Elsevier

World Development

Volume 39, Issue 6, June 2011, Pages 898-912
World Development

Does Microfinance Work as a Recovery Tool After Disasters? Evidence from the 2004 Tsunami

https://doi.org/10.1016/j.worlddev.2009.10.020Get rights and content

Summary

We evaluate the effectiveness of microfinance as a recovery tool after tsunami by testing the impact of an equity injection from foreign donors which recapitalizes a Sri Lankan MFI and allows it to refinance borrowers seriously damaged by the calamity. We find that loans obtained from the MFI after the catastrophic event have a positive and significant effect on the change in real income and in weekly worked hours, and that the impact on performance variables is significantly stronger for damaged than non-damaged borrowers. Results hold after controlling for selection effects and for heterogeneity in both the timing of the intervention and the characteristics of treatment and control samples.

Introduction

One of the main obstacles to economic development for the poor is the lack of access to traditional credit markets due to the scarce availability of collateral resources and the high screening, monitoring and enforcement costs incurred by financial intermediaries when lending to them (Hermes & Lensink, 2007). Microfinance tries to circumvent these problems with a mix of solutions.

Assessing the impact of microfinance programs is not easy. First, empirical studies may incur in self-selection bias since those who borrow may have better unobservable traits than the control sample, mainly as a consequence of the same bank screening process. Second, undocumented village-level differences could influence the demand for/use of credit, thereby leaving space for placement bias (Hulme & Mosley, 1996). Third, comparing old and new clients might be subject to attrition bias, with survived old clients being of “better type” than new ones, as underlined by Karlan (2001). Fourth, data collection is difficult and costly, especially when repeated across time. Nevertheless, a number of studies have found positive effects of microcredit programs on clients’ income, women empowerment, contraceptive use and nutrition (for a survey, see Goldberg (2005) and Armendariz de Aghion and Morduch (2005)).

The focus of our research is on the relatively less explored topic of the relevance of microcredit as a recovery tool after a natural catastrophe such as the 2004 Asian Tsunami.1 After a catastrophe occurs, the first financial source used to recover is self-insurance (savings and accumulated assets). Unfortunately, a relevant share of the poorest do not have enough savings after a natural disaster when the latter destroys their few available resources. For this reason, especially in low-income rural areas, it is common practice to form risk-sharing networks. The problem with them is that they work at best when members’ incomes are uncorrelated or negatively correlated, generally not the case for developing countries (Fafchamps & Gubert, 2007) and after natural catastrophes (Skees, Varangis, Larson, & Siegel, 2002). This is why an important recovery tool is represented by loans provided by traditional banks and MFIs. With respect to donations and charity, credit has the advantage that it does not affect income in the mere short term and that, if the loan is paid back, it perpetuates the financial flow and satisfies new investment opportunities.

It is important to notice that natural hazards tend to be accompanied by liquidity squeezes since, in spite of a boom in credit demand due to the need to restore destroyed and damaged buildings and economic activities, banks are often forced to reduce the supply of loans because of the sudden worsening in the quality of their assets. For this reason recapitalizing MFIs after calamities may be crucial. The recent historical evidence documents that microcredit programs contributed to reduce the vulnerability of the poor by assisting them to re-build assets and by providing emergency assistance after natural disasters. There are many examples of MFIs active in post-conflict and post-disaster countries whose loans have been claimed to be a useful recovery tool. The widespread diffusion of MFIs in Uganda and Bosnia, among other countries, in the post-war periods is a clear example. Another case refers to Thailand in the post-tsunami period where, as reported in the USAID’s web site,2 “a USAID-financed microfinance fund in a tiny, tsunami-ravaged village has proven so successful that it has been accepted as an associate member of the Credit Union League of Thailand.”3

Apart from this anecdotal information, rigorous and sound empirical evidence on the usefulness of microcredit as recovery tool after natural catastrophes is still scarce. Khandker (2007) studies the coping strategies adopted by rural households during the 1998 flood in Bangladesh and assesses their impact on welfare. The author concludes that “the presence of microcredit programs increased the amount of borrowing coping. Household borrowing also increased household welfare by raising both consumption and asset holding” (p. 179). Hoque (2008), using data from rural Bangladesh, finds that BRAC’s micro-credit program may increase participating households’ abilities to cope with economic hardships following floods and other natural disasters. Nevertheless, the author concludes that “further research to much more systematic information needs to be conducted about micro-credit program before conclusive results can be reached.” The purpose of our research is to contribute to fill in this gap.

Our specific focus is the evaluation of the effects of a donors’ intervention aimed at recapitalizing a Sri Lankan MFI4 which reported post-tsunami certified losses for 24.4% of its credit portfolio due to the serious damages to the business of a large part of its borrowers. This implies that, in case of adoption of a standard capital adequacy rule of, say, 10%, the MFI’s losses would amount to 250% of its capital. The recapitalization program was aimed to provide the MFI with the capital necessary to grant new loans to the damaged borrowers enabling them to start back their activity and proved to be much cheaper for the donors5 than more classical aid schemes. Our goal is to evaluate whether such intervention acted as an effective liquidity injection for the damaged borrowers enabling them to restore their economic activity and to significantly improve their economic conditions with respect to the immediate post-tsunami levels.

The advantage of our framework is that the tsunami event in fact creates two “randomly selected” groups: a treatment group (borrowers directly hit by the tsunami shock) and a control group (borrowers from the same MFI not affected by it). Our study can, therefore, be assimilated to a (quasi) natural experiment in which the exogenous shock makes a difference between the two above mentioned groups which are ex ante not significantly different in terms of borrower’s quality or seniority characteristics, overcoming the standard selection bias problem in microfinance impact analyses. We exploit this unique opportunity by focusing on the effects of post-tsunami MFI refinancing. More specifically, we evaluate its impact (measured by the size of the loans obtained after the tsunami scaled on the borrower’s post-tsunami pre-refinancing monthly income) on two performance variables (percent change in income and in worked hours after refinancing) by carefully taking into account problems related to heterogeneity of loan timing and endogenous size and timing of the loan (see Section 3).

The paper is divided into five sections including introduction and conclusions. Section 2 provides details on our survey. Section 3 describes the dataset, explains the methodology adopted and provides summary statistics. Section 4 presents the estimation approach and comments descriptive and econometric evidence. Section 5 concludes.

Section snippets

Agro Micro Finance and the survey

Agromart Foundation is a Sri Lankan NGO founded in 1989 to carry out grassroots work with a large number of communities in Sri Lanka. The Head Office is located in Colombo with nine other provincial offices in Uva, the Southern, North Western, and Eastern provinces. The core of its mission is strengthening the competencies of its members through participatory trainings. In order to achieve this goal Agromart Foundation created self-help groups in rural areas through the provision of technical

SUMMARY STATISTICS

With survey data collected on the field we obtain information on the respondents’ socio-demographic characteristics, on hours worked and on a series of economic indicators. Table 1a and b describe the socio-demographic characteristics and economic variables used in our study. Table 2a reports summary statistics for selected socio-demographic characteristics of AMF sample borrowers.

We can see in this table that slightly less than half of the sample has house and economic activity within one

EMPIRICAL ANALYSIS

Our empirical analysis focuses on the effects of MFI refinancing on damaged borrowers’ recovery with preliminary descriptive evidence on the damage and recovery in the first place and, after it, a series of econometric tests on the impact of refinancing which try to solve the usual methodological problems arising in this kind of impact analyses.

CONCLUSIONS

Our paper examines the role of MFI loans as an effective recovery tool after tsunami for a sample of 305 randomly selected clients of a Sri Lankan MFI. In order to reconstruct time series we devise an ad hoc retrospective panel data approach by asking interviewed borrowers to declare their current and remember their past economic levels. We carefully control for the reliability of our data by combining survey data and bank records, comparing results on income with those on a more memorable

Acknowledgments

We thank Robert Cull, Rafael Di Tella, Rita Ferrer-i-Carbonell, Robert Lensink, Enrico Longoni, Craig McIntosh, and Bruce Wydick for their useful comments and suggestions. We wish to thank David Berno, Salvatore Morelli, and Francesca Palermo for valuable research assistance and Laura Foschi, Francesca Lo Re, Marco Santori, and all Etimos team for their support. The usual disclaimer applies.

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