UPDATE 1-EU asks Croatia to rethink franc loan conversion law

(Adds Croatian govt reaction)

ZAGREB, July 8 (Reuters) - The European Commission asked Croatia on Friday to rethink a law ordering banks to convert Swiss-franc loans into euros, saying it disproportionately hurt local lenders, state media reported.

The law, brought in last year, was also applied retroactively, a move that could undermine investors’ confidence in the economy, state news agency Hina quoted Brussels officials as saying.

Croatia’s government said in a statement it had received a warning that the law broke EU rules and promised to “do all it can to prevent possible negative consequences,” without going into further details.

The legislation, brought in by a previous administration, ordered the conversion of loans denominated in Swiss francs at the banks’ expense - imposing about 1 billion euros ($1.11 billion) of losses on local lenders, almost all of them owned by parent companies from the European Union.

Most of Croatia’s Swiss-franc loans were made during the credit boom in the 2000s, driven by low interest rates, and were primarily used for mortgages or buying commercial property.

When the Swiss central bank lifted its cap on the value of the franc early last year and the franc surged, they became far more expensive to service.

“The costs of conversion have almost entirely burdened the lenders and the measure goes beyond what is necessary and proportionate to achieve a legitimate goal of protecting poorer borrowers and avoid a consumer credit crisis,” Hina quoted the Commission’s spokeswoman Vanessa Mock as saying in Brussels.

“We hope that Croatia will find a proportionate solution. It is important in the interest of all, consumers and investors,” Mock added.

Brussels expects an answer on the warning by mid-August and can take action through the European Court of Justice if it is unhappy with how Croatia responds.

Some banks have already filed a suit with the Constitutional Court and indicated they could seek international arbitration.

Croatia is facing another round of elections, most probably in early September.

$1 = 0.9025 euros Reporting by Igor Ilic; Editing by Andrew Heavens