MICROCAPITAL BRIEF: Wall Street Journal Article Highlights Foreign-Exchange Risks for Microfinance Institutions, Hedging Solutions Offered By The Currency Exchange Fund (TCX)

The Wall Street Journal, a US-based newspaper, recently commented on the potential of illiquid currencies and volatile monetary policy to have a negative impact on the loan portfolios of microfinance institutions (MFIs) in developing countries. Lenders that disburse loans in local-currency, but borrow on a wholesale basis in “hard” currencies like US dollars and euros must consider the possibility of a depreciation or devaluation of the local currency, which could affect the ability of the organization to repay its debts. Alternatively, organizations that disburse hard-currency loans to microenterprises that trade in local currency pass the same risk on to their clients, affecting their likelihood of repayment and thus the portfolio quality of the institution. By extension, the same risks are borne by wholesale lenders.

To manage this problem, banks and investment funds increasingly are choosing to deploy funds in local currencies. The Currency Exchange Fund (TCX) is a USD 750 million Netherlands-based investment facility that holds a variety of currencies from developing countries and uses interest rate derivatives to help wholesale lenders hedge foreign-exchange risks. TCX uses funds provided by international development agencies to purchase large volumes of currencies from approximately 80 countries, under the assumption that the net fluctuations in value will cancel out. It then lends in local currency to institutional investors that lend to MFIs.

Bai Tushum and Partners of Kyrgyzstan, an MFI that makes most of its loans in US dollars, is one example of an MFI that is looking to partner with a TCX-certified member to inject liquidity into its loan portfolio [1]. Although Bai Tushum recently received local-currency funding from the European Bank for Reconstruction and Development, a partner of TCX, the MFI is hoping to continue financing its operations through local-currency loans [2]. Because government bonds are attractive to local investors – due to yields of approximately 20 percent – MFIs in Kyrgyzstan face difficulty in raising domestic funds. For Bai Tushum to continue lending without bearing excessive risk, it needs to be able to borrow and lend in Kyrgyzstan soms [1].

By Rohan Trivedi, Research Associate

About The Currency Exchange Fund (TCX):
The Currency Exchange Fund (TCX) is a Netherlands-based financial institution that deals in long-term local currency and interest rate derivatives. TCX allows investors to hedge against exchange and interest rate risks that commonly pose problems for long-term investments in developing country currencies. TCX was launched in 2007 by investors that include European and African development finance institutions and commercial banks. As of July 2011, TCX reported total capital equivalent to USD 750 million.

About Bai Tushum and Partners:
Bai Tushum and Partners is a microfinance institution (MFI) based in the Kyrgyz Republic. It was founded in 2000 as a subsidiary of Bai Tushum Micro Credit Agency before transforming into an independent MFI in 2009. Bai Tushum’s products include agriloans; trade, service, and production loans; mortgage loans; consumer loans; and equipment financing. According to the US-based nonprofit Microfinance Information Exchange, as of December 31, 2010, Bai Tushum reported total assets of USD 59 million, a gross loan portfolio of USD 38.5 million, return on assets (ROA) of 4.48 percent, return on equity (ROE) of 21.9 percent and 29,600 active borrowers.

Sources and Additional Resources:

[1] The Wall Street Journal: “Microfinance Lenders Seek Ways to Hedge Forex Risks”, http://online.wsj.com/article/SB10001424052702303406104576443761441150244.html

[2] MicroCapital.org story, July 12, 2011: “MICROCAPITAL BRIEF European Bank for Reconstruction and Development (EBRD) Loans $6m in Local Currency to Microfinance Institution (MFI) Bai Tushum of Kyrgyz Republic”, https://www.microcapital.org/microcapital-brief-european-bank-for-reconstruction-and-development-ebrd-loans-6m-in-local-currency-to-microfinance-institution-mfi-bai-tushum-of-kyrgyz-republic/

MicroCapital.org story, June 11, 2011: “MICROCAPITAL PAPER WRAP-UP: Microfinance Foreign Exchange Facilities: Performance and Prospects, by David Apgar and Xavier Reille of CGAP”, https://www.microcapital.org/microcapital-paper-wrap-up-microfinance-foreign-exchange-facilities-performance-and-prospects-by-david-apgar-and-xavier-reille-of-cgap/

MicroCapital Universe Profile: The Currency Exchange Fund (TCX), https://www.microcapital.org/microfinanceuniverse/tiki-index.php?page=The+Currency+Exchange+Fund+%28TCX%29

MicroCapital Universe Profile: Bai Tushum and Partners, https://www.microcapital.org/microfinanceuniverse/tiki-index.php?page=Bai+Tushum+and+Partners

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