g. due to more favorable interest rates), which advocate more rational decisions.

Protection of Swiss Franc borrowers

The problem of loans in Swiss francs is not only Greek. At the same time, citizens from Poland, Croatia, Hungary, Austria, Romania, and Slovenia took out such loans with the same reasoning of the reduced interest rate. In the strict sense of a free economy, these Swiss franc borrowers should not be helped. This is their personal choice and the contract they signed and accepted with their bank, taking into account all the parameters. However, mass defaults can affect banks' profitability and financial picture, as there is a risk of many non-performing loans appearing at a time when all banks are trying very hard to manage them. Of course, this will not strongly affect the entire economy and is not a systemic problem for any of the aforementioned countries, as these borrowers do not make up a large part of the population. In addition, most of these loans have been largely repaid and are still a few years away from being fully repaid. A restructuring of installments and debt extension or refinancing might solve the problem for some, without the need for direct government involvement. However, what would create a systemic problem and distort the market is the mass cancellations of loan contracts and defaults and the possibility of thousands of auctions that will hit the real estate market if the banks decide to seize the property that has been put up as collateral.

One of the ways that borrowers could seek relief is through legal recourse, claiming that they were not informed of the risks and that taking out these loans required some certification from the bankers who issued them. That is, to rely on some technicalities throughout the process and exploit these details, for their various claims. The Court of Justice of the European Union has established the insufficient information of the borrowers by the banks, keeping quiet or often downplaying the exchange risk, but I consider such cases quite time-consuming and expensive with uncertain results, while the installments are running and the loan is at risk of becoming unserved. One of the priorities of the ECB's supervisory work is to prevent and tackle non-performing loans within the European banking system. A loan becomes non-performing when there are indications that the borrower is unlikely to repay the loan or has to pay the agreed installments for more than 90 days. That is why there is an interest in dealing with or even limiting this banking problem in Europe.

There are positive examples of different approaches from across Europe. The protection of consumers from these loans was left to the competence of each member state of the European Union. The first country to provide credit relief in Swiss francs was Hungary, which it did just two months before the Swiss National Bank freed up the Swiss franc exchange rate. It was then possible to convert all Swiss franc loans into the local Hungarian forint currency, at the exchange rate of 7/11/2014, regardless of the exchange rate at the time of borrowing, and continue repayment in local currency. Romania followed the same path in 2016 by converting the rest of the Swiss loans into leu. Croatia diversified a bit by giving the option of converting Swiss franc loans into either euros or kuna in September 2015. It is something that would be interesting to see happen in the country not only en masse but also individually for each borrower. I urge those who have a problem to discuss this alternative with their bank themselves and to renegotiate the terms of the loan, resulting in a win-win situation that favors both contracting parties. It is something more direct and faster compared to the legal way, especially if the borrower can propose some consideration to the bank with different repayment terms, improving the sustainability of the installments, which I think, is the number 1 priority. In Slovenia, a law passed this year forced banks to share the exchange rate risk and additional payment burden with borrowers, contributing to the problem but reducing their profitability. Of course, the banks blocked the implementation of the law as unconstitutional due to the retroactive effect, and the constitutional court is expected to decide on the issue. It would also be interesting to apply for protection so that the fluctuation of the exchange rate is limited to a certain percentage by recalculating installments. In 2008 in Poland, actions had been initiated to provide some additional options to borrowers, to smooth out the problem, but the banks charged very high processing fees for the modification and the application, which made the conversion and improvement of the loan unprofitable for consumers who chose this possibility, giving up the effort! Of course, I would expect nothing less... Obviously, these kinds of proposals will also be met with resistance as interests are affected and the banks lose scheduled revenue from these options...They are sure to be resisted in any way as they are the ones losing money. The only countries left without borrower protection from these loans are Poland and Greece.

Forecasts for the future

Given the international conditions, the energy crisis, and more so the inflation, the future for these borrowers is predicted to be bleak. All the central banks have been raising interest rates one after the other to make it more expensive to borrow money and to restrict the money supply in an attempt to tame inflation. The Swiss National Bank does the same, as do all the others. But rising interest rates usually also increase the exchange rates. Therefore, it is certain that Greeks will see even bigger increases in their monthly installments as the Swiss Franc continues to appreciate. Furthermore, I am not sure that any improvements to the terms of these loans or any possible conversion or protection will have a substantial benefit and impact on the protection of Swiss franc borrowers. You see all the above countries took action from 2014 to 2016 and only Slovenia did it in 2022 with a different action finally the constitutionality is affected due to retroactive effect. Under no circumstances could any decision or restructuring of Swiss franc loans be retroactive but should be limited to future payments only. It appears that the most realistic approach is to convert the remaining balance of the loan into Euros, as this tactic has been successful in 3 countries, but this is now unprofitable at today's rates and would require post-conversion and tranche restructuring to maintain sustainability, which can be achieved by extending the debt but also burdening it with interest. Moreover, there are still a few years left before the loan is fully repaid, which is now discouraging those involved from finding a solution because time has passed and it would not really help. The solution should have come much earlier as now it will not significantly help the borrowers, it will just give them a small relief. The Greek borrowers in Swiss francs are organized with an association and many legal efforts in the last years of inclusion in a protection regime. They even collect signatures to promote their proposals, but I personally have never considered such activities effective because of the long implementation time they require and the high cost. Nevertheless, I wish you the best of luck!

In conclusion, I would like to emphasize that a loan contract should be studied thoroughly, like any other contract, with great attention to all the clauses but also to the risks involved, without frivolities. Points that initially seem favorable, with a sudden change in conditions can be very strongly affected, giving rise to other problems. The advice of a financial advisor is necessary before the decision to take out a loan, who will thoroughly study all the alternative scenarios that may take place with their probabilities of occurrence, as well as the sustainability of the entire payment program in detail, as I did above with the tables. Access to finance and raising funds using debt through loans is very important for any economy to achieve growth, however, it carries risks. This does not mean that loans and banks should be demonized and avoided, perceptions that are quite common in Greece, because this limits development and the creation of new opportunities. What needs to be done is the right professional approach to financing, with a high level of analysis. Borrowers should be informed and guided by independent advisers whom they should hire and pay to protect themselves from unexpected developments but also to understand all the financial products on offer if they suit their needs. Cases like that of currency risk could easily be noticed by a professional financial advisor. I have seen people consult their accountant or their lawyer for the smallest things but at the bank, they are satisfied with the suggestions of the banker they are dealing with, who cannot in any way be independent as he is promoting his bank's products. Finding great independent partners is the foundation of success and financial peace of mind.