The Challenges of Kiva

7 June 2010 at 00:01 12 comments

By James Allman-Gulino, KF11 Uganda

Kiva funds are a great thing for microfinance institutions (MFIs) operating overseas because they come in the form of “no-interest” loans.  Unlike traditional sources of financial capital like large banks, which may charge upwards of 10% on their loans, Kiva is able to loan funds at 0% thanks to:

  • Kiva lenders’ willingness to invest without an expected financial return, but simply the social return of empowering entrepreneurs in the developing world
  • Kiva lenders’ willingness to make additional donations to Kiva, helping to cover the organization’s operating expense (traditional capital sources just cover operating expenses through the interest rate they charge on funds)

The 0% rate on Kiva capital allows MFIs to devote more of their resources towards providing borrowers with loans, which is a great thing.  But it’s worth noting that the “0%” certainly doesn’t mean Kiva funds are “free” to MFIs; there are a number of big challenges that MFIs face in working with Kiva, which lenders might not know about.  Some of the major ones:

Currency Exchange – Because Kiva works in so many different countries, and couldn’t make loans in all those countries’ local currencies, all Kiva funds are distributed in US dollars.  This means that MFIs receive monthly payments from Kiva in US dollars, but then have to “buy” back US dollars to make repayments.  When the value of the dollar appreciates significantly, as it has in the last few months, this creates a large expense for MFIs.  For instance, at the beginning of 2010, each US dollar was worth about 1900 Ugandan Shillings.  Today, the dollar is trading at about 2270 Ugandan Shillings – that’s about a 19% change in just six months!  This means that it’s now significantly more expensive for Ugandan MFIs to “buy” dollars to make repayments to Kiva.

As of now, Kiva lenders can’t really do anything about this – lenders can choose to cover currency exchange risk, but only in cases of extreme inflation in local currency.  And to be fair, the dollar can always depreciate as well, which would make it less expensive for MFIs to borrow (though this is rare, because developing country currencies tend to fluctuate more and aren’t apt to appreciate against the globally-used dollar).  But in the future, I wondered if Kiva lenders might be interested in covering all risk from currency exchange for MFIs.  For instance, if you lent $25 to a Ugandan MFI at the 1900 UGX/dollar rate referenced above, and then the exchange rate changed to 2270 UGX/dollar, if the MFI repaid in the same amount of local currency you would get about $20.90 back.  So how about it – would lenders be willing to risk that loss?

Administrative Costs – Kiva is incredibly unique in its peer-to-peer lending model, which connects Kiva lenders to individual entrepreneurs around the world.  However, this means that MFIs have to create lots of content for Kiva, whereas for regular sources of capital they don’t really need to create any (Kiva Fellows can help on this front, however).  This can become quite expensive for the MFIs, especially when Kiva lenders demand such a strong connection to borrowers.  Keeping track of a Kiva borrower’s business description, monthly repayment amounts, and journal updates for Kiva lenders requires much more work than for a non-Kiva borrower.  This information also has to come from the MFI’s branch offices, which may be located far from the MFI’s headquarters and lack the ability to send documents digitally.  For instance, my current MFI, BRAC Uganda, has 89 branch offices throughout Uganda, some of which are over 10 hours from the headquarters in Kampala and in very rural areas.  Collecting information from all of an MFI’s branches and posting it to Kiva is quite difficult; sometimes it results in inaccuracies, in which case a loan may be refunded or the error might be communicated in a journal update to Kiva lenders.  MFIs are generally excellent about record-keeping for Kiva, so these inaccuracies are usually rare; but it certainly happens, especially given the litany of challenges that posting Kiva loans can present.

This is all just to make lenders aware of the significant amount of work that MFIs do for Kiva, and the many challenges involved with maintaining the lender-borrower that our lenders value so much.  As the leadership of my MFI has said, they are very happy to work with Kiva because of the organization’s social mission and goal of connecting people across the world.  But it isn’t always easy!

To support BRAC Uganda and their work with Kiva, please consider making a loan to one of their clients today.

Entry filed under: BRAC Uganda, KF11 (Kiva Fellows 11th Class), Uganda. Tags: , , , , , , , , .

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12 Comments

  • […] We often hear about the high transaction costs faced by Microfinance Institutions (MFIs), who are making small loans in challenging economic environments.  A few of my favorite past blog posts on this subject are from Meg Gray and James Allman-Gulino. […]

  • 2. Magdalena  |  22 July 2010 at 05:54

    Great blog. Thanks!

  • 3. Schafer  |  10 June 2010 at 05:34

    Just wanted to let everyone know about this cool new program http://www.ishop4microfinance.org/

  • 4. Colette  |  8 June 2010 at 10:41

    I think that MFIs could pay into a fund to insure against currency loss. Say 1% of the total available to the MFI on Kiva. This could be drawn down if losses were over a certain percentage. There could be some tweaking for higher risk countries or for longer term loans. However individuals or companies could also contribute to this fund.

    I suspect that the cost to program the currency risk has been huge in programmer salary. The relief to MFIs has been fairly minimal. The loss of appeal to lenders has been great. I would rather donate $10 to this fund upfront and KNOW that the $500 I have invested wasn’t all at currency risk. Yes, I could select MFIs which don’t ask me to carry risk, but these are limiting. And many others want to ONLY loan without currency risk.

  • 5. Greg  |  7 June 2010 at 19:02

    James,
    Thanks for the really good post and taking time to respond to my off the cuff comment on FX profit/loss sharing.

    Over the last three years I have made a significant amount of loans in Africa and fully appreciate the hurdles that MFIs endure in order to work with Kiva. However, at this point I have lost over 5% of my lending capital to MFI defaults and am very leery of suggestions for lenders to take on even more risk and expense sharing.

    Perhaps the Kiva Fellows can focus some discussion on the financial sustainability issues that have caused the risk of MFI default to completely overshadow the risks we lenders assume in lender default and FX loss sharing.

    Thanks again,
    Greg

    • 6. James A-G  |  10 June 2010 at 00:18

      Greg,

      Thanks for your replies, it’s actually really good that we get your feedback as a Kiva lender. If you’ve seen the loss of a decent amount of the capital in your lending portfolio (and it certainly seems you have) and would thus be hesitant to take on any more risk, that’s excellent to know- we definitely want to fit what Kiva offers to our lenders’ desires. Also your suggested topic on financial sustainability issues for MFIs is a great one for some future Fellows blog posts.

      -James

  • 7. Dan  |  7 June 2010 at 17:31

    I understand that Kiva lenders cannot make a “profit” from currency exchange going in their direction. What I don’t understand is why Kiva’s system can’t provide that a gain back could at least offset a loss on a loan.

    • 8. James A-G  |  10 June 2010 at 00:10

      Dan,

      Thanks for the comment, I’m not quite sure in what form you were envisioning the “gain back” though? There are always possibilities for lenders getting insurance against loan losses (which are another whole topic), but not quite sure if lenders would prefer that as opposed to either just not accepting the currency risk, or accepting it in full. Feel free to respond though with details/ideas-

      James

  • 9. Fehmeen  |  7 June 2010 at 10:37

    I think the easiest way for Kiva to cover exchange rate risk is by venturing in the derivatives market, since the repayment time is known with relative certainty. This will lower to risk significantly, and the MFIs can be asked to provide the exchange at the stated value

  • 10. Ron Turley  |  7 June 2010 at 04:16

    James: Nice background piece. Helps lenders to understand the true costs to the MFIs.

  • 11. Greg  |  7 June 2010 at 02:22

    “So how about it – would lenders be willing to risk that loss?”

    The UGX peaked around 5/15/09 at 2,300 UGX per USD. It then spent 6 months declining to the 1,900 level before rising back to the 2,200 UGX/USD level.

    To be fair, you should also state whether the MFI’s are willing to allow lenders to make the profit that arises during periods when the dollar does devalue.

    Greg

    • 12. James A-G  |  7 June 2010 at 03:33

      Greg-

      Great point, I had somewhat purposefully left that out because it can’t actually happen under Kiva’s legal structure. Because Kiva is not regulated by the SEC, they can’t provide any type of interest-bearing product for depositors. So just in the way that Kiva can’t provide loans that would generate interest for lenders, the organization also couldn’t pass profits back to lenders based on currency exchange.

      But it is definitely worth noting, if lenders were to take on a risk like this it would be wholly one-side, because they couldn’t benefit at all if the local currency happened to appreciate significantly.

      -James


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