Monday, April 16, 2012

Kiva changes foreign currency risk policy to shoulder Field Partner costs

Kiva has always been sensitive to foreign currency fluctuations and how they impact our lenders and Field Partners. In particular, foreign currency shifts can have significant implications for our Field Partners' budgets. In 2009, we created a solution to help prevent partners from being adversely affected by these fluctuations. This year, we’re proud to be strengthening this policy, reducing partner risk even further.

First, a little explanation.

Kiva and Foreign Currency Today

Let’s start with the borrower. Halima raises and sells chickens in Kenya, and is taking out a loan through Kiva Field Partner Yehu Microfinance Trust. When a Kiva lender lends $25 to Halima, Kiva sends $25 in U.S. dollars to Yehu, which then covers the loan made to Halima. When Halima begins to repay her loan, Yehu sends Kiva the repaid funds, also in U.S. dollars, which are then returned to lenders.

Sounds pretty straightforward, but there’s a snag: Yehu doesn’t give Halima her loan in U.S. dollars -- she gets it in Kenyan Shillings.

This means that foreign currency exchange has to take place after the Field Partner receives loan funds from Kiva, and before the loan is disbursed to the borrower. Through a bank, Yehu exchanges U.S. dollars for shillings. Then, as Halima repays, it does it again, only this time converting shillings to dollars before sending the money back to Kiva.

The Problem

The real trouble occurs when the value of the local currency -- shillings in this case -- fluctuates up or down. For example, when Yehu first gets the loan money from Kiva, the exchange rate might be 83 shillings for every $1. But when it sends back repaid funds, the exchange rate might be 89 shillings for every $1. Currencies rise and fall based on the global economy, and sometimes unexpectedly.

If the U.S. dollar becomes more valuable than the local currency, a Field Partner will need to use its own funds to make up the difference when it sends repayments back to Kiva lenders. This negatively impacts the Field Partner in the short-term because it has to use funds that could otherwise be used to make more loans, provide additional services and more. To cover for future potential currency fluctuations, Field Partners may increase interest rates, which impacts borrowers as well. We call this foreign currency risk.

Kiva’s Solution

In 2009, Kiva introduced a new feature to address the currency exchange problem. This feature limited foreign currency risk for Field Partners to when the U.S. dollar appreciates, or becomes 20% more valuable than the local currency. So, if the U.S. dollar appreciated by more than 20% after Yehu received the loan money and before it started sending back repayments, lenders would help absorb the loss above 20%.

This year, starting today, Kiva is reducing Field Partner foreign currency risk even more by strengthening this feature. Now, if the dollar appreciates more than 10% in value, lenders will absorb the loss above 10%.

What does this look like in practice? Let’s say a Kiva lender makes a $25 loan to Halima. But when Yehu receives her repayments, the dollar has become 11% more valuable than the shilling. Yehu still has to make up the 10% currency exchange loss, but the Kiva lender will receive back only 99% of the principal repaid by the borrower. If the dollar appreciated 20%, the Kiva lender would only receive 90% of repaid principal. Based on our experience mitigating currency exchange loss since 2009, we estimate that 1 in 4 lenders could lose about 87 cents during a year.

Why this Solution?

Currencies are constantly in flux. Most of these shifts can be accommodated by Kiva’s Field Partners, but there are no guarantees. By giving our Field Partners the option to limit their risk, we give them better tools to manage their financial forecasts. Knowing that the greatest dollar appreciation they need to prepare for is 10%, they can adjust their budgets accordingly. Distributing the cost among many Kiva lenders also decreases the impact of currency devaluation on any one party.

Our goal with this change is to draw in socially-minded Field Partners that offer beneficial services -- like savings accounts, insurance, and more -- but may not otherwise be able to accept the risk of exchanging U.S. dollars. Keeping costs low could also help our partners keep interest rates in check.

Lender Impact

So how does this affect you as a lender, and what tools are available to you to manage foreign currency exchange loss? Here are some things to look out for when making your next loan:

1) Kiva Field Partners have the ability to opt into our foreign currency risk feature. They can choose to carry the burden of currency fluctuations themselves, or to pass on the risk of dollar appreciation over 10% to Kiva lenders. On each loan page, in the “Loan Overview” section, you’ll find the “Current Exchange Loss” indicator which will show one of the following:

Covered - If the Field Partner has not opted-in to share currency risk. This means the Field Partner absorbs all of the currency risk.
Possible - If the Field Partner has opted in to share currency risk. This means currency fluctuations above 10% will be shared with lenders. See image below.
N/A - If the Field Partner does not disburse funds in a local currency (they disburse in U.S. dollars). See image below.

2) The “Field Partner” section on any loan page references the Field Partner’s “Currency Exchange Loss Rate” (see below). This provides historical information on the percent of currency loss experienced by this partner. See image to right.

3) Under the 20% appreciation cap, 1 in 10 lenders experienced an average loss of 13 cents. While there are too many variables to predict the exact impact under the 10% currency risk feature, based on historical data, we estimate that 1 in 4 lenders may experience a loss less than $1.

4) We know that each lender has unique reasons for selecting a loan. If minimizing currency fluctuation loss is a goal, we suggest you take full advantage of the Field Partner data mentioned above, consider funding loans that are transacted in U.S. dollars (noted with an N/A in the “Currency Exchange Loss” field on the partner page), and/or diversify your portfolio of loans. You can also find affected loans by sorting by “loans with currency risk” on Kiva’s Lend page.

Have questions? You can learn more about this on Kiva’s Help Center. Or check out the video below, featuring Kiva partnership manager David Kitusa on why limiting Field Partner foreign currency risk is so important. You can also send questions or concerns to