ESRB issues recommendation on lending in foreign currency
The European Systemic Risk Board (ESRB), which has the task of issuing warnings and/or recommendations when there are serious risks to the financial stability of the EU, has today issued public recommendations for the first time. The recommendations are aimed at reducing the risks associated with lending in foreign currency from financial institutions to households and companies. They are addressed to, the National Supervisory Authorities, the European Banking Authority (EBA) and the Member States of the EU.
The extent of lending in foreign currency varies among the EU countries. Particularly in certain central and eastern European countries, a significant portion of households and certain small and medium-sized enterprises have large loans in foreign currency at the same time as their incomes are in the national currency. This means that these borrowers are vulnerable to unfavourable exchange rate fluctuations. A high proportion of lending in foreign currency may thus pose a threat to the financial stability of the affected countries, and even have contagion effects on other countries in the EU.
”We welcome the recommendations published by the ESRB today. Previous Swedish experiences – partly from the Swedish crisis of the 1990s, and partly from the crisis in the Baltic countries – have clearly shown the risks that lending in foreign currency constitutes to the stability of the financial system. We have thus actively contributed to the production of these recommendations”, comments Stefan Ingves.
The ESRB recommends affected authorities (in Sweden, Finansinspektionen), among other measures, to:
- require that borrowers receive adequate information on the risks associated with borrowing in foreign currency;
- allow loans in foreign currency to be granted only to borrowers that are creditworthy and have the capacity to withstand adverse shocks in the exchange rate; consider setting more stringent underwriting standards, such as debt service-to-income and loan-to-value ratios;
- monitor whether foreign currency lending is inducing excessive credit growth and, if so, adopt more stringent rules;
- ensure that financial institutions better incorporate the risks associated with lending in foreign currency in their internal risk management systems;
- require that financial institutions hold adequate capital to cover the risks associated with lending in foreign currency;
- monitor and, when necessary, limit funding and liquidity risks – particular attention is to be given to risks related to maturity and currency mismatches between assets and liabilities, to reliance on foreign markets for currency swaps, and to concentration of funding sources;
- impose measures to avoid regulatory arbitrage between EU countries.
Links to information about the ESRB's recommendations and background analysis, are given below.
