Jan Cienski in Warsaw -

As Poland's banks report their results for 2008, a casual observer could be forgiven for concluding that with profits up 8% from a year earlier and non-performing loans at only 4.4%, the sector is in rude health despite the economic crisis. But there are increasing worries about Poland's banks, in large measure due to the weakness of the zloty.

The reason is that about 35% of all lending - and 70% of mortgages - are denominated in foreign currency, mostly Swiss francs, and the zloty has dropped by about 40% since peaking against the franc last summer. Polish central bank governor Slawomir Skrzypek told the daily Dziennik in an interview published March 9 that the zloty is now "significantly undervalued."

Until recently, borrowing in foreign currency made sense; interest rates were lower than for zloty-denominated loans, and with Poland on track to eventually join the euro, the risk seemed small. But that tiny risk has grown enormously over the last six months. Following the collapse of Lehman Brothers last September, investors began to flee emerging markets and currencies like the zloty, Czech koruna and Hungarian forint dropped against the euro, dollar and Swiss franc. As a result, borrowers who had taken out mortgages in Swiss francs saw the size of their monthly payments rise and the value of their mortgages balloon in local currency terms, all at a time when the real economy began to sputter and unemployment rise.

So far, banks have not noticed an increase in problem mortgage loans, says Wojcieceh Kaczorowski, a spokesman for Millennium Bank, a subsidiary of the Portuguese bank and one of the most aggressive Swiss franc lenders on the Polish market. "In terms of importance, mortgages are essential and people are still paying those loans on time," he says.

But on the corporate side, banks are already beginning feel the tremors caused by the crisis. Millennium says 9.7% of corporate loans are in trouble, and the number is rising. Other banks are increasing their provision for future losses, and analysts expect profits to decline by about a third this year. "Mortgage lending is more or less fine at the moment," says Jiri Stanik, a banking analyst with Wood & Co., a Prague brokerage. "I'm more afraid of corporate lending exposure because of the slowdown of the German economy."

Not a good option

As well as companies being pushed to the wall by slumping exports and slowing domestic demand, banks are also facing a large problem tied to foreign currency hedges taken out by many companies last summer when the zloty appeared to be on track to continue strengthening. Some of those options were taken to cover the foreign currency exposure that is a normal part of exporting and importing, but in other cases companies took excessive positions to earn what seemed to be easy profits. However, with the dramatic fall in the zloty's value, companies now face losses of about PLN15bn (€3.2bn), according to Poland's Financial Supervision Authority. "I knew I was taking a risk, and now I'm paying the price," says Aleksander Bochenski, who runs a food processing business in central Poland, and who had loaded up on forex options last year.

The impact of declining currencies on the banking sector prompted Moody's Investors Service, the rating agency, to warn recently that Western European banks with significant operations in Central Europe faced possible downgrades. "Moody's expects continuous downward pressure on East European bank ratings as a result of weakening financial metrics predominantly driven by deteriorating asset quality and vulnerable liquidity positions," said a report by the agency that sent Central European currencies into yet another tailspin.

Those kinds of reports are driving local policymakers to distraction, as they argue the conditions are very different in each country. "Each of the CEE Member States has its own specific economic and financial situation and these countries do not constitute a homogenous region," said a joint statement put out by banking regulators in Poland, the Czech Republic, Slovakia, Bulgaria, Romania and Hungary in March.

They are correct; forex lending was almost non-existent in the Czech Republic, while in Hungary 70% of lending was in foreign currency and in the Baltics the number was even higher. The hope for Poland is that the banking system is healthy enough to ride out the problems caused by the falling zloty. "It will not increase risk so much that it will endanger the banking system," says Krzysztof Pietraszkiewicz, head of the Polish Banking Association.

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