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Impact of Index Insurance on Moral Hazard in the Agricultural Credit Market: Theory and Evidence from Ghana

Author

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  • John P Dougherty
  • Richard A Gallenstein
  • Khushbu Mishra

Abstract

Recent research suggests that coupling microfinance loans with an index insurance policy may be a cost-effective way to expand credit market access to smallholder farmers in developing countries. Index insurance can increase demand for credit and encourage increased supply of credit by protecting borrowers and lenders from covariate production shocks that discourage credit market expansion. In this paper, we propose that index insurance, when bundled with credit, may also reduce a different barrier to credit market access: high transaction costs caused by moral hazard in the credit market. We develop a theoretical model of a competitive credit market with moral hazard. In this market, lenders use either dynamic incentives or collateral to mitigate the moral hazard problem. The model shows that index insurance bundled with loan contracts can reduce moral hazard and increase borrower welfare. We then test the model and find some empirical support using a subset of data from a randomised control trial in northern Ghana.

Suggested Citation

  • John P Dougherty & Richard A Gallenstein & Khushbu Mishra, 2021. "Impact of Index Insurance on Moral Hazard in the Agricultural Credit Market: Theory and Evidence from Ghana," Journal of African Economies, Centre for the Study of African Economies, vol. 30(5), pages 418-446.
    • Handle: RePEc:oup:jafrec:v:30:y:2021:i:5:p:418-446.
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    File URL: http://hdl.handle.net/10.1093/jafeco/ejab003
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    Cited by:

    1. Khushbu Mishra & Richard A. Gallenstein & Abdoul G. Sam & Mario J. Miranda & Patricia Toledo & Francis Mulangu, 2023. "Does bundling credit with index insurance boost agricultural technology adoption? Evidence from Ghana," Agricultural Economics, International Association of Agricultural Economists, vol. 54(6), pages 778-792, November.

    More about this item

    Keywords

    index insurance; microfinance; moral hazard; collateral; dynamic incentives; JEL classification: O12; G21; G22;
    All these keywords.

    JEL classification:

    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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