Insured Loans Improve Credit Access and Technology Adoption of Ghanaian Farmers

The agricultural sector accounts for over half of total employment and one-fifth of gross domestic product (GDP) in SSA. Labor productivity is held back primarily by low rates of adoption and retention of improved production technologies, such as improved seeds. These technologies are critical for reducing rural poverty and improving household well-being in these economies. Yet, SSA countries have among the lowest rates of technology adoption in the world. The low rates of adoption are due to numerous barriers to adoption common across many developing countries, including low levels of education, poor soil quality, agro-climatic conditions, manure use, hiring of labor and extension services, cost and availability of seeds, credit constraints, informational barriers, and lack of effective commitment devices. Central to the barriers of adoption are two interrelated factors: (i) poor access to credit, particularly to overcome any lumpiness of investment and (ii) the riskiness of agricultural returns, primarily due to systemic weather shocks. These barriers affect both farmers' demand and banks' supply of agricultural credit. On the demand side, farmers are often reluctant to seek credit due to the risk of losing their assets pledged as collateral in the case of a failure to repay; a phenomenon called risk-rationing. This is particularly true for female-headed households owing to their lack of access and ownership of agricultural resources, fewer avenues to insure themselves against systemic shocks, credit constraints, and higher risk aversion. Mechanisms that reduce the risk of default during systemic events can spur higher demand of agricultural credit and attendant technology adoption among female farmers. On the supply side, widespread systemic weather events increase the variability of agricultural returns, thereby exposing lenders to substantial undiversifiable systemic risk. This can be particularly damaging for male farmers who are seen as less creditworthy due to their lower repayment records. Using data from 350 microfinance institutions from over 70 countries, researchers find that female clients are associated with lower portfolio risk, fewer write-offs, and higher repayment rates. A carefully designed drought index insurance (DII) product, when properly integrated into the financial market, may reduce the riskiness of agricultural returns in case of a drought and improve access to credit. DII pays out based on the observation of an objective rainfall index such as measures of precipitation from rainfall stations or satellite data. Relying on an exogenous index allows the insurer to avoid high transaction costs associated with indemnity insurance and informational asymmetry problems. Despite its expected benefits, early initiatives have seen limited uptake of DII by smallholder farmers in absence of substantial subsidization. The limited uptake of DII has been attributed to factors such as lack of trust, liquidity constraints, lack of understanding of the product, and the imperfect correlation between the index and realized losses, i.e. basis risk. Most of these issues can be mitigated by a better designed product. A novel use of index insurance where payouts go to risk aggregators such as micro-finance institutions, farmers' cooperatives, input suppliers (meso-level insurance) rather than to the farmers (micro-level insurance) has been recently proposed. Theoretical models have predicted that such a product can reduce the risk of defaults and improve farmer's creditworthiness, credit sustainability, and technology adoption. In this study, a randomized control trial (RCT) was conducted in northern Ghana to investigate the comparative impacts of coupling micro- and meso-level drought index insurance with agricultural loans on the supply and demand of smallholder agricultural credit and advanced technologies. The RCT targeted maize farmers organized in credit groups and employed a simple theoretical model to analyze the data. The results indicate that coupling loans with meso-insurance increases the likelihood of loan approval by 23 percentage points. Gender-level analysis shows that micro-insurance-coupled loans increase the likelihood of loan application for females while meso-insurance-coupled loans increase the likelihood of loan approval for both females and males, but with a larger impact for males. Overall, the study's findings suggest that insured loans hold significant promise for expanding credit access and technology adoption among smallholder farmers. The results also highlight the potential benefits of meso-level index insurance in reducing the risk of defaults and improving farmer's creditworthiness, credit sustainability, and technology adoption.