What is a Hard Loan?
A hard loan is an international loan that must be repaid using hard currency, a currency from a country known for its political stability and robust economy. For example, a developing nation might secure a hard loan denominated in U.S. dollars.
Key Takeaways
- A hard loan involves lending money in a reliable and stable hard currency, such as the U.S. dollar.
- They are frequently utilized by borrowers from developing countries to minimize risks associated with less stable native currencies.
- Currency fluctuations can affect repayment costs, increasing the load on the borrower if their currency devalues against the hard currency.
How a Hard Loan Works
Hard loans are formal agreements between lenders and borrowers from different countries, involving well-established hard currencies. These loans mitigate risks associated with volatile, less-stable currencies. They utilize currencies from financially and politically stable economies. For example, a hard loan can consist of euros lent to a Brazilian company, protecting the lender from severe currency devaluation risks.
However, if the borrower’s domestic currency weakens significantly against the hard currency, repayment becomes harder. For instance, a Brazilian manufacturer who took a loan in euros would face greater repayment costs if the euro rose by 20% against the Brazilian real, effectively increasing the loan’s outstanding amount by 20%.
Forex Considerations on Hard Loans
What makes a currency ‘hard’ is its stability over short periods and high liquidity in the foreign exchange (forex) market, where currencies are exchanged. Forex is the world’s largest and most liquid market, handling trillions of dollars daily without a centralized marketplace. Transactions occur around the largest financial hubs, like London, New York, Tokyo, and others.
A currency’s stable value often reflects its nation’s economic basics such as GDP and employment stats. For example, the U.S. dollar’s strength is partly due to America’s top-ranking GDP of $21.43 trillion as of 2019. Alternatively, despite having the second and fifth-largest GDPs respectively, the Chinese yuan and Indian rupee are not considered hard currencies. This shows how national central bank policies and monetary stability affect currency strength, with the U.S. dollar being a predominant reserve currency used in 88% of international trade.
Example of a Hard Loan
Consider a loan agreement where a Brazilian corporation borrows money from an Argentine bank payable in U.S. dollars. This arrangement exemplifies a hard loan, as both Brazilian real and Argentine peso are relatively unstable compared to USD, which has solidified itself as a global hard currency.
Related Terms: hard currency, reserve currency, forex, currency volatility, international trade.
References
- Nasdaq. “Forex Market Overview”.
- Bank for International Settlements. “Foreign Exchange Turnover in April 2019”.
- The World Bank. “GDP (Current US$)”.
- Bank for International Settlements. “Triennial Central Bank Survey, Foreign Exchange Turnover in April 2019”, Page 3.
