OREANDA-NEWS. The Basel Committee on Banking Supervision's proposal that banks apply a 50% risk weight surcharge to loans made in a currency other than the borrower's main source of income could discourage unhedged foreign currency (FC) lending, says Fitch Ratings. Such lending can reduce interest payments, but exposes the borrower to dramatic moves in the exchange rate, as occurred when the cap on the Swiss franc was abandoned in Jan 2015.

Most banks hedge FC risk on their loan portfolios, limiting their direct exposure to market movements. Consequently, the main risk is to asset quality, if unhedged FC borrowers are unable to service their debt when FX rates move.

In our opinion, unsecured FC corporate and commercial borrowings, along with FC retail and residential mortgage loans, are most likely to be affected by the additional charge. But the impact will vary by country, depending on the prevalence of FC lending, and existing regulatory treatments.

Within the EU, we think the proposals are unlikely to significantly raise overall capital needs for banks. This is because in a number of EU countries where FC lending is common, national regulators already require banks to hold additional regulatory capital for these exposures.

This is the case in Poland, where FC mortgages are 100% risk weighted and substantial additional capital buffers have recently been introduced for banks with large FC mortgage books. In Romania, lenders benefit from a sovereign guarantee on FC mortgages extended under a 'first-time buyers' programme, although this practice is currently under review. Hungarian banks have significantly reduced their FC retail portfolios and Bulgarian exchange rate risks are mitigated though its local currency peg to the euro, together with a currency board arrangement.

Outside the EU, practices vary. In Russia and Turkey, retail lending is predominantly or exclusively in local currency; Fitch views this positively because retail customers rarely have access to foreign currency income. However, FC lending to corporates is significant in both countries (in particular in Turkey) and in part comprises exposure to companies with no direct access to FC revenues or other effective hedging. Russia is in the process of introducing additional capital charges for FC lending to corporates but such exposures are not subject to additional risk-weighting in Turkey.

Within Latin America, banks in countries including Peru, Costa Rica and Nicaragua lend extensively in FC, reflecting high levels of dollarization in the region. We do not generally consider FC lending risks to be significant in the Middle East, Africa and APAC.