What Is a Back-to-Back Loan?

A back-to-back loan is an agreement by two companies in different countries to borrow money in each other's currency. The effect is a currency exchange.

The back-to-back lo🎉an is a hedge agai🌄nst currency risk. Each company gets the currency it needs while avoiding untimely currency rate fluctuations in the open market.

The back-to-back loan is also known as a parallel loan.

How a Back-to-Back Loan Works

Companies that do business in other countries need to obtain money in other currencies for ro🦹utine transactions. Normally, a company will trade on the for🌊ex for the currency it needs.

But because the values of some currenc𓄧ies fluctuate widely, a company can unexpectedly wind up paying far more for a given currency than it had expected. Companies with operatio🔯ns abroad may seek to reduce this risk with a back-to-back loan.

Companies could accomplish the same hedging strategy by trading in the currency markets, either cash or futures. These days, 澳洲幸运5官方开奖结果体彩网:currency swaps and similar instruments have largely replaced back-to-back loans🔯. But some companies still rely on back-to-ba💎ck loans to facilitate international trade.

Benefits of Back-to-Back Loans

One benefit of the back-to-back loan is that any currency can be exchanged this way. Only a few maj🍰or currencies regularly trade in the futures markets in a high enough volume to facilitate efficient trade.

Back-to-back loans often involve currencies that are unstable or trade in low volume. High volatility in such trad🐠ing creates a greater need among companies doing business in those countries to mitigate their currency risk.

Back-to-back loans, although not without risks, are generally more convenient and less risky than obtaining currency through the market.

Back-to-Back Loan Risks

The biggest problem companies face in arranging back-to-back loans is finding counterparties with similar funding needs. E🐓ven if they find appropriate partners, the terms and conditions of the two parties may not match. Some parties enlist the services of a 🐠broker, but brokerage fees add to the cost of the financing.

Most back-to-back loans come due within 10 years because of their 澳洲幸运5官方开奖结果体彩网:inherent risks. The greatest risk in such agreements is asymmetrical liability, which may not be covered in the back-to-back loan agreement. This liability arises when one party defaults on the loan leaving the other party still responsi🌠ble for repayment.

Default risk is thus a problem, as a failure by one party to pay back the loan does not release the obligations of the other party. Typically, this risk is offset by another financial agreement, or by a 澳洲幸运5官方开奖结果体彩网:contingency clause covered in the original loan agreement.

Back-to-Back Loan Examples

Say an American company wishes to open a European office and a European company wishes to open an American office. Each party needs to exchange money to pay for leasing 𒉰and other startup costs in the local currency.

The American company may lend the European company $1 million for initial leasing and other costs. Simultaneously, the European company lends the American company the equivalent of $1 million in euros at the current exchange rate.

Because both loans are made in the local currencies, there is no 澳洲幸运5官方开奖结果体彩网:currency risk (the risk that the exchan🐼ge rates between two currencies will swing widely) when the loans are pඣaid back.

Another example would be a Canadian company obtaining fin🐈ancing through a German bank. The company is concerned about the value of the Canadian dollar relative to the euro.ꦛ

The company and the bank can create a back-to-back lo꧟an. The company deposits CA$1 million with the bank, and the bank (using the deposit as security) lends the company CA$1 mi🅘llion worth of euros based on the current exchange rate.

The♉ company and the bank agree to a one-year term on the loan and a 4% interest rate. When the loan term ends, the company repays the loan at the fixed rate agreed upon at the beginning of the loan term, thereby ensuring against currency risk during the term of the loan.

The Bottom Line

Back-to🧸-back loans are not as common as they once were, given the availability of currency swaps anꦑd other strategies to mitigate currency risk in international trading.

Still, some companies still rely on this system to g♛ive them relatively easy and safe a🥂ccess to the foreign currencies they need to conduct business abroad.