Back To Back Loan

Back-to-back loan definition

The traditional back-to-back loan definition is any arrangement between two companies in different countries that allows each to borrow the other’s currency at a fixed exchange rate, providing a means for each company to benefit due to the elimination of paperwork and exchange rate calculations throughout the life of the loan. Essentially, companies help each other to do business in foreign countries by making an exchange of currency through these back-to-back loans, also known as parallel loans.

Historical usage of back-to-back loans

Although instances of back-to-back loans have been recorded as far back as the 18th century, back-to-back loans first achieved common usage in the 1970s when they were used in the United Kingdom to avoid taxes on foreign investments. By using a parallel loan rather than purchasing foreign currency, companies could bypass these regulations and gain the currency they needed in the foreign market they were interested in penetrating; this offered significant advantages to the companies who engaged in this practice. Additionally, the fixed rate of exchange ensured that no unpleasant financial shifts in the respective values of the currencies involved would create additional indebtedness for the companies.

Back-to-back loans today

Traditional back-to-back loan arrangements are not as commonplace today due to the increasing prevalence of currency swap transactions and other foreign exchange derivatives. Essentially, currency swaps represent a refinement of the back-to-back loan; actual cash is not transferred, but the financial aspects of the loan are transferred legally and the element of net present exchange value is retained. This allows companies to secure needed funds at the best available rates, while retaining the advantages afforded by a traditional back-to-back loan. By swapping only the liability for the loans, rather than the cash itself, companies can avoid the fluctuations in exchange rates in the same manner as was afforded by parallel loan transactions without the attendant exposure of exchanging actual funds. This enhancement allows back-to-back loans to continue to promote international trade without the necessity of actual currency changing hands at any point. Alternatively, companies may elect to exchange the principal amount of the back-to-back loan in currency without altering domestic loan arrangements; this allows each company to pay its loan off in its home country while obtaining the foreign funds they need to do business in another country. While these are technically currency swaps and not traditional parallel loan transactions, they borrow heavily from the concept of back-to-back loans, and are the natural successors to the older method.