In the absence of insurance markets, theory suggests that households can use credit to protect themselves against adverse income shocks. However, in many developing countries, access to credit in the aftermath of shocks is scarce as negatively aﬀected households are frequently denied loans.
This study tests whether a new ﬁnancial product that oﬀers guaranteed credit access after a shock allows households to insure themselves against risk with a large-scale RCT involving 300,000 subjects in Bangladesh with one of the country’s largest microcredit institutions. Microﬁnance clients were randomly pre-approved for loans that are made available in the event of local ﬂooding.
The results show that this unique type of microcredit improves household welfare through two channels: an ex-ante insurance eﬀect, where households increase investment in risky production, and an ex-post eﬀect, where households are better able to maintain consumption and asset levels after a shock. It also documents that households value this product, taking costly action to preserve their guaranteed access. Importantly, the extension of this additional credit improves loan repayment rates and MFI proﬁtability, suggesting that this product can be sustainably extended to households already connected to microcredit networks.