Use currency swaps to get better interest rates on foreign currencies.
In a currency swap, you essentially trade a loan with another party to obtain a lower interest rate on a loan. You and the other party take advantage of the fact that you can get cheaper loans in your respective countries.
What is a currency swap?
In a currency swap, you trade loan payments in one currency for the equivalent sum in a second currency. These loan payments include the principal — or the amount borrowed — and interest.
A company or a bank is the typical party of a currency swap, not necessarily an individual.
Why is a currency swap useful?
It’s often difficult to get favorable loans in foreign countries. For example, a business owner may be unable to get a foreign loan at a low interest rate.
In your home country, it’s relatively easy to get a loan with a reasonable interest rate. But it might be difficult for a foreign business owner to get equally favorable terms in your country. The same goes for you in other countries.
That situation creates the right elements for a currency swap. With a currency swap, you and a foreign business owner can essentially take out loans for each other, swapping those loans to mutually benefit from lower interest rates.
Currency swaps: An example
Say you need to borrow 500,000 euros to do business in France. You approach multiple French banks inquiring about loans, but you run into the same problem each time: The loans come with sky-high interest rates.
At the same time, a French business owner needs to borrow the same amount as you do but in US dollars — let’s say $550,000. Like you, all he gets from American banks are exorbitant interest rates.
There’s an opportunity for a currency swap here:
- First, you take out a $550,000 loan from your bank.
- At the same time, the French business owner takes out a 500,000 euro loan from his bank.
- Now you and the French business owner effectively swap your loans: You give him $550,000, and he gives you 500,000 euros.
- You repay the loan you took out from your bank, and he does the same with his bank.
Compare providers that can help you set up currency swaps
Are there any drawbacks?
With a currency swap, there’s a possibility the other party could default on loan payments. It may also be expensive to set up a currency swap, because you might need to use intermediaries to find another party that’s looking for a swap.
Is there anything else I should know?
A currency swap is different from a foreign exchange swap. A foreign exchange swap involves simultaneously borrowing currency from and lending currency to another party. Learn more about a foreign exchange swap. here.