mfi financing and currency risk: current mitigants and innovative instruments

ACP IF IV DivisionGuadalupe de la Mata– Loan Officer

MFI financing and currency risk: current mitigants and innovative instruments

European Microfinance Week 2007:“European responses to global microfinance challenges”

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

Agenda

Risk-Related Issues in Microfinance

increased role of microfinanceincreased 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



3. Other Mechanisms




Agenda

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

Options to Reduce Foreign Exchange Risk

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

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

Traditional Options to Reduce Foreign Exchange Risk (I)

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



3. Other Mechanisms




Agenda

Exploring Other Mechanisms (II)

Linking international capital markets and microfinance

by using diversification Promoting private equity funds investing in the capital of local MFIsPromoting international lending in local currency through international debt funds diversifying across local currenciesInternational securitisations (cross border)

by developing Hedging InstrumentsCreating a international fund proposing hedge instruments to microfinance lenders and donorsAttracting remittances to MFIs



3. Other Mechanisms




Agenda

Using partial loan guarantees to facilitate local bank lending

MicrocreditsLonger Term/Reduced

Rate

Local Bank

ME

ME

ME

ME

Microfinance Institution

ME

ME

ME

Portfolio of Microcredits

ExternalGuarantors(Donor)

Guarantee

Improving MFIs Access to LocalFinancial Markets (I)

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.

Improving MFIs Access to LocalFinancial Markets (II)



3. Other Mechanisms




Agenda

Guarantees to bond issuance

Bond

Issuance

SME

SME

SME

SME

SME

Microfinane Instituion/SME Bank

SME

SME

SME

SME

SME

Portfolio of

Microcredits or SME

loans

EIBInvestment

Facility

Local investorsPension Funds

Bond

Issuance

ME

ME

ME

ME

ME

Microfinane Institution/SME Bank

ME

ME

ME

ME

ME

Guarantor

Local investorsPension Funds

Debt service guarantee

Microcredits

Micro credit

portfolio

Improving MFIs Access to LocalCapital Markets (I)

Local microfinance securitisation

Improving MFIs Access to LocalCapital Markets (II)

MEME

Issuanceof ABS

MFIMFISeniorSenior

MezzanineMezzanine

JuniorJunior

MEME

MEME

MEME Microcreditportfolio

SPVSPVPurchase

of microcredit portfolio

Investment or Debt service

guaranteeInvestor orguarantor(Donor)

Investor orguarantor(Donor)



3. Other Mechanisms




Agenda

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

Tapping International Capital Markets (I)

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

Tapping International Capital Markets (II)

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

Tapping International Capital Markets (III)

Cross border microfinance securitisation

Tapping International Capital Markets (IV)

MEME

SpecialPurposVehicle

SpecialPurposVehicle

SeniorSenior

MezzanineMezzanine

JuniorJunior

MEME

Debt service guarantee or Investment

MFI 1MFI 1

MFI 2MFI 2

MFI (...)MFI (...)

Micro-finance loans

Micro-finance loans

Micro-finance loans

Funding granted to the MFIs

Investor or Guarantor

(donor)

Investor or Guarantor

(donor)

MEME

MEME

MEME

MEME

MEME

MEME

MEME

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

Tapping International Capital Markets (V)

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

Tapping International Capital Markets (VI)

Funds targeting Second tier and rural MFIsRural 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

Tapping International Capital Markets (VII)

Your Experiences and Ideas

Experiences from the working group

-Challenges

-Opportunities

Other instruments not mentioned

Other ideas Thank you for your kind attention.

mfi financing and currency risk: current mitigants and innovative instruments

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