Should Kiva Lenders take on currency exchange risk?

10 July 2010 at 00:02 11 comments

By Rosalind Piggot, KF10, Tajikistan

Until about a month ago, I didn’t realize that currency exchange loss protection was important to Kiva Lenders.  That was until Yelena (KF11, Azerbaijan) raised the issue, pointing out a discussion on kivafriends.  Many lenders don’t lend via Field Partners that share currency risk.  Why should Kiva Lenders take on the risk of currency loss when Kiva’s Field Partners can protect against it in other ways?

What is currency risk on Kiva?

Currency risk is embedded in the Kiva system.  Currency risk occurs because many Field Partners disburse loans in local currency.  However, they have to pay Kiva Lenders back in US dollars (USD).  So if the local currency loses value against the US dollar, the Field Partner still has to pay back e.g. 1000 USD even if the client only pays them the equivalent of 900 USD.

To help Field Partners manage this risk, Kiva introduced an option to share the risk with Kiva Lenders.  If the Field Partner selects this option, Kiva Lenders will bear the currency loss if the local currency goes down by over 20% against the USD.  You can see whether currency exchange loss is covered by the Field Partner (“covered”) or not (“possible”) in an entrepreneur’s business description.

Why should Field Partners cover the risk

When I first made a loan on Kiva, currency exchange loss was important to me.  I didn’t want my funds to be eroded over time.  I wanted to lend to Tajikistan, and, luckily, both of Kiva’s active Tajik Field Partners,  HUMO and IMON, assumed the currency risk.

Before coming to Tajikistan, I thought, “Kiva Field Partners charge interest rates, so they should bear the burden.”  I figured interest rates would be designed to cover any costs due to currency losses.

Contractual obligations v breaking even

But covering currency risk through interest rates doesn’t cut it in international finance.  Around 90% of Tajik micro-finance organizations’ debt in 2008 was in foreign currency, often times coming from abroad.  In contracts with foreign organizations, there is usually a cap on the currency risk that the Tajik partner can take on.  To stick to the contract, the Tajik organizations limit the amount of local currency loans they disburse. They disburse both local currency loans and loans denominated in USD.

New rules, and currency issues

However, the Tajik government has recently put pressure on micro-loan organizations to give only local currency loans.  This might mean breaching contracts that limit currency risk exposure.  If the pressure continues, Tajik micro-loan organizations will need to find alternative ways to get and manage funds to disburse to entrepreneurs.

‘Hard currency’ economy

One possible solution is finding funds in local currency.  But getting access to local currency from within Tajikistan can be tricky.  A lot of the money in Tajikistan is in foreign “hard currency.”  People use foreign currency as a store of value because it is more stable. Around 60% of money deposited in banks (many people don’t deposit in banks at all) is in foreign currency.  Also, big commercial banks (that can make loans to Kiva’s Partners) often have less than 50% of their loan portfolio in local currency.

Micro-loan organizations can also look for Tajik money from abroad.  This means finding new international partners that are willing to give out money in the Tajik local currency.  Although some partners are willing to do this, many are not.

Another option is hedging against currency risk.  Hedging, which usually involves paying some form of ‘fee’ to get rid of risk, is also not easy.  Micro-loan organizations and banks alike say there are no adapted hedging products here.  Although many organizations do have a few hedges, they are not enough, expensive, and short term.  You may think you are going to get a hedge, or renew it.  Then, at the last minute, the other party to the deal turns and says, “Sorry, we don’t have the resources.  We’ll let you know when we do.”

Everyone should share the risk … including Kiva Lenders?

With these challenges, one option proposed is for foreign partners to share the currency risk with Tajik micro-loan organizations.*  Kiva offers its Field Partners this type of option through the currency exchange loss feature.  With new government pressure, using Kiva’s currency risk protection seems like a reasonable solution.

However, it’s not something I would do if I was a Tajik Field Partner.  Tajik loans on Kiva usually raise slowly.  For many lenders, they are not as attractive as loans from other regions.  Kiva Partners here worry about how many loans to post per month, in case they expire.

In light of the discussion on kivafriends.org, sharing the currency risk might make these loans even less attractive.  It might solve one problem to create another.

What do you think?

If you would like to support entrepreneurs in Tajikistan, you can lend, join the team Supporters of Tajikistan, or learn more about Tajikistan from Kiva Fellow blog posts

* To be clear, this was not proposed by a micro-loan organization

Entry filed under: KF10 (Kiva Fellows 10th Class), Tajikistan. Tags: , , , , , , , , .

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11 Comments

  • […] Kiva updated their policy to put any currency loss greater than 20% on the lenders (up to 20% losses are taken by the bank, […]

  • […] protection is a hotly debated topic at Kiva and among our Kiva friends. As many fellows before have pointed out before. It is certain that sharing currency loss increases the financial risk to Kiva Lenders. However, […]

  • 3. waywardcats  |  14 July 2010 at 06:23

    Further to the point Richard has made, I will accept currency risk in a few cases, but only for Kiva Field Partners who are not for profit. In this way I can justify sharing the risk and consider any losses to be a donation to an organization doing good works.

    Conversely I feel that an organization that is for profit should manage this risk on their own and not rely on Kiva lenders.

    Another factor that was discussed in the Kiva Friends thread which Diane has linked is that Kiva lenders are not experts in currency exchange. There is a very steep learning curve if an active Kiva lender wants to understand what the risk is for each currency. You have done a good job here of discussing the issues for Tajikistan. Making this kind of information available easily to lenders may alleviate some of the lender concerns about sharing currency risk. Few people are willing to take risks that they do not have enough information to assess adequately.

  • 4. RichardF  |  11 July 2010 at 05:38

    Here are a few of my beliefs about Lenders sharing currency risk. It’s all about your own tolerance for risk in terms of personal factors like expectations, experiences and resources.

    You are more likely to share currency risk:
    • if you consider the money you send to Field Partners primarily as donations;
    • the less money you have lost on Kiva for any reason;
    • the more tools you have to manage risk.

    You are less likely to share currency risk:
    • if you consider the money you send to Field Partners primarily as loans;
    • the more money you have lost on Kiva for any reason;
    • the fewer tools you have to manage risk.

    For me, I expect my Kiva loans to be repaid, I’ve beaten the Kiva “Ended with Loss” average, and I’m a big fan of Kiva Bank (www.kivabank.org) to help me manage my overall portfolio risk. When currency risk sharing first came out, I totally avoided it. Lately, I ignored it because I used Kiva Bank to keep my loan terms almost always six months or shorter. As a result, about 40% of my active loans now share currency risk. In the future, I will add more longer term loans, but any with shared currency risk will be the rare exception.

  • 5. Melinda  |  10 July 2010 at 20:13

    I do my best to avoid loans with currency risk. I have limited funds to loan, and do not want to see them whittled away by financial hocus-pocus I don’t trust.

  • 6. DianeR  |  10 July 2010 at 13:35

    It is a complex issue. As a “larger lender”, I have to say that I have sided thus far with David and Dan, in that I will not participate in loans that “share” currency risk (which in effect means “any downside to lender, any upside to MFI”), at least until there’s more data on how this sharing has worked out over time. I do plan to recycle the funds I’ve put into Kiva, as loans not as contributions to MFIs, and the more currency risk hits I take, the fewer entrepreneurs I can support in the long run. The few exceptions I’ve added to my portfolio (which now approaches 5,000 loans) are special loans I chose to support, with an 8-month-or-less repayment term, so as not to string out any possible loss over a longer timeframe.

    While I appreciate that Rosalind linked her readers to a thread at kivafriends.org, there is a different thread about currency risk sharing at Kiva which would be worth reading. You can read it here: it starts in March 2009 when currency risk was first being discussed as a Kiva policy.

  • 7. Dan  |  10 July 2010 at 12:32

    First, I would say to EJ that you can select that option already by simply choosing the loans that share currency risk. It would be a nightmare for Kiva to have lenders on a single loan both sharing and not sharing currency risk. The loan itself would need to be one way or the other. The other point has to do with size of portfolios. If it were just one loan, I would have to agree that $5 isn’t much. But there are many dedicated Kiva lenders who have literally thousands of dollars of loans– this makes for significantly bigger amounts at risk.

    I think David has touched on a crucial aspect of Kiva’s currency risk sharing. It is a very complex issue that makes it almost impossible for the average person to assess the risk. The fear of the unknown risk is going to keep larger lenders away. Kiva’s current methodology for calculation plays a part– in that losses go to the lender, but gains stay with the MFI Field Partner. The “gains” should at least stay as credits to offset losses.

    Perhaps Kiva needs to rethink currency loss loans and aggregate all currency conversion issues into a shared risk pool which lenders share across the board to spread out the risk.

  • 8. EJ McKay  |  10 July 2010 at 09:48

    I agree with Richard. If I only get $20 back from a loan, rather than $25, it doesn’t affect my life as significantly as it does the person who has to repay the loan. What’s $5 in ours lives compared to those who receive our loans? $5 is a large Starbucks coffee? The gas to commute to work from the suburbs? Morning paper and a muffin? It’s not enough for me to worry about, but it can be yet another hurdle for people in the developing world trying to raise pigs, run a market shop or tailor clothes?
    Keep in mind, that since many lenders aren’t from the US, those of us from ourside the States have to contribute *more* than $25 in our currency to have it converted to US before we can support a business.
    I for one wish there were a “check box” or an option to say that we’re okay with currency fluctuations.

  • 9. David  |  10 July 2010 at 07:24

    For me, currency risk on a Kiva loan is a deal breaker.

    I have no way to evaluate currency exchange risk for the many currencies and countries I want to lend to on Kiva; I have to trust the MFI to evaluate that risk. If they opt to “share” currency risk it must be because they think the risk is real and sizable, and I trust their conclusion in that.

    If my money is lost to currency exchange it cannot be used to help other lenders, which is the beauty of Kiva in the first place.

  • 10. alan  |  10 July 2010 at 07:03

    For non-US lenders the issue is more complex. If the US dollar falls against the lender’s currency, then even the full repayment is less when translated back than the original loan. (Of course, this is only a paper loss which is only realized by withdrawing and can be deferred or avoided by relending.) This affects a large number of lenders. So for these lenders, all loans bear currency risk and choosing to bear MFI currency risk is a double risk, but only a single risk for US lenders.

  • 11. Richard Middleton  |  10 July 2010 at 05:10

    I take what is probably a very simplistic view of this problem:
    – I want to help local entrepreneurs through my support of Kiva
    – Most of them think and operate in local currency
    – None of them have any influence over the international exchange rates for their currency
    – I suspect that over time most local currencies fall against the dollar, and often these drops are far too big to be covered by “reasonable” interest rates
    – Therefore the more currency risk we transfer to the local MFIs and borrowers, the more we are jeopardizing their success
    – Absorbing currency fluctuations will hurt me far less than it will hurt them
    So personally I am willing to assume currency risks.


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