Liquidity Risk in Community Currency

A simulation of risks involved in Community Currency Shemes

A slum business using Community Currency in Kenya

We're very happy to start the year with a visit from our Director of Risk Management Jimmy Heyns from Belgium with over 18 years of international experience in the Financial Industry. As our community currencies move more and more toward cooperative toolsets for creating liquidity based on assets, we've been seeking to have a stronger and stronger credit policy.

As of 2016 there are thousands Complementary Currency Programs worldwide. Given this is still an unregulated industry the collateral requirements of the organization issuing community currency don't really exist. In the worst cases organizations can issue much more credit than they have any tangible backing for.

  • Generally all this credit ends up at the most popular shops
  • Those shops stops accepting it because they can't use it fast enough.
  • Other shops start to default – causing a chain reaction (reputation risk).
  • If everyone then wants to cash out – there isn't even enough euros (collateral) to satisfy them. This is basic Liquidity Risk. The organization is acting like an unregulated bank and issuing tons of uncollateralized credit to consumers.

If a community currency is being used in a commercial business – there must be some assurance that, that business won't get stuck with too much community currency. In the simulation there are enough cascading defaults that there is a critical system failure. Essentially the currency was a bubble that could not be sustained. This is bad for businesses and the economy at large.

When we first started we used mutual guarantee. Where members would back other members. And disputes were moderated. This was great at small scale but hard to implement for more than 100 business. So what we did was being to create cooperative businesses that were the liquid and asset collateral basis for the community currency.

So what do we recommend?

  1. First that all currency is backed fully in cooperatively owned liquid and physical assets. This means creating cooperative businesses in these communities that offer security for the currency.
  2. Second we allow for a steam release valve - which we call Credit-clearing. If you keep adding heat to a system – it gets too hot and needs a way to cool off – or it will explode. If business such as schools collect too much currency over a short period of time, we give them a way to exchange for national currency or other assets that the cooperative keeps as collateral.
  3. The amount of liquid (cash) collateral vs Asset collateral (stock or other assets) that needs to be kept on hand for credit-clearing is based on a risk analysis. We're lucky to have a risk manager on our board that can set our standards higher than those of the banking industry.