Often referred to as parallel loans, the concept of back-to-back loans involves two companies that are located in different countries. As a means of avoiding any factors associated with the risk of foreign exchange rates changing, the two companies agree to loan each other a fixed amount, guaranteed at the current spot exchange rate. This makes it unnecessary for either company to work out details of a loan that would be subject to a rise or fall in the rate of exchange between the two countries. By agreeing to in effect borrow currency from one another, the foreign exchange risk is eliminated altogether, and both companies benefit from the fixed rate.
The actual structure of back-to-back loans is simple. For instance, two companies, one based in the United States and one in Great Britain, determine to conduct a back-to-back loan arrangement. The US company would loan out a fixed amount of US currency to the British partner. In turn, the UK company would extend a specified amount of British currency to the US based company, with the exchange rate being based on the current daily exchange rate. The two companies would agree on a duration period for the loan, at which time they would exchange currencies once again, completing the cycle.
The idea of a parallel loan is nothing new. There are some indications that the arrangement was used as far back as the 18the century, between the United Kingdom and various European countries. The simplicity of exchanging one amount of currency in return for a comparable amount of another currency helped businesses to be competitive outside their own countries.
As the banking systems became more sophisticated in the 19th and early 20the centuries, back-to-back loans continued to be a quick and easy way for two companies in different countries to assist one another is growing their respective businesses. Back-to-back loans continued to be a popular option well into the 20th century. However, the implementation of currency swaps through the foreign exchange system helped to lessen the appeal of back-to-back loans. The result is that the back-to-back loan strategy is not employed often in today’s international business environment. Still, the concept of back-to-back loans is a viable option in some isolated cases, especially where there is a fear of a rapid rate of fluctuation with a particular currency. While the strategy is no longer widespread, it always remains an option.