Agricultural Finance Review

Purpose – This paper illustrates that natural disasters can significantly threaten financial institutions serving the poor. The authors test the case of a microfinance institution (MFI) in Northern Peru, where severe El Niño events create catastrophic flooding.

Design/methodology/approach – Portfolio-level, monthly data from January 1994 to October 2008 were examined using an intervention analysis. The paper tested whether the 1997-1998 El Niño increased problem loans and estimated the magnitude of the effect.

Findings – The results indicate El Niño significantly increased problem loans, specifically the level of restructured loans. While restructured loans averaged 0.5 percent of the total loan portfolio before the El Niño, the estimated cumulative effect of El Niño indicates that an additional 3.6 percent of the portfolio value was restructured due to this event.

Research limitations/implications – Future research could build on these results by modeling insurance-type mechanisms for the MFI. Additional research that replicates these analyses in another context would be highly valuable for comparison across natural disasters and financial institutions.

Practical implications – The findings demonstrate that the correlated risk exposure of many small borrowers can significantly affect the lender and the importance of considering bank management in assessing disaster risk of a financial institution.

Social implications – Lender strategies to minimize losses may require long-term restructuring that perpetuates the effects of the disaster in the community.

Originality/value – This paper may be of particular value to researchers and practitioners hoping to improve the effectiveness and efficiency of MFIs concentrated in regions exposed to natural disaster risk.