Risk Management Challenges in Rural Financial Markets: Blending Risk Management Innovations with Rural Finance

According to the author:

• Rural finance is about managing risk;
• Lenders can effectively pool and aggregate risk held by a large number of borrowers if the risk they face is largely independent;
• A major advantage of microfinance entities is their ability to pool risk;
• Correlated risk can not be pooled. Small rural finance entities (RFEs) are simply not capable of pooling and managing correlated risk on their own.

Agriculture remains a dominant activity in many rural economies of the poorest nations in the world. The author states:

• Risks in agriculture are correlated;
• Bad fortunes through price decline or natural disasters cause many households to suffer;
• Insurance markets lack in most developing and emerging economies, and rarely do local insurance markets emerge to address correlated risk problems;
• There are numerous challenges in developing financial markets to manage risk in developing countries.

The author hopes that reviewing innovations in global financial markets can provide unique opportunities for RFEs to manage correlated risk and expand their ability to help rural households. Two of such innovations are the use of:

• Global futures markets by intermediaries who can offer price insurance;
• Index insurance contracts to shift natural disaster risk into the global markets.

The author recommends the blending these forms of index insurance and rural finance.