Access to Credit as Insurance

Abstract

One main advantage of having developed credit markets is that there are better opportunities of dealing with risk. This paper measures access to credit in rural India and the role of credit institutions as insurance mechanisms. I am able to do this by comparing data for 720 rural households that I collected from two Indian states, Kerala and Uttar Pradesh. To measure a household's access to credit, I develop an equilibrium model of sorting based on a random utility approach. The initial results indicate that there are large disparities in access to credit, particularly from formal sources. The predominant sources of credit, however, are cooperative societies and informal ties between households. The main results indicate that access to credit serves as an insurance against idiosyncratic income shocks. This, however, crucially depends on the exact source of credit. While access to banks does not provide insurance against an income shock, access to cooperative societies and informal ties offer the best insurance against such shocks. Households that primarily rely on moneylenders for credit are the worst hit during an income shock. The results show that a 1 percent increase in access to cooperative, lowers the probability of reducing consumption expenditure against an income shock by 18 percent.