“Can Microcredit Help to Cope with Aggregate Shocks? Evidence from Ecuador”, by Gunhild Berg and Jan Schrader, Published by Social Science Research Network, November 2008
Available at:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1346565 (28 pgs)

In this paper, Gunhild Berg and Jan Scrader seek to determine the effect of major environmental shocks on microlending in the area. Following major environmental shocks, borrowers typically seek loans from either formal credit institutions or from family and friends. In addition, they may turn to personal savings. The effect of the presence of microfinance insitutions on the ability of low income families to cope with shocks have not yet been previously documented. In this study, the authors observe ProCredit Ecuador´s monthly loan approvals and applications from January 2002 to August 2007 in the cities of Riobamba and Ambato, cities near Tungurahura, the country´s most active volcano. Following Tungurahura´s most severe eruption in 2006, 19,000 people were evacuated and 23,000 hectares of crops were destroyed. Volcanic activity may also disrupt trade. ProCredit Ecuador runs 25 branches in Ecuador and had granted 58,000 loans totalling USD 166 million within the country. The authors correlate ProCredit´s loan data, including borrowers´profiles, with the Instituto Geofisico Ecuador´s monthly reports on seismic activity and eruptions of Tungurahua to determinine the influence of environmental shocks on a microcredit bank´s activities.

The authors find that monthly demand for loans increases following major volcanic eruptions and credit approval simultaneously increases at a rate far less than demand. Among clients who previously borrowed from ProCredit, credit approval increases more than credit demand although credit demand also increases following an eruption. More frequent explosions or high seismic activity in a six month period prior to the loan application reduces the overall probability of loan approval. Data from both affected and unaffected areas reveals that recent high volcanic activity negatively affects loan approval only for clients who have not yet received loans from the bank earlier. Old clients are typically equally or more likely to receive a loan. Overall, returning clients are 22 percent more likely to be approved for a loan than new clients. In 2007, 68 percent of existing or past clients applied for a loan with 58 percent of these loans approved. In 2007, ProCredit received 11,784 loan applications in total and approved 6,754 in Ambato and Riobamba. The authors thereby conclude that microcredit can serve as microinsurance only for the bank´s returning clients and that microsaving or microinsurance facilities are necessary to help low income people cope with shocks.

As a probable reason for this discrepancy, the authors hypothesize that MFIs possess low liquidity following eruptions due to clients withdrawing savings, saving less during the period following the eruption, missing loan payments, or appling for emergency loans. The bank may then take into consideration the reliability of the borrowers and will prefer clients who have had a history of repaying loans. In addition, the bank may be able to offer lower interest rates on emergency loans to long-term customers and charge higher rates for the same clients in future, more prosperous periods.

The authors observe several further trends in credit demand and approval following volcanic activity. Even returning clients were typically not loaned the amount requested on the loan application. In addition, their approved maturity was lower than maturity requested on the application. In general, the higher the loan amount requested, the less the likelihood of loan approval. Furthermore, volcanic activity reduces both credit demand and approval immediately after the crisis although both begin to increase in the following period. The authors suppose that clients are less likely to burden themselves with loans during critical periods although demand begins to increase later. In terms of the effect of a borrower´s profile on a loan application following volcanic activity, loan approval is reduced as the age of the borrower increases. Marriage increases the probability of loan approval by 4 percent. Women are more likely than men to be approved.

By Goda Thangada, Research Assistant