Currency Risk in Microfinance

This paper assesses the magnitude of the problem of currency risk for microfinance institutions (MFIs), and for the industry as a whole. It looks at how commercial investors are affected by that risk, and examines possible solutions.

The paper states that:

• The rapid growth of the microfinance industry has given rise to a new problem - that of currency risk,
• MFIs bear the brunt of this risk, both foreign and local, although investors are affected as well,
• If dollar-based lending continues to flow into the microfinance system, investment funds will have to reach out to a broader base of MFIs across regions where currencies are volatile,
• As that happens, MFIs will be forced to reduce their foreign exchange exposure to become competitive and to receive funding from private lenders,
• The need for funding from private lenders is becoming increasingly important as funding from public sources has declined in recent years.

The microfinance industry uses the following methods to mitigate currency risk:

• Risk avoidance,
• Off-setting risk,
• Risk diversification,
• Risk mitigation.

The paper concludes by recommending a coordinated, industry-wide effort to devise a standardized solution to the problem of currency risk.