Foreign Exchange Risk Mitigation Techniques: Structure and Documentation a Technical Guide for Microfinance Institutions

October, 2006     Cleary, Gottlieb, Steen & Hamilton LLP

Foreign exchange risk largely arises in microfinance when an MFI incurs debt in a foreign currency, usually U.S. dollars or euros, and then lends those funds in domestic currency. The MFI can suffer substantial losses if the value of the domestic currency depreciates (or loses value) in relation to the foreign currency, meaning that the value of the MFI’s assets drops relative to its liabilities. This is known as devaluation, or depreciation, risk. Organizations exposed to foreign exchange risk can “hedge” against their exposure. This Technical Guide addresses an MFI’s hedging options.