Effects of Index Insurance on Demand and Supply of Credit: Evidence from Ethiopia

Temesgen Belissa,Robert Lensink,Anne Winkel

doi:10.1111/ajae.12105

Abstract

Index‐based insurance offers a climate risk management strategy that can benefit the poor. This article focuses on whether adopting index insurance improves access to financial markets and reduces credit rationing, using empirical analyses focused on Ethiopia. With different identification strategies, including a newly developed method that leverages the varying availability of index insurance across areas, the authors control for potential selection biases by forecasting potential insurance adopters; they apply a cross‐sectional double‐difference method. Credit rationing can take the form of either supply‐side quantity rationing, in which case potential borrowers who need credit are involuntarily excluded from the credit market, or demand‐side rationing, such that borrowers self‐select and voluntarily withdraw to avoid transaction costs and threats to their collateral. By differentiating supply‐side and demand‐side forms and employing a direct elicitation method to determine credit rationing status, this study reveals that 38% of sample households are credit constrained. The preferred estimation techniques suggest that index insurance significantly reduces supply‐side rationing.

Highlights

This article focuses on a question that has not received much attention in prior literature: Does the adoption of index insurance improve access to financial markets and reduce credit rationing? Our empirical analyses focus on Ethiopia and leverage a situation in which Index-based insurance (IBI) is not yet available in some areas
With a hybrid identification strategy, in line with a cross-sectional double-difference method, we try to control for potential selection biases by forecasting potential insurance adopters
We can draw some tentative conclusions about the causal relationship between adopting IBI and credit rationing

Summary

Introduction

More information can be found on the University of Groningen website: https://www.rug.nl/library/open-access/self-archiving-pure/taverneamendment. Index-based insurance offers a climate risk management strategy that can benefit the poor. This article focuses on whether adopting index insurance improves access to financial markets and reduces credit rationing, using empirical analyses focused on Ethiopia. Index-based insurance (IBI) is an innovative hedging instrument that can mitigate the risks of drought or seasonality-based weather variations due to climate change. Because IBI unlinks loss assessments from individual behavior, it can avoid moral hazard and adverse selection problems (Barnett, Barrett, and Skees 2008; Skees 2008), which might improve credit access. This article offers initial insights into the impacts of IBI on credit rationing, using data from a drought-prone area in the Rift Valley zone of Ethiopia

Methods

Results

Conclusion