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(Adds reaction from banks in paragraphs 8-10)
By Igor Ilic
ZAGREB, April 7 (Reuters) - Croatia's Constitutional Court on Friday rejected local banks' request to assess whether a law forcing lenders to convert Swiss franc loans into euros is in line with the constitution.
Households and firms across Croatia and eastern Europe who had taken out Swiss franc mortgages to benefit from low interest rates were caught out by the surge in the franc, after Switzerland scrapped its cap on the currency in January 2015.
The previous Social Democrat-led government pushed through a law before an election in 2015 ordering banks to convert loans denominated in Swiss francs into euros at their own expense, imposing about 1 billion euros ($1.1 billion) of losses on them.
"Such a measure was necessary at the time to achieve a legitimate goal of protecting the borrowers from the firming of the Swiss franc," Constitutional Court head Miroslav Separovic said.
Eight local banks had asked for a constitutional assessment of the conversion law, saying the action did not fairly share the costs and that the government had acted retroactively.
But Separovic said "a calculation of costs did not take into account positive effects of conversion which improved the banks' lending portfolio, while the banks also got a tax exemption on the basis of conversion".
The vast majority of loans and deposits in Croatia are denominated in euros. Croatia's central bank keeps the national kuna currency in a tightly managed float against the euro.
Local bank association HUB said it was convinced enforced conversion was not in line with European Union legislation and obligations that Croatia accepted through international agreements.
"Such a legal solution does not exist in any other EU state," HUB said in a statement.
HUB did not say what further action banks could take, but some have indicated they could seek international arbitration. ($1 = 0.9400 euros) (Reporting by Igor Ilic; Editing by)