How Do Financial Systems Support Climate Resilience?

In Nigeria’s Kano state, an extended drought in 2021 was followed by very intense rainfall, dealing a one-two punch to farmers like Ummi, who we met in the first blog in this series. In Bangladesh, cyclone Alia wiped out crops in 2009, sending Masum on a years-long journey through multiple livelihood strategies and locations, as we saw in the second blog in the series.

The differences between rapid on-set climate events like cyclones or flooding, and slow on-set climate events like desertification, sea level rise, or salination of soil are well documented. However, in our research into grassroots climate resilience, very often we saw that a series of rapid onset events (such as a drought followed by a flood) occur within one season. We also saw that rapid on-set events (such as cyclones) can generate short-term emergency needs requiring rapid access to cash, and remarkably long impacts requiring larger sums of money to allow affected families to adapt or build resilience. 

Smallholder farmers in all three countries we studied (Bangladesh, India, and Nigeria) incurred financial losses due to their inability to protect their key livelihood assets: crops and livestock. Financial losses impaired their ability to invest in concrete houses and flood-resilient shelters for livestock, buy costly flood-resilient seeds, and repay their debt obligations to formal and informal creditors on time.

Different climate events, and different phases of those events, drive different needs for financial services.  We found it helpful to think about this in three broad categories: coping, recovery, and adaptation.

Coping during rapid on-set events

During the coping stage (or “muddling through”), for example, when flood waters remain high, rapid access to cash is essential for households to cope with climate impacts and protect their assets from distress sale. In this phase, affected people typically need fresh water, food, animal fodder, and medical supplies; the amounts required are not very large, but they are urgent. 

We found that easily accessible savings were typically the most valuable for households in the coping stage. These tended to be informal since mobility was often limited and formal branches often closed or were made inaccessible by the floods. Savings held in the home, informal savings groups, and borrowing from family and friends were important for affected people in all three countries.

In Bangladesh and India, immediately after each climate event, many affected people also borrowed from local moneylenders who could offer money faster than formal lenders, without collateral or documentation, and in cash. The latter is important as it avoids the need to go to bank branches, ATMs, or agents, which are often inaccessible during floods. Many formal financial institutions also do not lend money for consumption. 

In all three countries, we saw that remittances are an important source of regular income for a minority of households, but remittance flows do not significantly increase after a climate event so they played a more limited role than we had expected. 

Recovery after rapid onset events

Savings played an important role in the recovery phase as well. In Nigeria, in particular, savings were used to recover from the drought and intense rainfall by replanting or constructing shelters for livestock. In this less acute phase, access was less time sensitive and so savings in formal institutions played a greater role.  But these savings, even when supplemented by informal borrowing, were often inadequate. Many affected people were forced to sell assets to raise funds to rebuild. The lack of microfinance institutions (MFIs) or banks willing to lend to rural and poor people significantly reduces their options for financing recovery.

In contrast to Nigeria, formal credit was prevalent in both Bangladesh, through NGO MFIs, and India, through MFIs and self-help groups (SHGs) channeling loans from public sector banks. In these countries, credit was key to recovering after climate events for most households. In Bangladesh, many MFIs offered repayment freezes on existing loans and cheaper emergency loans for reconstruction and recovery. However, in India, borrowers noted that MFIs were often rigid, and offered no repayment freezes unless the impact of the flood was so severe that their collection officers were unable to access the villages. In contrast, SHGs were more understanding and permissive of flexible repayments. This flexibility was highly valued by clients. 

In Bangladesh, women have relatively higher access to both formal and informal microcredit as most MFIs target women, and informal women-led cooperatives are common. Nearly three-quarters of our quantitative survey respondents had borrowed from MFIs, half from relatives and neighbors, and a third from moneylenders. This highlights how credit is often patched together to build the amount required to recover.

Insurance could play an important role in the recovery phase but is generally not available (for example in Nigeria and Bangladesh) or not widely trusted or accessible (as we saw in India). There clearly remains an important opportunity to refine and increase access to weather index-linked or parametric insurance.

Adaptation to build resilience 

In all three countries, we saw affected people struggling to assemble the funds required to recover from climate events from a mix of formal and informal sources.  We saw some relatively low-cost adaptation measures – such as buying genetically modified seeds or modifying planting dates – in both India and Bangladesh. However, these were often associated with excessive use of fertilizer, and may well prove to be maladaptive in the medium- to long-run. Effective adaptation often requires even more significant sums of money than needed for recovery, as it typically entails capital expenditure to raise and strengthen housing, protect low-lying land, put in irrigation systems, etc. Lack of capital can therefore force people into maladaptive responses that will serve them poorly over time. 

Almost all MFIs and SHGs only offer working capital loans with small, regular repayments that are ill-suited to the large-scale, longer-term investments required for adaptation. Banks are sometimes more flexible – for the more affluent. We only saw borrowing directly from banks in a few cases in Nigeria, though. Blended finance instruments using international climate funds could increase the flow of public- and private-sector credit to support vulnerable communities.

The markedly different financial landscape of the three countries we studied highlighted the shortcomings of, and the opportunities for, existing and future financial services to play a role in response to climate events. Inclusive financial solutions will need to be reinvented if they are to play a valuable role in adaptation and resilience building for vulnerable communities, many of whom are already financially underserved.  We hope that our work can serve as a call to action for more research, experimentation, and scaling of solutions that can make a difference.

This three-blog series shares findings from research by CGAP along with Decodis and MSC on how people living in poverty in Nigeria and Bangladesh are preparing for, coping with, and adapting to climate shocks, and what role financial services are playing in supporting them. The first outlines how households in Nigeria are using financial services in responding to climate events, while the second considers the complexities of locally-led adaptation, and the third explores how financial systems can better support climate adaptation. 

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