GLOBAL financial DEVELOPMENT REPORT 2013
Credit guarantees can generate financial and economic benefits; however, because the programs are generally targeted to specific sectors, they are unlikely to have large macroeconomic effects. Also, they are not truly countercyclical tools since they do not tend to contract during periods of economic booms. At the same time, they can bring about sizable displacements and deadweight losses. For instance, there is evidence that a large and growing share of guarantees granted by FOGAPE have been allocated to the same firms (Benavente, Galetovic, and Sanhueza 2006). In addition, approximately half of the guaranteed loans in the Philippines went to borrowers with sufficient collateral, thus generating significant deadweight loss (Saldana 2000). In Pakistan, half of the subsidized credit for exporters went to financially unconstrained firms that did not need the funds, and the diversion in unneeded credit to beneficiary firms could have held GDP below its potential by 0.75 percent (Zia 2008). There is also evidence of significant costs in credit guarantee schemes among developed nations. The massive credit guarantee program implemented by the government of Japan between 1998 and 2001 rendered only a temporary availability of funds for the intended program participants, and their ex post performance deteriorated relative to nonusers of the guarantee. Also, major banks often used the guarantee scheme to replace nonguarantee loans with guaranteed ones to minimize their exposure to risky assets (Uesugi, Sakai, and Yamashiro (2010). Another scheme set up by the Japanese government in October 2008, the Emergency Credit Guarantee Program, failed to translate a greater availability of funds into higher investment and employment among user firms and, in addition, deteriorated their creditworthiness (Ono, Uesugi, and Yasuda 2011). The success of credit guarantees is tightly linked to the design of the scheme. The literature identifies and discusses a set of good practices that contribute to the successful implementation of a credit guarantee scheme (Beck and others 2010; Green 2003;
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Honohan 2010). For instance, credit risk assessment practices should be outsourced to the private sector (rather than being conducted by the government) to improve the quality of risk decisions and to minimize loan losses. However, outsourcing risk management in the case of public guarantee schemes could potentially lead the lender to assign to the guarantee the worst eligible risks in the portfolio. This can be mitigated by penalizing lenders that have high claims and by imposing higher future premium payments. Targeting for the credit guarantee scheme should be broad (for example, specific sector and areas) if the focus remains on credit-constrained groups, whereas too-specific targeting may involve high bureaucratic costs that might distort lending decisions. The coverage ratios determined by the scheme should provide incentives for lenders to properly assess and monitor borrowers. Most practitioners argue that lenders should retain a significant part of the risk—for example, from 30 to 40 percent. However, in practice, 40 percent of the 76 credit guarantee schemes analyzed in Beck and others (2010) offer guarantees of up to 100 percent. The median coverage is 80 percent, which is certainly not in line with providing incentives for lenders to properly assess and monitor borrowers. Guarantee programs with coverage ratios between 90 and 100 percent have been shown to bring about large losses. For instance, the rural credit guarantee fund established by the Lithuanian government, which offered 100 percent coverage for loans aimed at financing the purchase of tractors and other agricultural equipment, brought about a large number of bad loans within three years of its starting date (Rute 2002). Regarding the pricing of credit guarantees, the fees charged by the scheme should be high enough to ensure financial sustainability of the fund and low enough to secure adequate participation by lenders and borrowers. The payout of the guarantee should take place after the bank initiates legal action following default in order to reduce moral hazard on the side of the lender, who might be too quick to write off a loan after default.