Financial inclusion, climate-related shocks, and food insecurity in Ethiopia

Despite the commitment of Sustainable Development Goal 2 to end hunger by 2030, food insecurity remains a challenge in most African countries, with the number of hungry people reaching 282 million in 2022 (Food and Agriculture Organization [FAO], 2024). Adverse weather conditions and other shocks, such as Covid-19 and conflict, have been identified as major contributors to this deteriorating food security scenario (FAO, 2024). 

Recurrent climate-related shocks remain a significant threat to food security, especially for developing countries. The main channel through which exposure to extreme weather events such as droughts impacts food security and well-being is via reduced agricultural production in rural areas where rain-fed subsistence farming is the main form of crop production (Abebe & Amare, 2025). A decline in agricultural output can lead to a decline in food availability, an increase in local food prices, and a reduction in household real income and food accessibility. However, the extent to which climate-related or other shocks affect welfare outcomes is determined by factors such as households’ access to financial and physical assets, insurance, social safety nets, and risk sharing (Anshida et al., 2026; DeLoach & Smith-Lin, 2018; Riley, 2018).

In this research, we examine the impact of climate-related shocks on household food insecurity in Ethiopia and explore the extent to which formal financial services might help to attenuate the negative effects of these shocks. Ethiopia is one of the African countries frequently hit by climate-related shocks, and almost 80% of the population lives in rural areas, with rain-fed subsistence farming accounting for over 69% of employment. Our study aimed to answer two key questions: (1) What is the impact of climate-related shocks such as droughts on food insecurity in rural Ethiopia? (2) To what extent can access to financial services assist households to mitigate the negative impacts of climate-related shocks on food security? We hypothesised that climate-related shocks negatively affect household welfare. However, the decline in household welfare is expected to be less for households with access to financial services than for those without access. 

Financial inclusion, which refers to the provision of affordable and fit-for-purpose financial products to consumers who need them, has been recognised as an important coping mechanism helping households adapt to adverse shocks (Moore et al., 2019). In Ethiopia and other contexts, it is reported that households mostly rely on precautionary savings to reduce the impact of shocks (Moore et al., 2019; Ro & Lee, 2026). For instance, 49% of rural households who have experienced climate-related or other shocks reported that they rely on their own savings to cope with shocks (see Figure 1).

Figure 1: Household coping strategies following shocks in rural Ethiopia

Source: Authors’ compilation using data from ESS (2016).

Financial inclusion can improve household welfare by facilitating households’ access to credit, insurance, formal saving, and the ability to receive remittances or other payments, which are critical for households to adopt various coping and recovery strategies during shocks (Moore et al., 2019). However, empirical evidence on the effectiveness of financial inclusion as a coping mechanism is context-specific and produces mixed outcomes in various contexts (see Ro & Lee, 2026). For instance, while saving is associated with improved food security in rural areas, the use of credit is associated with lower food security (Baborska et al., 2020). These findings suggest that, although access to credit is an alternative means of obtaining funds in the absence of saving, debt repayment under high interest rates may compromise the budget available to meet the food demands of households (Baborska et al., 2020).

In this research, we used nationally representative panel data from the Ethiopian Socioeconomic Survey (ESS) collected in 2014 and 2016. This allowed us to estimate the impact of the 2015/2016 drought in Ethiopia, which was one of the worst in recent years. We used two indicators to measure food insecurity: the FAO’s Food Insecurity Experience Scale (FIES) and households’ responses to a question on whether they were ever in a situation where they did not have enough food to feed the family in the 12 months prior to the survey. To measure climate-related shocks, we combined household data with exogenous climate-related shock indicators derived from satellite-based weather data. We also used self-reported information to identify households that have experienced climate-related shocks. Financial inclusion is proxied for by account ownership, savings, and borrowing at formal financial institutions. Using these indicators, we created a financial inclusion index. Our econometric strategy relies on the correlated random effects (CRE) approach and an estimation approach that combines the CRE approach with a control function method (Bates et al., 2024). We instrumented the use of formal financial services using households’ proximity (in kilometres) to financial institutions in a village or community. Additionally, we used the proportion of community-level reported climate-related shocks to instrument for self-reported shocks.

Our findings show that households that had experienced climate-related shocks were more likely to become food insecure (Figure 2). We also show that the use of formal financial services is associated with a lower likelihood of reporting food insecurity. Our results also show that informal saving is associated with a lower likelihood of reporting food insecurity, suggesting that precautionary savings, whether formal or informal, can serve as a major financial resource for investment in diverse income-generating activities that improve household food security.

Figure 2: Impact of climate-related shocks on food insecurity

Source: Authors’ estimation using data from ESS (2013/14 & 2015/16). All regressions control for socioeconomic factors, as well as time- and region-fixed effects.

In addition, we find that the negative effects of climate-related shocks on food security are less pronounced among households that use formal financial services, including savings and borrowing (Figure 3). These findings contribute to the growing body of empirical evidence highlighting the mitigating role of financial access during shocks (Abiona & Koppensteiner, 2022; Riley, 2018). Our results suggest that access to formal financial products—such as savings accounts and credit—can serve as a valuable resource for smoothing consumption and investing in diverse income-generating activities, thereby strengthening household food security. Accordingly, expanding access to formal savings and credit facilities, particularly in rural and underserved areas, should be a priority for both governments and financial institutions, as it can help households to build financial resilience to climate-related shocks. Importantly, such financial products must be tailored to the needs of agricultural communities, accounting for the seasonal nature of income and expenditures, while also enabling savings and offering affordable credit during critical periods.

Figure 3: Testing for interaction effects of shocks and formal saving and borrowing

 Source: Authors’ estimation using data from ESS (2013/14 & 2015/16).

The revised version of the paper is undergoing a final review for the Review of Development Economics journal. 

Here is the link to the working paper version of the paper.

References

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