Cooperative Interlinked Credit Guarantee Failure
RCTReview
Attempts to expand production credit by interlinking weather index insurance with bank loans fail when intermediary cooperatives refuse to assume non-weather borrower default risks. Although insurance covers weather-related default, lenders and cooperatives still face un-hedged default risk from non-weather shocks or moral hazard.
Picture this
Imagine a bank offering to lend money to fruit vendors if a weather company promises to cover losses from rainstorms. However, the bank insists that local street market managers pay for any losses if vendors lose money for reasons other than rain. The market managers refuse to take on that burden, so no loans are ever handed out to the vendors.
What the evidence says
Zero interlinked loan contracts were executed due to cooperative unions refusing to guarantee non-weather default risk. Consequently, 100% of realized insurance sales were standalone policies. However, in interlinked villages, farmers who bought insurance demanded higher coverage (mean sum insured = 2,018 Birr vs. 1,295 Birr in standalone villages, p < 0.10) expecting it would unlock future credit.
- Who was studied
- N = 460 rural smallholder households across 23 treatment cooperatives in Amhara, Ethiopia (17 interlinked treatment villages and 17 standalone treatment villages initially assigned).
- How
- Field RCT testing interlinked loan-insurance contracts delivered via Dashen Bank, Nyala Insurance Company, and primary Cooperative Unions.
What to do
Structure interlinked agricultural credit contracts with clear institutional risk-sharing boundaries so intermediary cooperatives are not required to absorb non-weather default risk.
From the source
"These supply-side problems were particularly severe in the interlinked arm, where the contract required the local CUs to guarantee the nonweather-related part of the loan, a risk which the CUS refused to accept."
Productivity, credit, risk, and the demand for weather index insurance in smallholder agriculture in Ethiopia