PFS Technical Brief 5 - FX Lending - Taming the Beast - January 26, 2012

This Technical Brief is the fifth in a series that addresses financial sector challenges and opportunities in Southeast Europe and Eurasia, specifically the twelve Beneficiary countries of USAID’s Partners for Financial Stability program. The Technical Brief highlights the potential for ongoing fallout from the European debt crisis. The risk from high levels of foreign currency denominated and indexed lending to households and businesses requires more attention and concerted efforts to minimize the impact on businesses and individuals. Borrowing in foreign currency once appeared to be a wise financial decision but is proving to be a hardship and may undermine the progress made in increasing access to finance, promoting private sector growth, expanding the middle class and building credible government institutions.

The high level of bank lending denominated in hard currency (Euro, Swiss Franc, U.S. Dollar) in Central and Eastern Europe (CEE) and Eurasia contributed to the region’s sharp economic downturn that began with the 2008 global financial crisis. During the post-communist transition period in many of the emerging European countries, lending in foreign currencies has been the norm rather than the exception.

Lending in foreign exchange (FX or forex) can appear to be advantageous to borrowers as the interest rates are generally much lower, but these loans carry increased repayment risks for both banks and borrowers. In fact, borrowers with FX loans are, unwittingly, speculating in volatile currency markets.