Low interest rates and volatility have made the Swiss franc the currency of choice for mortgage and other private loans in Eastern Europe.

This carry trade is growing rapidly, particularly through Austrian banks, with a stock of over CHF 100 billion by mid-2006 (25% of Swiss GDP).

Swiss banks have limited direct exposure. The originating banks hedge currency exposure, but could be hit by counterparty risk.

The repercussions for Swiss banks are unclear.

Net external interbank lending from Swiss banks is growing, but represents only 1/2% of their international claims. To the extent these funds are used to finance foreign CHF retail loans, a sharp appreciation of the Swiss Franc could stress retail borrowers in Eastern Europe and reverberate back into Switzerland.

Moreover, some foreign banks directly place paper on the Swiss exchange and international markets. Swiss policies or exogenous shocks that appreciate the franc could stress retail borrowers and carry traders and eventually affect their Swiss Franc lenders.

(Total private sector CHF loans in selected countries, mid-2006: Austria -- CHF 80 billion, Poland -- CHF 16 billion, Hungary -- CHF 8 billion).