Adverse selections and microfinance in rural Africa: signalling through environmental services

The ability of microfinance institutions to identify sound and creditworthy clients in the area of agriculture in developing countries is difficult. The rural poor usually portray their farming activities as successful, even though this may not be the case. This gives rise to issues of adverse selection and loan default. Can certified environmental services (i.e. carbon credits) in rural sub-Saharan Africa provide adequate signalling for project success? This paper applies the standard game theory approach — similar to that set forth in previous publications — to adverse selection in developing countries in connection with certified environmental services. The results suggest that in a separating equilibrium, borrowers with certification (carbon credits) send a positive signal regarding the actual state of their farming activities which may ease adverse selection problems.