* Banks should offer swapping Swiss franc loans to euro-PSZAF
* Conversion is "no silver bullet" for non payment -banks
* Higher interest rates could make EUR payments high too -OTP
(Adds OTP Bank comment in paras 12-13)
BUDAPEST, Jan 11 (Reuters) - Hungary's banks should offer borrowers the option of converting Swiss franc-denominated household loans into euro-based ones to dampen exchange rate volatility, financial watchdog PSZAF said on Tuesday.
Hungarian households' large stock of foreign currency denominated loans, nearly half of which is in Swiss francs, has become a sticky problem for borrowers, banks and policy makers and is a key vulnerability for the country. Spokesman Istvan Binder told state television m1 that PSZAF had sent a letter to bank executives on Friday in which it outlined the reasons and benefits of such a conversion.
The Swiss franc was trading near record highs against the forint on Monday, boosting the costs of debt servicing for ordinary consumers across a country that was forced to seek IMF aid during the financial crisis.
"The last few years have shown that the Swiss franc has been much more volatile against the forint than the euro has been, posing a problem for people who hold franc-denominated loans," Binder said.
The switch would also benefit banks, as the steadier EUR/HUF exchange rate leads to fewer non-paying clients, Binder said.
"We do not propose immediately exchanging loans, rather for banks to develop products that incentivise conversion," he said.
Non-performing loan rates have reached 10.6 percent among households and 12.7 percent among companies by September 2010, the National Bank of Hungary has said, pointing to the franc's gains as a chief reason behind the rise.
The Hungarian Banking Association said it would consider the PSZAF proposal, but added that many banks already offer the option to switch currencies that loans are denominated in.
"It is one of the tools we use to try and help borrowers," Banking Association spokesman Janos Muller said. "Banks use it more and more often. However, the circle of clients for whom this solution is applicable is rather limited."
"There is no silver bullet to eradicate non-payments," he added. "This conversion idea isn't one either."
Hungary's OTP Bank, emerging Europe's largest independent lender, said in an emailed statement that it offered the option to switch already and very few clients had taken it, adding that the move might not result in lower payments.
"Although the CHF and EUR interest rates have come very near one another, on the long run the differential is more likely to return to average levels, resulting in a higher interest burden for clients who switch to euros," OTP said.
Analysts also warned that exchanging the loans now would lock in recent losses as the franc has also traded near record highs against the euro.
"Now that the franc is near record highs against the euro it would not be ideal to exchange the loans," Concorde Securities analyst Attila Gyurcsik said. "I would make it available for clients, though." "Somewhere around EUR/CHF at 1.35 and CHF/HUF at 200 it would make sense for many people to make the switch," he added.
"A switch like that would raise lots of questions that would have to be regulated carefully for the euro switch to be realistic. Interest rates, foremost, would have to take EURIBOR as a benchmark, with a sensibly set spread." (Reporting by Marton Dunai; editing by Stephen Nisbet)