What is Risk-Free Borrowing and Lending?

In any kind of business transaction, all of the parties generally acknowledge that there is a level of risk that could lead to unforeseen losses to either party. This is particularly true in borrowing or lending money. The borrower could default on the loan for any number of reasons, and the lender could be left short. In addition, the interest rate could change, forcing one of sides to receive a different total return on the transaction than originally anticipated, which could have far-reaching effects. In the world of finance, however, there is a concept of risk-free borrowing and lending, where both sides know exactly what they are getting at any particular time and the amount of money is virtually risk-free. A prime example of this time of borrowing and lending is through purchase of US Treasury Bills.

Borrowing and Lending through Treasure Bills

With Treasury Bills, the government is essentially agreeing to borrow a particular amount of money that it will pay back at the date of the bill's maturity. The rate of return is pre-determined, so both sides know what they are getting at all times. The government is getting the amount of money the lender uses to purchase the bill, and the lender is receiving the value of the bill at its maturity. The rate of return for the lender is not subject to change with fluctuations in interest rate or any other external factors, so the transaction can be characterized as risk-free for both the borrower and the lender. The us credit rating, which suffered a setback earlier in 2011 when Standard and Poor's downgraded the US government's AAA rating, however, could impact the stability of no-risk borrowing and lending in the future.

The Effects of the US Credit Rating Downgrade

Although many economics have indicated that the S+P downgrade of the us credit rating would have a minimal effect the world economy overall because it was anticipated in advance, one area that could experience a more substantial impact would for those who use US Treasury Bills as collateral for additional borrowing. If the Treasure Bills are devalued, banks and other lending institutions may require more collateral for loans with the same interest rates. That would mean that borrowers would have to tie up more of their capital on collateral or possibly sell off capital in order to increase cash flow. The downgrade could also impact the purchase of US Treasury Bills, since their risk-free nature was a product of its perfect AAA rating, which is no longer in place. While the Treasury will make every effort to restore the us credit rating as quickly as possible, the current period may cause potential lenders to look elsewhere for the time being, depending on how interest rates are effected and their effect on the rate of return for other forms of lending.