What Is a Hard Loan?
A hard loan is a foreign loan that must be paid in hard currency, which is the currency of a nation that has political stability and a reputation for economic strength. For example, a country classified as a developing country may borrow via a hard loan denominated in U.S. dollars.
- A hard loan occurs when a foreign borrower takes a loan denominated in a hard currency, such as a reserve currency like the U.S. dollar.
- Hard loans are often taken out by borrowers in developing countries, since loans denominated in less stable currencies can be risky for lenders.
- Currency volatility can harm borrowers in hard loans since a devalued currency will make it more expensive to repay the loan.
How a Hard Loan Works
A hard loan is a type of loan between a lender and borrower occurring in two different counties, and which is denominated in the hard currency. Hard currency refers to a monetary system or reserve currency that is widely accepted around the world as a form of payment for goods and services. It usually comes from a country that has strong economic and political standing, and it may not be the currency of either the borrower or the lender. A hard loan substantially reduces the risk that would exist if the loan were denominated in less-stable currencies.
There are some risks, however. If the borrower's home currency falls dramatically against the hard currency they may have great difficulty repaying the loan. For instance, if a Brazilian manufacturer takes out a hard loan denominated in euros, and the euro strengthens by 20% against the real over the life of the loan, it will effectively increase the interest rate on the loan by 20%, as well as the principal amount.
Forex Considerations on Hard Loans
What allows a currency to qualify as hard? It is expected to remain relatively stable through a short period of time and to be highly liquid in the foreign exchange—or forex (FX)—market, in which currencies are traded. The forex market is the largest, most liquid market in the world, with average traded values of trillions of dollars per day. It includes all of the currencies in the world.
Forex transactions take place on either a spot or forward basis and are executed over the counter and around the clock. There is no centralized market for forex transactions. The largest foreign exchange markets are located in major financial centers, such as London, New York, Singapore, Tokyo, Frankfurt, Hong Kong, and Sydney.
The hard currency must have a stable value. The value of a currency is mostly based on economic fundamentals such as gross domestic product (GDP) and employment. The international strength of the U.S. dollar is reflective of America's GDP, which, as of the third quarter of 2018, stood first in the world at $20.16 trillion. China and India had the second- and seventh-, respectively, ranked GDPs in the world, but neither the Chinese yuan nor the Indian rupee is considered a hard currency. This helps explain how central bank policies and stability in a country’s money supply also factor into exchange rates. The U.S. dollar is considered to be the world’s foreign reserve currency, which is the reason it is used in 70% of international trade transactions.
Example of a Hard Loan
An example of a hard loan would be a loan agreement between a Brazilian company and an Argentinean bank in which the debt is to be paid in U.S. dollars is a type of hard loan because U.S. dollars are considered to be hard currency and more stable than either the Brazilian real (BRL) or the Argentine peso (ARP).