| Abstract: |
Changes in frequency and intensity of climate and weather events are a key
challenge to agricultural production among farmers in Zambia. Climate
variability reduces farm productivity, which in turn contributes to household
food insecurity, income variability, and reduced overall economic growth.
Using improved technologies such as mechanization, improved seed varieties,
irrigation, and fertilizer can improve climate resilience and farm production
among smallholder farmers. However, in Zambia, as in many countries in
sub-Saharan Africa, most famers lack sufficient access to credit to purchase
these technologies. Limited access to credit is mainly attributed to lack of
collateral, fear of losing collateral in case of a default, and low financial
literacy among smallholder famers (Balana et al. 2022). Information asymmetry
also makes it risky and expensive for lenders to serve smallholder farmers,
thus they ration the quantity of credit offered and/or raise the interest
rates making credit too expensive and inaccessible for millions of smallholder
farmers. Bundling agricultural credit with insurance, commonly referred to as
risk-contingent credit (RCC), provides a mechanism for addressing some of the
credit access constraints faced by smallholder farmers in developing
countries. RCC is a loan product that is bundled with an insurance component.
RCC seeks to enhance long-term resilience to climate uncertainties by
promoting optimal farm investment and productivity among smallholders through
sustainable access to credit markets. Under RCC, qualifying smallholder
farmers borrow funds for agricultural production from formal financial
institutions such as banks and microfinance institutions with minimum
collateral requirements. The borrower’s ability to repay the loan is linked
to climate outcomes, which are highly correlated with farm productivity. An
insurance company underwrites the climate risks (either in the form of drought
or flood), such that if that underlying risk passes a certain threshold, the
insurance is triggered and part or all of the borrower’s liability is
transferred to the insurer. If the underlying risk remains below the
threshold, the borrower repays the loan at the agreed upon interest rates and
is also obligated to pay the insurance premium, as part of the loan repayment.
Linking farmers’ loan repayment obligations to an underlying risk, as
opposed to stringent collateral requirements, is expected to reduce the
borrowing constraints faced by many poor farmers. At the same time, de-risking
the lender by transferring a portion of risks to the insurance market is
expected to promote credit supply, hence expanding the rural credit market
(Shee et al. 2019). |