How Agricultural Finance Can Protect Farmers from Losing Crops to Climate Change
For small-scale farmers in developing countries, risk from the weather is a central fact of life. Across sub-Saharan Africa, drought can leave whole crops withering in the fields. In South Asia, severe storms can wipe out crops and even homes. In some areas, like central Mozambique, rural families face a risk of both.
Agricultural finance on its own doesn’t address these kinds of risks. Instead, finance makes it possible for farmers without ready cash to make investments to grow more food. Research supported by USAID shows ways that agricultural finance could actually do both, creating opportunities for farmers to be more resilient to weather-related disasters and freer to make the productive investments that financing makes possible.
Weather-Related Risk in Small-Scale Agriculture
Weather-related risk in agriculture affects small-scale farmers in two important ways. First, a shock like severe drought destroys people’s livelihoods, which can force a family to cope in ways that compromise their future. For example, a family may have to sell livestock or other assets. They may have to skip meals or pull their children out of school to cut costs.
Second, the risk of a severe shock also keeps families from investing their limited cash on more expensive seeds or other inputs that might fail anyway. For example, local seeds saved from last year are free, but will produce much lower yields than improved seeds and fertilizer that must be bought. A farmer who knows the consequences of a bad year will choose the cheaper loss.
Protection against losing everything in a shock could do more than provide stability. For example, a maize farmer in Tanzania who knows he will be able to withstand drought might invest in higher-yielding seeds. A rice farmer in Bangladesh who knows she is protected if her crop is washed away might increase her planting. Both farmers will produce more food than neighbors who have no way to protect themselves.
Tools to Manage Weather-Related Risk
Agricultural index insurance bases payouts on an easy-to-measure index of factors, such as rainfall or average yields, that predict individual losses. Index insurance is attractive in developing countries where the need to verify claims for a high number of small farms makes conventional insurance too expensive. For a small insurance premium paid at the start of the season, a farmer can have some security that insurance payouts will get him through to the next season.
More recently, researchers have experimented with contingent lines of credit, which convey the benefits of index insurance without the upfront cost. The idea was developed and tested by UC Berkeley researchers and BRAC in Bangladesh, where rice farmers face a regular risk of extreme flooding. With preapproval from BRAC, farmers received emergency loans in the event of severe losses predicted by the same kind of index used for insurance.
Agricultural finance can play a central role in creating access to these kinds of promising risk-management tools, and, in fact, can benefit substantially by making those tools available to their existing clients. For example, a recent field trial in Ghana found that bundling insurance with agricultural input loans can increase access to credit and agricultural technology adoption. Bundling insurance with microloans protects both lenders and borrowers from default while keeping farmers financially solvent.
Tightly integrated value chains also directly benefit from a stronger, more resilient base of farmers. In these value chains, the sector as a whole enjoys higher sales and profits when farmers are more financially stable and resilient. The alternative in a bad year could be the decapitalization of farmers who become unable to pay back loans or who leave the sector entirely.
In many of these value chains, companies provide inputs on credit with the crop itself as collateral. In these cases, a financial tool, like insurance, can be added quickly and at scale. In Burkina Faso and Mali, we partnered with a local cotton company and insurance provider to bundle agricultural index insurance with input loans. Our evaluation found that farmers with insurance were more stable financially after a shock, but also planted more cotton.
Scaling Tools to Manage Risk through Financial Service Providers
Right now, few financial institutions that specialize in microcredit have the technical capacity, resources or expertise to design and implement bundled tools to manage risk. However, researchers have made tremendous progress in not only designing these products but also testing their impacts. In many cases, field trials have yielded valuable lessons not just on the efficacy of product design, but also practical lessons on implementation.
At UC Davis, we are leveraging more than a decade of research funded by USAID with the Resilience+ Innovation Facility to expand the reach of flexible financial tools to manage risk for small-scale farmers in sub-Saharan Africa and South Asia. We are actively seeking partners in the private sector to work with us in developing and implementing these bundled tools in communities and regions where they can have the greatest impact.
This new endeavor leverages publicly funded research so private sector companies have the evidence base and technical support to quickly take tested products to market. In the field of agricultural finance, the private sector plays a critical role in making these opportunities available for the lasting benefit of small-scale farmers.
Tara Chiu is the associate director of the Feed the Future Innovation Lab for Markets, Risk and Resilience and the Resilience+ Innovation Facility at UC Davis.