Risk, insurance and small farm credit in developing countries: A policy proposal

Lending to small farmers is often too risky for commercial banks; consequently extremely high interest rates have to be paid. Agricultural development banks go some way towards solving the problem. However, default rates tend to be high, so that credit has to be subsidized by government grants or overseas aid. One cause of the problem is that loans lack proper security. Risks are increased by uncertainties of weather, disease and produce prices. The paper proposes a system of compulsory insurance of crops and livestock. The risks and associated costs are quantified for one particular case: the Small Farmer Development Programme administered by the Agricultural Development Bank of Nepal. The scheme is assumed to run on a no‐profit, no‐loss basis. The data suggest that the cost of insurance premiums, when added to Bank interest rates, would still leave the Bank competitive as a source of rural credit. The practical problems of implementation are considered and deemed surmountable by reinsurance and graduated premiums.