Access to finance: the place of credit guarantee schemes

Bernd BalkenholILO

www.ilo.org/socialfinance

Underlying issue:

Information asymmetry

Credit guarantee fund?

• Public funded

• Separate entity or account

• Single service

• Risk sharing

• To the benefit of targeted clients

• Settlement of bank claims on certain conditions

Different approaches to information asymmetry: MF and CGF

• External: third party of third party

• Internal: collateral substitution

Presence of guarantee funds: a function of SME density?

• High income countries

• Transition economies and post crisis

• Low income economies

Political economy of CGF

• SMEs are backbone of economy

• Organized lobby

• CGF flag government commitment

How do CGFs function?

• Referral bank to GF

• Appraisal guarantee worthiness

• Appraisal credit worthiness

• If default, bank turns against GF

• GF checks and settles

• GF tries to recover from debtor

Why would a bank play along?

• In theory, the default coverage assumed by GF turns a loss making proposition into a profitable operation (taking into account administrative costs involved)

• In practice, it’s more complicated.

GFs and MGAs

• Mutual guarantee associations are single product financial cooperatives.

• Member-based.

• Idea is that professionals know viability, risk and return of a loan application, better than administrations and banks.

• Otherwise very similar, even here much government involvement.

Rationale: why government?

Information on default risk costly to

generate and difficult to monopolize.

Alternatives to address information asymmetries

• Improve financial infrastructure

• Modernize judicial system and property rights

What makes a good credit guarantee fund: criteria

• Cost effectiveness

• Additionality

• Sustainability

• Systemic learning effects

• Scale

Why would ownership of the credit guarantee mechanism matter?

• Mutual type: information advantages, proximity, but also moral hazard and collusion

• Public type: size and diversification potential, revenue generation, but also adverse selection, lack of familiarity

Comparative performance

• Public type: more leverage, more outreach, but subsidy dependent (except SBLA in Canada)

• Mutual type: scope for additional collateral

• Otherwise: not much difference in performance; what matters more is scale advantages, design, competition in local financial market

A case

• Government goal: self employment for hundreds of thousands of laid off workers by 2010

• Challenge: microfinance not authorized. Need to involve local banks. Solution adopted by Government: set up thousands of credit guarantee schemes to facilitate access to bank credit.

Design of the credit guarantee schemes

• Max loan amount $ 2500

• Max maturity: 2 years

• Interest rate: fully subsidized and subject to control by central bank

• Max guarantee fee: 1%

• Risk sharing: 0% on the bank, 100% on CGS

• Max leverage: 1 : 5

Status of CGS (ILO evaluation)

• Guarantee capital average: $ 127,000

• Loans guaranteed in 3 years: from 662 to 7812 per scheme

• Target group precision: 82% to 89% LOW

• Average loan amount: $ 2150 – 6300

• RoA: - 33% to 1,2%

Design flaws

• No incentives, no stakes for banks

• Complicated procedures

• Lack of credit awareness borrowers

• Administrative interference

• High delinquency

• Pressure to disburse

• Governance diffuse

Lessons 1

• CGF need to be independent and professionally managed

• Credit risk must be shared

• Bank must do it own appraisal

• Set adequate guarantee level

• Qualified staff

Lessons 2

• Budget surpluses weaken considerations for sustainability.

• Short term policy emergencies overshadow legitimate longer term goals to ease market access problems.

• Excessive targeting and absent incentives produce lukewarm bank involvement.

• Under these circumstances it is a challenge to advise on better policy, but still necessary.

ILO work on guarantee funds

• Advise on design and management (Ministries of Labor managing social funds)

• Staff training (Boulder)

• Manual on CGF management

• Audits