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MicroFinance Currency Risk

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John Hunter

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I have been curious how Kiva deals with currency risk. Kiva is a great resource for providing micro-lending and the opportunity to engage in choosing who you will lend to. But my transactions are all in US$ and the loans in the field are in the local currency. This creates an issue of what happens when currency values fluctuate. I asked a question on the Kiva LinkedIn group (an excerpt is shown here):

A lender takes out a loan of $100 with 10 months to repay. If the loan is in the local currency, what if the value of that currency during the 10 months declines by 20%? Then the bank has received all their money back but they owe Kiva $100 but they only have $80 worth of the local currency (again ignore that the payments are made monthly – since it doesn’t effect the issue at hand – currency rates). Hows does Kiva deal with this currency risk? Do the local partner banks take the risk…?

I was directed to a great slideshow showing Kiva’s lending policies. It turns out Kiva does have the local banks take the currency risk. So they have to pay back $100, if the local currency value is now $80, they would have a loss, of course the local currency value could also have risen, then the local bank has a gain.

They have a chart showing the cost of capital to local Kiva lenders at 0-1% plus currency exchange risk (which they say some banks choose to hedge and others just take the risk), which is about the lowest cost of capital around. Kiva charges no interest on the loans to the local banks. The costs come from the requirements (the cost of adding a profile – the time of staff of the bank to add the information…) of using the Kiva website.

Updates
1) Kiva updated their policy to put any currency loss greater than 20% on the lenders (up to 20% losses are taken by the bank, above 20% are taken by those lending through Kiva). But the banks can chose to take the currency risk, which they could do to encourage lenders to select their loans to fund.
2) They updated it again to make it a decision by the bank, which means often the lenders bear the risk (it is stated on each loan how the risk is assigned)

Curious Cat Kiva connections: Curious Cats Kiva lending team – Curious Cat Kivans – Funding Entrepreneurs in Nicaragua, Ghana, Viet Nam, Togo and Tanzania – Kiva Fellows Blog: Nepalese Entrepreneur Success – Kiva related blog posts

Comments

8 responses to “MicroFinance Currency Risk”

  1. Ryan Calkins Avatar
    Ryan Calkins

    I had a chance to travel with Global Partnerships, a microfinance investment vehicle akin to Unitus or Oikocredit, to Nicaragua last fall. The interest rate charged by the local MFIs seemed high to many of us. But as we evaluated the risks the MFIs take on (including currency fluctuations, defaults, fraud) as well as the relatively high cost of loan administration, it became clear why interest rates ranged from 15%-35% annualized. The other anecdote that I and others on the trip took away from our conversations with borrowers was their savvy about this very topic. In a microfinance market like Nicaragua, where there is competition between MFIs in most areas, the borrowers shop around until they get the best deal.

    Reply
  2. John Avatar
    John

    Wow, I never knew that. It seems like that could lead to huge problems with Kiva if the banks aren’t hedging their risk.

    Reply
  3. Vielen Dank, Herr Spekulant? « Unternehmen Armut Weblog

    […] aufzubürden wirderspräche der Idee von Mikrofinanz komplett. Es die Mikrofinanzorganisation (so bei kiva) tragen zu lassen ist ebenfalls problematisch, da diese oft klein und mit wenig eigenem Kapital […]

    Reply
  4. Avatar
    Anonymous

    The news on this is that Kiva lenders will share part of the currency risk in future:
    http://www.wiseclerk.com/group-news/services-microfinance/kiva-lenders-share-currency-risk/

    Reply
  5. 100th Entrepreneur Loan at Curious Cat Investing and Economics Blog

    I made my 100th contribution to a micro-loan through Kiva last week. Participating with Kiva is a great antidote to reading about the unethical “leaders” taking huge sums to run their companies into the ground…

    Reply
  6. Zuber Karim Avatar
    Zuber Karim

    © Zuber Karim 2009
    MFIs are also exposed currency risk, however, all stakeholders ignore it as a major catastrophe has not occurred yet, therefore they envisage no need for implementing preventive measures (Currency Risk in Microfinance, 2005:3). Microfinance Institute discusses four ways MFIs employ to mitigate this risk (Currency Risk in Microfinance, 2005:3), given as follows:
    Risk Avoidance: This means that MFIs provide services to clients who generate dollars, specially those attached to the tourism industry. This leaves the poor segments unable to access financial services, thus undermining the very objectives MFIs intend to achieve.
    Off-setting Risk: This is done by increasing interest rates and fees. Thus, deterring a sizeable number of clients from taking high interest rate loans. A recommended strategy would be to combine base rate with a fluctuating rate reflecting the currency depreciation.
    Risk Diversification: This happens by investing in different countries, thus reducing risk on fund’s overall portfolio. However, this strategy is not used many. Thus, many major MFIs suffer from investment concentration [on one area] risk.
    Risk Mitigation: Many techniques can be used to mitigate risk such as opening a dollar account in the host country and quickly converting local repaid local currency into dollar (Currency Risk in Microfinance, 2005:3).
    Risk Diversification and Risk Mitigation better than the previous two as these strategies do not entail harming the poor which is evident in the former two. Adding to the latter two mitigating techniques, one wishes to propose that MFIs transact with the clients in dollars where in turn, the clients pay back using the same currency in cases where this is viable. In addition, MFIs may diversify the currencies they hold in a particular host country such as holding dollars, sterling, euros and yens simultaneously (Karim, 2008:9-10). Investors have woken up to this reality. Take an example of investment in GCC countries given on the graph below:

    (Unable to upload. It can be accessed from: http://www.failaka.com/downloads/Tabreed%2006%20assign.pdf )(p.10).

    Fig. 2 Source: Source: Dresdner Kleinwort, 2006 (Taken from Karim, 2008:10).

    The chart above clarifies that the dollar was the single currency used in the investment for four years. But this changed significantly when other currencies such as euros, francs and sterlings entered the arena in 2006. The above testifies the resolve of some investors to diversify the currencies in investment capital as strategy to reduce foreign exchange rate risk.

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  7. Kiva Entrepreneur Loans: Kenya, Honduras, Armenia… at Curious Cat Economics Blog

    When looking for loans I give preference to loans that improve productivity and increasing capacity of the entrepreneur… A nice example of this is the loan to Douglas Osusu, Kenya. He has requested this loan to purchase a dairy cow and a posho grinding mill…

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  8. Kiva Loans to Entrepreneurs in Columbia, India and Kenya at Curious Cat Investing and Economics Blog

    […] have called things defaulted that just had the borrower paying everything back but there was a currency exchange loss – which is a loss to the lender but not truly a default). I would hope Kiva fixed that, but I […]

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