Risk Management
Theme Paper: “Risk Management Challenges in Rural Financial
Markets: Blending Risk Management Innovations with Rural Finance”
by Jerry R. Skees (Professor, University of Kentucky and President,
GlobalAgRisk, Inc.)
Abstract
All financial intermediaries need to manage risk. As agriculture
and other rural activities are often associated with higher risk
than their urban counterparts, development of rural financial
markets places even greater importance on innovative risk management
mechanisms. Lenders can successfully manage, or pool, risk within
their loan portfolio if their borrowers are not all exposed to the
same risk at the same time. However, lenders cannot easily manage
risk by themselves when all their borrowers are vulnerable to the
same risk (correlated risk). In agriculture, correlated risk is
almost always a problem because changes in commodity prices and
natural disasters generally impact large groups of borrowers in
the same way. While in the US, there are independent mechanisms
to manage correlated risk and insulate lenders from its impact (i.e.¸
crop insurance), in developing countries such financial mechanisms
are essentially non-existent. This constrains access to finance
by rural families and agricultural enterprises.
Innovations in global financial markets can shift correlated risk
beyond the local community, reducing lender exposure to localized
risk (hurricanes, droughts). However, significant constraints remain
for the development of such mechanisms. This paper develops the
conceptual basis for analyzing these constraints and offers innovative
solutions, such as contingent-claims contracts, appropriate for
developing countries. At least two mechanisms will be investigated
with illustrations from real-life application:
- Use futures exchange markets to shift price risk; and
- Use index-based insurance products to shift natural disaster
risk.
|
Get
full text