Risk Perception and FX Risk Mitigation in MFI Refinancing

Risk perception and FX risk mitigation in MFI reﬁnancing∗†

Christopher Priberny‡ Department of Finance University of Regensburg, Germany Gregor Dorﬂeitner§ Department of Finance University of Regensburg, Germany and CERMi (Centre for European Research in Microﬁnance), Belgium First draft: February 15, 2011

We study the perception of risks, particularly of FX risk, in MFI reﬁnancing. A survey addressed to MFIs ans MFI funding organizations reveals that MFIs consider several types of risks as rather unimportant, among them FX risk, which is contrary to the common view of the relevant literature. We obtain further insights into the FX hedging practice of microﬁnance actors, and reveal, that many FX risk mitigation strategies and hedging tools are quite rarely used in practice.

JEL classiﬁcation: G21; Keywords: Microﬁnance; FX risk; risk mitigation; survey;

∗First draft, please do not cite or circulate! †ACKNOWLEDGMENT: We thank Daniel Uhlemann for data collection and extensive support. ‡e-mail: [email protected] §e-mail: gregor.dorﬂ[email protected]

1 1 Introduction

The microfinance sector was subject to rapid growth in the years 2006 to 2010. This de- velopment was mainly enabled by the sector’s ongoing interaction with international capital markets, which made MFIs more and more independent from donations. Many microfinance institutions (MFIs) were transformed from mainly government subsidized organizations into more professional and profit-orientated financial institutions. According to Ledgerwood and White(2006) the refinancing possibilities on international capital markets, allowing MFIs to enlarge their lending capacity, are “widely viewed as the best way to achieve the out- reach needed to substantially increase access to financial services for the world’s hundreds of millions of low-income households”. However, refinancing with international debt titles instead of donations makes MFIs more vulnerable to various risk typs, that are already well known in the commercial banking sector. Taking out micro loans to clients results not only in credit risk, but also due to the own refinancing process in liquidity risk, interest rate risk and foreign exchange risk for the MFI and further more operational risks, like staff fraud.1

Particularly FX risk is still regarded to be a challenging burden for the microfinance industry to overcome in order to archive an stable longterm MFI funding. MFIs, or microfinance investment funds (MFIF) providing MFIs with loans in local currency, are particularly meant to naturally have a large FX risk exposure. According to Barrès(2007) foreign exchange risk occurs due to the mismatch of currencies in which assets and liabilities are denominated, combined with uncertainty about future FX fluctuations. Many MFIs operating in emerging markets face a mismatch between the currency of liabilities (funds) and assets (loans given to micro borrowers). The financial markets in developing countries are in many cases not mature enough to provide sufficient funds for MFIs in local currency. Swanson(2008) points out several reasons for this phenomenon: The bond markets in most developing countries are poorly regulated and thin. Local commercial banks are often lacking further knowledge how to analyze the risk associated with microfinance and therefore shrink away from investing in MFIs, if they see better investment opportunities in larger corporations or even foreign companies. They might also underlie investment restrictions that exclude microfinance. Holden and Holden(2004) state, that therefore the majority of MFIs is forced to refinance themselves – at least partially – by borrowing in hard currencies (mainly USD and EUR), while offering loans to clients in local currency. Featherston et al.(2006) quote, that many developing countries face reasonably high FX fluctuations, which is backed by analysis on exchange rates in developing countries of Cava- zos(2004) and Abrams and Schneider-Moretto(2007a), the last one updated in Abrams (2008).

1Cf. Churchill and Frankiewicz(2006)

2 Instruments2 to mitigate FX risks are principally:

• Swaps

• Cross currency swaps

• Futures

• Options

• Back-to-back loans

• Foreign currency deposits, Countervailing deposits

• currency devaluation accounts

However, for many currencies the instruments mentioned above are not available. In these cases a currency exchange fund, like the TCX fund3, could be an appropriate alternative. MFIs can furthermore reduce the FX exposure by the limitation of funds received in foreign currency, and reﬁnancing by dept in local currency.

Existing literature has so far clarified in which way the microfinance industry is affected by FX risk4 and which tools can be used to mitigate the exposure.5 However fairly few insights exist about how market participants of the microfinance sector consider different risk types and mitigation strategies is known particularly regarding FX risk. To our best knowlege Barrès(2007) is currently the only author which has published survey results on FX risk management of MFIFs.

By conducting a survey on types of risks and FX mitigation strategies in the MFI reﬁnancing process we try to ﬁll the existing gap. In section2 we present the survey methodology, design and samples, and we present the descriptive results of individual questions. In the following section3 we discuss our results on selected issues with the existing literature and conclude.

2Those instruments have already been discussed and explained in detail by Holden and Holden(2004), Cavazos(2004), Bhatia(2004) andFeatherston et al.(2006). 3See http://www.tcxfund.com. 4Cf. e.g. Featherston et al.(2006), Abrams and Schneider-Moretto(2007b). 5Cf. e.g. Abrams(2008), Holden and Holden(2004), Cavazos(2004), Bhatia(2004) and Featherston et al. (2006).

3 2 Survey

From July 8th, 2010, to August 11th, 2010, we conducted a web-based survey asking ap- proximately 900 organizations involved in microfinance, how they asses the market situation regarding different types of risk, in particular FX risk, and hedging possibilities. The ad- dressees of the survey were affiliated to MFIs and institutions refinancing MFIs (in the following summarized as MFIFs). Furthermore, we allowed answers by experts consulting these organizations. We used a standardized online questionnaire to facilitate anonymity. 164 persons participated, which results in a response rate of approx. 18%6. The survey design differentiates between MFIs and MFIFs, as we suspect differences regarding the risk perception of both groups. This methodology allowed us to slightly adjust the questionnaire for MFIs or MFIFs. So were MFIs additionally been asked about their total loan portfolio size, number of employees or average loan size or country of operation. This additional data allowed us to form suitable subsamples fur further investigation in section 3. Theses key figures characterizing the MFI sample are shown in Table1. The results are presented using frequency tables and are shown in the appendix. Thereby the different levels of categorized data follow a numeric rating scale, in rare cases were also comments of responses allowed. In addition to the purely descriptive view, we apply the Wilcoxon signed rank test7 to test for significance. Regarding the responding experts as a representative sample, the test allows us to make conclusions on the whole microfinance investment scene. Whereas most questions asked the participants about how often instruments are used or how significant they consider different risks, we test for both directions (e.g. rare vs. often) with a significance level of α=10% and the comparative neutral value corresponding to the null hypothesis.

3 Selected issues and discussion

Which types of risk are considered as significant for microfinance actors? The results (Table3 for MFIs) on this questions indicate, that MFIs consider refinancing risk due to fluctuations of donations as rather unimportant (statistically significantly). Likewise they asses risks concerning political stability and – what’s surprising – fX risk. Especially the last finding is in deep contrast to the prevailing opinion, already mentioned in section 1. One possible explanation might be that the sample contains some MFIs that are not exposed to FX risk. To check this point we create a subsample of 47 MFIs8 that are all exposed to FX risk in the following way: We consider an MFI to be exposed to FX risk if some portion of its liabilities is denominated in foreign currency and the local currency is not plegged to the foreign currency. The results of the subsample regarding the same question are shown in Table4. Regarding FX risk a clear shift in the distribution towards importance is now observable, although this could not be proven by the significance test. The only risks seen by both samples, MFIs and MFIs exposed to FX risk, as statistically significantly important are driven by

6In fact 198 persons responsees were registrated. However 34 surveys were terminated after question 1, which just indicates the type of organization, and have therefore been excluded from the sample. 7Cf. Crawley(2007). 8The key ﬁgures of the subsample are displayed in Table2

4 macroeconomic factors, e.g. unemployment, inflation etc. The results regarding the MFIF sample, shown in Table 15 (and in Table 16 for a subsample that is exposed to FX) risk9, are in contrast to those of the MFIs. Even though MFIs and MFIFs come to the same opinion regarding the dependency on donations and macroeconomic factors, MFIFs consider also counter party, or credit risk and political stability as (statistically significantly) important means. Furthermore we test for differences regarding the judgment of MFIs and MFIFs considering the different types of risk by using the Mann-Whitney U test10. Again we test in both directions with a confidence level of α=10% . The results are displayed in Table 25. Notice that that MFIs consider liqidity risk as more signifactly than MFIFs.

What can be said about lending currencies? Table5 shows in which currencies liabilities of MFIs are denominated, while Table 17 displays the currency structure for loans to MFIs made by MFIFs. The large portion of MFIs that receive funds in local currency is remarkable. In fact, for 24 MFIs, i.e. 38.71% of the sample, are at least 76% up to 100% of their liablities denominated in local currency. On the other side, only 2 (4.88%) MFIFs report not to have made loans in local currencies. Despite the increasing meaning of local currency our survey shows that hard currency still play an important role, especially USD and EUR, whereas GBP and CHF play a secondary role.

Which strategies and instruments are used by MFIs and MFIFs to mitigate FX risk? On the MFI level we hereby diﬀerentiate between pure FX mitigation strategies 11, e.g. limits for FX exposed loans12, and hedging instruments. In contrast to the prevailing opinion in the literature, all mentioned hedging instruments are almost never used , with exception of Back-to-back loans, which are used by few MFIs. Although the test indicates a rare use of nearly all FX mitigation strategies, these are indeed more often used as hedging instruments by MFIs. For MFIFs the survey design is limited to hedging instruments only. According to the results in Table 21 (and Table 22) MFIFs are using these instruments more often as MFIs, particularly cross currency swaps and futures, but according to the result of the Wilcoxon test the use is rather less frequent.

Why remains FX risk exposure unhedged? So microfinance actors, particularly MFIs shrink away from using hedging instrument often described in the literature, leaving parts of their FX exposure unhedged. Table7 and Table8 show that none of the participating MFI is hedged completely against FX risk, even 66.67% leave their portfolio completely unhedged. According to our results presented in Table 13 and Table 14 (for MFIs) and Table 23 and Table 18 (for MFIFs), MFIs report high transaction cost as (statistically significant) reason. Note that the point, that MFIs seem to be well aware of FX risk. So 85.18% of the responsees of that sample considered no awarness of FX risk as more insignificant reason for neglecting to hedge. The participating MFIs are furthermore undecided with respect to

9The subsample was created analogously to the MFI case, in this case related to assets in local currency (meaning foreign currency for the MFIF). 10Cf. Mann and Whitney(1947). 11See Table9 and Table 10. 12See Table11 and Table 12

5 another reason for this phenomenon. This is the lack of adequate hedging tools due to thin ﬁnancial markets. We ﬁnd that MFIFs have the quite similar views.13 They regard the lack of adequate hedging tools as the most important reason.

We conclude that MFIs and MFIFs consider several types of risks as rather unimportant, among them FX risk, which is contrary to the common view of the relevant literature. Furthermore we reveal that many FX risk mitigation strategies and hedging tools, introduced in the respective literature, are quite rarely used in practice. The reason for this phenomenon can be seen in the lacking availability of suitable, cost effective hedging tools. Therefore, this paper contributes to the existing literature on FX risk and other types of risk in the microfinance sector by bringing out the risk perception of different players in the microfinance sector.

13This is also conﬁrmed, by the fact that, the Mann-Whitney U test lead no statistically signiﬁcant results.

6 3.1 MFIs

Region where MFI is mainly operating Developed economies Africa Latin America and the Caribbean Southern / Eastern Europe Middle East Asia Southeast Asia and the Paciﬁc Other NA (NA) 3 (3.53) 10 (11.76) 27 (31.76) 16 (18.82) 4 (4.71) 10 (11.76) 9 (10.59)

Size of MFI’s total loan portfolio [in mUSD] < 0.5 0.50 - 2.50 2.51 - 5.00 5.01 - 7.50 7.51 - 10.00 10.01 - 50.00 > 50 2 (2.35) 12 (14.12) 8 (9.41) 8 (9.41) 3 (3.53) 39 (45.88) 13 (15.29)

Number of MFI’s employees 1-10 11-50 51 - 100 101 - 500 > 500 2 (2.41) 11 (13.25) 20 (24.1) 31 (37.35) 19 (22.89)

Size of MFI’s average loan size < 100 100 - 500 501 - 1000 1001 - 1500 1501 - 2000 2001 - 2500 > 2500 3 (3.75) 20 (25) 16 (20) 18 (22.5) 7 (8.75) 3 (3.75) 13 (16.25)

Table 1: Key ﬁgures of MFI sample 7

Region where MFI is mainly operating Developed economies Africa Latin America and the Caribbean Southern / Eastern Europe Middle East Asia Southeast Asia and the Paciﬁc Other NA (NA) 1 (2.17) 6 (13.04) 16 (34.78) 6 (13.04) 3 (6.52) 4 (8.7) 4 (8.7)

Size of MFI’s total loan portfolio [in mUSD] < 0.5 0.50 - 2.50 2.51 - 5.00 5.01 - 7.50 7.51 - 10.00 10.01 - 50.00 > 50 1 (2.13) 5 (10.64) 4 (8.51) 6 (12.77) 1 (2.13) 22 (46.81) 8 (17.02)

Number of MFI’s employees 1-10 11-50 51 - 100 101 - 500 > 500 1 (2.13) 7 (14.89) 11 (23.4) 17 (36.17) 11 (23.4)

Size of MFI’s average loan size < 100 100 - 500 501 - 1000 1001 - 1500 1501 - 2000 2001 - 2500 > 2500 2 (4.26) 10 (21.28) 10 (21.28) 13 (27.66) 4 (8.51) 3 (6.38) 5 (10.64)

Table 2: Key figures of MFIs exposed to FX risk insignificant [1] 2 3 4 very sigificant [5] NA N sign. (α = 0.1) Dependency on donations for funding operations 30 (50) 8 (13.33) 13 (21.67) 3 (5) 6 (10) 35 95 less (p.-value: 1.75e-05) Operational risks 6 (8.33) 16 (22.22) 28 (38.89) 10 (13.89) 12 (16.67) 23 95 NA Counterparty risk from lending loans to micro-entrepreneurs 9 (13.04) 13 (18.84) 26 (37.68) 6 (8.7) 15 (21.74) 26 95 NA Liquidity risk 7 (9.86) 15 (21.13) 25 (35.21) 9 (12.68) 15 (21.13) 24 95 NA Foreign exchange risk 12 (19.67) 16 (26.23) 16 (26.23) 9 (14.75) 8 (13.11) 34 95 less (p.-value: 0.0881) Interest rate risk 7 (10.14) 18 (26.09) 22 (31.88) 16 (23.19) 6 (8.7) 26 95 NA Political instability 15 (22.06) 17 (25) 21 (30.88) 8 (11.76) 7 (10.29) 27 95 less (p.-value: 0.0129) Macroeconomic factors (e.g. inflation, unemployment,...) 4 (5.63) 14 (19.72) 22 (30.99) 20 (28.17) 11 (15.49) 24 95 greater (p.-value: 0.0191) Climatic risk factors (e.g. drought, floods, variations in temperature,...) 11 (15.28) 20 (27.78) 15 (20.83) 13 (18.06) 13 (18.06) 23 95 NA

Table 3: Analysis of Risk type assessment of MFIs Question: “How would you rate the following potential types of risk for your organization?” Sample: “MFIs”

insigniﬁcant [1] 2 3 4 very sigiﬁcant [5] NA N sign. (α = 0.1) Dependency on donations for funding operations 18 (50) 7 (19.44) 8 (22.22) 1 (2.78) 2 (5.56) 11 47 less (p.-value: 5.99e-05) Operational risks 3 (6.82) 8 (18.18) 20 (45.45) 6 (13.64) 7 (15.91) 3 47 NA Counterparty risk from lending loans to micro-entrepreneurs 4 (9.3) 8 (18.6) 18 (41.86) 2 (4.65) 11 (25.58) 4 47 NA Liquidity risk 4 (9.09) 11 (25) 14 (31.82) 6 (13.64) 9 (20.45) 3 47 NA

8 Foreign exchange risk 3 (7.14) 10 (23.81) 15 (35.71) 9 (21.43) 5 (11.9) 5 47 NA Interest rate risk 4 (9.52) 13 (30.95) 12 (28.57) 9 (21.43) 4 (9.52) 5 47 NA Political instability 9 (20.93) 9 (20.93) 13 (30.23) 5 (11.63) 7 (16.28) 4 47 NA Macroeconomic factors (e.g. inﬂation, unemployment,...) 2 (4.55) 8 (18.18) 15 (34.09) 9 (20.45) 10 (22.73) 3 47 greater (p.-value: 0.0142) Climatic risk factors (e.g. drought, ﬂoods, variations in temperature,...) 7 (15.91) 13 (29.55) 7 (15.91) 7 (15.91) 10 (22.73) 3 47 NA

Table 4: Analysis of Risk type assessment of MFIs exposed to FX risk Question: “How would you rate the following potential types of risk for your organization?” Sample: “MFIs exposed to FX risk” 0 01% - 25% 26% - 50% 51% - 75% 76% - 100% NA N EUR 9 (34.62) 8 (30.77) 2 (7.69) 4 (15.38) 3 (11.54) 69 95 USD 5 (10.2) 9 (18.37) 7 (14.29) 12 (24.49) 16 (32.65) 46 95 CHF 9 (90) 1 (10) NA (NA) NA (NA) NA (NA) 85 95 GBP 9 (90) NA (NA) NA (NA) NA (NA) 1 (10) 85 95 Local currency 2 (3.23) 17 (27.42) 12 (19.35) 7 (11.29) 24 (38.71) 33 95

Table 5: Analysis of currencies in which liabilities of MFIs are denominated Question: “In what currency does your organization receive funds (e.g. equity, loans,...) from investors?” Sample: “MFIs exposed to FX risk”

0 01% - 25% 26% - 50% 51% - 75% 76% - 100% NA N EUR 6 (31.58) 8 (42.11) 1 (5.26) 2 (10.53) 2 (10.53) 28 47 USD NA (NA) 9 (21.43) 7 (16.67) 12 (28.57) 14 (33.33) 5 47 CHF 5 (83.33) 1 (16.67) NA (NA) NA (NA) NA (NA) 41 47 GBP 5 (83.33) NA (NA) NA (NA) NA (NA) 1 (16.67) 41 47 Local currency 1 (2.7) 15 (40.54) 10 (27.03) 6 (16.22) 5 (13.51) 10 47 9 Table 6: Analysis of currencies in which liabilities of MFIs (exposed of FX risk) are denominated Question: “In what currency does your organization receive funds (e.g. equity, loans,...) from investors?” Sample: “MFIs exposed to FX risk” 0% 1% - 10% 11% - 20% 21% - 30% 31% - 40% 41% - 50% 51% - 60% 61% - 70% 71% - 80% 81% - 90% 91% - 99% 100% NA N 32 (66.67) NA (NA) NA (NA) 1 (2.08) 3 (6.25) 6 (12.5) NA (NA) 3 (6.25) NA (NA) 3 (6.25) NA (NA) NA (NA) 47 95

Table 7: Portfolio share hedged against FX risk by MFIs Question: “If the funding currency of your loan portfolio diﬀers from the operating currency, what percentage of funds received is hedged against foreign exchange rate ﬂuctuations?” Sample: “MFIs”

0% 1% - 10% 11% - 20% 21% - 30% 31% - 40% 41% - 50% 51% - 60% 61% - 70% 71% - 80% 81% - 90% 91% - 99% 100% NA N 23 (65.71) NA (NA) NA (NA) 1 (2.86) 2 (5.71) 5 (14.29) NA (NA) 1 (2.86) NA (NA) 3 (8.57) NA (NA) NA (NA) 12 47

Table 8: Portfolio share hedged against FX risk by MFIs (exposed to FX risk) Question: ‘If the funding currency of your loan portfolio diﬀers from the operating currency, what percentage of funds received is hedged against foreign exchange rate ﬂuctuations?” Sample: “MFIs exposed to FX risk” 10 never used [0] rarely used [1] 2 frequently used [3] 4 often used [5] NA N sign. (α = 0.1) Limits how much funds may be received in hard currency 6 (13.04) 12 (26.09) 3 (6.52) 7 (15.22) 6 (13.04) 12 (26.09) 49 95 less (p.-value: 0.072) Indexation of loans to hard currency (devaluation of the local 21 (44.68) 12 (25.53) 5 (10.64) 5 (10.64) 1 (2.13) 3 (6.38) 48 95 less (p.-value: 1.11e-07) currency leads to higher interest payments on the loans provided to micro-entrepreneurs) Debt issuance in local currency to fund operations 17 (37.78) 7 (15.56) 2 (4.44) 5 (11.11) 3 (6.67) 11 (24.44) 50 95 less (p.-value: 0.000471) Funding through conventional loans from domestic banks in local 7 (15.22) 6 (13.04) 8 (17.39) 9 (19.57) 6 (13.04) 10 (21.74) 49 95 NA currency Foreign currency deposits / Countervailing foreign exchange de- 14 (31.11) 10 (22.22) 9 (20) 4 (8.89) 1 (2.22) 7 (15.56) 50 95 less (p.-value: 6.26e-05) posits Currency devaluation accounts 23 (52.27) 10 (22.73) 5 (11.36) 2 (4.55) 2 (4.55) 2 (4.55) 51 95 less (p.-value: 5.02e-08)

Table 9: Use of FX mitigation strategies by MFIs Question: “Indicate what instruments or strategies other than hedging your organization uses to reduce your foreign exchange risk.” Sample: “MFIs”

never used [0] rarely used [1] 2 frequently used [3] 4 often used [5] NA N sign. (α = 0.1) Limits how much funds may be received in hard currency 4 (11.76) 9 (26.47) 3 (8.82) 7 (20.59) 4 (11.76) 7 (20.59) 13 47 less (p.-value: 0.057) Indexation of loans to hard currency (devaluation of the local 13 (37.14) 10 (28.57) 4 (11.43) 5 (14.29) 1 (2.86) 2 (5.71) 12 47 less (p.-value: 8.01e-06) currency leads to higher interest payments on the loans provided

11 to micro-entrepreneurs) Debt issuance in local currency to fund operations 14 (42.42) 4 (12.12) 2 (6.06) 3 (9.09) 3 (9.09) 7 (21.21) 14 47 less (p.-value: 0.00111) Funding through conventional loans from domestic banks in local 7 (20.59) 4 (11.76) 7 (20.59) 6 (17.65) 4 (11.76) 6 (17.65) 13 47 less (p.-value: 0.0331) currency Foreign currency deposits / Countervailing foreign exchange de- 12 (36.36) 7 (21.21) 7 (21.21) 2 (6.06) 1 (3.03) 4 (12.12) 14 47 less (p.-value: 0.000101) posits Currency devaluation accounts 17 (51.52) 7 (21.21) 4 (12.12) 2 (6.06) 1 (3.03) 2 (6.06) 14 47 less (p.-value: 3.33e-06)

Table 10: Use of FX mitigation strategies by MFIs (exposed to FX risk) Question: “Indicate what instruments or strategies other than hedging your organization uses to reduce your foreign exchange risk.” Sample: “MFIs exposed to FX risk” never used [0] rarely used [1] 2 frequently used [3] 4 always used [5] NA N sign. (α = 0.1) Foreign exchange trade desk of another international bank 5 (50) 3 (30) 2 (20) NA (NA) NA (NA) NA (NA) 85 95 less (p.-value: 0.00257) OTC: entering currency swaps 6 (60) 2 (20) NA (NA) 1 (10) NA (NA) 1 (10) 85 95 less (p.-value: 0.00705) OTC: buying/selling currency forwards 4 (40) NA (NA) 3 (30) 1 (10) 1 (10) 1 (10) 85 95 less (p.-value: 0.0402) OTC: buying/selling currency futures 7 (77.78) 1 (11.11) 1 (11.11) NA (NA) NA (NA) NA (NA) 86 95 less (p.-value: 0.00303) OTC: buying/selling currency options 7 (63.64) 1 (9.09) NA (NA) 2 (18.18) NA (NA) 1 (9.09) 84 95 less (p.-value: 0.00523) OTC: entering cross currency swaps 5 (55.56) 2 (22.22) 2 (22.22) NA (NA) NA (NA) NA (NA) 86 95 less (p.-value: 0.00393) Back-to-back loans 13 (29.55) 8 (18.18) 10 (22.73) 8 (18.18) 2 (4.55) 3 (6.82) 51 95 less (p.-value: 1.18e-05)

Table 11: Use of FX heding instrument by MFIs Question: “If there is hedging in place for at least a portion of the portfolio, which of the following hedging strategies does your organization use to reduce foreign exchange risk?” Sample: “MFIs”

never used [0] rarely used [1] 2 frequently used [3] 4 always used [5] NA N sign. (α = 0.1) Foreign exchange trade desk of another international bank 4 (50) 2 (25) 2 (25) NA (NA) NA (NA) NA (NA) 39 47 less (p.-value: 0.00644) OTC: entering currency swaps 5 (62.5) 1 (12.5) NA (NA) 1 (12.5) NA (NA) 1 (12.5) 39 47 less (p.-value: 0.0175) OTC: buying/selling currency forwards 3 (37.5) NA (NA) 2 (25) 1 (12.5) 1 (12.5) 1 (12.5) 39 47 less (p.-value: 0.0992) OTC: buying/selling currency futures 6 (85.71) 1 (14.29) NA (NA) NA (NA) NA (NA) NA (NA) 40 47 less (p.-value: 0.00735) OTC: buying/selling currency options 6 (85.71) 1 (14.29) NA (NA) NA (NA) NA (NA) NA (NA) 40 47 less (p.-value: 0.00735) 12 OTC: entering cross currency swaps 4 (57.14) 2 (28.57) 1 (14.29) NA (NA) NA (NA) NA (NA) 40 47 less (p.-value: 0.00995) Back-to-back loans 8 (25) 5 (15.62) 7 (21.88) 7 (21.88) 2 (6.25) 3 (9.38) 15 47 less (p.-value: 0.00118)

Table 12: Use of FX heding instrument by MFIs (exposed to FX risk) Question: “If there is hedging in place for at least a portion of the portfolio, which of the following hedging strategies does your organization use to reduce foreign exchange risk?” Sample: “MFIs exposed to FX risk” insignificant reason [1] 2 significant reason [3] 4 very significant reason [5] NA N sign. alpha = 0.1 Not aware of any foreign exchange risk 12 (44.44) 11 (40.74) 3 (11.11) 1 (3.7) NA (NA) 68 95 less (p.-value: 1.27e-05) No adequate financial markets available 6 (16.22) 7 (18.92) 9 (24.32) 7 (18.92) 8 (21.62) 58 95 NA High transaction costs due to small loan size 2 (5.26) 4 (10.53) 18 (47.37) 6 (15.79) 8 (21.05) 57 95 greater (p.-value: 0.0238) Regulatory obstacles 9 (27.27) 7 (21.21) 9 (27.27) NA (NA) 8 (24.24) 62 95 NA Bureaucracy 13 (43.33) 9 (30) 3 (10) NA (NA) 5 (16.67) 65 95 less (p.-value: 0.00814) Inefficiencies, e.g. long time to set up a bank account 17 (54.84) 7 (22.58) 3 (9.68) 3 (9.68) 1 (3.23) 64 95 less (p.-value: 4.09e-05) Acceptance of higher risk to gain returns 14 (48.28) 2 (6.9) 9 (31.03) 4 (13.79) NA (NA) 66 95 less (p.-value: 0.000206) Company policies allow higher risk 12 (38.71) 8 (25.81) 7 (22.58) 3 (9.68) 1 (3.23) 64 95 less (p.-value: 0.000413)

Table 13: Reasons why MFIs are neglecting FX risk mitigation Question: “If a part of your foreign exchange risk exposure remains unhedged, indicate how signiﬁcant the following issues are for this situation.” Sample: “MFIs”

insignificant reason [1] 2 significant reason [3] 4 very significant reason [5] NA N sign. alpha = 0.1 Not aware of any foreign exchange risk 8 (42.11) 7 (36.84) 3 (15.79) 1 (5.26) NA (NA) 28 47 less (p.-value: 0.000399) No adequate financial markets available 5 (17.86) 5 (17.86) 7 (25) 5 (17.86) 6 (21.43) 19 47 NA High transaction costs due to small loan size 1 (3.45) 2 (6.9) 16 (55.17) 5 (17.24) 5 (17.24) 18 47 greater (p.-value: 0.0283) Regulatory obstacles 6 (25) 4 (16.67) 8 (33.33) NA (NA) 6 (25) 23 47 NA Bureaucracy 10 (45.45) 6 (27.27) 3 (13.64) NA (NA) 3 (13.64) 25 47 less (p.-value: 0.00992)

13 Ineﬃciencies, e.g. long time to set up a bank account 13 (59.09) 3 (13.64) 3 (13.64) 2 (9.09) 1 (4.55) 25 47 less (p.-value: 0.000648) Acceptance of higher risk to gain returns 11 (50) 1 (4.55) 8 (36.36) 2 (9.09) NA (NA) 25 47 less (p.-value: 7e-04) Company policies allow higher risk 8 (33.33) 7 (29.17) 7 (29.17) 2 (8.33) NA (NA) 23 47 less (p.-value: 0.000646)

Table 14: Reasons why MFIs (exposed to FX risk) are neglecting FX risk mitigation Question: “If a part of your foreign exchange risk exposure remains unhedged, indicate how signiﬁcant the following issues are for this situation.” Sample: “MFIs exposed to FX risk” 3.2 MFIFs

insignificant [1] 2 3 4 very significant [5] NA N sign. (α = 0.1) Dependance on funding from donations 18 (60) 3 (10) 5 (16.67) 3 (10) 1 (3.33) 39 69 less (p.-value: 5.75e-05) Operational risks 3 (7.5) 11 (27.5) 12 (30) 12 (30) 2 (5) 29 69 NA Counterparty risk from lending loans to MFIs (Default risk) 4 (9.09) 7 (15.91) 8 (18.18) 11 (25) 14 (31.82) 25 69 greater (p.-value: 0.00574) Liquidity risk 9 (20.93) 11 (25.58) 9 (20.93) 13 (30.23) 1 (2.33) 26 69 less (p.-value: 0.0299) Foreign exchange risk 7 (17.95) 8 (20.51) 8 (20.51) 10 (25.64) 6 (15.38) 30 69 NA Interest rate risk 5 (12.2) 10 (24.39) 14 (34.15) 10 (24.39) 2 (4.88) 28 69 NA Political instability in the countries your organization lends money to 5 (11.63) 2 (4.65) 10 (23.26) 15 (34.88) 11 (25.58) 26 69 greater (p.-value: 0.0066) Macroeconomic factors (e.g. inflation, unemployment,...) 1 (2.22) 7 (15.56) 16 (35.56) 14 (31.11) 7 (15.56) 24 69 greater (p.-value: 0.00463) Climatic risk factors (e.g. drought, floods, variations in temperature, ...) in the 5 (11.36) 13 (29.55) 15 (34.09) 10 (22.73) 1 (2.27) 25 69 less (p.-value: 0.052) regions loans are lent to Competition from other investors funding microfinance 5 (11.9) 9 (21.43) 14 (33.33) 9 (21.43) 5 (11.9) 27 69 NA

Table 15: Analysis of Risk type assessment of MFIFs Question: “How would you rate the following potential types of risk for your organization?” Sample: “MFIFs”

14 insignificant [1] 2 3 4 very sigificant [5] NA N sign. (α = 0.1) Dependance on funding from donations 13 (65) 2 (10) 3 (15) 2 (10) NA (NA) 12 32 less (p.-value: 0.000191) Operational risks 2 (6.67) 6 (20) 11 (36.67) 10 (33.33) 1 (3.33) 2 32 NA Counterparty risk from lending loans to MFIs (Default risk) 1 (3.33) 3 (10) 6 (20) 7 (23.33) 13 (43.33) 2 32 greater (p.-value: 0.000325) Liquidity risk 3 (10) 10 (33.33) 8 (26.67) 9 (30) NA (NA) 2 32 NA Foreign exchange risk 4 (13.79) 6 (20.69) 7 (24.14) 8 (27.59) 4 (13.79) 3 32 NA Interest rate risk 3 (10.71) 6 (21.43) 12 (42.86) 6 (21.43) 1 (3.57) 4 32 NA Political instability in the countries your organization lends money to 1 (3.33) NA (NA) 6 (20) 14 (46.67) 9 (30) 2 32 greater (p.-value: 6.21e-05) Macroeconomic factors (e.g. inflation, unemployment,...) NA (NA) 4 (12.9) 9 (29.03) 12 (38.71) 6 (19.35) 1 32 greater (p.-value: 0.00085) Climatic risk factors (e.g. drought, floods, variations in temperature, ...) in the 3 (9.68) 8 (25.81) 11 (35.48) 8 (25.81) 1 (3.23) 1 32 NA regions loans are lent to Competition from other investors funding microfinance 3 (10) 5 (16.67) 12 (40) 7 (23.33) 3 (10) 2 32 NA

Table 16: Analysis of Risk type assessment of MFIFs (exposed to FX risk) Question: “How would you rate the following potential types of risk for your organization?” Sample: “MFIFs exposed to FX risk” 0 01% - 25% 26% - 50% 51% - 75% 76% - 100% NA N EUR 3 (13.64) 11 (50) 2 (9.09) 2 (9.09) 4 (18.18) 47 69 USD 1 (3.45) 9 (31.03) 4 (13.79) 7 (24.14) 8 (27.59) 40 69 CHF 13 (100) NA (NA) NA (NA) NA (NA) NA (NA) 56 69 GBP 15 (100) NA (NA) NA (NA) NA (NA) NA (NA) 54 69 Local currency 2 (4.88) 16 (39.02) 4 (9.76) 1 (2.44) 18 (43.9) 28 69

Table 17: Analysis of currencies in which liabilities of MFIFs are denominated Question: “In what currency do you provide funds for MFIs?” Sample: “MFIFs”

0 01% - 25% 26% - 50% 51% - 75% 76% - 100% NA N EUR 2 (10) 10 (50) 2 (10) 2 (10) 4 (20) 12 32 USD 1 (3.7) 8 (29.63) 4 (14.81) 7 (25.93) 7 (25.93) 5 32 CHF 12 (100) NA (NA) NA (NA) NA (NA) NA (NA) 20 32 GBP 13 (100) NA (NA) NA (NA) NA (NA) NA (NA) 19 32 Local currency NA (NA) 16 (55.17) 4 (13.79) 1 (3.45) 8 (27.59) 3 32 15

Table 18: Analysis of currencies in which liabilities of MFIFs (exposed of FX risk) are denominated Question: “In what currency do you provide funds for MFIs?” Sample: “MFIFs exposed to FX risk” 0% 1% - 10% 11% - 20% 21% - 30% 31% - 40% 41% - 50% 51% - 60% 61% - 70% 71% - 80% 81% - 90% 91% - 99% 100% NA N 14 (31.11) 3 (6.67) 5 (11.11) 17 (37.78) 1 (2.22) 1 (2.22) 2 (4.44) 1 (2.22) NA (NA) NA (NA) 1 (2.22) NA (NA) 24 69

Table 19: Asset portfolio share hedged against FX risk by MFIFs Question: “Indicate what percentage of your organization’s loan portfolio lent to MFIs in local currencies is hedged against foreign exchange rate ﬂuctuations.” Sample: “MFIFs”

0% 1% - 10% 11% - 20% 21% - 30% 31% - 40% 41% - 50% 51% - 60% 61% - 70% 71% - 80% 81% - 90% 91% - 99% 100% NA N 6 (18.75) 2 (6.25) 4 (12.5) 14 (43.75) 1 (3.12) 1 (3.12) 2 (6.25) 1 (3.12) NA (NA) NA (NA) 1 (3.12) NA (NA) 0 32

Table 20: Asset portfolio share hedged against FX risk by MFIFs (exposed to FX risk) Question: “Indicate what percentage of your organization’s loan portfolio lent to MFIs in local currencies is hedged against foreign exchange rate ﬂuctuations.” Sample: “MFIFs exposed to FX risk” 16 never used [0] rarely used [1] 2 frequently used [3] 4 always used [5] NA N sign. (α = 0.1) Foreign exchange trade desk of another international bank 7 (41.18) 2 (11.76) NA (NA) 1 (5.88) NA (NA) 7 (41.18) 52 69 less (p.-value: 0.0416) OTC: entering currency swaps 10 (66.67) NA (NA) NA (NA) 1 (6.67) NA (NA) 4 (26.67) 54 69 less (p.-value: 0.00291) OTC: buying/selling currency forwards 5 (25) 3 (15) 1 (5) 4 (20) 1 (5) 6 (30) 49 69 NA OTC: buying/selling currency futures 14 (87.5) 2 (12.5) NA (NA) NA (NA) NA (NA) NA (NA) 53 69 less (p.-value: 7.5e-05) OTC: buying/selling currency options 14 (82.35) 3 (17.65) NA (NA) NA (NA) NA (NA) NA (NA) 52 69 less (p.-value: 5.81e-05) OTC: entering cross currency swaps 7 (31.82) NA (NA) 1 (4.55) 2 (9.09) 3 (13.64) 9 (40.91) 47 69 NA Back-to-back loans 7 (41.18) 3 (17.65) 3 (17.65) 3 (17.65) NA (NA) 1 (5.88) 52 69 less (p.-value: 0.00149)

Table 21: Use of FX heding instrument by MFIFs Question: “When lending to MFIs in a currency other than a hard currency, indicate what instruments or strategies you use to hedge your loan portfolio against foreign exchange risk” Sample: “MFIs”

never used [0] rarely used [1] 2 frequently used [3] 4 always used [5] NA N sign. (α = 0.1) Foreign exchange trade desk of another international bank 6 (42.86) 2 (14.29) NA (NA) 1 (7.14) NA (NA) 5 (35.71) 18 32 less (p.-value: 0.0361) OTC: entering currency swaps 9 (69.23) NA (NA) NA (NA) 1 (7.69) NA (NA) 3 (23.08) 19 32 less (p.-value: 0.00368) OTC: buying/selling currency forwards 5 (26.32) 3 (15.79) 1 (5.26) 4 (21.05) 1 (5.26) 5 (26.32) 13 32 less (p.-value: 0.0694) OTC: buying/selling currency futures 13 (86.67) 2 (13.33) NA (NA) NA (NA) NA (NA) NA (NA) 17 32 less (p.-value: 0.000126) OTC: buying/selling currency options 13 (81.25) 3 (18.75) NA (NA) NA (NA) NA (NA) NA (NA) 16 32 less (p.-value: 9.69e-05) 17 OTC: entering cross currency swaps 6 (30) NA (NA) 1 (5) 2 (10) 3 (15) 8 (40) 12 32 NA Back-to-back loans 6 (37.5) 3 (18.75) 3 (18.75) 3 (18.75) NA (NA) 1 (6.25) 16 32 less (p.-value: 0.00253)

Table 22: Use of FX heding instrument by MFIFs (exposed to FX risk) Question: “When lending to MFIs in a currency other than a hard currency, indicate what instruments or strategies you use to hedge your loan portfolio against foreign exchange risk” Sample: “MFIs exposed to FX risk” insignificant reason [1] 2 significant reason [3] 4 very significant reason [5] NA N sign. alpha = 0.1 No adequate hedging tools (illiquidity of financial markets) 4 (17.39) 1 (4.35) 5 (21.74) 1 (4.35) 12 (52.17) 46 69 greater (p.-value: 0.0242) High transaction costs, due to small loan size 5 (21.74) 3 (13.04) 6 (26.09) 3 (13.04) 6 (26.09) 46 69 NA Regulations that hinder installing the required capacities 7 (35) 4 (20) 6 (30) 1 (5) 2 (10) 49 69 less (p.-value: 0.0296) (legal issues, transferring money,...) Too much bureaucracy (filing documents,...) to set up 10 (52.63) 7 (36.84) 1 (5.26) 1 (5.26) NA (NA) 50 69 less (p.-value: 0.000151) required capacities Inefficiencies (e.g. long time to set up bank accounts,...) 8 (40) 5 (25) 4 (20) 1 (5) 2 (10) 49 69 less (p.-value: 0.0141) that delay quick set up of hedging facilities Acceptance of higher risk in order to gain higher returns 7 (36.84) 4 (21.05) 2 (10.53) 4 (21.05) 2 (10.53) 50 69 less (p.-value: 0.0594) Company policies allow partly unhedged portfolio 8 (50) 2 (12.5) 1 (6.25) 3 (18.75) 2 (12.5) 53 69 less (p.-value: 0.0408)

Table 23: Reasons why MFIFs are (partly) neglecting FX risk mitigation Question: “Which of the following issues do you consider a signiﬁcant reason why part of your organization’s loan portfolio might not be hedged against foreign exchange risk?” Sample: “MFIFs”

insignificant reason [1] 2 significant reason [3] 4 very significant reason [5] NA N sign. alpha = 0.1 No adequate hedging tools (illiquidity of financial mar- 2 (10.53) 1 (5.26) 4 (21.05) 1 (5.26) 11 (57.89) 13 32 greater (p.-value: 0.00695) kets) 18 High transaction costs, due to small loan size 4 (22.22) 2 (11.11) 5 (27.78) 3 (16.67) 4 (22.22) 14 32 NA Regulations that hinder installing the required capacities 5 (31.25) 4 (25) 5 (31.25) 1 (6.25) 1 (6.25) 16 32 less (p.-value: 0.0274) (legal issues, transferring money,...) Too much bureaucracy (filing documents,...) to set up 8 (50) 7 (43.75) 1 (6.25) NA (NA) NA (NA) 16 32 less (p.-value: 0.000252) required capacities Inefficiencies (e.g. long time to set up bank accounts,...) 6 (37.5) 5 (31.25) 4 (25) NA (NA) 1 (6.25) 16 32 less (p.-value: 0.00854) that delay quick set up of hedging facilities Acceptance of higher risk in order to gain higher returns 7 (50) 2 (14.29) 2 (14.29) 2 (14.29) 1 (7.14) 18 32 less (p.-value: 0.0209) Company policies allow partly unhedged portfolio 6 (46.15) 1 (7.69) 1 (7.69) 3 (23.08) 2 (15.38) 19 32 NA

Table 24: Reasons why MFIFs (exposed to FX risk) are (partly) neglecting FX risk mitigation Question: “Which of the following issues do you consider a signiﬁcant reason why part of your organization’s loan portfolio might not be hedged against foreign exchange risk?” Sample: “MFIFs exposed to FX risk” 3.3 Comparative analysis: MFIFs vs. MFIs

insignificant [1] 2 3 4 very sigificant [5] NA N sig. (α=0.10) insignificant [1] 2 3 4 very insigificant [5] NA N Dependance on funding 18 (60) 3 (10) 5 (16.67) 3 (10) 1 (3.33) 39 69 NA 30 (50) 8 (13.33) 13 (21.67) 3 (5) 6 (10) 35 95 from donations Operational risks 3 (7.5) 11 (27.5) 12 (30) 12 (30) 2 (5) 29 69 NA 6 (8.33) 16 (22.22) 28 (38.89) 10 (13.89) 12 (16.67) 23 95 Counterparty risk from 4 (9.09) 7 (15.91) 8 (18.18) 11 (25) 14 (31.82) 25 69 NA 9 (13.04) 13 (18.84) 26 (37.68) 6 (8.7) 15 (21.74) 26 95 lending loans to MFIs (Default risk) Liquidity risk 9 (20.93) 11 (25.58) 9 (20.93) 13 (30.23) 1 (2.33) 26 69 less (p.-value: 0.0401) 7 (9.86) 15 (21.13) 25 (35.21) 9 (12.68) 15 (21.13) 24 95 Foreign exchange risk 7 (17.95) 8 (20.51) 8 (20.51) 10 (25.64) 6 (15.38) 30 69 NA 12 (19.67) 16 (26.23) 16 (26.23) 9 (14.75) 8 (13.11) 34 95 Interest rate risk 5 (12.2) 10 (24.39) 14 (34.15) 10 (24.39) 2 (4.88) 28 69 NA 7 (10.14) 18 (26.09) 22 (31.88) 16 (23.19) 6 (8.7) 26 95 Political instability in the 5 (11.63) 2 (4.65) 10 (23.26) 15 (34.88) 11 (25.58) 26 69 NA 15 (22.06) 17 (25) 21 (30.88) 8 (11.76) 7 (10.29) 27 95 countries your organization lends money to Macroeconomic factors 1 (2.22) 7 (15.56) 16 (35.56) 14 (31.11) 7 (15.56) 24 69 NA 4 (5.63) 14 (19.72) 22 (30.99) 20 (28.17) 11 (15.49) 24 95 (e.g. inflation, unemployment,...) Climatic risk factors (e.g. 5 (11.36) 13 (29.55) 15 (34.09) 10 (22.73) 1 (2.27) 25 69 NA 11 (15.28) 20 (27.78) 15 (20.83) 13 (18.06) 13 (18.06) 23 95 drought, floods, variations in temperature, ...) in the regions loans are lent to

Table 25: Comparative analysis “MFIFs vs. MFIs”: Types of risk 19

never used [0] rarely used [1] 2 frequently used [3] 4 often used [5] NA N sig. (α=0.10) never used [0] rarely used [1] 2 frequently used [3] 4 often used [5] NA N Foreign exchange trade desk of 7 (41.18) 2 (11.76) NA (NA) 1 (5.88) NA (NA) 7 (41.18) 52 69 NA 5 (50) 3 (30) 2 (20) NA (NA) NA (NA) NA (NA) 85 95 another international bank OTC: entering currency swaps 10 (66.67) NA (NA) NA (NA) 1 (6.67) NA (NA) 4 (26.67) 54 69 NA 6 (60) 2 (20) NA (NA) 1 (10) NA (NA) 1 (10) 85 95 OTC: buying/selling currency 5 (25) 3 (15) 1 (5) 4 (20) 1 (5) 6 (30) 49 69 NA 4 (40) NA (NA) 3 (30) 1 (10) 1 (10) 1 (10) 85 95 forwards OTC: buying/selling currency 14 (87.5) 2 (12.5) NA (NA) NA (NA) NA (NA) NA (NA) 53 69 NA 7 (77.78) 1 (11.11) 1 (11.11) NA (NA) NA (NA) NA (NA) 86 95 futures OTC: buying/selling currency 14 (82.35) 3 (17.65) NA (NA) NA (NA) NA (NA) NA (NA) 52 69 less (p.-value: 0.0912) 7 (63.64) 1 (9.09) NA (NA) 2 (18.18) NA (NA) 1 (9.09) 84 95 options OTC: entering cross currency 7 (31.82) NA (NA) 1 (4.55) 2 (9.09) 3 (13.64) 9 (40.91) 47 69 NA 5 (55.56) 2 (22.22) 2 (22.22) NA (NA) NA (NA) NA (NA) 86 95 swaps Back-to-back loans 7 (41.18) 3 (17.65) 3 (17.65) 3 (17.65) NA (NA) 1 (5.88) 52 69 NA 13 (29.55) 8 (18.18) 10 (22.73) 8 (18.18) 2 (4.55) 3 (6.82) 51 95

Table 26: Comparative analysis “MFIFs vs. MFIs”: Hedging instruments used insignificant reason [1] 2 significant reason [3] 4 very significant reason [5] NA N one-side Wilkoxon-Test (0.1) insignificant reason [1] 2 significant reason [3] 4 very significant reason [5] NA N No adequate hedging tools (illiq- 4 (17.39) 1 (4.35) 5 (21.74) 1 (4.35) 12 (52.17) 46 69 NA 6 (16.22) 7 (18.92) 9 (24.32) 7 (18.92) 8 (21.62) 58 95 uidity of financial markets) High transaction costs, due to 5 (21.74) 3 (13.04) 6 (26.09) 3 (13.04) 6 (26.09) 46 69 NA 2 (5.26) 4 (10.53) 18 (47.37) 6 (15.79) 8 (21.05) 57 95 small loan size Regulations that hinder installing 7 (35) 4 (20) 6 (30) 1 (5) 2 (10) 49 69 NA 9 (27.27) 7 (21.21) 9 (27.27) NA (NA) 8 (24.24) 62 95 the required capacities (legal issues, transferring money,...) Too much bureaucracy (filing doc- 10 (52.63) 7 (36.84) 1 (5.26) 1 (5.26) NA (NA) 50 69 NA 13 (43.33) 9 (30) 3 (10) NA (NA) 5 (16.67) 65 95

20 uments,...) to set up required capacities Ineﬃciencies (e.g. long time to set 8 (40) 5 (25) 4 (20) 1 (5) 2 (10) 49 69 NA 17 (54.84) 7 (22.58) 3 (9.68) 3 (9.68) 1 (3.23) 64 95 up bank accounts,...) that delay quick set up of hedging facilities Acceptance of higher risk in order 7 (36.84) 4 (21.05) 2 (10.53) 4 (21.05) 2 (10.53) 50 69 NA 14 (48.28) 2 (6.9) 9 (31.03) 4 (13.79) NA (NA) 66 95 to gain higher returns Company policies allow partly un- 8 (50) 2 (12.5) 1 (6.25) 3 (18.75) 2 (12.5) 53 69 NA 12 (38.71) 8 (25.81) 7 (22.58) 3 (9.68) 1 (3.23) 64 95 hedged portfolio

Table 27: Comparative analysis “MFIFs vs. MFIs”: Reasons for neglecting FX hedging References

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