Daring Game: Financing in Foreign Currency

Foreign currency financing has always discredited the spirits: advocates see it as an appropriate way to reduce the cost of real estate financing, and adversaries see borrowing in a foreign currency more as an element of speculation rather than an asset-building tool.

What happens with foreign currency financing ? The principle is actually quite simple. A loan is not taken in euros but in another currency. Popular foreign currencies are the Japanese yen or the Swiss franc. In principle, however, loans can be taken in any major currency.
The goal of foreign currency financing is to exploit differences in the interest rates of different currency areas. For example, interest rates in Japan are traditionally very low because the country has been in a deflationary scenario since the 1990s. A low interest rate is trivially good for borrowers and allows faster repayment of liabilities.
Any installment the borrower uses to repay his exposure is converted into the loan currency. The exchange rate is not constant, but is subject to fluctuations whose direction and extent are unpredictable.
Here is the risk of foreign currency financing : If the value of the euro falls against the loan currency , a larger euro amount must be used for the repayment. So the real debt burden is rising. Experience shows that the price fluctuations on the foreign exchange market can take on considerable proportions.

However, the exchange rate fluctuations also offer a chance. If the price of the euro increases against the foreign currency , the debt burden decreases because a smaller amount of euro is needed for the debt service. At best, a significant portion of the loan will pay off “by itself” through foreign exchange gains.

The price risk requires special security measures. As a rule, banks require a significantly larger share of equity than is the case with conventional financing in the euro. In addition, a foreign currency loan is accompanied by active currency management, which redirects the loan to another currency in the event of major exchange rate losses, thus preventing worse.

Whether the risk of a foreign currency loan pays off can ultimately be judged only after the fact. However, since the basic motivation for borrowing in yen, francs and Co. is the reduction of the interest rate, the special risk should only be accepted if it faces a corresponding opportunity. In other words, foreign currency financing is only worthwhile if the interest level in the loan currency is significantly lower than in the euro zone.

 

Leave a Reply

Your email address will not be published. Required fields are marked *