From Dollar to Dinar: The Rise of Local Currency Lending and Hedging in Microfinance

This paper highlights recent advances in minimizing foreign exchange risk in microfinance through local currency lending by international investors as well as risk hedging by MFIs. Several factors have converged to increase international investor lending to MFIs in local currency. These include:

• Growing competition among international investors to lend to MFIs;
• MFI insistence on local currency debt funding;
• Scaling up of several international investment funds, enabling partnerships with commercial financial institutions that can provide exchange risk hedging;
• Increasing willingness of investment funds to mitigate currency risk by applying known portfolio diversification principles to un-hedged local currency loans to MFIs.

The paper reports on three MFIs and their innovative hedging strategies through purchases of foreign exchange hedging products. MFI use of currency hedging instruments, however, is rare, and international investors are far better positioned than MFIs to address the need to eliminate or minimize foreign exchange risk. Continued competition and increased awareness among international microfinance investors may lead to local currency lending becoming the norm.