Research & Analysis

MFI Capital Structure Decision Making: A Call for Greater Awareness

Determining optimal borrowing—whether it be loans or bonds, domestic or cross-border—requires analysis of many factors, including fully loaded costs, tenor, currency denominations, collateral requirements, covenants and penalties, and considerations about diversifying and building future access. The study indicated that most MFIs base debt financing decisions primarily on price, and few MFI managers could cite many of the variables that affect the cost of debt, or took them all into account when choosing among funding alternatives.

In particular, few managers accurately calculated currency depreciation risk when comparing interest rates in different currencies or priced in the cost of a hedge to cover foreign exchange risk.

Clearly cross-border, hard currency debt often appears cheaper that local debt because of lower nominal interest rates. But even when cross-border debt was denominated in local currency, managers saw the foreign debt as less expensive than domestic debt. Cross-border debt may have longer tenors, be cheaper, and often require less collateral as compared with local debt because foreign funders are more familiar with MFI risk and/or because their social motivation leads them to accept terms that are below levels that would maximize profits.

Sub-topics: Payments