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Article
Publication date: 2 November 2012

Calum G. Turvey, Vicki L. Bogan and Cao Yu

Firms facing significant income volatility can often suffer from downside risk such that return on assets is insufficient to meet fixed financial obligations. The purpose…

1922

Abstract

Purpose

Firms facing significant income volatility can often suffer from downside risk such that return on assets is insufficient to meet fixed financial obligations. The purpose of this paper is to provide a prescriptive credit solution for small businesses facing exogenous income risk.

Design/methodology/approach

Formulas for risk‐contingent operating and collateralized loans are developed and simulated in the context of a specific business sector.

Findings

The paper demonstrates that a structured credit product with an imbedded option can reduce or eliminate financial risks by providing payouts that decrease the amount of principal and/or interest that firms must repay under low income states.

Originality/value

The overall objective of this paper is to provide a means to mitigate exogenous income risk faced by firms through the design and application of a risk‐contingent credit product that is tied to primary markets and simple to implement. In this context, risk contingency credit refers to a suite of financial products with payoff schedules (loan principal) that are linked to specific commodities or indices. The authors are in fact unaware of any commercial financial products of the type considered in this paper and thus their approach is a prescriptive solution to the identified problem.

Details

The Journal of Risk Finance, vol. 13 no. 5
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 7 September 2015

Apurba Shee, Calum G. Turvey and Joshua Woodard

The purpose of this paper is to assess the feasibility of risk-contingent credit (RCC) by presenting an experimental and participatory game designed to explain the concept…

Abstract

Purpose

The purpose of this paper is to assess the feasibility of risk-contingent credit (RCC) by presenting an experimental and participatory game designed to explain the concept of RCC to Kenyan pastoralists and dairy farmers. The paper investigates the uptake potential of RCC through qualitative assessment of field experiments and focus groups.

Design/methodology/approach

The paper presents a method of community engagement through a participatory game played in a series of Focus Group Discussions (FGDs). The paper also presents theoretical justification of RCC in credit market structure.

Findings

The game effectively explains the concept and mechanism of RCC by reflecting local situation and production potential. Participatory exercises within focus group discussions indicate that there exists a strong interest and support for RCC.

Research limitations/implications

The methodology described in this paper can be used in extension programs for promoting innovative rural microcredit in developing countries but should be modified according to the local production and associated weather and market risks.

Originality/value

Micro-insurance and credit program delivery can be improved by the innovative approach of community engagement for explaining financial products.

Details

Agricultural Finance Review, vol. 75 no. 3
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 26 August 2014

Million Tadesse

– The purpose of this paper is to investigate the impact of access to credit and safety nets on fertilizer adoption in rural Ethiopia.

1213

Abstract

Purpose

The purpose of this paper is to investigate the impact of access to credit and safety nets on fertilizer adoption in rural Ethiopia.

Design/methodology/approach

A panel data set collected in 2005 and 2007 on 278 households and over 5,700 plots from the Southern Highlands of Ethiopia is examined. The authors developed a theoretical model relating input use and credit contract under third-party credit collateral agreement. The estimation is based on instrumental variables regressions to account for the endogeneity of credit access, and safety nets in fertilizer demand equation.

Findings

Despite increasing trends in fertilizer and improved varieties adoption since mid-2003, only 22 percent of the plots in the sample is actually received fertilizer. Households with more assets measured by livestock wealth are more likely to adopt fertilizer but less likely to participate in the local credit market as they have better savings that could be used to buy fertilizer/improved seeds without credit contract. This suggests poorer farmers heavily depend on credit than wealthier. Participation in safety nets programs did not contribute for increased use of fertilizer suggesting that the program either competes with agricultural labor or the low wage income was not enough to pay for farm inputs.

Practical implications

The findings show that with a heavier reliance on credit by poorer farmers it appears that much might be gained by targeting policies toward increasing credit access to this group.

Originality/value

Studies that utilize repeated plot- and household-level observations are limited. To the knowledge, this is the first study showing the relationship between credit accesses, public work program and fertilizer adoption over time in rural Ethiopia.

Details

Agricultural Finance Review, vol. 74 no. 3
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 1 January 2012

Pinaki Bag and Michael Jacobs

The purpose of this paper is to build an easy to implement, pragmatic and parsimonious yet accurate model to determine an exposure at default (EAD) distribution for CCL…

Abstract

Purpose

The purpose of this paper is to build an easy to implement, pragmatic and parsimonious yet accurate model to determine an exposure at default (EAD) distribution for CCL (contingent credit lines) portfolios.

Design/methodology/approach

Using an algorithm similar to the basic CreditRisk+ and Fourier Transforms, the authors arrive at a portfolio level probability distribution of usage.

Findings

The authors perform a simulation experiment which illustrates the convolution of two portfolio segments to derive an EAD distribution, chosen randomly from Moody's Default Risk Service (DRS) database of CCLs rated as of 12/31/2008, to derive an EAD distribution. The standard deviation of the usage distribution is found to decrease as we increase the number of puts used, but the mean value remains relatively stable, as the extreme points converge towards the mean to produce a shrinkage in the spread of the distribution. The authors also observe, for the sample portfolio, that an increase in the additional usage rate level also increases the volatility of the associated exposure distribution.

Practical implications

This model, in conjunction with internal bank financial institution research, can be used for banks' EAD estimation as mandated by Basel II for bank CCL portfolios, or implemented as part of a Solvency II process for insurers exposed to credit sensitive unfunded commitments. Apart from regulatory requirements, distributions of stochastic exposure generated can be inputs for different economic capital models and stress testing procedures used to capture an accurate risk profile of the portfolio, as well as providing better insights into the problem of managing liquidity risk for a portfolio of CCLs and similar exposures.

Originality/value

In‐spite of the large volume of CCLs in portfolios of financial institutions all (for commercial banks holding these as well as for insurance companies having analogous exposures), paucity of EAD models, unsuitability of external data and inconsistent internal data with partial draw‐downs have been a major challenge for risk managers as well as regulators in managing CCL portfolios.

Details

The Journal of Risk Finance, vol. 13 no. 1
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 5 May 2015

Ron Weber, Wilm Fecke, Imke Moeller and Oliver Musshoff

Using cotton yield, and rainfall data from Tajikistan, the purpose of this paper is to investigate the magnitude of weather induced revenue losses in cotton production…

Abstract

Purpose

Using cotton yield, and rainfall data from Tajikistan, the purpose of this paper is to investigate the magnitude of weather induced revenue losses in cotton production. Hereby the authors look at different risk aggregation levels across political regions (meso-level). The authors then design weather index insurance products able to compensate revenue losses identified and analyze their risk reduction potential.

Design/methodology/approach

The authors design different weather insurance products based on put-options on a cumulated precipitation index. The insurance products are modeled for different inter-regional and intra-regional risk aggregation and risk coverage scenarios. In this attempt the authors deal with the common problem of developing countries in which yield data is often only available on an aggregate level, and weather data is only accessible for a low number of weather stations.

Findings

The authors find that it is feasible to design index-based weather insurance products on the meso-level with a considerable risk reduction potential against weather-induced revenue losses in cotton production. Furthermore, the authors find that risk reduction potential increases on the national level the more subregions are considered for the insurance product design. Moreover, risk reduction potential increases if the index insurance product applied is designed to compensate extreme weather events.

Practical implications

The findings suggest that index-based weather insurance products bear a large risk mitigation potential on an aggregate level. Hence, meso-level insurance should be recognized by institutions with a regional exposure to cost-related weather risks as part of their risk-management strategy.

Originality/value

The authors are the first to investigate the potential of weather index insurance for different risk aggregation levels in developing countries.

Details

Agricultural Finance Review, vol. 75 no. 1
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 23 June 2020

Michael K. Ndegwa, Apurba Shee, Calum G. Turvey and Liangzhi You

Drought-related climate risk and access to credit are among the major risks to agricultural productivity for smallholder farmers in Kenya. Farmers are usually credit

Abstract

Purpose

Drought-related climate risk and access to credit are among the major risks to agricultural productivity for smallholder farmers in Kenya. Farmers are usually credit-constrained due to either involuntary quantity rationing or voluntary risk rationing. By exploiting randomized distribution of weather risk-contingent credit (RCC) and traditional credit, the authors estimate the causal effect of bundling weather index insurance to credit on uptake of agricultural credits among rural smallholders in Eastern Kenya. Further, the authors assess farmers' credit rationing, its determinants and effects on credit uptake.

Design/methodology/approach

The study design was a randomized controlled trial (RCT) conducted in Machakos County, Kenya. 1,170 sample households were randomly assigned to one of three research groups, namely control, RCC and traditional credit. This paper is based on baseline household survey data and the first phase of loan implementation data.

Findings

The authors find that 48% of the households were price-rationed, 41% were risk-rationed and 11% were quantity-rationed. The average credit uptake rate was 33% with the uptake of bundled credit being significantly higher than that of traditional credit. Risk rationing seems to influence the credit uptake negatively, whereas premium subsidies do not have any significant association with credit uptake. Among the socio-economic variables, training attendance, crop production being the main household head occupation, expenditure on food, maize labour requirement, hired labour, livestock revenue and access to credit are found to influence the credit uptake positively, whereas the expenditure on non-food items is negatively related with credit uptake.

Research limitations/implications

The study findings provide important insights on the factors of credit demand. Empirical results suggest that risk rationing is pervasive and discourages farmers to take up credit. The study results also imply that credit demand is inelastic although relatively small sample size for RCC premium subsidy groups may be a limiting factor to the authors’ estimation.

Originality/value

By implementing a multi-arm RCT, the authors estimate the factors affecting the uptake of insurance bundled agricultural credits along with eliciting credit rationing among rural smallholders in Eastern Kenya. This paper provides key empirical findings on the uptake of RCC and the effect of credit rationing on uptake of agricultural credits, a field which has been majorly theoretical.

Details

Agricultural Finance Review, vol. 80 no. 5
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 1 July 2014

Leslie J. Verteramo Chiu, Sivalai V. Khantachavana and Calum G. Turvey

– The purpose of this paper is to determine the extent of risk rationing among potential rural borrowers in Mexico and China.

Abstract

Purpose

The purpose of this paper is to determine the extent of risk rationing among potential rural borrowers in Mexico and China.

Design/methodology/approach

Using primary survey data from 730 farm households in the Shaanxi province of China and from 372 farmers in northeastern Mexico, the authors investigate factors associated with risk rationed, price rationed and quantity rationed farmers. The survey was instrumented to self-identify borrower typologies. In addition the authors created within the survey a discrete-choice credit demand build to determine borrower credit demand elasticities. The analysis applies a linear probability which the authors found to be consistent with multinomial and binary logit models.

Findings

The authors find in China the incidence of risk rationing in farmers to be 6.5, 14 percent for quantity rationed and 80 percent for price rationed. In Mexico, 35 percent of the sample is risk rationed, 10 percent quantity rationed and 55 percent price rationed. The results from China support the hypothesis that the financially poor are more likely to be quantity rationed; in Mexico, however, the level of education is found to be important in determining quantity rationed. In both countries, asset wealthy farmers are less likely to be risk rationed; however, income does not appear to have an impact. The paper provides evidence that the elasticity of demand for credit is different among the three credit rationed groups: risk rationed, price rationed and quantity rationed. Risk aversion and prudence are significantly correlated with risk rationing in China, while only risk aversion is significant in Mexico. The results suggest that efforts to enhance credit access must also deal with risk and risk perceptions.

Practical implications

Risk rationing is an important concept in the understanding of rural credit markets. The findings that only 6.5 and 35 percent of Chinese and Mexican farmers are in stark contrast to each other. For agricultural economies such as Mexico with a significant number of farmers being risk rationing, more effort should be put into financial education and financial practices, including perhaps the use of risk-contingent credit to remove collateral risk. As property rights in China evolve, and new laws are promulgated to permit borrowing against land use rights, the collateralization issue will become much more important in rural credit markets.

Originality/value

This paper is the first to investigate risk rationing in China and Mexico and one of the few research studies empirically investigating risk rationing. A comparative analysis of Mexico and China is enlightening because of the structural differences in the respective agricultural economies. The use of a credit demand build and the enumeration of individual credit demand elasticities is an original contribution to this literature.

Details

Agricultural Finance Review, vol. 74 no. 2
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 26 July 2013

Calum G. Turvey

The purpose of this paper is to present a discussion on the idea of “policy rationing”. Policy rationing refers to constraining impacts on farm credit through policy…

1006

Abstract

Purpose

The purpose of this paper is to present a discussion on the idea of “policy rationing”. Policy rationing refers to constraining impacts on farm credit through policy action or inaction. To present the ideas the author discusses ten themes in policy rationing, ranging from macro‐finance policies to smart lending and financial inclusion.

Design/methodology/approach

The paper is developed as a narrative on agricultural credit policies based largely on existing literature.

Findings

This paper argues that the various critiques of rural credit policy in favor of free market principles have generally not worked in developing economies. Large numbers of farmers do not have access to formal credit. It is argued that there is a role for government and credit programs.

Research limitations/implications

The opinions expressed in this paper are based on existing literature and not all ideas hold with general agreement across researchers and practitioners. The discussion is not exhaustive and in some cases the ideas might have been parsed further.

Practical implications

In this paper the author discusses ten themes that he thinks are relevant for a balanced discussion of farm credit in a development context. These themes illustrate a variety of complexities with respect to rural credit policy. The author ends by restating the themes in the form of ten questions that should be asked in whole, or in part, before any farm credit policy is field‐implemented.

Social implications

This paper deals with a broad range of issues on rural credit policy. It is directed towards a reformation of ideas about credit policy, especially in developing economies. It is argued that, all things considered, on balance there is a role for government in rural credit policy.

Originality/value

There is much discourse amongst development economist about the role of government and credit policy in agricultural development. By thinking of government action or inaction as a form of policy rationing, some clarification is brought to the policy debate.

Details

Agricultural Finance Review, vol. 73 no. 2
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 26 July 2013

Ron Weber and Oliver Musshoff

Using a unique dataset of a commercial microfinance institution (MFI) in Madagascar, the purpose of this paper is to investigate how credit access probabilities and loan…

2704

Abstract

Purpose

Using a unique dataset of a commercial microfinance institution (MFI) in Madagascar, the purpose of this paper is to investigate how credit access probabilities and loan volume rationing magnitudes for farmers change if the MFI switches to offer flexible microfinance loans, which can account for agricultural production specifics.

Design/methodology/approach

The authors estimate probit models for the probability of receiving a loan and Heckman models to investigate the magnitude of volume rationing for all micro loan applications and disbursements of the MFI, differentiating between farmers with standard microfinance loans and farmers with flexible microfinance loans.

Findings

The results reveal that agricultural firms with flexible microfinance loans have significantly higher credit access probabilities than non‐agricultural firms and agricultural firms with standard microfinance loans. Furthermore, it was found that agricultural firms with flexible microfinance loans are stronger volume rationed than non‐agricultural firms and agricultural firms with standard microfinance loans.

Research limitations/implications

Even if the authors can show that access to credit for agricultural firms in Madagascar can be enhanced by the provisioning of flexible microfinance loans, the investigated MFI only introduced flexible microfinance loans in 2011 and currently only offers them through five branch offices. Thus, the product is new to the MFI, and results might change with increasing outreach to other geographic regions in Madagascar. Furthermore, the conditions for agricultural production in Madagascar are unique, and the results might change in different country contexts.

Practical implications

The paper's findings suggest that flexible microfinance loans can contribute to the financial inclusion of farmers with seasonal production types. They also suggest that standard microfinance loans seem to be adequate for farmers with less seasonal production types, e.g. animal husbandry.

Originality/value

To the best of the authors' knowledge, this is the first paper to investigate the effects of flexible microfinance loan provision for credit access of small agricultural firms in developing countries in general, and in Madagascar in particular.

Details

Agricultural Finance Review, vol. 73 no. 2
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 5 February 2018

Freya von Negenborn, Ron Weber and Oliver Musshoff

Although the microfinance sector in developing countries has seen an impressive development in recent years, many small-scale farmers in rural areas are still…

Abstract

Purpose

Although the microfinance sector in developing countries has seen an impressive development in recent years, many small-scale farmers in rural areas are still undersupplied with capital. One of the main reasons for this undercapitalization is the exposure to weather risks. Weather index insurance is assumed to bear high potential for accelerating agricultural lending. The index design hereby is of particular importance. The purpose of this paper is to estimate the influence of evapotranspiration and precipitation indices on the credit risk of farmers in Madagascar.

Design/methodology/approach

The authors base the analysis on a unique borrower data set provided by a commercial microfinance institution in Madagascar and weather data provided by CelsiusPro. In this context, evapotranspiration and precipitation indices both at aggregated bank level and at branch level are identified and their influence on credit risk of small-scale rice farmers is estimated.

Findings

The results show that the weather-related part of the credit risk of farmers can be better explained by an evapotranspiration then by a precipitation index. The precipitation index underestimates the weather influence on credit risk especially during the harvesting season. The results suggest a potential for weather index insurance which is based on an evapotranspiration index. The results are of similar importance for developed and developing countries.

Practical implications

The results suggest that, should insurance be considered as an appropriate risk management instrument for the farmers or the bank, weather index insurance has the potential to mitigate a certain part of the credit risk. The authors also find that the focus on precipitation-based index insurance products would underestimate the weather influence on credit risk. Furthermore, the results suggest that insurance products should be tailored to branches to be most effective.

Originality/value

To the authors’ knowledge, this is the first study that compares the explanatory values of evapotranspiration and precipitation indices in general and for the credit risk of small-scale farmers in particular.

Details

Agricultural Finance Review, vol. 78 no. 2
Type: Research Article
ISSN: 0002-1466

Keywords

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