Risky Business: An Empirical Analysis of Foreign Exchange Risk Exposure in Microfinance

This study examines the extent of MFIs' foreign exchange risk. It studies various aspects of currency exposure to assess its size, direction, potential risk to MFIs' viability and effect of currency fluctuation on earnings.

The paper discusses four different measures of MFI foreign exchange risk, namely, net open position, net open position as a percentage of equity, asset-liability ratio and foreign exchange gains or losses. The study reveals high levels of prevalence and complexity of MFI foreign exchange risk.

The paper makes recommendations to help mitigate foreign exchange risks. They are:

• Developing industry-wide prudent foreign exchange risk exposure guidelines;
• Expanding availability and usage of hedging resources;
• Providing training and capacity-building for MFIs in asset-liability management and financial risk management;
• Limiting foreign currency onlending and maintain foreign exchange risk exposure at prudent levels;
• Tracking and monitoring foreign exchange risk at MFI level;
• Improving transparency of MFIs;
• Encouraging disbursement of local currency loans by cross-border lenders;
• Disclosing foreign exchange risk levels;
• Establishing mandatory prudent foreign exchange risk exposure limits at national level.