In the late 1980s, the populace of Eastern European countries rebelled against their governments, client regimes under the dominance of the Soviet Union that was soon to collapse itself.
The West promised freedom. What large sections of these countries’ populations got instead was a new form of servitude. By Evan Jones.
All the Eastern European countries had ill-developed financial systems, with high interest rate regimes and vulnerable currencies. Most of these countries are now within the European Union (accession in 2004, 2007 and 2013, with some still knocking at the door). However, that change of status has only deepened the complexity of national financial systems.
Many banks, domestic and foreign, rushed in to offer unsuspecting borrowers a great deal – loans denominated in foreign currencies, which carried significantly lower interest rates than those attached to loans in domestic currencies. Later, euro-denominated loans were a half-way house in terms of interest rates.
Banks flogged foreign currency loans (FCLs), especially denominated in Swiss francs (CHF), to the masses in staggering quantities – for home loans and even for consumer loans like cars. As night follows day, the strong CHF (especially in troubled times) started rising again and borrowers found their loan principal in domestic currency terms blowing out to unsustainable levels. The banks, as is their custom, started foreclosing on indebted borrowers’ residences.
The issue has become a political football, as victim associations and supportive professionals fight the system – both domestically and in Europe.
Where have we heard this before? Why right here in Australia and in New Zealand (dominated by Australian banks) in the 1980s. But nobody in Europe was paying attention to the antipodean experience.
My occasional writings on the FCL experience in Australia led to me being contacted by various activists in Eastern Europe. These contacts led to my contributing an article on the Australian and New Zealand experience with FCLs to a Hungarian-edited and -published book on the FCL experience in various European countries.
The books details are: Zoltan Kiss et al (eds.), Devizahitel? Tanulmányok, esszék, vitairatok, a ‘speciális banki termék’ ről [Foreign currency loans? Studies, essays, polemical treatises on the ’special banking product’], Budapest: Rejtjel Publishing House, 2018. The 600 page tome is available here. Half of the book is in Hungarian, but the other half comprises chapters in English on various countries and on the particular character of foreign currency loans.
My chapter in that book on the FCL experience in Australia is reproduced below. I should note that this extraordinarily significant event, highlighting immediately the failures of financial deregulation, although reported well in the contemporary media, has received minimal coverage and analysis in the relevant academic and official literature in Australia. After all, financial deregulation is good a priori. The inevitable downside to deregulation has to be buried and prevented from entering the consciousness of successive generations.
[The following article is 4,300 words in length.]
* * *
The Foreign Currency Loan Experience in Australia
The 1980s: the era of foreign currency loans
In 1981, a mammoth report into the Australian financial system (Campbell, 1981: 1) had as its guiding motif:
‘The Committee starts from the view that the most efficient way to organise economic activity is through a competitive market system which is subject to a minimum of regulation and government intervention.’
This stance, driven by banking interests and ideology, ignored Australia’s turbulent financial history and the substantive reasons for the establishment of a significant post-1945 regulatory structure.
The Campbell Report’s recommendations for comprehensive deregulation and privatisation were gradually adopted on a bipartisan basis by successive governments. Coincidentally, the Australian dollar (AUD) was fully deregulated in December 1983.
In the early 1980s, loans denominated in select foreign currencies (FCLs) – mostly Swiss franc (CHF), also US dollar and Japanese yen – were aggressively marketed by Australian and New Zealand banks to their small business and farmer customers, and to small-scale property developers.
Quantitative AUD lending restrictions and high interest rates were in place – a hangover from the previous regulatory regime in attempting to restrain inflation. But these measures co-existed with a new laissez-faire attitude to bank practices. The formal attraction to borrowers was a much lower interest rate on foreign currencies – approximately 6.5% compared to 13% and over.
The means of FCL funding remains shrouded in mystery. Some victims claim that the intrinsic nature of the arrangement and entire FCL funding involved the banks taking currency and risk positions contrary to those offered and charged to borrowers, with all risks attributed to the borrowers. If so, all profits made from FCL borrowers were fraudulent, and assets seized from foreclosed borrowers illegally obtained.
Most FCLs were nominally channeled through Singapore. Singapore was used as a front with FCL-related profits routed through Singapore by ‘transfer pricing’ to take advantage of Singapore’s lower corporate tax rate.
It is possible that a percentage of FCLs were not sourced from foreign currencies at all, but were falsely denominated – to bypass domestic lending restrictions and generate super profits at the same time.
The banks loaded secret commissions on interest and on currency conversions and took the opportunity to pile up discretionary charges for their ‘services’.
In addition, the Australian banks loaded the interest charge with a 10 per cent loading for an ‘interest withholding tax’ (IWT). Such a tax was applied in Australia to foreign-sourced investments as an interim measure before ultimate profit repatriation by foreign investors. However, the IWT was inapplicable to such FCLs (because they were secured by mortgages, in breach of the Income Tax Act) but the banks knowingly applied the loading regardless.
There is no evidence that the bulk of the IWT charges collected were ever forwarded to the Australian Taxation Office. The ANZ bank acknowledged its ‘mistake’ in 1994 in adding this loading. However, only a select number of ANZ borrowers received their IWT payments back. Several other victims achieved IWT settlements in court.
A colleague estimates that these extra commissions and charges in total approximated the interest differential which seduced borrowers into FCLs in the first place.
These practices, coupled with the naked self-interest expressed in internal bank documentation, highlights that corruption had rapidly infused bank culture since the onset of deregulation.
The total number of FCL loans in Australia is unknown, but estimated to be approximately 4,500. The number issued in New Zealand was roughly 400 – 500, the majority issued by the then state-owned Bank of New Zealand, the public-private Development Finance Corporation and by Australian-owned banks in NZ. The New Zealand impetus was a direct result of copying Australian developments.
The newly-deregulated AUD plummeted in 1985, leading to a rapid blowout of the FCL debt totals in both currencies – more than double in the case of CHF loans.
CHF per AUD$1.00
There followed 15 years of dispute – between banks and borrowers, within bank personnel, in court litigation and in politics, initially extensively reported in the media.
A handful of borrowers survived. A handful beat the banks in the courts; a handful, possessing ‘smoking gun’ evidence, made confidential deals with the banks. A substantial majority of the rest lost everything. Some victims are still living daily with their loss.
Fundamentals of FCLs
FCLs are essentially a long dated foreign exchange forward contract, delivering a funding stream with the borrowers’ property and livelihood taken as security.
When banks created and contracted an FCL they established an agreement to sell the borrower a local currency, AUD or NZD, benchmarked against a foreign currency. This is a notional agreement because the borrower receives a local currency credit in his/her account.
An understanding of the ‘trade’ is vital. Far from being a trusted advisor, the bank is trading against the borrower. The bank is taking an equal and opposite risk position to that of the client.
The conflict of interest is fundamental.
When the contract is signed – in finance market parlance – the bank is Short (sells) AUD and is Long CHF. The borrower is Long AUD (buyer) and Short CHF. There is equal and opposite risk, with one winner and one loser – a zero sum game. In theory, at the end of the term of the loan these positions would be reversed to ’close out’. If the trade goes against the borrower during the term, more security is called in (a margin call) or at the end a loss crystallised. Inevitably this is exactly what happened to FCL borrowers.
The advantage goes to the party which understands the likely market direction and how to manage the risk if unexpected outcomes arise. Here, the advantage is all in the favour of the banks and against the ill-informed borrower. The banks had resources and power to look after their own interests via international finance markets. Most borrowers wouldn’t have understood the contract, let alone how to protect their own interests. Borrowers only discovered their disadvantage as deteriorating balances had to be met out of personal or business cash flow and settled immediately.
In the context of taking the opposing side of the trade with borrowers en masse, banks were taking on considerable risk, but sought to mitigate this with a range of financial instruments. It is a complicated picture of offshore funds held in foreign banks accounts, Eurobond issues and Currency and Interest Rates Swaps. These instruments are enabled through wholesale international interbank finance markets. The objective for the banks was to generate funding lines and to hedge their risk via offshore banking relationships. There was no flow of foreign currency which the borrower was accessing for purposes of the loan. The processes were never disclosed, but over the years a few key internal bank memos and records have surfaced which have partially exposed the methods banks used to generate funding lines and ‘swap’ away risk.
One New Zealand borrower attempted legal discovery of his facility’s full transactions records, but he was denied access via all official, court and financial channels, both in NZ and through the New York-headquartered SWIFT organisation that facilitates financial transactions communications. A former BNZ employee who examined the available records indicated that it was very unlikely that a foreign exchange transaction supporting a genuine offshore loan had existed in this case.
Declarations to the Reserve Banks (the Central Banks) and 1985-86 Annual Reports support the assertion that the banks only had modest foreign exchange exposures as required at the time. These were far below the value of loans issued. Either the banks didn’t have a substantial exposure (the loans locally created?) or they falsified their returns to the authorities.
The foreign currency loan as innately toxic facility
The issue is straightforward – FCLs were a toxic product. They were transparently not fit for purpose. They were not designed to suit customer needs. They were strategically used to expand market opportunities in an environment then under macroeconomic policy constraints. First introduced in a small way by marginal players, the major banks saw FCLs as a vehicle to enhance market share with a facility atypically lucrative. They were sold to the customer in a totally unprofessional ‘cowboy’ atmosphere.
The loans were unhedged – the costs of hedging would have negated the interest differential – and the customers were so advised. They were given to domestic businesses not generating income in the denominated currency.
From the dismantling of the Bretton Woods system after 1971, senior bank managers were aware of the dangers of fluctuating currencies. During the 1970s, FCLs were made available only to large corporations and only under stringent conditions. After 1981, the banks raced to push this known toxic facility onto an inappropriate market segment, guaranteed to incur huge losses.
Relevant bank staff remuneration and status was linked to their sales performance, so there was an inbuilt need to misrepresent the risk of FCLs to the borrowers, and an intrinsic conflict of interest on the banks’ part.
Commentary on an internal memo by a Westpac senior manager, 17 February 1986, encapsulates the innate flaw: “This document encapsulates the whole dilemma with this product, it was the only product marketed within the Banking system where neither the Bank nor the borrower had control over the principal. … Neither the Bank nor the borrower has control of liabilities”.
In a 1990 judgment by Justice Rogers favouring the customer (Mehta v Commonwealth Bank of Australia), the judge summarised succinctly the facility’s flaws: “Nobody in his right mind, after being told that the possible loss was unlimited, that the necessary implementation of safeguards would be limited in their effect and would require continuous attention which the bank refused to provide, would contemplate making the borrowing”.
Claims were made by legal counsel for the banks that the borrowers were generally sophisticated and of necessity risk-takers. The argument is absurd. Yet the Mehta case was overturned on appeal for the bank on such ‘reasoning’.
The borrowers’ competence was not as currency dealers (the expertise then highly specialised) but in the field of their business. The competencies are of a dramatically different kind.
Moreover, the borrowers were not ‘gamblers’. The borrowers would have had the expectation of reliable credit instruments that would allow them to concentrate on the risks associated with their particular stock in trade.
The long war of position
From mid-1985 there was a long impasse, with customers confronting their threatened default and panicked bank staff examining the fallout. All participating banks publicly denied any obligation to borrowers. The rare bank staff who supported the wronged borrowers were marginalised or persecuted.
Bank documentation discovered during court litigation disclosed that bank personnel dealing directly with borrowers had no understanding themselves regarding foreign currency markets. The ignorance of bank personnel and/or concerns regarding the dangers of FCLs were not conveyed to potential borrowers. Rather, in the aggressive marketing push, the risks were claimed to the borrowers as minimal.
Borrowers spent several years obsessed with whether to revert to AUD soon (and incur probable default) or to wait, dependent upon ill-informed expectations of AUD movements – having to operate their businesses at the same time.
The banks established various service ‘risk management advisory’ centres, formally to assist bereft borrowers with currency market advice, hedging possibilities, etc. However, the banks cared foremost about the asset security behind their loans. Charges for these perfunctory and dysfunctional services were added to the borrower account.
Customer attempts at hedging compounded the fiasco. Given that the AUD-CHF relationship was mediated by the flexible USD cross rate, the complexities of currency monitoring could only be handled by the most sophisticated of bank personnel with the latest equipment.
An affidavit made by Max Dodd, a long-time employee of the Commonwealth Bank of Australia (CBA), in 1998 summed up the rot at the heart of the FCL scandal. Key comments included:
• ‘[The loan] had at the outset no form of in built safety mechanism to protect the borrower and the bank against a dramatic fall in the AUD, such as a stop loss mechanism’
• ‘most borrowers typically: were virtually completely inexperienced in foreign currency matters [and] had a poor understanding of the contents of the letters of offer used by the bank for such loans, and instead relied on the explanations they had been given verbally by a bank officer’
• ‘few if any Branch Managers and Loans Officers had meaningful knowledge of the facility. Similar comments applied to many of the approving Control Officers in the State Administration’
• ‘Typically borrowers said that they had been told by a bank officer prior to taking up an FCL some or all of the following: that the Swiss franc was stable; that Swiss interest rates were dramatically below the level of domestic rates; that they would become onshore loans if the rate moved more than 5% against them’
In May 1989, Dodd had written an internal memo with the intent of trying to save as many borrowers as possible. He put the onus of responsibility for the crisis entirely on the bank itself:
‘In carrying out this task we should keep in mind our litigation experience but acknowledge privately that all of the problems we are experiencing are essentially of our own making.’
Many FCL borrowers took their banks to court during the late 1980s and 1990s. Battles in the courts hinged on the character of information and advice offered by bank officers and influence exercised on borrowers in contracting for a FCL loan. This in turn hinged on judges’ determination of the credibility of bank officers versus that of borrowers in their testimony. Bank officers lied in court, claiming that they offered only information. But bank documentation disclosed that FCLs had been aggressively marketed and their risks discounted.
A handful of borrowers won their case, highlighting that some judges were prepared to stand against strong legal conventions regarding bank-customer relations.
The case involving Chiarabaglio v Westpac (1989) is representative. Like many post-1945 migrants to Australia, Domenico Chiarabaglio had no formal education and remained barely literate in English. Nevertheless, he acquired engineering skills and ran a successful agricultural equipment repair business, and he also became involved successfully in property development.
In his business dealings, Chiarabaglio had shown himself to be extremely prudent, and he had a long term relationship with Westpac in whose professionalism and integrity regarding financial matters he placed absolute trust.
Chiarabaglio had heard about FCLs and in April 1982, he met with Westpac’s s Queensland FCL marketing manager. Chiarabaglio left with a FCL of $500,000 in Japanese yen. In early 1985, the loan was converted to CHF. By late 1985, with the dramatic devaluation of the AUD compared to CHF, he was required to give the bank more security for his expanding loan principal.
The replacement FCL manager offered Chiarabaglio empty promises regarding the value of hedging, etc.
In 1986, Chiarabaglio took Westpac to court. He sued Westpac both under Common Law for negligence and under statute law (the 1974 Trade Practices Act) for ‘misleading representation’.
Other victims did the same. But judges perennially preferred to handle these cases under Common Law with which they evidently felt more comfortable.
The judge found Chiarabaglio’s testimony credible. The judge found negligence on the part of the bank FCL manager in assertively pushing the FCL facility as an attractive proposition and in failing to fully explain the risks associated with the facility. The judge found reliance – Chiarabglio had acted on the manager’s advice – and causation – Chiarabaglio’s subsequent financial losses were caused by the bank manager’s negligence. Given Chiarabaglio’s history, he would never have contracted for such a risky facility if he had been fully and accurately advised as to its character.
In the circumstances of this particular facility the judge determined that the bank had a ‘duty of care’ to the customer. Justice Andrew Rogers, who presided over several FCL cases (including Mehta, above) elaborated on this reasoning in an academic article (Rogers, 1990). Rogers, rarely for such litigation, closely examined discovered bank documentation – highlighting the implication of bank guilt in these documents. A sample of such documentation is analysed in Jones (2005).
Several other court cases followed the same pattern. But why were such judgments not universal for all FCL litigants? Rather, a majority of court judgments in FCL litigation were for the bank.
The majority of court judgments in FCL litigation highlighted a deep legal and judicial bias in favour of bank lenders (confirmed by other banking litigation over decades). The bias is a product of Australian judicial dependence on the English Common Law, with its emphasis on the ‘sanctity of contract’ and the presumed informed and rational self-interest of all parties.
The question of whether the bank lender may have abused its asymmetric dominance of the borrower is subject to considerable discretion at the hands of the judiciary. However, judicial culture, reflected in judgment ‘precedents’ purporting to give case law a semblance of coherence and ‘objectivity’, has dramatically narrowed the terms on which the more powerful bank lender has a ‘duty of care’ to the borrower.
The evolved culture of the Australian judiciary holds it that commerce operates under ‘the law of the jungle’, and that the more powerful party has a right to exploit that power. More, a credit relationship is treated as no different to any other commercial relationship. Thus Wickrema Weerasooria, author of Australia’s preeminent banking law textbook, has stridently claimed:
“Banks owe no fiduciary or ‘special duty’ to customers” (Weerasooria, 2000) – summing up both court litigation history and articulating his own prejudices.
An additional dimension is involved. Westpac FCL borrower Lionel Potts won his case in the lower court in 1990 (accompanied by several other victories against Westpac), but it was overturned on appeal in April 1992. The appeal judgment for Westpac is so bereft of due procedure and of intelligence that it points to naked corruption (Jones, 2014). In this instance, elite forces coalesce to ensure that bank corruption and its perpetrators escape redress.
In general, FCL borrowers did not achieve a deserved justice in the courts, facing instead a judiciary both culturally prejudiced and complicit with bank malpractice.
The regulatory and political arena
The federal Treasury and the Reserve Bank of Australia, responsible for what remained of bank regulation, refused to intervene. RBA personnel were aware of bank foreign currency exposure, contrary to official policy, but ultimately did nothing.
On the political front, the government, committed to deregulation, offered no support to borrower victims. The FCL scam was merely the most sensational dimension of an escalation of bank malpractice. Paul McLean, Senator for a minor Parliamentary party, became a recipient of many complaints which he raised in Parliament.
The then Labor Government set up a Parliamentary Inquiry to divert the criticism, fueled by significant media coverage. Submissions to the Inquiry disclosed much important detail of the FCL affair. Bank personnel consistently lied and dissembled before the Inquiry. The subsequent report (Martin, 1991) was a whitewash, ignoring the incriminating evidence submitted.
Senator McLean himself was vilified and forced out of Parliament.
The banking sector was facing massive losses from contemporaneous ill-considered lending to incompetent and/or corrupt corporate mavericks, compounded by the early 1990s recession (brought on by inappropriate government policies). Major banks had reported significant losses and Westpac, in particular, was near-bankrupt. The government’s priority was to prop up the banks at the expense of the victims.
Of particular importance was the government-owned Commonwealth Bank of Australia, a key participant in FCL loans. The CBA had been created in 1911 and re-fashioned in 1945, on both occasions by Labor governments, to serve the public interest. Now in the 1980s it had joined with the private banks in unethical practices. In addition, the Labor Government decided in the late 1980s to privatise the bank, so maintaining the bank’s viability was of prior concern. A comparable imperative existed in NZ in shoring up (for later privatisation) of the state-owned BNZ.
FCL victims made ongoing attempts to involve Members of Parliament in their plight, but without success. There were no court victories for victims after 1991. The media gradually lost interest.
Lessons from the antipodean experience
Following private banking crises and selective orientation during the 19th Century, state-owned banks were established for broader coverage and the system was gradually subject to more stringent regulation. However, a resurgent powerful banking lobby was complemented by the rise of neoliberalist ideology in the 1970s. The banking sectors were subsequently subject to privatisation and deregulation in Australia and NZ, as elsewhere.
The selling of FCLs per se is probably best understood as an aberration in the antipodean context. By contrast with Eastern Europe, the banking infrastructure was well established. None of the major lenders were foreign owned, and they held no natural counter-balancing assets in foreign currencies.
There was a peculiar confluence of events – a period in transition from tight regulation to deregulation. There were quantitative lending restrictions still in place from the pre-deregulation era, high inflation and high interest rates, in conjunction with a premature tolerance of banks’ prerogative to compete on any terms for market share, and in the face of new foreign entrants scheduled for 1986. In addition, the FCLs were conceived and initially sold when the AUD and NZD were fixed (to a basket of currencies) but the currencies were floated soon after, reinforcing the unsuitability of the facility.
There were elements in common with the East European experience. These elements include the competitive pressure to market a toxic product, and dishonestly, to customers totally unsophisticated in financial matters, and left ill-informed by bank lenders (c/f Schepp & Mátrai-Pitz, 2016: 478).
However, only small businesses and family farmers were targeted in Australia and New Zealand. The minimum loan in Australia was $500,000. Local government borrowing was still under strict central control by the statutory Australian Loan Council. There is no internal documentation to suggest that the banks ever considered home mortgage FCLs. The sums were too small, it would have required active marketing and exposure to the authorities, and management of foreign currency exposure would have been understood to be intolerable for banking staff still generally unfamiliar with foreign currency management.
What was not an aberration was that the FCL lending was the first reflection of a transformed culture in which the banks were given free rein to engage in loose lending practices, by which incompetence and corruption became embedded in the banking sector’s practices.
Following the whitewash Martin Inquiry Report, the government condoned self-regulation in the banking sector. The banks, now also dominant in wealth management and insurance, have used this unregulated environment to continue with corrupt practices. There have been many subsequent Parliamentary inquiries into the banking sector, resulting in minor reforms, but the financial sector essentially continues its incompetent and corrupt practices with impunity.
One doesn’t have to be conspiratorial to understand the continuing failure of the authorities. The highly profitable major banks donate to the major political parties. The banks are powerful lobbyists for their interests. They threaten media management, by withdrawing advertising, if adverse reporting appears in the media. They bribe politicians, if not directly then of promises of high-paid employment following retirement from politics. Law firms subordinate ethics in pursuit of bank litigation business. All judges and politicians have personal banking relationships, in which their self-interest is possibly uppermost in their minds.
Unfortunately, there are few optimistic lessons to be learnt for current FCL victims overseas from this experience. A complicit legal and judicial culture is a deep-seated problem that must be strategically addressed in the long term.
However, the anti-social practices of banks have not been tolerated in past periods, so an anti-corruption regime is conceivable. Bank corruption in Australia has become so pronounced, across most facets of bank portfolios, that there is in 2017 an unprecedented call for a Royal Commission into the sector, including from the Labor Party currently in Opposition. The time is propitious for a public accounting of bank malpractice during the era of deregulation since the 1980s.
[Campbell] Committee of Inquiry into the Australian Financial System (1981), Australian financial system: final report. September.
Chiarabaglio v Westpac Banking Corporation (1989), Foster J, Federal Court of Australia, 21 July.
Martin Committee [Parliament of the Commonwealth of Australia, House of Representatives Standing Committee on Finance and Public Administration] (1991), A pocket full of change: banking and deregulation, November.
Jones, Evan (2005), “The Foreign Currency Loan Experience in 1980s Australia with particular reference to the Commonwealth Bank of Australia: bank documents, bank culture, and foreign currency loan litigation”, Working Papers, ECOP 2005-3, Department of Political Economy, University of Sydney, December.
Jones, Evan (2014), “Westpac, the Foreign Currency Loans Scandal and the de Jersey Factor”, bankvictims.com.au, March.
Mehta v Commonwealth Bank of Australia (1990), New South Wales Supreme Court, 27 June.
Rogers, [Justice] Andrew (1990), “Developments in Foreign Currency Loan Litigation”, Journal of Banking and Finance Law and Practice, September, 201-210.
Schepp, Zoltá & Mátrai-Pitz, Mónika (2016), ‘Foreign currency borrowing in Hungary: the pricing behaviour of banks’, in Sabri Boubaker, et.al., Risk Management in Emerging Markets: Issues, Framework and Modeling, Bingley, UK: Emerald Group Publishing, pp.469-504.
Weerasooria, Wickrema (200), ‘Banks owe no fiduciary or ‘special duty’ to customers: a reaffirmation’, Australian Banking and Finance Law Bulletin, 15, 9, April.