Can Insurance Unlock Credit for Farmers in Developing Countries?

Smallholder farmers in developing countries are often credit-constrained due to inefficient and incomplete market mechanisms that make lending unattractive to both farmers and lenders as embedded risks are not completely mitigated. By bundling credit with crop insurance, some risks can be mitigated, unlocking credit and allowing farmers to improve their livelihoods. However, other elements like basis risk, which entails a standardized payout uncorrelated to the actual loss suffered by farmers, require further analysis of the conditions under which linking index insurance with credit could be a game-changer. The study analyzed the scenarios in which taking out a loan along with index insurance is beneficial for farmers and supports the repayment of the loan. Based on empirical data of Ethiopian maize-growing farmers, the study performed a cash flow analysis to inform farmers’ repayment ability in 16 scenarios. The study also delved into the determinants of lending decisions by financial services providers (FSPs) by incorporating the results of a survey to FSPs with agricultural portfolios in emerging economies. The team found that insurance is the price that a not-creditworthy farmer has to pay to avail a loan and that some level of income diversification is key to reduce the farmer’s probability of default and make the loan feasible. Insurance provides maximum utility to farmers in regions with significant weather uncertainty or growing highly vulnerable crops, and positive outcomes are found even with moderate levels of basis risk. Lastly, a customizable digital tool is made available by the team for future additional analysis.