MICROCAPITAL STORY: Muhammad Yunus Warns of the Dangers of Foreign Currency at Sa-Dahn Microfinance Conference

Muhammad Yunus, the Nobel Laureate who made microfinance a success in Bangladesh, has warned of the pitfalls for microfinance institutions relying on foreign money. The comments, reported by The Hindu Business Line, came at the recent Sa-Dahn National Microfinance Conference 2009 in New Delhi, India.

“Financial crisis makes it more clear dependence on foreign money is not a great idea at all. It gets you exposed to other things, so my recommendation is to rely on the local money,” said Yunus, the founder of Grameen Bank. “Unless we can solve the money problem, micro credit will not go anywhere. In order to solve the money problem, the best solution is to create yourself into a bank, taking deposits and lending money.”

Mr. Yunus said a separate banking law is required for the success of microfinance, “We should be making it very clear to the legislature that we need a separate law.” India recently proposed a Micro Finance Institution Bill in Parliament that is currently being examined by the Standing Committee, to read highlights of the bill click here. “Without the legislation, we will be stumbling again and again,” he said.

As detailed in a MicroCapital Institute White Paper entitled “Currency Risk in Microfinance” with the move towards commercialization, MFIs have been funding themselves from dollar-, euro, and yen-based private investors who expect to be paid back in their own currency. Unfortunately the MFIs are in turn lending that money in countries like Nigeria, Argentina, Indonesia, Guatemala, Russia and a dozen other developing markets whose weak local currencies are frequently depreciating against the world’s hard currencies. Hedging against these currency moves is costly and difficult given that many of these emerging market currencies are not widely traded. To avoid this added cost, most MFIs have not hedged themselves.

Now, as the global credit crunch spreads, liquidity is declining and volatility is increasing. As a result the cost of hedging and the cost of capital are increasing for MFIs. As illustrated in a recent guest editorial on MicroCapital, in mid-2008 a microfinance investment vehicle (MIV) could charge a Peruvian MFI roughly 11.3 percent for a one-year loan in PEN in order to achieve the equivalent of a 10 percent return in USD. By October, in order to achieve the same rate of USD return, the MIV would have to charge over 15 percent. In response to the difficulty MFIs have encountered hedging illiquid currencies, Cygma, a microfinance foreign exchange (FX) risk management group, plans to launch this year an FX hedging facility for hedging emerging markets currencies. To read a recent MicroCapital Story on Cygma click here.

The solution to these issues, Mr. Yunus says, is for MFIs to become banks and take deposits, however many regulatory environments prevent MFIs from taking deposits. Also, international best practices recommend that not all MFIs should be permitted to take deposits, but rather deposit-taking should be allowed only for those MFIs that demonstrate the capacity to do so. When done well deposit-taking provides an essential service to the poor and provides funds for lending, when done unsuccessfully deposit-taking can subject a disadvantaged and vulnerable population to more risk.

A series of papers by the Consultative Group to Assist the Poor (CGAP) in 2006 explored the issue of deposit-taking by MFIs and found that over the course of seven years the seven deposit-taking MFIs that were studied experienced massive growth, strong profitability and improved efficiency.

By Laura Anderson, Research Associate

Additional Resources:

The Hindu Business Line: Crisis Exposes Danger of Relying on Foreign Money: Yunus

MicroCapital Story November 2008: New Microfinance Foreign Exchange Risk Management Group, Cygma, Believes Credit Crunch Provides Business Opportunity

Cygma: Home

MicroCapital Guest Editorial October 2008: Ties to Capital Markets Challenge Microfinance Institutions

MicroCapital Institute White Paper: “Currency Risk in Microfinance”

CGAP: Savings Month, Article Four: Learning from the Progress of Seven Microfinance Deposit-Taking Institutions

Consultative Group to Assist the Poor: Home

India Together: Microfinance Bill