This document discusses mechanisms to mitigate foreign exchange and currency risk for microfinance institutions (MFIs). It outlines traditional options used by donors and MFIs, such as lending in local currency, matching foreign currency liabilities to assets, and creating foreign currency reserves. It also explores other options like improving MFI access to local financial and capital markets through loan guarantees and bond guarantees. Finally, it discusses tapping international capital markets through private equity funds that invest in MFIs in local currency, and microfinance debt funds that provide loans to MFIs across currencies to diversify risk.

1. MFI financing and currency risk: current
mitigants and innovative instruments
European Microfinance Week 2007:
“European responses to global microfinance challenges”
ACP IF IV Division
Guadalupe de la Mata– Loan Officer

2. Agenda
1. Risk-Related Issues in Microfinance
2. Traditional Options to Reduce Foreign Exchange
Risk
3. Other Mechanisms
3.1 Improving MFIs Access to Local Financial Markets
3.2 Improving MFIs access to Local Capital Markets
3.3 Tapping International Capital Markets

3. Risk-Related Issues in Microfinance
increased role of microfinance
increased foreign funds and higher commercial approach for
microfinance support raise
Issue of foreign exchange risk, its potential impact in MFI’s
development and survival, and the mechanisms to avoid or limit it
 foreign exchange risk typically arises when an MFI borrows funds in a
foreign currency and onlends to local micro-enterprises in domestic
currency

4. Agenda
1. Risk-Related Issues in Microfinance
2. Traditional Options to Reduce Foreign Exchange
Risk
3. Other Mechanisms
3.1 Improving MFIs Access to Local Financial Markets
3.2 Improving MFIs access to Local Capital Markets
3.3 Tapping International Capital Markets

5. Options to Reduce Foreign Exchange
Risk
I. Options to reduce the foreign exchange risk traditionally used by
stakeholders
Mitigating mechanisms used by donors/ lenders ready to lend in
local currency.
Mitigating mechanism used by MFI accepting finance in foreign
currency
II. Exploring other mechanisms
deepening local financial and capital markets
attracting finance from the international capital markets

6. Traditional Options to Reduce Foreign
Exchange Risk (I)
Mitigating mechanisms used by donors/ lenders ready to
lend in local currency
1. Lending in local currency- apply a premium to cover the
currency risk
2. Lending in local currency and issuing a bond in local currency
to cover the exchange risk
3. Lending in local currency- Borrowing from a local bank and
on-lending to the MFI
4. Hedging the risk through derivatives

7. Traditional Options to Reduce Foreign
Exchange Risk (I)
B) Mitigating mechanism used by MFI accepting finance in foreign
currency
1. Lending in hard currency- MFI accepts the foreign exchange risk
and takes the loan in hard currency
2. Lending in hard currency- MFI Matches liabilities denominated
in foreign-currency to assets denominated in that same
currency
3. Lending in hard currency – MFI creates foreign currency
reserves
4. Lending in hard currency -Back-to-back loans

8. Exploring Other Mechanisms (I)
1. Improving MFIs access to local financial markets
 Using partial loan guarantees to facilitate local bank lending
 Using portfolio guarantees
 Hedging the risk through derivatives
2. Improving MFIs access to local capital markets
 Guarantees to bond issuances
 Domestic securitizations of microcredits
3. Linking international capital markets and microfinance

9. Agenda
1. Risk-Related Issues in Microfinance
2. Traditional Options to Reduce Foreign Exchange
Risk
3. Other Mechanisms
3.1 Improving MFIs Access to Local Financial Markets
3.2 Improving MFIs access to Local Capital Markets
3.3 Tapping International Capital Markets

10. Exploring Other Mechanisms (II)
Linking international capital markets and microfinance
by using diversification
Promoting private equity funds investing in the capital of local
MFIs
Promoting international lending in local currency through
international debt funds diversifying across local currencies
International securitisations (cross border)
by developing Hedging Instruments
Creating a international fund proposing hedge instruments to
microfinance lenders and donors
Attracting remittances to MFIs

11. Agenda
1. Risk-Related Issues in Microfinance
2. Traditional Options to Reduce Foreign Exchange
Risk
3. Other Mechanisms
3.1 Improving MFIs Access to Local Financial Markets
3.2 Improving MFIs access to Local Capital Markets
3.3 Tapping International Capital Markets

12. Improving MFIs Access to Local
Financial Markets (I)
Using partial loan guarantees to facilitate local bank lending
M
E
M Microfinance
E Institutio
n
M Longer External
E Microcredits Guarantors
Reduced
Term/
Local (Donor)
M Rate Bank
Guarantee
E
M
E
M
Portfolio of
E
M Microcredits
E

13. Improving MFIs Access to Local
Financial Markets (II)
Hedging the risk through derivatives
 In order to develop the local financial market, some
international donors are structuring hedging instruments to
mitigate the foreign currency risks.
 For example, the International Finance Corporation (IFC)
offers currency swaps to allow clients to transform existing or
new foreign currency liabilities into local currency.

14. Agenda
1. Risk-Related Issues in Microfinance
2. Traditional Options to Reduce Foreign Exchange
Risk
3. Other Mechanisms
3.1 Improving MFIs Access to Local Financial Markets
3.2 Improving MFIs access to Local Capital Markets
3.3 Tapping International Capital Markets

15. Improving MFIs Access to Local
Capital Markets (I)
Guarantees to bond issuance
ME
SME
ME
SME
SME
ME Microfinane
Instituion/
Institution/
ME
SME SME Bank
ME
SME Bond
Microcredits Issuance Local
SME
ME investors
Pension
SME
ME Funds
Portfolio
Micro
SME
ME of
credit
Microcred
portfolio
its or SME
ME
SME loans
ME
SME Debt service
guarantee
EIB
Investment
Guarantor
Facility

16. Improving MFIs Access to Local
Capital Markets (II)
Local microfinance securitisation
MFI
MFI Senior
Senior
ME
ME
SPV
ME SPV
ME Purchase Issuance
of of ABS
microcredi
ME t portfolio
ME Microcredit Mezzanine
Mezzanine
portfolio
ME
ME
Junior
Junior
Investment or
Investor or Debt service
Investor or
guarantor
guarantor guarantee
(Donor)
(Donor)

17. Agenda
1. Risk-Related Issues in Microfinance
2. Traditional Options to Reduce Foreign Exchange
Risk
3. Other Mechanisms
3.1 Improving MFIs Access to Local Financial Markets
3.2 Improving MFIs access to Local Capital Markets
3.3 Tapping International Capital Markets

18. Tapping International Capital Markets (I)
 increasing number of institutions willing to fulfil certain
Corporate Social Responsibility (CSR) requirements
 increasing number of socially responsible individuals are
interested in investments and vehicles that combine financial
returns and positive social impact
Microfinance as interesting opportunity for this type of
investors:
 it is increasingly moving from a pure development tool to a
potential new asset class
 provides both a financial return and a positive social impact

19. Tapping International Capital Markets (II)
Private Equity Funds
 allow linking international investors with MFIs are equity
funds.
 invest in MFI, improving its capital base and providing the
soundness required to further mobilise debt funding
 MFIs are not exposed to exchange risk as equity
investments are in local currency
 risk is absorbed by the fund and reduced by the country
and currency diversification as investor’s participations in
the fund are usually in hard currency

20. Tapping International Capital Markets (III)
Microfinance debt funds
 allow diversifying the risk by providing loans to MFIs in
different countries in selected local currencies
 risk might be reduced by the portfolio approach as
movements in one currency might be offset by movements
in another
 exposures to each individual currency should be limited to a
certain percentage of the total portfolio
 some of these funds can also hedge exposures through
swaps when available
 bonds in the local currency of the loan to the MFI to fund the
local currency financing can be issued
– BVVA
– Dexia

21. Tapping International Capital Markets (IV)
Cross border microfinance securitisation
ME
ME
MFI 11
ME MFI
ME
Micro-finance
ME loans
ME
Special
Special Senior
Purpos Senior
Purpos
ME Vehicle
ME Funding Vehicle
granted to
ME MFI 22 the MFIs
ME MFI
Micro-finance
Mezzanine
ME loans Mezzanine
ME
ME
ME
Junior
Junior
MFI (...)
ME MFI (...)
ME
Micro-finance Debt service
loans guarantee or
ME Investment
ME Investor or
Investor or
Guarantor
Guarantor
(donor)
(donor)

22. Tapping International Capital Markets (V)
Creating a international fund proposing hedge
instruments
 Donors are exploring other mechanisms to solve the
problem in a sustainable manner
 two sample projects: TCX and Match
TCX
 partnership structured by FMO to pool local currency
exposures with other donors and investment partners
 Main benefits
– more efficient management of forex risk
– a faster and deeper diversification;
– improvement of terms available for this activity
– a professional and specialised management team

23. Tapping International Capital Markets (VI)
IFC Matching Assets Through Currency Hedging (Match)
 IFC is working on creating a global fund to provide local
currency hedges for loans disbursed by IFC
 will begin as a pilot project capitalised with USD 30
million, which is expected to facilitate between USD
100 to USD 200 million of local currency loans.
 Initial focus will be on microfinance, health and
education, and SME projects

24. Tapping International Capital Markets (VII)
Funds targeting Second tier and rural MFIs
Rural Impulse Fund (RIF)
 Majority of existing microfinance investment vehicles
targets urban MFIs
 RIF makes debt and/or equity investments in MFIs which
provide financial services to the rural poor
 RIF focusses on rural MFIs with at least 20% of clients in
rural areas
 contributes to the alleviation of poverty in rural areas
underserved by the microfinance industry (especially in
sub-Saharan Africa)
 expected to promote the expansion of urban MFIs into
rural areas
 complements existing microfinance investment vehicles
by

25. Your Experiences and Ideas
Experiences from the working group
-Challenges
-Opportunities
Other instruments not mentioned
Other ideas
Thank you for your kind attention.