nep-mfd New Economics Papers
on Microfinance
Issue of 2013‒06‒24
five papers chosen by
Olivier Dagnelie
Instituto de Analisis Economico, CSIC

  1. Premium Benefits? A Heterogeneous Agent Model of Credit-Linked Index Insurance and Farm Technology Adoption By Farrin, Katie; Miranda, Mario J.
  2. Moral Hazard, Risks and Index Insurance in the Rural Credit Market: A Framed Field Experiment in China By Cheng, Lan
  3. Exclusive finance: How unmanaged systemic risk continues to limit financial services for the poor in a booming sector By Collier, Benjamin
  4. The Role of Credit and Deposits in the Dynamics of Technology Decisions and Poverty Traps By Guizar-Mateos, Isai; Miranda, Mario J.; Gonzalez-Vega, Claudio
  5. Informal or Formal Financing? Or Both? First Evidence on the Co-Funding of Chinese Firms By Degryse, H.A.; Lu, L.; Ongena, S.

  1. By: Farrin, Katie; Miranda, Mario J.
    Abstract: Lack of protection from downside risk has been posited as one explanation for sluggish technology uptake among subsistence agricultural households in the developing world. Access to credit and insurance is thought to be a stimulant to technology adoption where new methods are riskier but higher yielding on average, or, in the alternative, require sunk costs of investment that can be significant for households that already consume very little when harvests are poor. Despite recent efforts to pilot index-based insurance to smallholder farmers where no formal insurance was previously available, demand for individual-level contracts has been unexceptional at best, even when premiums are highly subsidized. On the flip side, the effect of index insurance on credit supply is ambiguous: if clients are insured against potential losses, theory suggests that credit supply should increase, as banks face lower probabilities of systemic default; however, due in part to the nature of basis risk that is inherent in index-based contracts, there are cases in which mandatory index insurance that indemnifies the policyholder directly can lead to decreased internal rates of return for lending institutions. In this paper, we employ a dynamic, stochastic, heterogeneous agent model where farm households have access to contingent credit or credit-linked insurance, and may also make dichotomous choices regarding technology and loan repayment in each period. The approach we take is novel in that insurance is modeled as a meso-level product, where the bank is first indemnified before any payouts are distributed to its borrowing clients. Thus, the model we put forward takes into account both supply- and demand-side concerns, and shows the possibilities of a trickle-down effect when index insurance contracts are sold not to individual households, but instead to risk aggregators for whom basis risk is lower. Results show that insurance can have a positive effect on technology uptake, while letting the lender lay first claim on indemnities lowers default rates.
    Keywords: Agricultural and Food Policy, Agricultural Finance, Risk and Uncertainty,
    Date: 2013
  2. By: Cheng, Lan
    Abstract: Abstract This paper studies the interaction between index insurance market and the rural credit market by investigating how the availability of index insurance affects borrowers' moral hazard behavior. Among different types of moral hazard problem in the credit market, we focuses on credit diversion, which occurs when borrowers violate loan contracts and use some or all of production loans for consumption purpose. We build a theoretical model to show that credit non-diverters are likely to benefit from and purchase index insurance, while credit diverters are not. For credit non-diverters, index insurance provides consumption smoothing and increases future income by preventing loan default. For credit diverters who are already implicitly insured by diverting credit from risky investments to consumption, index insurance increases their consumption risks and can even lower expected consumption level. The fundamental reason for the difference of the impact between credit diverters and non-diverters is that index insurance pays indemnities based on external indices rather than farmers' realized outcome. Therefore, the availability of index insurance encourages farmers to choose full investment of loans instead of credit diversion. To test these theoretical predictions empirically, we conducted a framed field experiment with 450 rural households in the north region of China. Coinciding with theoretical predictions, experimental results show that index insurance reduces the number of credit diverters by 75.8%. The treatment effect on credit diversion is heterogeneous across farmers depending on their risk preferences and ethical costs associated with violating loan contracts. The theoretical and empirical results have important policy implications for stimulating credit supply to agriculture and reducing credit rationing. They suggest that lenders can use index insurance as a signaling instrument to overcome information asymmetry in the credit market. Index insurance can be substituted for collateral requirements and lessen both quantity and risk rationing caused by collateral requirement.
    Keywords: Moral Hazard, Index Insurance, Credit Market, Credit Rationing, Agricultural Finance, Institutional and Behavioral Economics, International Development, Risk and Uncertainty,
    Date: 2013
  3. By: Collier, Benjamin
    Keywords: Financial Economics, Public Economics, Risk and Uncertainty,
    Date: 2013
  4. By: Guizar-Mateos, Isai; Miranda, Mario J.; Gonzalez-Vega, Claudio
    Abstract: This paper investigates the farm-household decisions of adopting and abandoning higher-productivity technologies, under different scenarios of inclusion into the credit and deposit markets. The financial environment is further characterized by shallow financial markets, represented by a comparatively large wedge between high interest rates charged on loans and low interest rates paid on deposits and by relatively stringent borrowing limits. Via the numerical approximation of infinite horizon, dynamic, stochastic models, the analysis begins by solving the representative farmer’s dynamic decision problem for three different scenarios of financial exclusion/inclusion in just loan or deposit markets. Then, by expanding the model to a whole economy of heterogeneous farmers, the effects of financial development are examined at the aggregate level. The results show that the scenarios of partial inclusion, either to deposits or to credit markets, bring notably greater benefits in terms of the sustained adoption of the advanced technology than the scenario of financial exclusion. Simulations using different borrowing limits show that, unless the credit limit is sufficiently nonrestrictive, the provision of deposit facilities is a superior policy to boost the rates of technology adoption and prevent its abandonment. In the case of credit, the steady-state adoption rates are insensitive to the interest rate levels. Thus, the simulations actually reflect cases of non-interest credit rationing. In contrast, when only deposit facilities are available, the adoption rate is higher and the abandonment rate is lower as the interest rates paid on financial savings increase.
    Keywords: Technology Adoption, Technology Abandonment, Financial Inclusion, Financial Deepening, Credit Rationing, Agricultural Finance, Community/Rural/Urban Development, Financial Economics, International Development,
    Date: 2013
  5. By: Degryse, H.A.; Lu, L.; Ongena, S. (Tilburg University, Center for Economic Research)
    Abstract: Abstract: The recent financial crisis has reopened the debate on the impact of informal and formal finance on firm growth in developing countries. Using unique survey data, we find that informal finance is associated with higher sales growth for small firms and lower sales growth for large firms. We identify a complementary effect between informal and formal finance for the sales growth of small firms, but not for large firms. Informal finance offers informational and monitoring advantages, while formal finance offers relatively inexpensive funds. Co-funding, i.e. the simultaneous use of formal and informal finance, is the optimal choice for small firms.
    Keywords: Informal Finance;Formal Finance;Co-Funding;Growth.
    JEL: G21 G32 P2
    Date: 2013

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