Sick of politics

One down, four to go. Counting down days until the end of his term and wishing him good health.

One of keystone vows of Mr Duda as a candidate was to convert toxic foreign currency mortgage loans to PLN at the rate at which they had been taken out. As the problem is quite intricate, it has been tackled by a dedicated task force several times. The first proposal of loan conversion into PLN at “fair rate” was unveiled in January 2016, another “draft” of set of measures to ease CHF-mortgage-ridden debtors was laid out in June 2016. Last week the president’s experts finally presented the draft law whose core element is the obligation for banks to refund the borrowers overcharged spreads…

YES WE CAN’T, one would love to paraphrase Barack Obama’s campaign slogan. After several promises to bail out borrowers (majority of whom are either well-off and their only problem is that their properties cannot be sold, or are suckers who wanted to outwit their fellows indebted in the domestic currency) the final scheme has been grossly whittled down in comparison to what had been pledged. Yet, as Mr Dera sincerely confessed, perception of a candidate differs from perception of an incumbent president.

Thanks to the new scheme hapless debtors will see principals of their loans decline by the amount of spreads overcharged at disbursement and at each instalment payment until August 2011, when anti-spread law came into force. Essentially, if you look at this detail, president Duda’s task force’s proposal is just the extension to the banking law amendment enacted by PO-PSL government (and initiated by former president Komorowski in the wake of soaring CHF in mid-2011) since it applies to payments between banks and borrowers made between January 2000 and August 2011.

So far no one has mentioned the risk of new law’s illegality. It needs to be noted though banks had charged FX-debtors excessive spreads, or simply had ripped them off, they had done it within the letter of law (there had been no limits on spreads) which in principle is not retroactive. Yet with constitutional tribunal brought to the heel, this should no longer be a concern.

Even if the total cost for banks in Poland reaches PLN 10 billion, the burden will be bearable and will not shake stability of the financial system. “Ensnared” borrowers are let down by Mr Duda’s scheme, while the refund of overpaid spreads will in fact constitute a transfer of wealth from banks’ stakeholders (not only shareholders but also clients) to a relatively wealthy group of PO and Nowoczesna’s electorate who will have their mortgage loans prepaid (or if they have paid off their debt, they will receive cash).

The 72^nd anniversary of Warsaw Uprising outbreak was marked by a dispute to who the homage should be paid at W-hour. A handful of insurgent were called to minister Macierewicz’s office and forced to agree to a compromise that the full list of 96 fatalities of Smolensk air crash would not be read out, instead names of five persons involved in nurturing the remembrance of the Uprising would be read out.

The presence of Smolensk tribute during each and every event assisted by the army not only contributes to denigrating remembrance of 96 Tu-154 passengers who died in the tragic transport accident, but also is the top point on the agenda of rewriting the history.

Besides, the PiS-inspired industry of hatred is running at full steam. The two victims are 99-year-old general Scibor-Rylski accused of collaboration with communist secret services in post-war years and Zbigniew Galperyn. Beyond all doubt general Scibor-Rylski did co-operate in these bleak times, however by all accounts the collaboration was tactical and did not harm anyone. The campaign against Mr Galperyn kicked off just recently, after he criticised combining commemorations of Warsaw Uprising and Smolensk air crash and is backed by no evidence, a similar article could be written about anyone doing anything.

Actually it does not matter whether they collaborated with communist regime before 1989. Many today’s zealous supporters (Jerzy Zelnik) and politicians (Stanisław Piotrowicz) of PiS did it and their past does not disqualify them out of public discourse. What only matters is one’s attitude towards PiS today. The moment you firmly oppose against what knights of dobra zmiana pursue is the moment before the mud-slinging machine is set in motion.

Seven years after this pledge, my approach to the Warsaw Uprising has not changed. I still pay homage to inhabitants of Warsaw who valiantly fought against the Nazi occupier and to civilians who either lost their lives in the Uprising or endured probably the biggest humanitarian catastrophe in the history of Poland. I am sick when I see people who show off how they pay tribute to the insurgents, use the W-hour anniversary as an opportunity for lansik or when public figures attempt to capitalise on the anniversary. Commemorate, but not celebrate. Stop for a minute, in silence, with your head down and be thankful you live a in free, peaceful country.

Meanwhile, first serious cracks can be seen among affiliates of the ruling party who have relished on power. Backdrop of the decision to oust Mr Kurski from the public TV broadcaster’s CEO seat and then to defer his departure by nearly three months laid bare clashes between coteries. Unlike some of you may think, supporters of PiS are not a uniform group. Gazeta Polska entourage is not fond of wSieci / wPolityce and the other way round. The two entourages have also little in common with priest Rydzyk’s empire, not as influential as in 2005-2007. Just read Toyah’s blog to learn more. He often gripes about Rafał Ziemkiewicz, Tomasz Terlikowski and moans how other accolades of PiS hinder the good cause.

Quarrels between coteries do not herald break-up of the wide front of PiS supporters, yet the more perceptible they are, the more they remind Poles PiS politicians are no different than their predecessors, they go back on promises and become corrupt by power

Swiss Francs, no easy way out

One of pre-election campaign promises made by president Duda and the bevy of politicians he hails from was a bail-out for FX mortgage borrowers ensnared into toxic loan agreements and trapped in their unsellable properties for years to come.

In January 2016, exactly a year after the Swiss currency had been freed to float, Mr Duda’s office laid out a proposal of converting CHF mortgages into PLN at a “fair rate”, different for each debtor and reflecting benefits received by debtors on account of favourable CHF/PLN rates before September 2008 and lower interest rates in CHF (for broader explanation in plain language click here and scroll down to the third paragraph from the bottom). The proposal has been assessed as hazardous for the Polish banking system and… shelved. Five month on, the sketch of the solution has not developed into a draft law ready for legislative process… Which is reassuring, since if Mr Duda’s experts are mindful of dire consequences of banks going under or loss of trust among foreign investors, they have held back from pursuing it and set out to reshape the proposal…

On Tuesday the “CHF task force” held a fifty-one minutes long conference, during which they attempted to outline the major conclusions of their work on the bail-out scheme until now. I will be nasty, but I will exercise my right to speak it out… This was one of the most ludicrous conferences I have ever seen in life. I have got accustomed to listening to politicians who speak a lot and say nothing. This time self-styled economic experts have told a story of guys who met up several times to sip coffee, munch biscuits and waffle on quandaries of benighted individuals who wanted to chase their dreams too much…

OK, the malice cap has been reached, time to move on to what audience have been spared, namely details…

The participation in the bail-out will be voluntary, what in practice means some better-off borrowers might not decide to get rid of their Swiss Franc burden, in practice they will continue to bet on depreciation of CHF in years to come. I personally know people who accumulate savings and hope one day they pay off their whole mortgage with one shot at favourable CHF/PLN rate.

The bail-out package consists of several measures distressed debtors could choose between, however I still cannot make out whether they are mutually exclusive or not.

One interesting measure which could theoretically be implemented with another one is the obligations to lenders (banks) to refund the borrowers the overpaid currency spreads. I came, I saw, I did not understand at all. This concept leaves more questions than answers. Firstly, what would constitute an overpaid spread? Banks naturally earn on difference between rate at which they buy and sell foreign currencies, whereas the problem with the CHF mortgages was that spreads were far higher than reasonable (bid-ask spread often above 6%)… So would lawmakers define a reasonable spread banks had been entitled to charge, or would they set National Bank of Poland rate as benchmark? Secondly, would banks give this money to borrowers’ hands or would they obligatorily prepay mortgage loans? Thirdly, would the refund include penalty interest accrued for period between it had been unduly charged and the day of refund? Fourthly, would the measure cover also instalments paid after August 2011 (enacted swiftly the PO-PSL government in reaction to soaring Swiss Franc) when the anti-spread law (amendments to the banking law) came into force?

Fifthly, facing the truth, the banks were not prohibited by the law to rip off borrowers, so would reversing it be interpreted as violation of the precept that law is not retroactive?

The concept of the “fair rate” has been revisited in the presentation. The expert spoke of four variants of the fair rate, however decided to share only two of them with the audience. One draws on the algorithm presented in January 2016, the other would additionally take into account current well-being of a borrower, with debt-to-income ratio (percentage of after-tax income spent on instalments) a key criterion. The very concept of what is “fair” and for who gives ample room for disputes and will most likely by one of moot points if works on the bail-out scheme move on.

Another measure, whose legal feasibility is questionable, is the option for a borrower to extinguish their mortgage debt by renouncing ownership of the mortgaged property. In Poland mortgage debt has recourse nature, i.e. a debtor is liable for it with all their present and future assets. Such scheme again casts doubts whether law does not work retroactively (a bank when it was granting mortgages, relied in creditworthiness assessment on claim on debtors’ assets and income). Incidentally, introduction of pure non-recourse mortgage lending under which a lender could recover from collateral only, could civilise Polish mortgage lending, but at the expense of higher cost of such debt, being the compensation for lenders for relinquishing the recourse to debtors.

The professors mentioned in passing 30 billion PLN as the total cost of their proposal (which one exactly?). No one still knows how their arrived at that figure, but to be honest, to my best knowledge none of the figures presented by any participant of the CHF debate has been backed by substantive calculations or estimations holding water.

The experts (I pull a grumpy cat’s face when I write this word, as Poland’s current ruling elites lack backing of competent experts) also claimed the effects of the bail-out would be spread over around 30 years, yet failed to explain how such spreading over time be brought into line with International Financial Reporting Standards which proscribe to recognise a loss in full amount in the period an entity learns it is going to incur the loss. One of the task force members murmured something about SPVs and securitisation as tools for spreading the cost over time. A word of explanation here… SPVs are used by banks to remove loans from their balance sheets. Some assets (pools of CHF mortgage loans) are swapped for other assets – cash. Hence a bank has its problem solved immediately, provided it sells portfolios of loans to SPVs at face value. If it sells dicey loans at discount, it recognise a loss (or pre-sale write-down) immediately. At this stage the story is not over. An SPV which buys dicey loans from banks must pay cash for it. Cash is an asset which must be funded with equity or liabilities. Who would then provide equity or liabilities? Whoever it would be, they would be exposed to sizeable haircut in their investment, as SPVs would absorb the losses on loan conversions into PLN…

The Tuesday’s proposal has been slated by nearly everyone. Economists criticised it for lack of details (during the conference the task force experts were struggling to answer most questions asked by the audience). Disgruntled debtors, who put faith in Mr Duda’s promises, also do not perceive the unveiled concept of the bail-out package as a step forward.

I suppose PiSites and Mr Duda know well only time may solve the problem of CHF loans and therefore they play on time. Month by month outstanding debt declines as borrowers make repayments and so the scale of the problem diminishes. They fully realise if they run out of money, voters will knock them out of power (if voting regulations are not tampered with), so their spending spree fortunately has halted after 500 PLN child allowance programme kicked off. I bet works on the draft law will drag on for months and by the end of this year the legal framework will not be passed.

Meanwhile on the markets

The recent weeks brought some noteworthy developments on financial markets, some particularly worth highlighting and commenting on. Observations of how markets behave leads me to conclude my academic grasp of economic theorems is being rendered obsolete, while new paradigms unfold…

1. Interest rates

In early March Poland’s monetary authorities decreased the policy rate by 50 basis points, to (yet another) record-low 1.50%. In terms of historical levels of central bank’s rates, the current level appears hazardously low, however put into broader perspective, Poland’s monetary policy does not come out as extremely easy. Absolute level of interest rates is among the highest in the EU and oddly enough, real interest rates have not been that high since many years. Current real rate is around 3% (1.50% policy rate + 1.60% y/y deflation), while in the past years inflation-adjusted interest rates would not seldom run into negative territory. Do notice this reasoning bears some simplification, since inflation records are backward-looking while interest rates as of today refer to future periods and time mismatch exists.

The Polish central bank’s governor has also stressed there was no room for further monetary easing and over the coming months monetary authorities would take the “wait and see” approach. The only justification for such scale of monetary loosening is the ongoing deflation, which however is spurred by factors beyond central bank’s control. By slashing interest rates to record-low levels the central bank only adjusted its policy to evolution of price level in the economy (the question remains whether NBP would be capable of swiftly reacting to increasing inflation). Lower interest rates will not kick-start the economy, as it is expanding in a healthy and sustainable pace, consumption will also not be much stimulated, since propensities to spend, save and borrow are driven by several other more meaningful factors than monetary policy. Consequently, the most aggrieved by the recent rate cut are depositors whose savings do not grow as fast as they would like to be.

The other group hit are banks. They “suffer” (i.e. fall short of their shareholders’ expectations towards profits reaped in Poland) because rate decrease is followed by drop in cap on interest rates they are allowed to charge borrowers which is 4 times central bank’s lending rate, now 4 times 2.50%, i.e. 10%. Evidently banks find several ways of circumventing the regulation. Quite recently I learnt an up-front fee for a cash loan is on average 10% these days. In practice it means if you want to borrow let’s say 10,000 PLN you either effectively have to borrow 11,000 (and pay interest on it) or effectively get only 9,000 (but pay interest on 10,000). Banks will pass the unfavourable impact of monetary policy to their clients, as they will do with an increased deposit insurance fund contribution. The fund, intact between 2001 and 2014, has been recently depleted by 3 billion PLN to fund payments to depositors who had entrusted their money to insolvent credit unions (since October 2012 covered by deposit insurance system and the same rules of financial supervision as banks). The fraudulent activity of credit unions has been harnessed for full-blown mud-slinging in the current presidential campaign, yet this is a topic for another post…

Worth also mentioning the financial watchdog issued a warning to banks against evaluating mortgage loan applicants creditworthiness based on current interest rates and show clients stress simulations, i.e. how their instalments would rise if interest rates increased by a specific number of basis points. A commendable move, given currently granted mortgage loans could turn out to be a time bomb akin to CHF-denominated mortgages foisted upon client when the Swiss France cost not much above 2 PLN. Seven years ago Polish central bank’s policy rate was 6%. Unless a new paradigm emerges (i.e. interest rates higher than zero being an abnormal phenomenon), return of interest rates to such level within 25 or 30 years when mortgage loan is to be repaid, is definitely conceivable.

2. Stock market

Since taking up the job with the New Factory I am subject to stringent restrictions on trading, hence in order to avoid requesting approval for each single transaction, reporting transactions ex-post after each trade, reporting not executed trades and submitting breakdowns of orders and transactions at the end of each reporting period, I terminated my brokerage account and spare myself adrenaline by putting all my money into saving accounts and term deposits.

WIG, the broad market index covering almost the entire universe of stocks listed on Warsaw Stock Exchange, performed quite well in the first quarter of this year. It must be noted this index is a total return index, i.e. takes into account dividend income, in contrast to for instance WIG20, covering 20 biggest in terms of market capitalisation companies on WSE.

For this index I deliberately have chosen 10Y time interval for comparison, to illustrate for over two years the index has been in a clearly sideways trend. WIG20 is a price index, hence its readouts fail to reflect dividend income distributed to shareholders, which may make up a large portion of income, since many of index’s components are state-controlled cash cows whose dividends are a vital source of money to the government budget. Yet the chart clearly indicates those who invested in the index portfolio four years ago might not have broken even, even despite reaping several generous dividends.

Conclusions: the discrepancy between broad-market WIG index and blue-chip WIG20 index reflects not only differences in calculation formula but also the fact smaller companies outperform larger. WIG is hence a better business cycle gauge, yet not only because of its width. WIG20 composition is quite specific and not well-diversified. Banks have a large weight in the index, besides mining, oil and gas and electricity are strongly represented in the WIG20, making the index undesirably reliant on sentiments in a few industries and to regulatory and market environment having substantial impact on earnings of companies underlying the index.

3. Currency market

USD/PLN, here the pair purposely presented over 10Y horizon, has recently hit its 10-year high of 3.95 (some 0.05 higher than in memorable February 2009). The psychological barrier of 4.00 has not been even neared. Unlike six years ago, it was not the weakness of Polish zloty, but the strength of the US currency that drove USD/PLN quotations to exorbitantly high levels.

Polish currency recently has been amazingly stable as never before in its history which is well illustrated by EUR/PLN quotations. For more than two years, EUR/PLN has not broken out of quite narrow range from 4.00 to 4.30, while most of the time it stayed between 4.10 and 4.20. Such volatility is characteristic for mature markets. What also needs to be underlined, level on which the exchange rate has stabilised is neutral for the Polish economy, i.e. it well strikes balance between ensuring competitiveness of Polish exports and fending off prohibitive prices of imported goods. The issue of EUR adoption in Poland is also intensively exploited in the presidential campaign.

The divergence between skyrocketing USD/PLN and fairly stable EUR/PLN must lie on cross pair, EUR/USD. Quotes of the most liquid currency pair in the world dropped for a moment below 1.05 in the second week of March, thus also hitting 10Y low and then bounced back, yet remain below 1.10. The quaint FX rate movement reflects relative strength of the US economy and imminent monetary tightening (although Fed’s declaration interest rates will not be jacked up very soon brought appreciation of USD to a halt) as well as doldrums in which the EU economy is, compounded by increased scale of quantitative easing pursued by the ECB.

And for the very end, CHF/PLN quotations for which in my view the most relevant period for observation is three months. After shooting up on 15 January 2015, the Swiss currency slowly depreciated and CHF/PLN levelled off around 3.90, some 8% higher than before the SNB spun its currency out of control. For the indebted in CHF, impact of rising CHF/PLN has been well offset by negative LIBOR (currently near –0.85%) Polish banking sector’s concerted spread decrease (banks have not done it off their own bat, but have been coerced by financial sector watchdog). Mortgage debts of many households are now some 8% higher than in late 2014, yet their monthly debt service cash flow has not been hit.

4. Commodities

For sake of brevity I will focus only on crude oil prices that were searching for trough in second and third decade of January 2015. The subsequent rebound was a typical reaction of speculators to clearly oversold market. The scale of incline in the first half of February 2015 was impressive, since Brent oil price went up by some 30% within two weeks. In March oil quotations were very volatile, best proven by price fluctuations over the last two trading days. On 26 March oil went up by 5% in the wake of news of military action in Yemen to retreat by 5% on 27 March and wipe out almost the whole price increase from the previous day.

The question which naturally comes up these days is where the markets are heading. The only answer that naturally comes up to my mind is “I have no idea”. The most intensive period of my study of economics fell into 2008-2010, the run-up to the financial crisis, its most severe phase and early recovery. Near-zero interest rates at that time were considered a temporary measure employed to buoy up economies. Today, after six and a half years of ultra-loose monetary policies and no prospect of returning to long-term average levels of interest rates in developed economies one should ask what the current level of neutral interest rate in Taylor rule equation is.

I cannot even tell you in which phase of the traditionally defined business cycle we are. In Poland in 2000s we could witness recovery, early upswing, late upswing and downturn, in second half of 2009 we saw recovery, late upswing was in 2011, then the Polish economy slowed to record sluggish growth in 1Q2013. Are we now in early upswing or in late upswing? Needless to say, with hindsight it is easier to judge. But if we bear in mind stock market is said to be good indicator of future trends in the economy and it has been flat or mildly rising in the past months, economic growth should slightly accelerate. Economists’ forecasts in unison foresee a period of flat, but stable growth of 3% - 4% until 2017. Overly optimistic? Economists’ dreams of smoothed out business cycle fluctuations coming true? Time will only tell. One thing I am pretty sure of is that there might be many external shocks which may shatter all plausible projections. Keep the faith though.

Swiss Franc going bonkers

Disclaimers:

1. I am employed by one of financial institutions involved in mortgage lending denominated in CHF, my financial well-being might be negatively affected by aftermaths of sudden appreciation of CHF.

2. I do not possess any substantial (in equivalent of more than 1,000 PLN) liabilities nor assets in or denominated to any foreign currency.

With hindsight it sinks in to me the decision of Swiss monetary authorities from 15 January 2015 deserve some more attention. The Swiss National Bank, apart from discontinuing its policy of warding off appreciation of the country’s currency, decided also to slash interest rates by 50 basis points, pushing policy rate further down into negative territory…

This move calls into questions one of economic paradigms I would take for granted during five years of studies and four years of banking career. Until recently in the economic theory the “floor” for interest rates was zero. Whenever the range of a central bank’s instruments in monetary loosening was described, one mentioned decreasing interest rates to zero and if this turned out to be insufficient, enlarging monetary base. Whenever I asked chaps from market risk department to estimate maximum negative valuation of an interest rate swap, it went without saying the scenario to analyse was an overnight drop in interest rate in a given currency to zero. Time and central bankers proved us wrong…

Interest rate is cost of money. Because as a matter of principle money cannot be bought or sold, the price is paid for temporary transfer of money, i.e. for borrowing or lending it. Theoretically, the cost of money can be negative, but in practice it seemed irrational. Recent goings-on have disproved economic theory. Thus we witness theory of economics is still in the making.

Negative interest rates have serious implications for stability of financial system. We already see the first apparently eerie effects of SNB’s move. Yields of Swiss governments bonds have entered negative territory, not only on secondary market, but also on debt auctions. In practice if yield on a10-year bond is –0.09%, you pay now 100.91 units of a currency to be paid back 100.00 units in ten years. At first glance it such investment makes little sense and the negative yield can be interpreted as safekeeping fee. Nonetheless, investors snap up on such bonds. Why? “The Economist” has beaten it to me in providing a comprehensive answer.

Government bond market naturally crops up as the first illustration of how central bank’s policy impinges on financial system. Let’s examine the outcomes for other economic actors.

Interest rates at which commercial banks lend or borrow money are strongly tied to rates set by a central bank shaping monetary policy of a currency in which those banks lend and borrow. On the lending side the situation is at first sight straight-forward. Components of cost of credit are a variable rate taken from inter-bank market (LIBOR) which is the cost of funding for a bank and the bank’s margin over LIBOR, standing for reward for credit risk borne by the bank. Whenever positive margin is higher than negative LIBOR, the cost of credit remains positive. If the margin, however, was low enough not to fully cover negative LIBOR, we would be faced with a situation when a borrower would have to repay less than they had borrowed. Consider a 1Y 10,000,000 CHF overdraft with cost of 1M LIBOR + 100 bps a Swiss company takes out. The principal is to be repaid at maturity, interest to be paid monthly. But if 1M LIBOR is –1.12%, then what? My first answer would be that no interest payments would occur, but how to handle loan principal? Should the net cost of –0.12% per annum be amortised over time and decrease outstanding loan by 1,000 CHF? If so, what if within a year 1M LIBOR rises above –1.00%? Loan administration staff and finance staff at some banks should begin to scratch their heads now!

From the borrowers’ (no matter if talk of individuals or enterprises) perspective the loan with negative cost is a veritable bargain. Probably the SNB intended to spur borrowing, thus increase monetary base and trigger inflation that would result in currency depreciation. The side effect of this action is that the break-even point for borrowers has been set too low, i.e. some entities that would not be eligible for a loan if LIBOR ran at 1% are now creditworthy. This pool of borrowers will likely default on their debts when interest rates increase, threatening economic growth in the future.

From the depositors’ perspective negative interest rates make horrible news. If commercial banks are to get funding on market conditions, they should pay depositors LIBOR. Businesses have no choice and will need to accept the negative rate. No one would imagine companies switching from bank transfer to handling payments in cash. Individuals, however, might choose to withdraw money from banks and decide to keep their savings in cash in a piggy bank / in a drawer / under the carpet. Of course if you keep cash at home, you are exposed to risk of physical damage or theft, but I presume some depositors would be willing to take those risks. A sudden outflow of cash from the banking system could pose a threat to banks’ liquidity. The effects could be comparable to a regular bank run.

In Poland, the Banks’ association and the Ministry of finance have worked out and agreed on measures to ease the pain of over half a million CHF mortgage borrowers. The proposals are modest and require banks to make some concessions that will somewhat decrease their profits, but in return should fend off provisions for past due debts. The measures will include:

1. lower or no FX spread on instalments – directly hits banks’ earnings, however gives a relief of up to 4% to borrowers,

2. using negative LIBOR as a base rate, however the total sum of base rate and margin might not fall below zero – at best a borrower would not pay any interest on the loan,

3. banks will refrain from calling for additional collateral – it has to be underlined in extreme cases LTV ratio, measure relation of outstanding debt to property market value, might be reaching even 200% (e.g. a borrower owns a flat which could be sold for 500,000 PLN but their debt in PLN is 1,000,000 PLN), the concession is a violation of one of Financial Supervision’s recommendations on mortgage lending, but given the current market situation, it is the best possible solution,

4. extension of lending periods, which would result in lower monthly instalments – given record-low credit cost in CHF and prospects of CHF/PLN returning to levels seen before 15 January 2015, it is a reasonable to wait out the period of ultra-strong CHF.

The compromise is very wise, since both banks and borrowers will share responsibility for the event which has taken both sides aback. That being said, one must not forget during the lending spree which reached in climax between 2006 and 2008 banks aggressively foisted upon their customers loans denominated in foreign currencies, particularly to those mortgage applicants who could not afford to service mortgage loans in PLN, but in CHF, in which interest rates were lower, were creditworthy.

For those with shorter memory, a short reminder, how in July 2006 the same politicians who today bleat how evil CHF lending was, expressed their disapproval of Financial Watchdog’s efforts to curb mortgage lending in foreign currencies.

The Polish Financial Supervision has also come out with another proposal that seems to hold water. The distressed borrowers could be given the option to convert their loans into PLN at the CHF/PLN rate from the day the loan was taken out, however they would need to return to banks difference between lower interest paid in CHF and PLN. The CHF appreciated rapidly in late 2008 and despite staying around or above 3.00 since then, a monthly instalment of a rate in CHF was lower than a monthly instalment in PLN until the first quarter of 2013. This was due to interest rate differential between CHF and PLN that offset CHF appreciation. This proposal should remind CHF borrowers for many years they benefited from their decision, however the reward was accompanied by FX risk… Impact for banks is very hard to estimate, in depends on so many technical assumption of the operation that any attempts to give a ballpark figure are doomed to fail.

The proposal, apart from questions of legal nature, gives rise to several technical / mathematical questions, e.g.:

1. how the current outstanding debt in PLN would be determined (not only FX rate but also loan amortisation needs to be taken into account),

2. how the difference is interest base and effects of loan amortization and changing time value of money would be accounted for,

3. would the borrowers have to return the difference in interest paid in cash, or would banks be willing to add it to the outstanding debt, if yes, would breach of currently binding Recommendation S in terms of max. LTV ratio be allowed,

and many other, proving this idea makes sense, but is on account a quick fix.

Many accuse banks of reaping profits from CHF appreciation. Had it worked like this, we would see enormous profits of institutions involved in CHF-denominated lending in their 1Q2015 financial reports. But we will not. CHF-denominated loans are banks’ assets, but they are effectively funded by liabilities. Because Polish banks do not take deposits in CHF, rarely issue bonds in CHF and generally do not take out loans in CHF (there are exceptions when funding is secured by parent companies), they have to replace funding in PLN by funding in CHF. This is done with use of FX swaps, derivatives which compose of FX spot and FX forward. For example, in order to replace a 3M deposit in PLN with a 3M deposit in CHF, a Polish bank sells PLN and buys CHF at a current date at spot CHF/PLN rate and agrees to conclude a reserve transaction in 3 months, at pre-agreed CHF/PLN rate which reflects interest rate differential between PLN and CHF. Thus effective cost of funding is LIBOR rather than WIBOR. Such operations are risky, because long-term assets are matched by short-term liabilities which needs to rolled over frequently. The roll-over risk materialised in late 2008 when access to FX swap virtually dried out and intermediation of Polish and Swiss central banks was requisite to match positions on Polish banks’ balance sheets.

Banks’ earnings on loans denominated in foreign currencies are made up of spreads. When such loan was disbursed, a bank earned profit on a spread between market FX rate and bid rate (i.e. if NBP CHF/PLN rate was 2.30 PLN, a bank would convert CHF into PLN at 2.20). Then banks earned on spread between market FX rate and ask rate each time an instalment was repaid. This practice was curbed in 2011 thanks to anti-spread law. I dare to claim as of today portfolios of FX-denominated loans, after costs of hedging and provisions for bad debts, generate negative income for the banks.

My own guess is that the period of negative interest rates and ultra-high CHF will not last long. Negative cost of money will lead to distortions in financial system, while strong CHF will send the Swiss economy into deep recession. Bright future is not ahead though. Just three days ago ECB announced it would launch out into quantitative easing. If without near-zero interest rate and expanding money supply economies of the Euro zone are unable to grow, it means they are still on their knees, almost seven years since the outbreak of full-blown crisis in early autumn of 2008. This time there will be more than seven lean years…