This paper highlights recent advances in minimizing foreign exchange risk in microfinance, via both local currency lending by international investors, and risk hedging by microfinance institutions.
Until recently, foreign lending to microfinance institutions (MFIs) has been overwhelmingly in hard currencies such as the US dollar or the euro. Now, increasing numbers of international investors are finding ways to lend MFIs in local currency, and in some cases, the local currency investments are being left unhedged on international investors’ books.
Why is this trend towards increased local currency lending such an important development? MFIs for the most part lend to their client borrowers in local currency, with certain exceptions in a few wholly or partially dollarized (or euroized) countries. When the MFI borrows in hard currency but lends to its clients in local currency, the resulting currency mismatch means that the MFIs earnings are subject to volatility risk of exchange rate movements. This focus note updates findings published in 2004 tracking currency appreciation and depreciation of 23 currencies, showing continued volatility in the movement of the currencies, leading to uncertainty for the MFI holding foreign currency loans.Download the English VersionDownload the Spanish Version