Wednesday, June 20, 2007

Common Characteristics of Foreign Currency Loans

Based on the Austrian Experience

A foreign currency loan is a loan denominated in a currency other than that of the borrowers home country that must be repaid also in this currency. The majority of foreign currency loans are granted with a maturity of up to 25 years, but are rolled over every three or six months; the interest rate is linked to the London Interbank Offered Rate (LIBOR) of the relevant currency. The bank charges an additional 1.5% to 2%, depending on the size of the loan, the nature of customer relations, the collateral provided, etc.2) Interest (and principal) payments are due retroactively upon maturity and have to be made in the currency in which the loan is denominated. In many cases, the borrower may repay the loan before it is due or switch to another currency (including euro) at the rollover dates.

Loans denominated in a foreign currency are usually bullet loans combined with funding plans, which may differ from bank to bank. This means that until maturity, the borrower makes only interest payments. In addition, the borrower pays into a repayment vehicle during this period, for instance a life insurance policy or a mutual fund, which is to cover the principal to be repaid at maturity. Foreign currency loans at fixed interest rates are granted very rarely. The minimum amount required for currency swaps involving Japanese yen, for instance, would be too high; such arrangements may only be made in Swiss francs by large Austrian banks which are active in the Swiss market. In this case, however, borrowers do not have the option to cancel the foreign currency loan before maturity.

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