It made the headlines for many years in Poland; it happened in Hungary, Austria, Croatia and even a bit in France, and I had never heard of it: FX mortgage loans.

I was asked by a client to speak about the ethos in banking in Poland in October, and a few people reached out after my speech to ask my opinion on this exotic lending product. I got curious, and I wanted to know more. So, I scheduled a call with a Polish banker involved in the matter.

Being involved in the issue for many years, he explained in a very nuanced way what happened.

The background

Owning a house in Poland was a status symbol, a sign of success in this new capitalist economy. Renting a house was considered a temporary situation for students or at the start of a professional career until, somewhere in the future, a higher salary would allow for a mortgage.

Banks were more than happy to realise people’s dream of buying that house. One option was a regular mortgage in local currency (PLN). An alternative was the FX mortgage.

The construct was a helpful tool to assist more Polish consumers in buying a house. The reason is simple: the interest rate in other territories was lower than the local Polish rates, meaning buying a house happened at more attractive mortgage conditions. On top of that, more people could afford that mortgage because the conditions were more favourable.

In 2008, for example, the annual interest rate in Zlotys was around 8,7%, compared to the one in Swiss francs 4.4%.

Are you frowning like I did when I first heard of it? You see where this story leads us. What could possibly go wrong?

What went wrong?

The FX was predominantly between the Polish Zloty and Swiss Francs. Other sometimes used currencies were the Deutsche Mark, euro, US dollars and even the Japanese Yen—all economies perceived as safe and stable.

The FX mortgage became a big business in 2004, when Poland joined the European Union, with hundreds of thousands Poles taking mortgages in foreign exchange, mainly in Swiss francs.

The country was in full development, and in 2004, the future looked bright. The overall belief back then was that the Polish economy could only go up faster than the old economies like Switzerland. These banks warned consumers about the risk, but the risk was perceived as very low, and chances seemed higher that people would make a profit than that it would lead to a loss.

Politics stimulated the FX mortgage development. Poland had just joined the European Union, and they were one of the fastest-growing European economies. They saw it as a way to improve their economy through real-estate growth, and thanks to these stimuli, more voters could afford a house.

Enter 2008: the fall of Lehman Brothers made people slide nervously on their chairs. Banks were sitting on an enormous pile of FX positions and were trapped in equity gaps where those mortgages were much more expensive than the underlying claim.

Even after selling the house, people couldn’t repay the mortgage in this new economic reality. Close to 700.000 FX mortgage loans were in circulation at the time.

The Polish Financial Supervision Authority (known locally as KNF), the Polish banking sector regulator, stepped in and published recommendations to limit the origination of FX loans to Polish customers, to those who earn their salary in the respective currency. That limited the foreign exchange risk for consumers who signed up for new mortgage loans. Existing mortgage contracts remained at risk.

The crisis remained controlled as long as people kept paying for their mortgages.

Unfortunately, this is not the end of the story.

What happened next?

Enter 15 January 2015: Switzerland announced scrapping its currency peg with euro of 1,20 to the euro. The Swiss franc jumps 20%. Polish Zloty to Swiss franc jumps from 3,5 to 5 Zloty overnight. Since the collapse of Lehman Brothers, the impact was even bigger when Zloty stood at 2,18. Gone is the argument of holding a mortgage in a stable and safe environment. Only FX mortgages in Swiss franc were problematic for this reason. The other currencies didn’t generate such a significant loss.

It was a societal drama for many, leading to a revolt of close to 20% of customers who started claims against their bank. Polish courts decided banks had sufficiently warned customers about the potential FX risk. The main complaint, though, was the need for more transparency in how the FX rates were calculated. Also, in this argument, the court concluded that there was no problem: banks used a market standard by calculating a daily FX rate, which should have been sufficient.

20%, or close to 150.000 customers, filed a complaint. The reason why only some Polish customers filed a court case is the high cost of doing so. A lawyer would quickly cost 4-5.000€, which is not something everyone can afford.

The court decision

So, these bank clients submitted their case to the European Court of Justice (ECJ), which agreed that customer protection wasn’t sufficient.

So, until today, there have been more than 130.000 legal cases in Polish courts. Especially since 2019 and the first major ECJ verdict in the Polish case, up to 99% of litigations are being ruled in favour of borrowers.

As explained, more people suffered from the Swiss event on January 15, 2015, in countries like Hungary, Austria and Croatia. In Hungary, the government overnight transformed all FX loans into Forint loans, for which the banks covered the loss. In Croatia, these loans were converted into euros. In Austria, the Supreme Court ruled against any changes and customers needed to take the loss.

Poland was the only country where the product was so widespread and at such a scale.

The verdict in Poland was “contract invalidation”, as if the mortgage transaction had never happened. In result borrowers are being refunded with all the payments they made to banks and banks should get the initial value of loan principal. Very often the net result leaves the borrower with property and decent amount of cash from the bank.

The impact on Polish banks

It left scars on the Polish banking sector. Bear in mind that for example, MBank had 51,6% of its mortgages in Swiss-denominated loans, Bank Millennium 41,3% and BNP Paribas Polska 36,9%

Banks like Getin Bank were being restructured in 2022 by a joint venture of a fund set up by the eight biggest banks and the Bank Guarantee Fund (the institution responsible for protecting deposits of private individuals). Capital ratios were below statutory and regulatory thresholds for too long, and they carried a huge portfolio of FX mortgages, which played against them. The bank was being split into a good and a bad bank, where the bad bank purely existed to handle the FX files.

Other banks, like Raiffeisen Poland, Deutsche Bank Poland, and BPH Bank, were put up for sale, but no one risked taking them over as whole because of their FX mortgage portfolio. They were also being split up into a good and a bad bank, with the healthy part being sold to other institutions.

The bad banks required a capital increase to survive and had one purpose: service the portfolio of PLN and FX mortgage loans, handle court cases and try to settle with customers as much as possible before they take the bank to court. In the best case, that leads to a remaining capital that can be paid back to the shareholders. That mission should take another ten or more years, until the termination date of the longest remaining mortgage deals.

On June 15, 2023, The European Union’s top court ruled that "EU law does not preclude, in the event of the annulment of a mortgage loan agreement vitiated by unfair terms, the consumers from seeking compensation from the bank going beyond reimbursement of the monthly instalments paid," the court said in a statement. "By contrast, it precludes the bank from relying on similar claims against consumers."

The ruling means that Polish banks are facing a $25 billion hit on the ongoing Swiss franc mortgage case, equal to 50% of own funds held by local commercial banks. Despite the ruling, the financial regulator stressed that Polish lenders were safe.

Even if the ruling does not end up being a systemic risk on the Polish banking market, it does put additional pressure on the trust people have in this financial institution.

In conclusion

This case is so interesting because these Polish banks didn’t act in bad faith. They were convinced that the Polish Zloty would grow stronger. They saw that the Swiss franc was pegged to the euro and all that happened in stable financial times.

They arrived in a perfect storm. But OK, they should have been more cautious. My friend acknowledged that management boards back then were blinded by the short-term gains of FX mortgages without much considering bad experiences in the past, like in Italy. However, overall, in 2004, the FX mortgages made banks realise more people’s dreams.

They mismanaged their risks, and as everything collapsed, they tried to keep consumers liable for the risks they signed up for and suddenly lost the trust of people, politicians and society.

People, politicians, and society accepted the risks in the first place, wrongfully assuming that chances for a favourable scenario were more likely than an FX loss for consumers.

Logos, pathos, ethos…