Opinion of the European Central Bank of 16 April 2018 on the conversion of Swiss franc loans (CON/2018/21)

OPINION OF THE EUROPEAN CENTRAL BANK of 16 April 2018 on the conversion of Swiss franc loans (CON/2018/21) Introduction and legal basis

On 31 January 2018 the European Central Bank (ECB) received a request from the National Assembly of the Republic of Slovenia (hereinafter the ‘National Assembly’) for an opinion on a draft law on relations between lenders and borrowers concerning credit agreements in Swiss francs (hereinafter the ‘draft law’). The ECB’s competence to deliver an opinion is based on Articles 127(4) and 282(5) of the Treaty on the Functioning of the European Union and the third and sixth indents of Article 2(1) of Council Decision 98/415/EC , as the draft law relates to Banka Slovenije and rules applicable to financial institutions insofar as they materially influence the stability of financial institutions and markets. In accordance with the first sentence of Article 17.5 of the Rules of Procedure of the European Central Bank, the Governing Council has adopted this opinion.

1. Purpose of the draft law

1.1 The purpose of the draft law is to restructure consumer loans denominated in, or linked to, Swiss francs (hereinafter ‘Swiss franc loans’), by requiring credit institutions established in Slovenia to convert Swiss franc loans concluded between 28 June 2004 and 31 December 2010 into loans denominated in euro. 1.2 The draft law aims to place borrowers of Swiss franc loans in the same position that they would have been in had their loans been denominated in euro from inception. To this end, the draft law sets out the following conversion mechanisms: (i) the principal amount of the Swiss franc loans will be converted into euro at the exchange rate set out in the credit agreement applicable on the date the Swiss franc loans were drawn by the borrowers. In case the principal amount was paid out in euro at the time of drawdown then, for the purposes of the conversion, the actual amount as paid out in euro is to be taken into account; (ii) the agreed interest rate, comprising the London interbank offered rate (LIBOR) and a margin agreed in the loan agreement, will be converted into another interest rate, comprising the euro interbank offered rate (EURIBOR) at the date on which the loan was drawn and the same margin agreed in the loan agreement. The agreed period for

recalculations of the interest rate remains unaltered. According to the explanatory memorandum on the draft law, using EURIBOR in the conversion mechanism protects the legitimate business interests of credit institutions by enabling the usual interest rates for euro denominated loans to be taken into account; (iii) the lender is required to prepare a new loan repayment schedule calculated in accordance with the measures set out above and using the same methodology as for the original repayment schedule; (iv) the instalments that have already been paid by the borrower in line with the original repayment schedule will be converted into euro at the exchange rate applicable on the date of payment of each instalment. In case the instalments were repaid in euro then, for the purposes of the conversion, the actual amount of the instalments as repaid in euro is to be considered. Paid instalments will serve as the basis for settling the amounts due under the new loan repayment schedule, whereby the same order for settling obligations as under the original loan agreement is to be used for settling the amounts; (v) if the total amount of instalments already paid by the borrower and converted in euro (as described in point (iv) above) is higher than the total amount of converted instalments calculated according to the new loan repayment schedule (referred to in point (iii) above), this amount will be considered an ‘overpayment’. Depending on the amount of this overpayment, it will be treated as follows: a. if the amount of the overpayment does not exceed the sum of converted instalments that are still to be paid in line with to the new repayment schedule, the overpayment will be proportionally distributed for the settlement of future outstanding instalments, and the loan agreement will remain in force; b. if the amount of the overpayment exceeds the total sum of a converted Swiss franc loan that the borrower has to repay in line with the new repayment schedule, then the lender must return this overpayment to the borrower within 30 days from the date the borrower confirms the conversion proposal and the loan agreement will be terminated. 1.3 Conversion of Swiss franc loans applies not only to outstanding loans but also to (i) fully repaid loans; (ii) loans that were repaid early; (iii) loans that were converted to euro prior to the entry into force of the draft law; (iv) loans that were acquired by new creditors; and (v) loan agreements that were terminated early by the lenders. The draft law requires lenders to prepare new repayment schedules and sets out supplementary conversion rules for each of these categories. With respect to loans that were acquired by new creditors, the draft law provides that the original lenders remain responsible in relation to borrowers for the conversion, unless they can ensure that the party acquiring the outstanding balance takes this conversion into account. 1.4 The lender must prepare a new repayment schedule and recalculate the existing Swiss franc loans and submit these to the borrower along with the conversion proposal within 15 days of the entry into force of the draft law. The borrower must confirm or reject the conversion proposal within 30 days of its receipt.

1.5 The conversion procedures under the draft law are to be supervised by Banka Slovenije, which is also to act as the competent minor offence authority in case of breaches of the provisions of the draft law. 1.6 The draft law provides that the lender, although required to propose and perform the conversion of Swiss franc loans for the borrower, also has the right to challenge the conversion before a court within six months following the conversion, provided that the lender disclosed to the borrower all relevant information regarding the risks pertaining to loans in the relevant foreign currency in a manner that fulfils the standard of ‘informed consent’ at the time the loan agreement was concluded. The draft law sets out criteria for informed consent, which are based on, inter alia, the reasoning of the Court of Justice of the European Union in a recent judgment concerning the interpretation of Council Directive 93/13/EEC on unfair terms in consumer contracts in relation to foreign currency denominated loans . 1.7 According to the explanatory memorandum, the objective pursued by the draft law is to implement the constitutional principle of the ‘welfare state’ and to introduce sanctions for breaches of obligations arising under contractual relationships, thereby providing legal protection for consumers who have taken out Swiss franc loans. The explanatory memorandum questions the legality of linking credit agreements to Swiss franc, in particular in a euro area country with a stable currency, where loans were granted mainly in euro. The explanatory memorandum argues that the use of currency clauses, the risk of which is predominantly borne by borrowers, is an unfair practice used by credit institutions, in particular combined with the lack of informed consent by the borrowers of Swiss franc loans. 1.8 The draft law and explanatory memorandum are accompanied by an assessment of the financial impact of the draft law prepared by the Frank Association (Združenje Frank), a consumer organisation representing the interests of borrowers. The assessment is based on a sample of approximately 10% of currently outstanding Swiss franc loans. According to the assessment, the ‘overpayments’ by borrowers arising from 16,000 Swiss franc loans that were granted in Slovenia would amount to around EUR 488 million if the draft law is not adopted. This amount represents the costs that would be redistributed among the 14 credit institutions granting Swiss franc loans to consumers with the adoption of the draft law. The assessment indicates that the average maturity of Swiss franc loans is 252 months and that most of the loans are in the middle of the repayment period. The assessment estimates that the total amount of overpayments would be distributed over a period of 10 years and that the average burden per bank would be approximately EUR 3.5 million a year. The distribution of the burden would, however, vary from bank to bank, and would be greater for foreign-owned credit institutions which granted the majority of Swiss franc loans.

2. General observations

2.1 Prior to the global financial crisis, borrowing in foreign currencies by households and non-financial 5 6 corporations was popular in several Member States . As previously noted by the ECB , the lower interest rates applicable to foreign currency loans compared to loans in the domestic currency increased the demand for such loans. According to the documentation included in the explanatory memorandum and the draft law, the majority of Swiss franc loans were and still are mortgage loans and were granted by foreign-owned credit institutions. 2.1.1 The ECB notes that the draft law anticipates that the conversion of the outstanding and already terminated Swiss franc loans to loans denominated in euro will be voluntary only for borrowers. The ECB also notes that the draft law provides for the possibility for credit institutions to challenge the conversion after it has been implemented, restoring the parties to the position they were in under the terms of the original Swiss franc loan, if they can prove in court that the borrower entered into the Swiss franc loan on the basis of informed consent, as defined in the draft law. 2.2 Legal aspects on retroactivity 2.2.1 As previously noted by the ECB, introducing measures with retroactive effect undermines legal certainty and is not in line with the principle of legitimate expectations , and may also interfere with acquired rights. 2.2.2 Article 23(1) of Directive 2014/17/EU of the European Parliament and of the Council , which applies to credit agreements in existence from 21 March 2016 , stipulates that Member States shall ensure that an appropriate regulatory framework is in place for credit agreements in respect of foreign currency loans to ensure, at a minimum, that (a) the consumer has a right to convert the credit agreement into an alternative currency under specified conditions or (b) there are other arrangements in place to limit the exchange rate risk to which the consumer is exposed under the credit agreement. Article 23(5) of Directive 2014/17/EU allows Member States to further regulate foreign currency loans provided that such regulation is not applied with retroactive effect. The retroactive effect of the draft law is not in line with the general aim of Article 23(5) of Directive 2014/17/EU , which reflects one of the general principles of Union law, namely the principle of 11 12 legal certainty that supports the limitation of retroactive laws .

2.2.3 It is for the Slovenian authorities to assess whether the retroactive character of the draft law also complies with Slovenian legal and constitutional principles.

3. Specific observations

3.1 Eligibility criteria 3.1.1 The draft law does not prescribe specific criteria for borrowers to be eligible to participate in the conversion, which raises some concerns with regard to the purpose of the draft law. 3.2 Effects on the banking sector 3.2.1 The implementation of the draft law is expected to entail financial costs for the Slovenian banking sector. Credit institutions may be affected to different degrees to the extent that they have concluded Swiss franc loans between 28 June 2004 and 31 December 2010. This, in turn, is expected to have a negative impact on the profitability, capitalisation and future lending capacity of the banking sector as a whole. 3.2.2 As regards the possibility for credit institutions to reverse the conversion if they can prove the loans were concluded based on borrowers’ informed consent, it is noted that this option can only be exercised on an ex post basis before the national court, which creates additional litigation costs for the Slovenian banking sector and the risk of being unable to recover the relevant amounts from borrowers. It should also be noted that the conversion will lead to a one-off increase in operational costs for the affected credit institutions in Slovenia, in particular due to the restructuring of existing hedges, refinancing measures, and the costs associated with the obligation to recalculate the Swiss franc loans in order to notify each borrower individually thereof. 3.3 Effects on the financial stability 3.3.1 The ECB has pointed out on several occasions the risks associated with foreign currency loans . In particular, foreign currency loans have constituted a major risk to financial stability in several Member States, where the share of foreign currency loans is relatively high. The ECB points, in this respect, to the analysis of such risks made by the ESRB in Recommendation ESRB/2011/1 . 3.3.2 As regards the long-term effects on financial stability, when introducing measures in relation to settling and converting foreign currency loans, due consideration should always be given to fair burden sharing among all stakeholders in order to avoid moral hazard in the future . The explanatory memorandum argues that the interests of credit institutions are taken into account in the draft law, for example, in the conversion process higher interest rates are to be used for the preparation of the new repayment schedules, reflecting common practices in euro denominated loans. However, the draft law provides for the replacement of LIBOR with EURIBOR for recalculation purposes, whereas the original loan-based margin remains the same, which appears

to potentially deviate from the common practices of credit institutions which typically apply a higher loan-based margin for euro denominated loans than for Swiss franc denominated loans. 3.3.3 Given that Slovenia only joined the euro area in 2007, the conversion of any loans from Swiss franc into euro between 2004 and 2007 could result in an unequal treatment of other customers, depending on exchange rate developments between the Slovenian tolar and Swiss franc during this period. A reconciliation method may therefore be needed to reflect exchange rate developments between the tolar, Swiss franc and euro during this period. 3.4 Effects on the Slovenian economy 3.4.1 As the ECB has noted previously , the conversion of Swiss franc loans with retroactive effect, as envisaged by the draft law, could have negative effects if it were to lead to a deterioration of foreign investor sentiment due to a perceived increase in legal uncertainty and country risk.

4. Conferral of new tasks on Banka Slovenije

4.1 New task of Banka Slovenije 4.1.1 The draft law confers the task of supervising the conversion procedures in relation to credit institutions on Banka Slovenije and designates Banka Slovenije as the competent minor offence authority in case of a breach of the provisions of the draft law. The draft law does not specify in detail the scope of this new task. The ECB understands that the Banka Slovenije’s supervisory task in this respect would essentially require Banka Slovenije to supervise the compliance of credit institutions with the requirements of the draft law in relation to the restructuring of their private contractual relationships with individual customers in the context of the conversion of Swiss franc denominated loans into euro denominated loans. Banka Slovenije has been designated as the competent minor offence authority in relation to breaches of the draft law, within the scope of the performance of its prudential supervisory tasks over credit institutions , and also has, to a certain extent, an existing customer protection role . However, Banka Slovenije has no comparable responsibilities in respect of the supervision of the compliance of credit institutions with the legal requirements relating to the restructuring of privately negotiated loan contracts by credit institutions with their customers. The draft law therefore confers a new task upon Banka Slovenije. 4.1.2 The ECB underlines that a proposed conferral of new tasks on a national central bank (NCB) in the European System of Central Banks must be assessed against the prohibition on monetary financing under Article 123 of the Treaty. For the purposes of that prohibition, Article 1(1)(b)(ii) of Council Regulation (EC) No 3603/93 defines ‘other type of credit facility’, inter alia, as ‘any financing of the public sector’s obligations vis-à-vis third parties’.

Ensuring that Member States implement a sound budgetary policy is one of the key objectives of the monetary financing prohibition, which may not be circumvented . Therefore, the task of financing measures, which are normally the responsibility of the Member States, and which are financed from their budgetary sources rather than by the NCBs, must not be entrusted to NCBs. To decide what constitutes financing of the public sector’s obligations vis-à-vis third parties, which can be translated as the provision of central bank financing outside the scope of central bank tasks, it is necessary to carry out, on a case-by-case basis, an assessment of whether the task to be undertaken by an NCB is a central bank task or a government task, i.e. a task within the responsibility of the Member States. In other words, adequate safeguards must be in place to ensure that circumventions of the objective of the monetary financing prohibition of maintaining a sound budgetary policy of Member States do not take place. 4.1.3 As part of its discretion in the exercise of its duty, on the basis of Article 271(d) of the Treaty and Article 35.6 of the Statute of the European System of Central Banks and of the European Central Bank (hereinafter the ‘Statute of the ESCB’), to ensure that NCBs honour the obligations laid down by the Treaty, the Governing Council has endorsed safeguards of that kind in the form of criteria for determining what may be seen as falling within the scope of a public sector’s obligation within the meaning of Article 1(1)(b)(ii) of Regulation (EC) No 3603/93 or, in other words, what constitutes a government task as follows: First, central bank tasks are in particular those tasks that are related to the tasks that have been conferred upon the ECB and the NCBs by the Treaty and the Statute of the ESCB. These tasks are mainly defined in Article 127(2), (5) and (6) and Article 128(1) of the Treaty, as well as Article 22 and Article 25.1 of the Statute of the ESCB. Second, as Article 14.4 of the Statute of the ESCB allows NCBs to perform ‘other functions’, new tasks, i.e. tasks that are not related to tasks that have been conferred upon the ECB and the NCBs, are not precluded per se. However, new tasks that are undertaken by an NCB and which are atypical of NCB tasks or which are clearly discharged on behalf of, and in the exclusive interest of the government or of other public sector entities should be considered government tasks. Third, an important criterion for qualifying a new task as atypical of an NCB task or as being clearly discharged on behalf of and in the exclusive interest of the government or other public sector entities is the impact of the task on the institutional, financial and personal independence of that NCB. In particular, the following aspects should be taken into account: (a) whether the performance of the new task creates conflicts of interest with existing central bank tasks which are not adequately addressed and does not necessarily complement those existing central bank tasks. If a conflict of interest arises between existing and new tasks, sufficient safeguards to mitigate that conflict should be in place. The complementarity between a new task and the existing central bank tasks should not be interpreted broadly, so

as to lead to the creation of an indefinite chain of ancillary tasks. Such complementarity should be examined in relation to the financing of those tasks; (b) whether without new financial resources the performance of the new task is disproportionate to the NCB’s financial or organisational capacity, and may have a negative impact on the capacity to perform properly the existing central bank tasks; (c) whether the performance of the new task fits into the institutional set-up of the NCB in the light of central bank independence and accountability considerations; (d) whether the performance of the new task harbours substantial financial risks; (e) whether the performance of the new task exposes the members of the NCB decision-making bodies to political risks which are disproportionate and may also have an impact on their personal independence and, in particular, on the guarantee of term of office set out in Article 14.2 of the Statute of the ESCB. 4.1.4 On the basis of the criteria set out above, the following paragraphs assess whether the new task of Banka Slovenije is in line with the prohibition of monetary financing. 4.2 Tasks related to the tasks conferred upon the ECB and the NCBs by the Treaty and the Statute of

the ESCB

4.2.1 Supervising the compliance of credit institutions with the requirements of the draft law in relation to the restructuring of privately negotiated loan contracts with their customers is not among the basic central banking tasks listed in Article 127(2) or (5) of the Treaty or otherwise conferred upon the NCBs by the Statute of the ESCB. The new task conferred on Banka Slovenije does not form part of the prudential supervisory tasks of Banka Slovenije. Thus, the new task conferred on Banka Slovenije under the draft law is not directly related to the tasks conferred on the ECB and the NCBs by the Treaty and the Statute of the ESCB. Consequently, a careful assessment of the conferral of this task on Banka Slovenije is required in order to determine whether it constitutes a government task, and whether the related funding gives rise to monetary financing concerns . 4.3 Tasks which are atypical of NCB tasks 4.3.1 The new task conferred on Banka Slovenije by the draft law relates to the supervision of the compliance by credit institutions with the requirements under the draft law relating to the restructuring of privately negotiated loan agreements between credit institutions and their customers. Banka Slovenije’s new task can be seen, to a certain extent, as being related to the protection of consumers. 4.3.2 It is necessary to analyse whether this new task is atypical of NCB tasks. While the majority of NCBs do not appear to have been assigned tasks of this nature, the ECB has identified two 23 24 Member States where NCBs have been given similar tasks. In Cyprus and Hungary , the NCBs

have been given tasks relating to the supervision of the compliance by credit institutions with the legal requirements in relation to the restructuring of private, contractual loan agreements between credit institutions and their customers. In the case of Hungary, these tasks are substantially similar to the tasks to be conferred on Banka Slovenije under the draft law. In addition, the NCBs in 25 26 27 28 29 Croatia , the Czech Republic , Ireland , Italy and Slovakia have been given similar supervisory tasks relating more generally to consumer protection and the transparency of loan arrangements. In this regard, also taking into account the consumer protection roles which are currently fulfilled by numerous ESCB NCBs in the field of financial services , the new task does not appear to be completely atypical of NCB tasks. However, the new task would be considered as atypical if Banka Slovenije’s supervisory role would extend to the resolution of disputes between contractual parties, which is a matter that is usually handled by the courts. 4.4 Tasks clearly discharged on behalf of and in the exclusive interest of the government 4.4.1 According to the explanatory memorandum, the objective of the draft law is to implement the constitutional principle of the ‘welfare state’ and to introduce sanctions for breaches of obligations arising under contractual relationships, thereby providing legal protection to a number of consumers who have taken out Swiss franc loans. The draft law is therefore intended to provide protection to consumers of financial services. As previously noted by the ECB the NCB ‘is best placed to assess the terms and conditions of loan contracts entered into by consumers and the impact of the new legal measures on financial institutions. Within the scope of its tasks, the [NCB] can contribute to the prevention and mitigation of systemic risks to financial stability’. Due to the retroactive application of the draft law, it is not clear whether the draft law would effectively guarantee the fulfilment of the objective of protecting consumers of financial services. Thus, there is a potential risk that, in carrying out its supervisory functions, Banka Slovenije would act exclusively in the interest of another public entity.

4.5 Extent to which performance of the new task creates conflicts of interest with existing central bank

tasks

4.5.1 It may be considered that the new task at least partially complements other similar existing supervisory and consumer protection tasks of Banka Slovenije. As with other consumer protection tasks, sufficient mitigation measures must be put in place to ensure that in the event of a conflicts of interest supervisory considerations prevail . 4.6 Extent to which performance of the new task is disproportionate to the financial or organisational

capacity of Banka Slovenije

4.6.1 The principle of financial independence requires that Member States may not put their NCBs in a position where they have insufficient resources to carry out both their ESCB-related tasks and their national tasks, from an operational and financial perspective. Furthermore, when allocating specific new tasks to NCBs, each NCB concerned should have sufficient financial and human resources at its disposal to ensure that the tasks can be carried out without impacting on the NCB’s financial or operational capacity to perform its ESCB tasks . In order to ensure that Banka Slovenije’s capacity to perform its ESCB-related tasks is not impaired, Banka Slovenije must, therefore, be in a position to avail itself of the necessary resources to carry out its duties under the draft law. At this early stage, it is difficult to predict what additional resources Banka Slovenije will require in order to perform its new supervisory task under the draft law. However, it is likely that Banka Slovenije will have to dedicate additional human, technical and financial resources to implement this new supervisory task. This may impose an additional burden on existing NCB and supervisory tasks performed by Banka Slovenije. While supervised entities are required to pay fees to Banka Slovenije in respect of the performance of its supervisory tasks under the Law on consumer credit , the draft law does not provide for Banka Slovenije to be reimbursed for the costs of carrying out this new task. The ECB invites the consulting authority to consider the impact of the draft law on the resources of Banka Slovenije. 4.7 Extent to which performance of the new task fits into the institutional set-up of Banka Slovenije, in the light of central bank independence and accountability considerations 4.7.1 The potential impact of the new task on the institutional, financial and personal independence of Banka Slovenije must also be taken into consideration. 4.8 Extent to which the performance of tasks harbours substantial financial risks 4.8.1 The draft law does not contain any specific provisions on liability in relation to the exercise of Banka Slovenije’s powers under the draft law or the failure to exercise such powers. Banka Slovenije’s potential liability in respect of the performance of the new task will thus be subject to the rules on liability for damages caused in the exercise of public authority pursuant to the Law on banking and the general liability regime under Slovenian law. The general liability regime would also apply with respect to any potential damages in connection with decisions of Banka Slovenije

delivered in supervisory proceedings pursuant to the draft law which are later declared to be invalid in the courts. 4.9 Extent to which the performance of the new task exposes members of the decision-making bodies of Banka Slovenije to disproportionate political risks and impacts on their personal independence 4.9.1 Due to the sensitivity of the subject matter and the high degree of public attention being given to the restructuring of Swiss franc loans in Slovenia, due consideration should be given to any disproportionate political risk or impact on the personal independence of the members of the decision-making bodies of Banka Slovenije that may arise in the performance of the new task. In this respect, consideration might be given to the possibility of conferring this task on a separate government agency to which Banka Slovenije could provide technical support in view of its expertise and experience in dealing with the Slovenian banking sector . 4.10 Conclusion 4.10.1 The following should be noted as regards the compatibility of the draft law with the prohibition on monetary financing. The new task of Banka Slovenije of supervising the compliance of credit institutions with the requirements under the draft law in relation to the restructuring of privately negotiated loan agreements between credit institutions and their customers can be regarded as a central bank task. However, as the new task conferred upon Banka Slovenije by the draft law must not adversely affect its capacity to carry out its NCB or ESCB-related tasks, careful consideration should be given to its impact on Banka Slovenije’s operational capacity. In addition, careful consideration should be made of any disproportionate political risk or impact on the personal independence of the members of the decision-making bodies of Banka Slovenije that may arise in the performance of the new task.

This opinion will be published on the ECB’s website.

Done at Frankfurt am Main, 16 April 2018.

[signed]

The President of the ECB

Mario DRAGHI