Understanding Currency Exchange Loss with Kiva
In my travel hacking quest I came across the great idea to Deposit into Kiva to meet minimum spend requirements. I can deposit money into Kiva, make the loans, and then withdraw the repayments when they come back. This way I can use the money again when I apply for a new credit card.
Not only would I be able to “spend” money without actually losing it but I would be able to do it in a way that helps entrepreneurs in low-income countries. A virtuous cycle and a Win-Win.
But wait, where’s my money?
Having already been exposed to Kiva in college I had deposited $100 and had been lending it for a couple years now. So why did my balance in Mint say that I had only $97.72?
I had lost $2.28! Where did it go?!
Currency Exchange Loss
Doing some digging into my loans I found out that some of the loans had been repaid with a loss.
And some more digging shows that it was due to not a missed payment but….Currency Exchange Loss! Don’t worry Luz, I know it’s not your fault.
The whole point of travel hacking is to save money. If I’m going to lose money through currency exchange loss then it might not be worth it which is a shame because I really want this to work!
What is Currency Exchange Risk?
I needed to do some more digging into currency exchange loss so where do I turn? Google.
The first article I come across is from 2010 asking if Kiva Lenders should take on Currency Exchange Risk.
In the beginning stages of Kiva it had a problem. Kiva’s field partners (the microfinance institutions on the ground that actually made the loans to people) was losing money due to fluctuations in currency values. So in 2009 Kiva introduced Currency Risk Protection.
Kiva explains the problem pretty thoroughly with an example:
Let’s use an example of a pig-farmer in Vietnam, whose loan is being facilitated by Kiva’s Field Partner, TYM Fund. When a Kiva Lender lends $25 U.S. to the pig-farmer, Kiva sends $25 U.S. to TYM Fund, who then disburses the loan to the pig-farmer. When TYM Fund posts to the Kiva website that a repayment has been made on the pig-farming loan, TYM Fund will then send Kiva the repayment, also in U.S. dollars. Kiva then sends the repayment back to the Kiva lenders, also in U.S. dollars.
The problem is, the pig-farmer doesn’t receive U.S. dollars from TYM Fund. She is receiving Dongs, the Vietnamese currency.
Therefore, at some point in this process, a foreign currency exchange must take place. For all partners disbursing funds in a non-U.S. dollar currency, the exchange takes place after they have received loan funds from Kiva, and before they disburse the loan funds to the borrower. So, in the case of the Vietnamese pig-farmer, TYM Fund receives the loan from Kiva in U.S. dollars, then exchanges the U.S. dollars for Dongs using their local bank in Vietnam, and then disburses the loan to the pig-farmer in Dongs. As repayments are made by the pig-farmer to TYM Fund, TYM Fund converts the repaid Dongs to U.S. dollars, before sending the repayments off to Kiva, to be distributed to the Kiva Lenders who contributed to the pig-farmer’s loan.
Let me break that down into something a little simpler.
1. I deposit $25 to Kiva.
2. I “lend” that $25 to the pig-farmer. What I’m really doing here is telling Kiva that I want the pig-farmer to receive the $25. so…
3. Kiva lends $25 to TYM, Kiva’s field partner that requested the loan for the pig-farmer.
4. TYM then converts the $25 to the local currency, Dongs. Lets say it’s 100 Dongs.
5. TYM then lends 100 Dongs to the pig-farmer. The pig-farmer will repay the loan with 5 monthly payments of 20 Dongs.
6. Month one comes around and the pig-farmer makes a payment of 20 Dongs to TYM.
7. TYM converts 20 Dongs to $5. There has been no change in the value of the currencies so there is no currency exchange loss.
8. Month two comes around and the pig-farmer makes a payment of 20 Dongs to TYM.
9. TYM converts 20 Dongs to $4. Uh-oh, the Dong-to-Dollar exchange rate has gone up. The Dong has lost 20% of its value.
10. TYM still has a loan to pay back to Kiva though so it pays Kiva $5, losing $1 in the process.
11. Kiva pays me $5.
This is a very expensive process for the Field partner and the risk posed by currency exchange loss can make it very unattractive from a business standpoint. If they go on like this then they will continue to bleed money and because of the 2008 financial crises they were.
In 2008 alone, pressure due to the U.S. economic crisis has caused emerging market currencies to devalue relative to the U.S. dollar. For instance, the maximum U.S. dollar depreciation over a 4-month period experienced by Ukraine in 2008 was -39%. Other countries such as Indonesia, Mexico, Kenya, Pakistan, Bosnia, Herzegovina, Bulgaria, Uganda and Paraguay have experienced 4-month depreciations greater than -20%.
In order to make sure field partners continued to work with them, Kiva introduced Currency Risk Protection. Field partners would be protected whenever a currency lost more than 20% of it’s value but only the amount greater than 20%.
So, if the Dong lost 20% of it’s value against the dollar, then TYM would pay for the loss. But if it lost 25%, then TYM would pay for the 20% loss and the Kiva lender would pay for the 5%.
As described by Kiva:
So, if a Kiva Lender makes a $25 loan to the pig-farmer in Vietnam, but when a repayment is made, the Vietnamese Dong has devalued by 21%, TYM Fund must make up the missing 20%, but the Kiva Lender will receive back only 99% of their loan value. If the Vietnamese Dong has devalued by 30%, TYM Fund would again make up the missing 20%, but the Kiva Lender would receive only 90% of their loan value, because Kiva lenders bear the cost of the additional 10% devaluation.
This makes sense. Given that Kiva is a social enterprise it would make sense that lenders on Kiva, who are not investing to make money but to do good, would not mind if they lost a little money here and there if it meant that the model worked.
However, In 2012, Kiva changed their Currency Risk Policy to better shoulder the burden of the field partners.
This changed the Currency Risk protection from 20% to 10%, meaning the Kiva lender would take on more of the burden if there were large fluctuations in currency which brings us back to my $2.28.
Taking a quick look around I can’t find any fast data on what this means for how often I will lose money when lending but I would imagine it is quite a bit more often. But does it really matter?
It’s not so bad
So how much did I really lose?
My stats on Kiva say that I have lent $225.
I’m going to remove $25 of that as it’s a sign-up bonus that we don’t actually get back. So $200.
So what’s $2.28 of $200? 1.14%, if my math is right (aka I read googles calculator correctly).
That’s over the course of about a year.
So am I losing money? Well lets assume that my sign-up bonus triggers on $4000 (like the Chase Sapphire Preferred).
1.14% of $4000 is… $45.60
What’s the sign-up bonus? At least $500. Meaning that this method will result in at least $454.40 in bonus. And since there is no extra spending there’s no waste. It will, however, lock $4000 in Kiva for the lending term and technically I’m not guaranteed that money back so I’ll have to keep that in mind.
Looks Good to Me
Well, I think that straightens that out. At least now I have a basic understanding of what currency exchange loss is.
Next will be actually going through the process. Seeing how I can minimize the exchange loss while maximize the impact. Not to mention create a sustainable investment cycle for Travel Hacking Goodness.