MFX's Development Mission: Focus on the Micro-Entrepreneur in High Risk Markets

The real measure of better currency risk management is how it affects the ultimate borrower: the micro-entrepreneur. As an insurer against currency volatility, MFX's mission is, in part, to make sure that existing flows of microfinance lending are not disrupted by currency devaluation. But MFX's mission is also based on the idea that reducing currency risk can drive lending to countries and clients who otherwise would not have access to microfinance. MFX therefore will focus on high-risk markets in Africa and elsewhere where hedging can have a transformative effect.

Here is how reducing currency mismatch can directly benefit poor borrowers in developing countries:

• Continuity of lending growth: MIVs can lend safely in local currency or MFIs can borrow more safely in hard currency when they hedge currency risk. In each case the lender or borrower can convert the unwanted currency into the currency that matches its own balance sheet. Either way the MFI is protected in the event of a currency devaluation and the micro-entrepreneur is protected from a sudden reduction in lending capacity.
• Avoiding pass-through risk: A common practice for MFIs facing currency risk is to pass the risk on by lending in hard currency to their micro-entrepreneur customers or by indexing their lending interest rates to a given foreign exchange rate. In the event of a devaluation, this hurts the borrowers who face higher than expected payments relative to their domestic currency revenue and thus higher default risk. By hedging currency risk, MFIs can lend to their clients in their own currency, ending the morally questionable practice of passing currency risk to the most vulnerable link in the microfinance value chain.
• Efficient use of capital: Currency mismatch requires microfinance institutions to set aside additional capital to compensate for the risk of devaluation. This is capital that could otherwise be leveraged for additional lending. Hedging permits more capital to be available for funding loans so MFIs can serve more micro-entrepreneurs.
• Increase lending to underserved markets: When MFX asked microfinance lenders where they would lend if they knew they could hedge the risk, the results were striking (Chart 1). The current portfolios of MIVs are heavily weighted to Latin America and Eastern Europe, which account for roughly 80% of total lending. However, with cost-effective hedging available, lenders indicate they would dramatically shift new lending toward Africa and other higher-risk markets. The chart below shows that providing lenders with the means to manage currency risk can fundamentally change lending patterns in the industry in favor of micro-entrepreneurs in the Africa and other underserved markets.