Deleveraging and Foreign Currency Loan Conversion Programs in Europe

Abstract

This paper first reviews the developments in the size and composition of the European banking sectors’ balance sheets since the Global Financial Crisis and then assesses the impact of foreign currency loan conversion programs on systemic risk. Aggregate data from 2009Q1 to 2019Q3 indicate three major developments. First, the deleveraging process in Europe has been sizeable, while credit growth may be hampered in several countries. Secondly, macroprudential measures and conversion programs have only partially achieved their goal of lowering financial dollarization in Central and Eastern Europe. Lastly, systemic risk remains elevated in the non-euro area.

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Fig. 1

Sources: IMF IFS, CHF Lending Monitor, central banks, own calculations. Notes: The size of the banking sector is defined as total assets of the banking sector in a given quarter divided by the GDP of the previous year. Financial centers are Denmark, Luxembourg, and the UK. The samples of countries in the euro area and non-euro area change over time, due to new countries joining the euro area during the sample period. For example, for the euro area countries, the size of the banking sector is calculated as the sum of total assets of the euro area countries in a given quarter divided by the sum of their GDP during the previous year. Countries are included in this calculation only when their data are available for both the nominator and denominator

Fig. 2

Sources: IMF IFS, CHF Lending Monitor, central banks, own calculations. Notes: The loan-to-deposit ratio is defined as the sum of loans to resident non-banks and non-resident non-banks divided by the sum of deposits by resident non-banks. Financial centers are Denmark, Luxembourg, and the UK. The samples of countries in the euro area and non-euro area change over time, due to new countries joining the euro area during the sample period. Countries are included in this calculation only when their data are available for both the nominator and denominator in the same quarter

Fig. 3

Sources: IMF IFS, CHF Lending Monitor, central banks, own calculations. Notes: Domestic credit is defined as the sum of loans to resident non-banks divided by annual GDP. Financial centers are Denmark, Luxembourg, and the UK. The samples of countries in the euro area and non-euro area change over time, due to new countries joining the euro area during the sample period. Countries are included in this calculation only when their data are available for both the nominator and denominator in the same quarter

Fig. 4

Sources: CHF Lending Monitor; own calculations. Notes: Financial dollarization in loans to households is defined as foreign currency loans to resident households divided by total loans to resident households. Financial centers (FC) are Denmark, Luxembourg, and the UK. The samples of countries in the euro area (EA) and non-euro area (Non-EA) change over time, due to new countries joining the euro area during the sample period. Countries are included in the calculation only when their data are available for both the nominator and the denominator

Fig. 5

Sources: CHF Lending Monitor; own calculations. Notes: Financial dollarization in deposits of households is defined as foreign currency deposits by resident households divided by total deposits by resident households. Financial centers (FC) consist of Denmark, Luxembourg, and the UK. The samples of countries in the euro area (EA) and non-euro area (Non-EA) change over time, due to new countries joining the euro area during the sample period. Countries are included in the calculation only when their data are available for both the nominator and denominator. The series for the non-euro area in 2009 assumes fixed values for Croatia in 2010Q1 in the calculation

Fig. 6

Sources: CHF Lending Monitor; own calculations. Notes: Financial dollarization in the banking sector is defined as foreign currency assets of the banking sector divided by total assets of the banking sector. Financial centers consist of Denmark, Luxembourg, and the UK. The samples of countries in the euro area and non-euro area change over time, due to new countries joining the euro area during the sample period. Countries are included in the calculation only when their data are available for both the nominator and denominator

Fig. 7

Source: CHF Lending Monitor; own calculations. Notes: Swiss-francization is the share of CHF-denominated assets in total assets of the banking sector in each country. Financial dollarization is the share of foreign currency assets in total assets of the banking sector. Data for these countries are complete and there is no missing information on the currency breakdown of assets in the CHF Lending Monitor

Fig. 8

Source: CHF Lending Monitor; own calculations. Notes: Systemic risk is calculated following formula (1). Countries within each group are sorted from the highest systemic risk to the lowest. For Austria and the Czech Republic, Total Assets do not include Total Other Assets. Data on the sectoral breakdown of foreign currency loans are missing for France, Iceland, Latvia, Poland, and Slovakia in 2009Q1 and for France, Poland, and Slovakia in 2019Q3; therefore, the foreign currency mismatch cannot be calculated for these countries in these quarters. The data for Croatia in the left-hand panel are for 2010Q1. The data for Italy in the right-hand panel are for 2018Q4

Fig. 9

Source: CHF Lending Monitor; own calculations. Notes: Systemic risk is calculated following the formula given in (1). Data for Croatia starts in 2010Q1. The temporary jump in 2018Q3 in Serbia is not related to foreign currency loans to households or the loan conversion program. The spike is merely due to a sudden increase in deposits from non-resident banks in that quarter, which reverses in 2018Q4. Data for these countries are complete and there is no missing information on the currency breakdown of assets in the CHF Lending Monitor

Notes

  1. 1.

    The BIS Locational Banking Statistics are compiled following principles that are consistent with balance of payments statistics.

  2. 2.

    However, central banks are free to decide not to disclose certain variables because of confidentiality or the unavailability of certain banking statistics.

  3. 3.

    In the Vienna Initiative, major international financial institutions such as the European Bank for Restructuring and Development, regulatory and fiscal authorities such as the European Commission, and international organizations such as the International Monetary Fund and the World Bank, played a key role. The main objectives were to prevent a large-scale and uncoordinated withdrawal of cross-border bank groups from emerging Europe, and to ensure that parent bank groups maintained their exposures and recapitalized their subsidiaries in emerging Europe. European Investment Bank (2019) provides a comprehensive overview of the Vienna Initiative and assesses its effectiveness.

  4. 4.

    The domestic credit crunch has been acute in the UK and in Hungary, despite the targeted policies of the respective central banks to stimulate domestic retail lending. The Bank of England and the UK government introduced the Funding for Lending Scheme in 2012 to encourage banks and building societies to lend more to households and businesses, providing funds at cheaper rates than those prevailing in current markets. Similarly, the Magyar Nemzeti Bank (Hungarian National Bank) introduced the Lending for Growth Scheme in 2013 to restore the functioning of the small and medium enterprise loan market and to promote growth.

  5. 5.

    In this paper, the foreign currency is not legal tender but is used in parallel to the domestic currency by residents.

  6. 6.

    Beckmann (2017) shows that an awareness of loan conversion programs has no effect on loan demand in general, but positively and significantly increases the demand for foreign currency loans, based on a survey of households in Central, Eastern, and Southeastern Europe.

  7. 7.

    Foreign currency loan conversion programs generally reduced the value of total assets in banks’ balance sheets by converting CHF loans into another currency at an exchange rate below the effective market value at the time of the conversion. As a result, these programs may have contributed to the deleveraging process.

  8. 8.

    Exchange rate movements undoubtedly affect the evolution of the share of foreign currency loans to total loans through valuation changes. Yet, the figure does not exhibit any evidence that valuation changes slowed or reversed the downward trend in the financial dollarization of loans, despite the sharp appreciation of the Swiss franc vis-à-vis the euro during this period.

  9. 9.

    Most derivative markets around the world are insufficiently active and do not offer a wide variety of instruments to hedge exchange rate risk (see the BIS Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets in 2019). We can thus safely abstract from any potential off-balance sheet hedging by banks in CEE when calculating systemic risk.

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Acknowledgements

The authors would like to thank an anonymous referee and Paul Wachtel (the editor), as well as Romain Baeriswyl and Andreas Fischer for valuable comments. Pınar Yeşin would like to thank conference participants at the 25th Dubrovnik Economic Conference for helpful discussions on foreign currency loan conversion programs in Central and Eastern Europe. Any remaining errors are our own. The views expressed in this paper are those of the authors and do not necessarily represent those of the Swiss National Bank.

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Appendix

Appendix

See Tables 3, 4 and Figs. 10, 11, 12, 13.

Table 3 Data template of the CHF Lending Monitor.
Table 4 Country and time coverage in the CHF Lending Monitor.
Fig. 10
figure10

Sources: IMF BOPS (International Investment Position | Assets | Other Investment | Deposit-taking corporations, except the central bank); CHF Lending Monitor (Assets of resident banks | loans to non-residents | Total); IMF IFS; IMF WEO; own calculations. Notes: UK’s IMF BOPS data is missing. According to the CHF Lending Monitor, UK’s cross-border banking assets were 192% GDP in 2009Q1 and 154% GDP in 2019Q3. In addition to the countries illustrated in this figure, Luxembourg lies outside the scale. In 2009Q1, Luxembourg’s cross-border assets were 1230% GDP according to the CHF Lending Monitor and 1262% GDP according to the IMF BOPS. In 2019Q3, they were 784% GDP according to the CHF Lending Monitor and 723% GDP according to the IMF BOPS. The slight deviation from the 45-degree line may be due to differences in the treatment of foreign branches by these two data sets

Cross-border banking assets based on CHF Lending Monitor and IMF BOPS data.

Fig. 11
figure11

Sources: IMF BOPS (International Investment Position | Liabilities | Other Investment | Deposit-taking corporations, except the central bank); CHF Lending Monitor (Liabilities of resident banks | Deposits by non-residents | Total); IMF IFS; IMF WEO; own calculations. Notes: UK’s IMF BOPS data is missing. According to the CHF Lending Monitor, UK’s cross-border banking liabilities were 215% GDP in 2009Q1 and 153% GDP in 2019Q3. In addition to the countries illustrated in this figure, Luxembourg lies outside the scale. In 2009Q1, Luxembourg’s cross-border assets were 1163% GDP according to the CHF Lending Monitor and 1054% GDP according to the IMF BOPS. In 2019Q3, they were 644% GDP according to the CHF Lending Monitor and 595% GDP according to the IMF BOPS. The slight deviation from the 45-degree line may be due to differences in the treatment of foreign branches by these two data sets

Cross-border banking liabilities based on CHF Lending Monitor and IMF BOPS data.

Fig. 12
figure12

Sources: IMF BOPS; IMF IFS; IMF WEO; CHF Lending Monitor; own calculations. Notes: UK’s IMF BOPS data is missing. According to the CHF Lending Monitor, UK’s net cross-border banking asset position was − 23% GDP in 2009Q1 and 2% GDP in 2019Q3. In addition to the countries illustrated in this figure, Luxembourg lies outside the scale. In 2009Q1, Luxembourg’s net cross-border assets were 67% GDP according to the CHF Lending Monitor and 208% GDP according to the IMF BOPS. In 2019Q3, they were 140% GDP according to the CHF Lending Monitor and 128% GDP according to the IMF BOPS. The slight deviation from the 45-degree line may be due to differences in treatment of the foreign branches by these two data sets

Net cross-border asset positions of banking sectors based on CHF Lending Monitor and IMF BOPS data sets.

Fig. 13
figure13

Sources: CHF Lending Monitor; IMF IFS; own calculations. Notes: The left panel shows the size of the banking sector in each country calculated as total assets divided by country GDP. The largest three banking sectors relative to country GDP are in Luxembourg, the UK, and Denmark. The right panel shows the banking sectors’ cross-border financing calculated as liabilities to non-residents divided by country GDP. Once more, Luxembourg, the UK, and Denmark have the largest cross-border liabilities relative to country GDP. Based on these two criteria, therefore, we classify Denmark, Luxembourg, and the UK as financial centers

Classifying financial centers.

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Vidaházy, V., Yeşin, P. Deleveraging and Foreign Currency Loan Conversion Programs in Europe. Comp Econ Stud 62, 215–241 (2020). https://doi.org/10.1057/s41294-020-00116-1

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Keywords

  • Deleveraging
  • Foreign currency lending
  • Financial dollarization
  • Loan conversion programs
  • Systemic risk

JEL Classification

  • F15
  • F21
  • F32
  • F36
  • G21