A latest study by the Indian School of Business (ISB) has shed light on the pivotal role of ‘financial inclusion’ in mitigating climate risks for rural households.
The study pointed out that ‘financial inclusion’ alleviates the need to hold liquidity, relieving the resource constraint and enabling rural households to respond better to known climate risks.
The study, conducted in the semi-arid tropics across nine States including Karnataka, Odisha, Bihar, Jharkhand, Gujarat, Telangana, Andhra Pradesh, Madhya Pradesh and Maharashtra— focuses on how access to formal financial institutions empowers rural households in vulnerable communities to navigate the challenges posed by climate change.
It examines the relationship between climate risk, financial inclusion, and household liquidity using household-level panel data from 1,082 rural households in Indian semi-arid tropics from 2010-2014.
Authored by Professor Ashwini Chhatre, executive director, Bharti Institute of Public Policy (ISB), along with Professor Prachi Deuskar of ISB and collaborators in England and Australia, including Javed Mohib and Deepanshi Bhardwaj, the research study titled ‘Financial Inclusion Mitigates Climate Risks for Rural Households: A Study in Semi-Arid Tropics’, was recently published in multidisciplinary science journal Scientific Reports-Nature.
According to the study, households facing higher climate risks tend to hold a larger proportion of their assets in a form that can be easily converted to cash. This allows them to cope with unpredictable climate shocks. Generally, this strategy forces households to reduce investments in productive assets, which typically cannot be easily converted to cash at short notice.
Allocating resources efficiently
However, access to formal financial institutions, such as banks reduces this need for liquid assets. Households with financial inclusion hold a smaller share of their assets in liquid form compared to those without such access. This suggests that financial inclusion enables rural households to allocate resources more efficiently towards addressing climate risks, as they do not need to rely as much on liquid assets.
The study demonstrates that access to formal financial institutions plays a transformative role. Financially included households have a reduced need to hold liquid assets as they can rely on banks and other financial institutions for support during climate shocks.
The study shows that 59% of the households experienced climate shocks in at least one of the five years and 13% faced them in more than two years. Out of the 633 households that faced at least one adverse climate shock affecting their livelihoods, a large fraction 358, which is 57%, reported their own savings as the primary coping mechanism.
“Our results show that financial inclusion reduces the need for rural households to keep assets in a form that can be liquidated and converted quickly into cash in case of unpredictable climate shocks. Liquid assets have lower returns (for example, savings account earns lower interest than fixed deposit). Investments to reduce exposure to climate risk (such as irrigation equipment or water storage) are not amenable to liquidation without substantial loss of returns. With access to formal financial services, households will have more resources to invest in such investments because they no longer need to worry about liquidity as much,” Mr. Chhatre told The Hindu.
He added, “So far, financial inclusion is not seen as a complement to climate adaptation. Access to formal financial institutions will increase the uptake of climate-smart technologies in rural areas, reducing the negative impacts of extreme weather events. Our results provide a strong additional justification for intensifying our efforts at expanding and deepening financial inclusion of the poor.”
According to the World Bank ‘financial inclusion’ means that individuals and businesses have access to useful and affordable financial products and services that meet their needs— transactions, payments, savings, credit and insurance— delivered in a responsible and sustainable way.
