Design and Rating of Risk-Contingent Credit for Balancing Business and Financial Risks for Kenyan Farmers

Weather related agricultural risks and limited access to credit are serious impediments to agricultural productivity and growth in developing countries. This paper describes a novel insurance linked credit model piloted in Kenya, where insurance markets are effectively absent and farmers do not borrow because of the risk of losing their collateral. One of the challenges in deigning bundled credit products, in the absence of traded securities, is the actuarial pricing and risk rating of the insurance and the loan product. We develop a rainfall linked risk-contingent credit that transfers drought risk related perils from borrower to lender via insurance mechanism that provide a balance between business and credit risks for smallholder farmers. We describe the methodology used to design and rating of a risk-contingent structured operating agricultural credit instrument using CHIRPS rainfall data from 1981-2016 in Kenya. We illustrate the use of Monte Carlo methods to risk modelling that can be integrated within general insurance and credit rating framework. The innovative design and methodology presented in this paper are as important as the product delivery mechanism and will be of interest to specialists in development economics and agricultural finance