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Does weather matter? How rainfall affects credit risk in agricultural microfinance

Author

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  • Niels Pelka
  • Oliver Musshoff
  • Ron Weber

Abstract

Purpose - – Small-scale farmers in developing countries are undersupplied with capital. Although microfinance institutions (MFIs) have become well established in developing countries, they have not significantly extended their services to farmers. It is generally believed that this is partly due to the riskiness of lending to farmers. The purpose of this paper is to combine original data from a Madagascan MFI with weather data to estimate the effect of rainfall on the repayment performance of loans granted to farmers. Design/methodology/approach - – The basis of the empirical analysis is a unique data set of a commercial MFI in Madagascar and weather data provided by the German Meteorological Service. The repayment performance of loans granted to small-scale farmers is estimated using a two-step estimation approach based on linear probability models (LPMs) and a sequential logit model (SLM). Findings - – The results reveal that an excessive amount of rain in the harvest period of rice increases the credit risk of loans granted to small-scale farmers in Madagascar. Furthermore, the results confirm that credit features affect the repayment performance of loans. Research limitations/implications - – Since the returns from weather index-based insurance (at least as a future contract) are perfectly correlated with weather events, the authors can set the effect of weather events on the repayment performance of loans equal to the effect of the returns of weather index-based insurance on the repayment performance of loans. Thus, the results imply that weather index-based insurance might have the potential to mitigate a certain part of the risk in agricultural lending. Practical implications - – The focus and results of the present study are very relevant for MFIs, potential providers of weather index-based insurances as well as for farmers. The results confirm that weather events are a primary reason for the risk perception of lenders in developing countries toward small-scale farmers. Future research should, hence, concentrate on the development of index-based insurances in agricultural lending and consider interventions on different levels, e.g., insurance on the farm and the bank level. Originality/value - – To the knowledge, this is the first study that combines original loan repayment data from a Madagascan MFI with weather data in order to estimate the effect of weather events on the repayment performance of loans granted to farmers. Furthermore, to the knowledge, this is the first study that uses a two-step estimation approach based on LPMs and a SLM to investigate the repayment performance in agricultural lending.

Suggested Citation

  • Niels Pelka & Oliver Musshoff & Ron Weber, 2015. "Does weather matter? How rainfall affects credit risk in agricultural microfinance," Agricultural Finance Review, Emerald Group Publishing Limited, vol. 75(2), pages 194-212, July.
  • Handle: RePEc:eme:afrpps:v:75:y:2015:i:2:p:194-212
    DOI: 10.1108/AFR-10-2014-0030
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    Citations

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    Cited by:

    1. Ulf Römer & Oliver Musshoff, 2017. "Can agricultural credit scoring for microfinance institutions be implemented and improved by weather data?," Agricultural Finance Review, Emerald Group Publishing Limited, vol. 78(1), pages 83-97, December.
    2. Frederick Murdoch Quaye & Denis Nadolnyak & Valentina Hartarska, 2017. "Factors Affecting Farm Loan Delinquency in the Southeast," Research in Applied Economics, Macrothink Institute, vol. 9(4), pages 75-92, December.
    3. Nicolás de Roux, 2021. "Exogenous shocks, credit reports and access to credit: Evidence from colombian coffee producers," Documentos CEDE 19769, Universidad de los Andes, Facultad de Economía, CEDE.
    4. Komarek, Adam M. & De Pinto, Alessandro & Smith, Vincent H., 2020. "A review of types of risks in agriculture: What we know and what we need to know," Agricultural Systems, Elsevier, vol. 178(C).
    5. Ölkers, Tim & Liu, Shuang & Mußhoff, Oliver, 2023. "A typology of Malian farmers and their credit repayment performance - An unsupervised machine learning approach," 97th Annual Conference, March 27-29, 2023, Warwick University, Coventry, UK 334547, Agricultural Economics Society - AES.
    6. Bertrand, Jean-Louis & Brusset, Xavier & Chabot, Miia, 2021. "Protecting franchise chains against weather risk: A design science approach," Journal of Business Research, Elsevier, vol. 125(C), pages 187-200.
    7. Rozzani, Nabilah & Mohamed, Intan Salwani & Syed Yusuf, Sharifah Norzehan, 2017. "Risk management process: Profiling of islamic microfinance providers," Research in International Business and Finance, Elsevier, vol. 41(C), pages 20-27.
    8. Nicolás de Roux, 2020. "Weather Variability, Credit Scores and Access to Credit: Evidence from Colombian Coffee Farmers," Documentos CEDE 17800, Universidad de los Andes, Facultad de Economía, CEDE.
    9. Icíar García-Pérez & María Ángeles Fernández-Izquierdo & María Jesús Muñoz-Torres, 2020. "Microfinance Institutions Fostering Sustainable Development by Region," Sustainability, MDPI, vol. 12(7), pages 1-23, March.

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