Q: Why does the FSL have to be denominated in a major currency, and then converted into local currency? Why not denominate the FSL in local currency to begin with?
A: The Bank would not commit an FSL in a borrower's currency because it may not always be able to access the local currency markets when borrowers wish to have disbursements or at terms that are acceptable to them. Pre-funding loan commitments in local currency and holding the liquidity until disbursements are made might be a way to address such funding risk. However, holding liquidity in local currency is likely to result in negative cost of carry for the Bank given the volatility and illiquidity of emerging financial markets and the limited numbers of instruments with acceptable credit rating in which the Bank can invest. Pricing the funding and liquidity risks into the loan charges for an FSL in local currency would make these products uncompetitive. Therefore the Bank has opted to provide local currency financing through the use of currency swaps from a major currency into a borrower's local currency.
Q: Why can't undisbursed amounts of FSLs be converted into local currency?
A: The conversion of fixed-spread loans into local currency is limited to disbursed loan balances so that the Bank can intermediate the currency swap transactions on the basis of known projected cash flows. Converting undisbursed amounts of FSL into local currency is equivalent to having FSL commitments in local currency which would expose the Bank to financing and liquidity risks. Please refer to the answer to the previous question for further explanation.
Q: Why can't the entire loan be converted into local currency?
A: The Articles of the Agreement permit the Bank to provide local currency financing only under exceptional circumstances. Since these circumstances are basically the same as those under which the Bank is authorized to finance local expenditures with foreign exchange, the amount of the loan that can be converted into local currency is limited to that part of the loan that is used to finance local expenditures.
Q: What local currencies are available?
A: As of November 2000, an indicative list of emerging market currencies in which the World Bank might be able to undertake currency swap transactions included South African rand, Czech koruna, Polish zloty, Thai baht, Hungarian forint, Philippine peso, Indian rupee, Brazilian real and Mexican peso. However, the availability of these currencies, and the terms and conditions that the Bank could obtain at a given point in time will depend on swap market conditions at the time of execution of the proposed transactions. At the same time, since conditions in emerging financial markets can change rapidly, the Bank would determine, upon a borrower's request, whether conditions would enable it to offer financing in a specific currency.
Q: Swap maturities in most emerging market currencies are short. What happens if the Bank is unable to roll over a maturing local currency hedging transaction?
A: At the maturity of the Bank's hedging transaction, an FSL will revert to the original loan currency. The remaining loan principal repayments will reflect any exchange rate adjustment, representing the difference between the exchange rate used in the initial swap transaction and the market exchange rate at the time of the final principal payment on the initial swap. Such calculation may cause the remaining principal repayments to be more or less than they would have been in the absence of a conversion. For further information, refer to Section 4.6.2, "Partial Maturity Currency Conversion" of the Guidelines for Conversion of Loan Terms For Fixed-Spread Loans ("Conversion Guidelines").
In the case of free-standing local currency swaps whose maturity is shorter than that of the underlying FSL, on the maturity date of the swap there will be a principal exchange for an amount equal to the remaining principal on the underlying loan. The principal exchange on the currency swap will be settled on a net basis; i.e., the net of the payable and receivable legs of the swap will be settled in the local currency. At the maturity of the free-standing local currency swap, borrowers would have the option to enter into another currency swap for the remaining principal balance of the loan plus the net amount of the maturing currency swap, provided that market circumstances permit.
Q: Why has the volume of multilateral development bank's (MDBs) local currency transactions been small?
A : The volume of local currency transactions by MDBs has been small mainly because of funding constraints. MDBs do not generally hold unhedged currency positions on their balance sheet either because of statutes' restrictions or financial policy considerations. They confine their transactions to currencies for which a liquid swap market exists in order to be able to hedge the exchange rate, interest rate and liquidity risks. The requirement of a liquid swap market limits the transactions to a small number of local currencies. Furthermore, the MDBs' competitive advantage vis-??-vis their clients in local currency financing is much lower than in foreign currency loans. The lower comparative advantage makes local currency financial products less attractive to some borrowers.
Q: How can a borrower request a conversion or hedge into local currency?
A : For FSL conversions, the borrower would submit a Conversion Request to the Bank's Loan Department, substantially in the form specified in the FSL Conversion Guidelines (borrowers should refer to Section 2 of the Guidelines for Conversion of Loan Terms For Fixed-Spread Loans). The Bank will then investigate the availability of swaps in the requested local currency, and will inform the borrower. The details of the procedure for conversion of FSLs are set forth in the Conversion Guidelines.
In the case of free-standing hedges, a borrower must first enter into a Master Derivatives Agreement (MDA) with the IBRD. A borrower would also need to provide the IBRD with a list of signatures of officers authorized to request IBRD hedge transactions. After the MDA is in place, to request a hedge into local currency a borrower needs to send a Hedge Request form to IBRD's Loan Department. (Model Hedge Request forms will be available soon on this site).
Q: What are the advantages of borrowing from the Bank in local currency, if the government can raise local currency funding at the same, or a lower price?
A: A government would not derive any cost advantage from borrowing from the Bank in local currency if it can raise the local currency at the same or lower cost. Nevertheless, some countries prefer to keep the management of sub-sovereign institutions at arm's length from government and let sub-borrowers manage their financing independently. Some of these sub-borrowers may have limited access to the local capital markets on reasonable terms.
Q: Are the IBRD lending rates in local currencies expected to be higher than those of the major currencies?
A: In executing local currency swaps, the Bank will convert the full lending rate (i.e. the base rate and the total spread) applicable in the original loan currency into a local currency equivalent lending rate. The total spread over the local currency base rate will reflect the local currency equivalent of the FSL spread over LIBOR plus a basis swap adjustment. Depending on the interest rate differential between the original loan currency and the local currency and swap market conditions, the local currency spread over the base rate and the lending rate altogether could be higher or lower than those of major currencies.
Q: Why are the Bank's indicative prices for local currency financing so high when its pricing in the major currencies is highly competitive?
A: Because of its fine credit rating in international capital markets, the Bank has a significant cost advantage over its borrowers in intermediating foreign currency-denominated financing. Many Bank borrowers have stronger credit rating in their local currency than in foreign currency. This explains why the indicative rates for IBRD's local currency financing may not be as competitive as the rates for foreign currency financing.
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