Microfinance foreign exchange facilities : performance and prospects

Foreign capital investment in microfinance has been booming over the past four years. Commercial cross-border debt and equity invested in microfinance surpassed US$11 billion in 2009, representing an estimated 20 percent of the funding base for specialized microfinance providers. Foreign investment brings important benefits for microfinance institutions (MFIs). It can provide longer term debt maturity and risk capital that often is not available in the local market, but it can come with a significant string attached: foreign exchange risk. The first section of this paper describes the aspirations and risk management plans of these foreign exchange hedge alternative projects and traces the unusual conditions under which the new facilities are emerging. The second section, largely based on interviews, analyses MFI and investor demand and experience with the facilities. The third section looks ahead to future risk management challenges. Finally, the fourth section considers whether deeper local currency markets can, by themselves, solve many of the problems the facilities are trying to address.