Financing Recovery after Disasters: Explaining Community Credit Market Responses to Severe Events

Abstract

Credit provides a means for uninsured households and businesses to manage disaster losses, but access to credit may be tenuous after severe events. We examine the effects of natural disasters on credit supply in a panel of community lenders in developing and emerging economies. We find that disasters reduce lending; top quartile events reduce loan growth by 30 percent. We consider two potential causes of lending reductions: 1) disasters reduce expected returns on loans made after the event or 2) capital constraints, lenders’ difficulty replacing equity lost during the event. We develop a dynamic model that informs our empirical identification of these causes and conclude that capital constraints cause observed credit contractions. We also examine the effects of insurance market development and find evidence that insurance preserves the creditworthiness of borrowers. Our results highlight the importance to small and medium enterprises of proactively managing risk and identify new insurance market opportunities.