Tim Gosling in Prague -

Hungary's government suffered a setback on December 16 in its attempt to rid the country of foreign currency loans, as the supreme court ruled the banks are not to blame for borrowers losses. The ruling sent bank shares and the forint rising from monthly lows.

Shares of the country's biggest bank OTP had fallen to a two-month low ahead of the meeting of the country's top court, known as the Kuria. However, the shares finished the day 2.77% higher after the court said that risks associated with currency rate fluctuations should be borne by the borrower, and that even should certain terms within loan contracts be found null and void, it would not invalidate the overall contract.

"Just on the basis of the exchange rate risk for the borrower, this type of contract is not against the law, or good morals and is not usury," Judge Gyorgy Wellman told reporters, according to Reuters.

Court intervention isn't the appropriate tool to deal with the adverse effect of foreign-currency loans and politicians need to pass appropriate laws if they want to help borrowers, the Kuria added, according to Bloomberg. "Legislative intervention would remove the competence of particular judges," it said.

The ruling suggests the government will need to pull back on the volume of losses to be absorbed by the banks if it wants to push through a relief scheme for forex borrowers ahead of elections set for the spring. The ruling Fidesz party had called on the Kuria to offer a legal framework for the thousands of legal claims currently backlogged in the country's courts, which are held up by the fact that the Hungarian legal system does not act on precedent.

Prime Minister Viktor Orban last month urged judges to take "the side of the people." Other government officials insisted in mid-December that Budapest will act ahead of elections, which are due by April, despite the legal uncertainties.

Short-term reprieve

The banks have been on tenterhooks since the government announced in the late summer it would return to the forex loan issue. They were hit with huge losses in a scheme run in late 2011 to reduce the huge volume of forex mortgages, which were issued in the boom years ahead of 2008 when the forint was soaring against the Swiss franc and the euro. The issue not only hurts households and the wider economy, but also tethers economic and monetary policy due to the huge exposure it creates to the value of the forint.

Following the announcement by the Kuria, the currency traded below 300 to the euro for the first time this month, reported Bloomberg, while yields on the sovereign's benchmark 10-year paper dropped 10 basis points to 5.72%.

"Suffice to say good news for banks, and the market," says Tim Ash at Standard Bank. "I think the consensus was that the court would not rule against banks on the €12bn or so in these liabilities - as it would have caused carnage across the sector - but the mere risk of an unpredictable court ruling was hanging over the market. I guess this will force the government and banks back together to figure out a more moderate means to help address the issue."

Unsurprisingly, the Hungarian Banking Association welcomed the support of the court. "The Kuria decision on Monday confirmed that banks were acting in a legitimate manner in their foreign currency lending practices. This concluded a number of open questions and legal maneouvring," Secretary-General Levente Kovacs told Reuters.

However, the relief is only likely to be temporary. On the one hand, Budapest has made it plain that it will push through some sort of scheme. While it may be limited in the terms it can insist upon for now, Fidesz looks set to win another term, meaning it will have another four years in office. The Kuria ruling was only seen as a means to accelerate the process at the lower courts.

Those cases still need to be heard, and that is likely to set out the parameters for any future government scheme that could be imposed on lenders. In fact, the European Commission said recently that the banks could well have missold the loans. Meanwhile, the government has also suggested it has asked the country's constitutional court to look into the constitutionality of the forex loan contracts.

Delaying the inevitable?

Never a government to shrink from pushing its way into the judicial sphere, Fidesz was swift to condemn the supreme court. Party whip Antal Rogan criticized the court for "siding with the banks," according to portfolio.hu, and sought to show a bullish face. "Once the Kuria's substantive position statements are available, hopefully at the earliest opportunity, parliament is going to formulate its own position," he claimed.

Still, while the threat of an immediate, hard-hitting scheme looks to have receded, an imposition costing lenders large sums is likely to follow at some point. That has many foreign banks, which as a whole are at the tipping point where the profit made ahead of Fidesz' entry to office in 2010 is balanced by the losses since, suggesting they could leave the market.

However, at the same time, the delay to any scheme will only make an exit harder. Hungary's banks have HUF1.8 trillion (€6bn) of forex mortgages and another HUF1.7 trillion in forex home-equity loans. With borrowers struggling from a drop of 75% in the value of the forint to the Swiss franc, the volume of non-performing loans (NPL) has been growing.

However, the government's promises of more action has seen NPLs rising in recent months, despite recovery of the economy. One in five forex loans is non-performing, reports Bloomberg. On top of that, the uncertainty has seen the banks effectively stop lending. That has seen the government controlled central bank practically the only credit provider to power economic growth through schemes unveiled earlier this year.

The Kuria also left another question dangling. It said that it would not rule on accusations that the banks made one-sided amendments to the contracts until after the European Court of Justice reaches a preliminary ruling on the issue in a related case.