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However, there is a dearth of schemes that structure the payout so as to maximize incentives for lenders to minimize loan losses (Beck and others 2010). Finally, among risk management practices, guarantee schemes can reduce lenders’ own ex post exposure to loan defaults through reinsurance, loan sales, or portfolio securitization. Risk diversification abilities are tied to the development of local capital markets and financial products. Beck and others (2010) find that 76 percent of guarantee schemes use risk management tools. This figure is encouraging since the authors also find that schemes that do not use risk management tools exhibit higher incidence of default losses. Finally, recent research shows that 49 percent of the 76 credit-guaranteed schemes covered in Beck and others (2010) are funded by governments. The government has a much more limited role in management, risk assessment, and recovery: less than 20 percent of schemes are managed by governments, and credit risk assessment and recovery are conducted by governments in only approximately 10 percent of the schemes. Government-backed guarantee schemes with responsibilities in credit risk and recovery are typically older, are more prone to guarantee loan portfolios, pay out after the bank initiates recovery, and lack a risk management program. These results are consistent with the notion that guarantee schemes with greater government involvement are less likely to manage risk and losses. Consistent with these findings, Beck and others (2010) find that government involvement in credit decisions is associated with higher incidence of default losses. Overall, although government-backed credit guarantee schemes might help jumpstart lending to certain borrowers in certain sectors, these schemes are not likely to have large macroeconomic effects nor are they likely to work as truly countercyclical tools. Furthermore, they cannot substitute for reform of the underlying institutional requirements of an effective credit system and should not diminish the focus on these long-term reforms. For instance, improving collateral
GLOBAL financial DEVELOPMENT REPORT 2013
laws and enforcement mechanisms is preferable to government interventions in addressing inadequacies of the legal framework associated with the credit system (Holden 1997; Vogel and Adams 1997). Although rigorous impact evaluations of their costs and benefits are still scarce, their performance hinges on good design, which is more challenging to get right in weak institutional environments. Best-practice lessons suggest that the most successful credit guarantee schemes are those that move to broad eligibility and other criteria, reduce subsidies, and make greater use of the portfolio and wholesaling approach in preference to case-by-case evaluation by the guarantor of retail loans. Finally, deploying credit through stateowned banks and extending credit guarantees were not the only means used by governments to prop up financial conditions during the recent crisis. 25 Some countries implemented alternative strategies to offset the credit crunch using their central banks. In addition to traditional policies such as interest rate cuts to support aggregate demand, developed economies tried to revive the ailing financial markets by implementing unconventional monetary policies that led to the expansion and change in the composition of their central bank’s balance sheets. The wide array of measures implemented include the U.S. Federal Reserve Board’s purchase of long-term Treasury bills, the European Central Bank’s purchase of covered bonds, relaxation of the collateral framework to access the discount window, changes in funding terms or auction schedules, support of money markets, and foreign currency swaps.26 Using the central bank as a countercyclical tool in times of crisis has its advantages. This type of intervention not only has smaller implementation lags but also is easier to unwind. Generating mechanisms to retrench lending activity by state-owned banks is more cumbersome, especially during the expansion that follows a crisis. However, legal constraints and credibility issues due to high inflation episodes may make it difficult for emerging markets to use a more unconventional approach to central banking and credit