How Agricultural Risk Management Can Improve Access to Finance

1. World Bank Group How Agricultural Risk Management Can Improve Access to Finance Ground breaking weather risk and price risk transactions from and India and Tanzania demonstrate how market based risk management enhances access to rural finance Commodity Risk Management Group/ARD Ulrich Hess Self-insurance groups can enhance access to finance for productive but asset poor farmers: the Mexican case Olivier Mahul Contractual Savings and Insurance Practice, FSE-OPD

2. Risk Management in Rural Finance • Price and weather risks threaten viability and livelihoods of rural households • Systemic risks are among the major obstacles to access to finance in agriculture • Traditional risk mitigation involves over-diversification of assets and under-investment in crops • Access to formal Risk Management such as insurance can make farmers creditworthy – but few have access • CRMG seeks to bridge the gap between supply and demand of these instruments through TA and by facilitating pilot cases with strong demonstration effects

3. Weather Risk Insurance for Farmers in India 2003: • 1500 farmers bought insurance against excess and lack of rainfall in two states from ICICI Lombard reinsured in US 2004: • ICICI Lombard expands farmer insurance in AP and orange farmers in Rajasthan • Two more insurance company followed 2003 example • Total of 18,000 weather risk insured farmers in India!

4. First Farmer weather insurance policy

5. Weather Risk Insurance for a Rural Finance Portfolio • BASIX finances 150,000 poor households in six Indian states and has a large crop lending portfolio • BASIX experimented with crop insurance since 1997 and pioneered weather insurance • In 2004 BASIX insured its crop lending portfolio against extreme weather shocks with Indian insurer backed by reinsurance • Thanks to this weather hedge BASIX will not withdraw from two drought-prone “risky” districts • Eventually BASIX plans to launch weather indexed crop lending products

6. Managing Price Risk for Financial Institutions • Privatized in 1995, 3rd largest bank in Tanzania, total assests US$ 370 million • Loans and advances to coffee and cotton • Lends to private sector gins and buyers as well as cooperatives • In the past price volatility has made clients unable to repay bank loans and made the bank hesitant to extend lending • Biggest exposure is to cooperatives who set minimum prices to farmers in advance of the season • Bank uses collateral management to protect volume risk, BUT remains unprotected against price risk

7. Minimizing Price Risk for CRDB’s Coffee & Cotton Clients • CRDB encourages clients to “identify their risk” and use the most efficient means to manage that risk • CRDB is taking two different approaches in the use of derivatives: • Hedging to protect its own portfolio • Offering risk management as a service to clients • In order to do this – • CRDB opened an account with international broker • Developed hedging strategies for each of its clients based on breakeven analysis • Determined the exposure of CRDB’s portfolio to volatility • First transaction took place in July 2004 • CRDB cotton client protected a minimum price on the international market through the purchase of a put option

8. Agricultural Insurance Institutional framework • Agricultural insurance • Agricultural insurance can only deal with the remaining part of production risks that cannot be managed using cost-effective mitigation measures • Underdeveloped agriculture cannot be developed or restored purely by the introduction of an insurance program • Agricultural insurance has no purpose without viable agriculture and conversely, viable agriculture could not exist without adequate insurance. Asset base Market-based solutions as enhancing the agricultural business viability high Market-based solutions as restoring the agricultural business viability Social response • Business viability • Production risk characteristics • Farmer’s financial profile • Typology of agricultural business activities low low high profitability • Insurance industry • Financial capacity to absorb adverse exogenous shocks • Trained staff • Adequate regulatory and supervisory infrastructure

9. Self-Insurance Funds in MexicoAgricultural Insurance providers for productive farmers • Late 1980’s • Transformation of the agricultural sector to an open market economy • New markets for commercial farmers • Major constraint: access to credit • Self-insurance funds (Fondos) • Non-profit organizations constituted by farmers, without any monetary capital endowment • Established to offer insurance to members as a loan collateral to get access to credit • Concentrated in productive agricultural regions generating financially viable business • Total sum insured (annual basis) in 2002: USD 407 millions

10. Self-Insurance Funds in MexicoEnhancing access to finance • Institutional framework • Actuarially sound insurance practices • Mutual co-responsibility (control of moral hazard and adverse selection) • Strong financial solvency of the Fondos • Reserves and reinsurance (unlimited stop loss) • Insurance as a loan collateral • Positive externalities • Surpluses directed towards activities for new business opportunities • Once consolidated, Fondos become a very important source of information about farmers’ financial profile (credit history) • Information used by the Banks to offer better financial terms