Foreign exchange rate risk in microfinance : what is it and how can it be managed?
Littlefield, Elizabeth | Mwangi, Patricia | Featherston, Scott
The primary goal of this Focus Note is to raise awareness in the microfinance sector of the issues associated with foreign exchange risk. First, it explains what exchange risk is. Second, it looks at the techniques being employed by microfinance institutions (MFIs) and investors to manage this risk. Finally, it makes recommendations on managing or avoiding exposure to exchange risk. Many borrowing MFIs are not adequately managing their exposure to foreign exchange rate risk. There are at least three components of foreign exchange rate risk: 1) devaluation or depreciation risk; 2) convertibility risk; and 3) transfer risk. Since MFIs operate in developing countries where the risk of currency depreciation is highest, they are particularly vulnerable to foreign exchange rate risk. And, as any veteran of the sovereign debt restructurings of the 1980s and '90s is likely to observe, convertibility and transfer risks, although less common than devaluation or depreciation risk, also occur periodically in developing countries. However, a recent survey of MFIs conducted by the Consultative Group to Assist the Poor (CGAP) indicates that 50 percent of MFIs have nothing in place to protect them from foreign exchange risk.
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