The National Bank of Poland (NBP) warned of substantial negative effects for the country’s banking sector, public finances, and the economy, should the government push on with a draft bill to force conversion of Swiss franc-denominated loans, in a report released on February 10.

The central bank's report on the stability of the financial system total costs to the banking system of close to PLN78bn (€17.6bn). The presidential office, which put forward the draft without any discussion of the tab, has asked regulator KNF to estimate the costs to lenders. The watchdog has said it should have a figure sometime in March.

The bill, and lack of detail on cost and timing, has extended the huge uncertainty overhanging the Polish banking sector. The cost "would exceed current banking sector profits several times over, which would threaten system stability," the central bank warns.

The NBP report estimates the direct cost of the conversion - which the bill says would use a "fair FX rate" - at PLN38bn-44bn. The higher PLN78bn estimate is for total costs, including the effects of depreciation of the zloty, a refund on forex spreads, and lower income from interest, according to the NBP’s calculations.

"In most banks, losses would be very large in relation to the scale of their activities," the report comments. That would lead to a deline of up to 27% in equity value and push 18% of the sector to solvency rates below regulatory requirements.

Costs of such magnitude would have a substantial negative effect on lending, the NBP adds. The knock on effect would be felt in public finances and the wider economy, the central bank says. It recommends the conversion should be “avoided.”

The NBP's nightmare scenario may, however, face trouble gaining traction with the ruling Law and Justice (PiS) party. PiS has been hugely critical of the banks and made the loan conversion for over 500,000 borrowers a flagship policy during its successful campaign ahead of the October election. Officials in the presidential office, also controlled by PiS, have suggested only that the scheme could be spread out time wise should it appear the costs would come in above PLN10bn.

The NBP also warns that the effect of the conversion would be compounded coming on top of other challenges faced by Polish banks. On top of record low interest rates and elevated contributions to the Bank Gurantee Fund, the government launched a tax on bank assets at the start of the month. The NBP report also warned over the effects of the levy yet again.

Polish banks will need to reduce lending action, the NBP sums up, which will have a detrimental effect on economic growth. Poland is forecast to post growth of 3.6% in 2015 with followed by 3.5% in 2016 and 2017, according to the European Commission.

Public finance will also suffer, the NBP claims, pointing to reduced income from dividends from banks in which the state has stake, as well as diminished income from corporate income tax. The risk of legal action from investors will also increase, it forecasts, while the sovereign credit rating could see further downgrades, leading to higher cost of servicing debt.

Poland had a foretaste of the potential effects of a rating cut after Standard and Poor’s delivered a surprise downgrade on January 15, causing depreciation of the zloty and spiking bond yields. To abate the effect, Polish officials have embarked on an international road show to convince investors the economy is in good shape.