Variable-rate loans and foreign currency loans are often appealing because of their attractive initial terms. However, these financial instruments conceal complexities and risks that can turn a financing project into a financial trap. Their structure, which indexes the cost of borrowing to external and unpredictable factors such as market rates or currency parities, exposes the borrower to variations that can have far-reaching consequences. The lender's remuneration, which appears advantageous at the outset, can change unfavourably. Understanding the mechanisms involved in these loans, the extent of legal protection and possible remedies is therefore essential for any borrower, whether an individual or a company director. The aim of this article is to demystify these products and give you the keys to assessing how dangerous they are. For a broader overview of the components of the cost of credit, you can consult our guide to lender remuneration.
Understanding variable-rate loans: mechanisms and uncertainties
A variable-rate loan, also known as an adjustable-rate loan, is a loan where the interest rate is not fixed for the entire term of the contract. It rises or falls according to fluctuations in a reference index, usually an interbank market rate. This variability distinguishes it radically from a fixed-rate loan, where the borrower knows from the moment he signs the contract the exact amount of his repayments until the end of the term. The initial attraction of the variable rate lies in a starting rate that is generally lower than that of a fixed-rate loan, but this potential saving is offset by a future risk.
Functioning and benchmarks
The variation in the interest rate on a variable-rate loan is contractually linked to a market index. The most common are European interbank rates, such as EURIBOR (Euro Interbank Offered Rate) or, in the past, EONIA. The loan contract specifies the frequency of the review (annual, quarterly, etc.) and the margin that the bank adds to the index. In practical terms, your rate corresponds to the reference index on a given date, plus the bank's margin. If EURIBOR rises, so will your rate.
To limit the risk of rising interest rates, some contracts include protection mechanisms. The best known is the "capped rate". A capped variable-rate loan is one where the rate cannot exceed a ceiling defined in the contract. For example, a loan capped at +2 % on an initial rate of 3 % can never see its interest rate exceed 5 %. This security comes at a cost, often in the form of a higher bank margin than for an uncapped loan.
The problem of negative interest rates
An unprecedented economic situation has seen certain benchmark indices, such as CHF Libor or EURIBOR, move into negative territory. This anomaly has raised a complex legal question: if the reference index becomes so low that the calculation formula (index + margin) produces a negative overall interest rate, must the lender remunerate the borrower? This idea, which runs counter to the very nature of the loan contract, has given rise to a great deal of litigation.
The Court of Cassation clarified the situation in a major decision (Cass. 1re civ., 25 March 2020, no. 18-23.803). It ruled that the nature of a loan contract implies that the borrower must return the funds and pay interest as remuneration. Consequently, "the lender may not be required, even temporarily, to pay any remuneration to the borrower".. Unless explicitly provided for in a contractual clause, the variability of the rate cannot therefore lead to a reversal of roles and oblige the bank to pay interest. In the absence of any stipulation to the contrary, the floor rate for a loan is therefore 0 %.
Loans denominated in foreign currencies: specific features and exchange risks
Foreign currency loans are a special category of structured loans. They are taken out in euros, but their outstanding capital is denominated in a foreign currency (Swiss franc, yen, dollar, etc.). The monthly instalments, paid in euros, are calculated according to the exchange rate between the euro and the currency at the time of each instalment. The appeal of these loans was based on historically low interest rates in certain currencies, such as the Swiss franc. The risk, often underestimated by borrowers, is that of exchange rate fluctuations.
Terms and conditions of subscription
Because they are so dangerous, legislators have introduced strict restrictions on taking out such loans. Article L. 313-64 of the French Consumer Code is very clear: individuals may only take out a loan denominated in a foreign currency if they declare that they receive the majority of their income or hold assets in that currency. This rule is designed to ensure that the borrower has the natural resources to cope with an appreciation of the foreign currency against the euro. If the borrower does not meet this condition, the loan can only be granted if the exchange rate risk is fully hedged, i.e. borne by the lender, which is extremely rare in practice.
Currency risk: a vulnerability for borrowers
The main danger with these loans is the exchange rate risk. If the foreign currency rises sharply against the euro, the amount of capital outstanding in euros increases automatically. After several years of repayment, a borrower may find that he or she owes more in euros than the capital initially borrowed. This is what happened on a massive scale with Swiss franc loans when the Swiss currency soared against the euro.
Faced with this considerable risk, the Court of Justice of the European Union (CJEU) has strengthened consumer protection. In its landmark ruling Kásler (CJEU, 30 April 2014, Case C-26/13), it established that the requirement for clarity in an exchange clause is not merely grammatical. The contract must transparently set out how the conversion mechanism works. Above all, the borrower must be put in a position to assess, "on the basis of precise and intelligible criteria, the potentially significant economic consequences". arising from this clause. In other words, simply mentioning the risk is not enough; the bank must ensure that the borrower has truly understood the extent of the danger.
Legal framework and protection for borrowers
Legislation and case law have gradually introduced safeguards to limit the abuses of structured loans and protect borrowers. This protection is based on specific regulations, but also and above all on the duty of advice and information incumbent on credit professionals.
Specific regulations and limitations
Faced with the ravages caused by the "toxic loans" taken out in the 2000s, the legislator has intervened to prohibit or limit access to them for certain entities. Local authorities, their groupings and fire and rescue services may no longer take out loans with rates indexed to complex formulae or speculative indices (article L. 1611-3-1 of the French General Code for Local Authorities). Similar restrictions have been introduced for low-income housing organisations (HLM) by article L. 423-17 of the French Construction and Housing Code, and for public health establishments. The aim of these laws is to restrict these public bodies to simple, predictable financial products.
Duty to advise and unfair terms
For non-professional borrowers, protection rests mainly on two pillars: the banker's duty to warn and the theory of unfair terms. The lender, as a professional, has a duty to warn the uninformed borrower of the specific risks of the proposed loan, particularly where there is a significant exchange rate or interest rate risk and the contract may lead to excessive indebtedness.
Information on the total cost of credit is also essential. Clear and accurate information on the Annual Percentage Rate (APR), or Taux Effectif Global (TEG) for consumer credit, is essential. If the TEG is incorrect or not communicated, the lender can be severely penalised. To find out more about this technical point, see our article dedicated to the calculation of the TEG/TAEG and its penalties.
In addition, a clause which has not been individually negotiated and which creates a significant imbalance between the rights and obligations of the parties to the detriment of the consumer may be deemed unfair. In the case of foreign currency loans, the French courts, under the impetus of the CJEU, are examining whether the lack of transparency on exchange rate risk constitutes such an imbalance. If a clause is found to be unfair, it is deemed unwritten, i.e. it is removed from the contract, which can have major consequences for the loan.
Recourse and defence strategies in the event of a dispute
When a borrower gets into difficulty because of a variable-rate loan or a loan denominated in a foreign currency, there are several possible avenues of recourse. The complexity of these disputes and the constant development of case law mean that the assistance of a lawyer who is an expert in banking law is essential if an effective defence strategy is to be devised.
Actions for nullity or liability
The most common form of action is to have a contractual interest stipulation annulled because of an error or omission in the TEG/TAEG. For a long time, the penalty was the substitution of the statutory interest rate, which is much lower, for the contractual rate. Since an order of 17 July 2019, the penalty has been unified: the lender may be deprived of its right to interest in a proportion set by the judge, depending on the damage suffered by the borrower.
Another strategy is to hold the lender (and sometimes the notary) civilly liable for breach of their duty to warn or advise. If the borrower is able to prove that the bank did not properly warn him of the risks inherent in the transaction and that he has suffered loss (for example, the loss of an opportunity not to enter into the contract or to enter into it on less risky terms), he may be awarded damages.
In the most serious cases of concealment of information, criminal proceedings for misleading commercial practices are also possible. The limitation period for most civil actions is five years. For non-professional borrowers, this period generally runs from the day on which they knew or should have known of the error or omission, which is often the date on which the problem is revealed (for example, on receipt of a statement showing an explosion in the capital owed).
The impact of case law and preliminary rulings
Litigation over structured loans is strongly influenced by the decisions of the highest courts. The Cour de Cassation in France and the CJEU at European level regularly issue rulings that clarify the scope of banks' obligations and borrowers' rights. French courts have the option of submitting 'preliminary questions' to the CJEU to ensure that their interpretation of national law complies with EU law. This dialogue between judges has been a powerful driving force in strengthening consumer protection in Europe. Keeping abreast of the latest case law is expert work, enabling us to adjust our defence strategies and identify new opportunities for aggrieved borrowers.
The complexity of variable rate and foreign currency loans, and the financial stakes they represent, demand absolute vigilance. If you have taken out such a loan or are considering doing so, legal advice is more than a precaution - it's a necessity. To analyse the compliance of your contract and defend your interests, contact our law firm specialising in banking law.
Sources
- Consumer Code
- Monetary and Financial Code
- Civil Code
- General Code of Local Authorities
- Law no. 2010-737 of 1 July 2010 reforming consumer credit
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