# **<u>Box 4.3: World Bank Intermediation Services for Malawi Weather Indexed Insurance</u>**

Weather derivatives are designed to provide compensation for financial loss related to adverse weather events. Contracts can be based on measureable weather events, such as excessive or insufficient rainfall, temperatures (extreme heat/cold), and tropical storms, hurricanes, cyclones, and typhoons. Contracts are based on an underlying weather index and payments are triggered by adverse weather events according to prespecified conditions. Weather risk management transactions can be customized according to each country’s specific needs: the type of weather hazard, level of protection, and estimated financial loss associated with a severe and catastrophic event. These can be applied to agriculture and energy production, as well as hedging tourism revenues.

Even though these instruments became available in the late 1990s, some countries, such as Malawi, have reduced access to market-based risk-management tools because of market inefficiencies and limited capacity. Almost 90 percent of Malawi’s population lives in rural areas and engages mainly in smallholder, rain-fed subsistence farming. Agriculture contributes 38 percent of the country’s GDP, and the weak and erratic performance of the agricultural sector, mostly a result of the impact of drought, has constrained growth in the country. Maize production, in particular, is a crucial element of food security and recurrent drought leads to chronic and widespread malnutrition.

In response to the Government’s request, the World Bank helped identify when weather risk management instruments can be appropriately used as part of a comprehensive agricultural risk management framework. Based on this analysis, the Bank structured a market-based tool for commodity price risk reduction. The contract was designed as an option on a rainfall index. The index links rainfall and maize production so that, if precipitation falls below a certain level, the index will reflect the projected loss in maize production. Under the contract, if the maize production in the country, as estimated by the rainfall index, falls 10 percent below the historical average, Malawi will receive a payout of up to a maximum of US$5 million. DfID paid the premium for the contract on behalf of the Government and the World Bank. The Bank’s Treasury Department then transacted the contract with a market counterparty. The payout could be used as part of a broader framework to finance commodity price risk management strategies.

_Source:_ IBRD.

# 4.34 **Multilateral development banks, such as IBRD, are increasingly involved in**

**providing technical assistance and intermediation services for currency swaps** , for example, by embedding them in IBRD Flexible and Fixed Spread Loans or as stand-alone products for other IBRD loans and non-IBRD creditors’ debt. The Bank’s intermediation of swaps allows borrowers to benefit from IBRD’s superior credit rating to achieve better terms at a lower cost. For instance, an IBRD swap for Mexico transferred foreign currency risk from the borrower to the market. Swap intermediation for Bulgaria helped reduce the vulnerability of its debt portfolio to external shocks by reducing its exposure to U.S. dollars. Swaps can also help change the currency composition of developing country debt portfolios. In 2004, IBRD contracted with financial intermediaries in the market to swap U.S. dollars for euros, and a variable interest rate for a fixed rate for the maturity of the loan. This reduced Morocco’s U.S. dollar liabilities and the interest rate risk of its external debt portfolio.

4.35 **In countries where swap markets are illiquid or nonexistent, back-to-back financing allows IBRD to extend a loan in local currency to sovereign borrowers.** To undertake this transaction, IBRD issues a local currency-denominated bond in the domestic market and uses the proceeds to extend a loan with similar terms. Depending on country conditions, this type of transaction can help mitigate currency risks while enabling domestic market development. For instance, in one application of this approach, IBRD issued a Uruguayan peso-denominated bond at levels lower than the Government of Uruguay’s own cost of funding.

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