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In a recent study conducted by researchers at the International Crop Research Institute for the Semi-Arid Tropics, the impact of financial inclusion on climate risk management for rural households in low- and middle-income people was investigated.
The study published in the journal Scientific Reports revealed that access to formal financial institutions plays a crucial role in enabling rural households to address climate risks effectively.
Rural households in the semi-arid tropics face significant challenges due to climate change, including unpredictable weather events and income crises. To mitigate these risks, households often resort to keeping a fraction of their assets in liquid forms, such as cash, gold, silver, and financial investments, to quickly access funds during negative income shocks.
Banking Reduces Rural Climate Risks
The research results showed that financial inclusion, defined by indicators of access, use and barriers to formal financial institutions, has a positive impact on the ability of rural households to manage climate risks. The study examined data from 1,082 households in 30 villages in the semi-arid tropics of India, covering the period from 2010 to 2014.
The study found that 59% of households experienced weather shocks at least once during the five-year period, and 13% faced them in more than two years. Of the households affected by weather shocks, 57% relied on their own savings to manage the impacts. However, without access to liquid assets, rural households often resort to high-interest loans from informal sources.
The survey also revealed the hierarchy of sources of financial assistance during crises, with households primarily relying on family and relatives for support, followed by friends, village communities, moneylenders, and banks.
On average, households had 15.6% of their assets in liquid form. However, households with bank accounts had 1 to 13 percentage points less liquid assets when facing higher weather risks compared to those without bank accounts. In regions with higher risks of rain and temperature, economically excluded households were predicted to keep almost 50% of their assets in liquid form, while banked households only had 20%.
Financial inclusion reduces weather vulnerability
Households with access to formal financial institutions were found to have a lower proportion of their assets in liquid form compared to those without such access. This indicates that financial inclusion reduces the need for households to rely on holding liquid assets as a hedge against weather risks. Consequently, resources are available for investments in adaptation to climate change, improving long-term resilience and reducing vulnerability.
In regions with high climate variability, where the risk of weather-related shocks is more pronounced, the study found that households are more likely to hold a higher proportion of their assets in liquid form. The availability of formal financial institutions mitigates this need by offering alternative avenues for risk management.
A significant finding was that households facing climate shocks mainly rely on their own savings as the main coping mechanism. However, when formal financial institutions, such as banks, are considered among the top three reliable sources of assistance during crises, households are less reliant on lenders.
This indicates that access to formal financial institutions strengthens the economic resilience of households and reduces their reliance on high-interest, informal loans, which can exacerbate vulnerability.
The study emphasized the importance of expanding financial inclusion efforts in rural areas, mainly through the establishment of bank accounts.
India, for example, has made significant progress in expanding rural banking over the years, supported by policies to provide subsidized credit and other financial products to the agricultural sector.
Savings products offered through formal financial institutions provide security, better cash management, and enable more productive investments, ultimately helping to increase agricultural production.
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