Resolution of Croatian Loan Conversion Fiasco Important for Eurozone Recovery

Resolution of Croatian Loan Conversion Fiasco Important for Eurozone Recovery

Croatia is in talks with some of its largest banks – most of whom are subsidiaries of parent companies based elsewhere in the European Union – to try and find a settlement over the ongoing controversy surrounding the 2015 conversion of Swiss franc-denominated loans. Five years ago, the Croatian government, desperate to curry favour before elections, forced banks to convert loans that had been originally taken out in Swiss francs into euros, incurring significant losses for the lenders in the process.

It would be an encouraging sign if Croatia shows it is ready to make reparations for the shortfalls that banks were forced to swallow – not just for the country’s financial sector, but also for the wider stability of Europe’s financial system writ large. Despite promising indicators that a viable coronavirus vaccine is now on the horizon, fresh lockdown measures have sent business activity plunging across Europe. That commercial stagnation, coupled with news that European banks are facing a potential wave of bad loans and predictions that profits in the financial sector could continue to suffer until 2022, indicates that governments must extend whatever help the bloc’s financial institutions require in order to allow them to continue to support the EU’s recovery from the crisis engendered by Covid-19.

Croatian loan resolution in sight?

The furore over the Croatian loan saga stretches back to 2015, when the outgoing government headed by Prime Minister Zoran Milanović made the controversial decision to force through the conversion of all Swiss franc-denominated bank loans into euros. Approximately 60,000 Croats held such loans, attracted by the low interest rates that Swiss banks offered during the mid-2000s, with their borrowing equating to 9% of the banks’ overall loan portfolios and a total of €3 billion in capital. However, when Switzerland lifted the cap on its exchange rate against the Euro and the franc flourished, the loans became far more expensive for ordinary Croatians to pay off.

Milanović, seeing a chance to garner support from the public, ordered banks to not only convert the loans into euros, but to apply the conversion retroactively, thus leaving them hundreds of millions of euros out of pocket. The European Commission bristled at the legislation, asking the new government to reconsider repealing the decisions made by its predecessor, which earned only a lukewarm response from Finance Minister Zdravko Marić and no concrete action. The banks, frustrated by the injustice of their treatment and the inertia of the subsequent government to address the situation, took matters into their own hands.

A number of international banks operating in Croatia have filed lawsuits worth a cumulative €418.6 million through the International Centre for Settlement of Investment Disputes (ICSID), and Hungary’s OTP Bank recently added to the barrage of legal action against the loans conversion, filing its own €29.6 million claim in October. After an interminable deadlock, it feels like the Croatian government may finally be close to a resolution with the banks, as sources close to the deal indicate it may involve Croatia lowering the obligatory rate of contributions that lenders must pay to the secured-deposit fund (which is currently over three times the EU minimum).

Tough time ahead for European financial sector

Such a breakthrough would represent a huge step forward for the Croatian financial sector and go some way towards restoring investor confidence in the country – something which was particularly shaken by the decision to implement the conversion retroactively. On a deeper level, however, a resolution to the dispute—particularly given how the major players in Croatia’s banking sector come from all over the EU— would be conducive towards shoring up a European economy that is on the ropes. While it’s hoped that an efficacious vaccine can be rolled out across the continent in the medium term, short-term lockdown restrictions have hamstrung business balance sheets once more.

The service sector, which accounts for two-thirds of total economic output in the EU, has been particularly badly affected as governments impose regulations that limit physical contact, as is evidenced by the Purchasing Managers Index (PMI). Compiled by data analytics firm IHS Markit, the PMI is regarded as a barometer of activity in services and manufacturing. It makes for gloomy reading for anyone employed in either sector, with the index falling from 50.0 in October to 45.1 in November – its lowest level since May. The PMI also recorded the ninth consecutive month in which unemployment figures in the bloc continued to climb.

Thankfully, the fiscal fallout from the most recent crunch is not expected to be as pronounced as earlier in the year. While economists are predicting a 2.3% contraction in the eurozone economy in Q4 of 2020, that’s far less catastrophic than the 11.8% slump it endured in Q2. However, the European Central Bank (ECB) has stated it believes there will be no easy road to recovery, with banks not expected to return to the same levels of profitability they enjoyed pre-pandemic until 2022. In fact, that date could be postponed even longer if their direst predictions about a potential €1.4 trillion in bad loans come to pass. If even a fraction of that value is defaulted, there is the very real possibility that banks will not have the capital necessary to lend as they and their customers require.

Weight of obligation falls on governmental shoulders

Taking all of that into account, it’s clear that governments across Europe must step up and provide the support required to give banks the breathing room they need to fulfil their vital role in society. The news regarding the emergence of possible Covid-19 vaccines is, of course, promising, but there still remain major question marks over how quickly it can be distributed among the general populace and who will receive it first.

In the meantime, financial institutions are instrumental in ensuring those who are still at a disadvantage due to the pandemic are not left behind. Governments have already shown themselves capable of bailing out a flagging financial sector in the aftermath of the 2007 crisis – which was, of course, one of its own making. Now that banks across the bloc are facing an existential threat over which they have no control, the authorities must ensure that they receive the same level of support at a time when institutions, individuals and economies need it most.

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