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Public Disclosure Authorized

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WORLD BANK TECHNICAL PAPER NUMBER 58
INDUSTRY AND FINANCE SERIES

Credit Guarantee Schemes

for Small and Medium Enterprises
Public Disclosure Authorized

Jacob Levitsky and Ranga N. Prasad

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Public Disclosure Authorized

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Public Disclosure Authorized
 WORLDBANKTECHNICALPAPERNUMBER56
INDUSTRYAND FINANCESERIES

CreditGuaranteeSchemes
for SmallandMediumEnterprises

JacobLevitskyand RangaN. Prasad

The World Bank

Washington.D.C.
Copyright i 1989
The International Bank for Reconstruction
and Development/THE WORLDBANK
1818H Street, N.W.
Washington, D.C. 20433,U.S.A.

All rights reserved

Manufactured in the United States of America
First printing September 1989
Third printing June 1995

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Jacob Levitsky is an operations adviser and Ranga N. Prasad a staff member in the Industry Department
of the World Bank.

Library of Congress Cataloging-in-Publication Data

Levitsky, Jacob, 1924-

Credit guarantee schemes for small and medium
enterprises.

(Industry and finance series, ISSN0256-2235 ; v. 19)

(World Bank technical paper, ISSN 0253-7494 ; no. 58)
Bibliography: p.
1. Insurance, Credit. I. Prasad, Ranga N.,
1957- . II. Title. III. Series. IV. Series:
World Bank technical paper ; no. 58.
HG9977.L48 1987 658.8'7 86-32571
ISBN 0-8213-0866-1
 iii

ABSTRACT

This paper provides informationon a variety of credit guarantee

schemes in 27 developed and developing countries. Some of the schemes have
been In operation for 40 to 50 years, while others have been introduced
only in the past few years. Difficultieswere encounteredin obtaining
reliable data on the experienceof some of the schemes, particularlythe
more recent ones, so, regrettably,there are some gaps in the completeness
of the data and the periods covered. While the authors make no claim to
completeness,it is believed that the informationgiven in the paper will
enable the reader to understand the essential elements, scope, and variety
of such schemes, and the problems they face in their operations.

The first part of the paper is devoted to a comprehensivereview

of the issues involved in the design and implementationof credit guarantee
schemes, based on the experienceaccumulated in the countrieswhere such
schemes have operated.
 iv

ACKNOWLEDGMENTS

Acknowledgments are due to the work of the consultants--

Robert Davenport,who providedsome of the material on the U.S. scheme, and
Alan Doran, from whose paper most of the informationon the schemes in
Europe and Japan has been taken. Other sources of informationare given itn
the bibliography.
 v

TABLE OF CONTENTS

CHAPTER 1. A REVIEW OF THE ISSUES IN THE OPERATION OF CREDIT

GUARANTEE SCHEMES ..........
.. ............. . ..
... *. *. . 1

Objectives of Schemes 1
I...................
Operation of Schemes ...... *.
. *.
.......... .... . 3
Assessment of Guarantee Schemes ................ 11

PART I. SCHEKES IN OPERATION IN DEVELOPED COUNTRIES ...... 15

CHAPTER 2. NORTH AMERICA ............. 17

United States ..... .17

Canada 21

CHAPTER
3. EUROPE ............... 23

France 23
Germany, Federal Republic of 26
Italy 29
Netherlands .............. 31
Portugal o...34
UnitedKingdom 36

CHAPTER 4. ASIA AND THE PACIFIC ............ 39

Japan 39
New Zealand 41

PART II. SCHEKES IN OPERATION IN DEVELOPING COUNTRIES ..... 43

CHAPTER 5. ASIA 45

India 45
Indonesia 50
Korea, Republic of 51
Malaysia 54
Nepal 57
Philippines ..... 59
Sri Lanka ......... 63
Tbailand 64

CHAPTER 6. AFRICA ................. 66

Cameroon 66
Ghana 68
Liberia 71
Morocco 73
Tunisia 76
 vi

CHAPTER 7. LATIN AMERICA AND THE CARIBBEAN .................. 77

Barbados .........
o..oo..o.....
... og...
oo...........
eoo...... 77
Colomabia ...
o........e...o..oooo...oo...oo.....o....ooo......
80
Haiti ................................................... *.e 82
Jamaica ................ ..................... 84
U.S. Aid Programs ....... ........................ 85

SELECTED BIBLIOGRAPHY ... .......................... 89

 CHAPTER 1

A REVIEW OF THE ISSUES IN THE OPERATION

OF CREDIT GUARANTEE SCHEMES

Smaller business enterprises in both industrializedand

developingcountrieshave difficultiesin obtaining financialassistance
from banks and financial institutions. In fact, studies have shown that
most small enterprisesstart their lives without any institutional
help. The entrepreneurusually obtains the small amount of finance he
needs from his own savings or from his family. However, small enterprises
find it difficult to grow without the opportunityto borrow from lending
institutions.

The reasons why small enterpriseshave limited access to

institutionalfinance are well known. They are:

(1) Lending to small enterprises is consideredto be risky. The

uncertaintiesfacing small industry, the high mortality rate of
such enterprisesand their vulnerabilityto market and economic
changes make banks reluctant to deal with them, and there is a
parallel reluctanceon the part of small-scaleenterprises (SSE)
to borrow from banks.

(2) Banks and financial institutionsare biased in favor of lending

to large corporate borrowers. In some countries there are links
between banks and corporate borrowers that take the forms of
joint directorships,joint ownerships,and various other joint
financial dealings.

(3) The administrativecosts of lending to small enterprisesare

high and cut deep into the profitabilityof such loans.

(4) Small enterprisesseeking loans are unable or unwilling to

provide accountingrecords and other documentationrequiredby
banks, or to provide securitiesor collateralfor the loans.

In an attempt to overcome some of these problems,particularly

the perceived high risks of lending to small enterprisesand their
inability to provide collateral,credit guarantee schemes have been
introduced.

OBJECTIVESOF SCHEMES

Credit guarantee schemes are set up with the purpose of covering

some portion of the losses incurredwhen borrowers default on loans. The
purpose of such schemes is to encourage financial institutions,and in
particularcommercialbanks, to lend to small businesseswith viable
projects and good prospects of success but which are unable to provide
adequate collateralor which do not have a suitable record of financial
transactionsto prove that they are creditworthy. In some cases the
 -2-

schemes provide guaranteesonly for loans for investmentin fixed assets;

in others the schemes guarantee loans for working capital as well. The
Canadian and French schemes, for example, specificallyexclude guarantees
for working capital. The majority of guaranteesgiven in Japan, on the
other hand, are for working capital loans. In most industrializedcoun-
tries, guarantee schemes for loans for fixed assets or for working capital,
or both, are the main form of governmentassistanceto the small business
sector. Such schemes operate in the United States, Canada, Japan,
Australia,New Zealand, and in virtually all the countries of Western
Europe.

The basic feature of most guarantee schemes is that the risk of

loss is shared in an agreed proportionbetween the lender and the guarantee
organization. Experience indicatesthat guarantee schemes tend to work
best when the guaranteesare given for creditworthyclients with good proj-
ects who are unable to obtain loans because they cannot satisfy the len-
der's requirementfor collateral. Even in developed countries,guarantee
schemes that have attempted to provide guaranteesfor risky borrowersor
risky projects have generally run into problems. All banks are, in effect,
guaranteeingagainst defaultswhen they make loans as a normal part of
their business. It is inherent in banking operationsthat commercial
lenders should be prepared to take such risks and to guarantee their own
loans. No amount of collateralor guarantee can, or should, entirely
eliminate the risk. In practice, the majority of bank lending is to busi-
nesses, organizations,or individualswith whom the institutionhas already
developed a relationship. In this way the risk is reduced to defaults due
to unexpectedhappeningsor a general deteriorationof the economy. There
remains, however, the problem of first-timeborrowers,new enterprises,and
those borrowers who, for one reason or another,have still to establish a
record of creditworthiness.

It is often argued that healthy financial institutions,and

particularlycommercialbanks, should extend a certain amount of unsecured
credit-that is, loans without adequate collateral-on the basis of know-
ledge of, and belief in, a particularborrower'sbusiness capacity and
economic prospects. In practice, such lending is quite limited. Most
financial institutionsbelieve that they must protect themselvesin the
event that the borrower becomes unable or unwilling to repay the loan.
They, therefore,demand securitiesor the pledging of assets or collateral
which may be possessed in the event of default.

Baniksface a more complex situationwhen they make loans that

will be repaid over a period of several years. While it may be acceptable
to rely on judgementsof the character,ability,and financialprospects
of a borrower applying for short-termcredit, this becomes much more
difficult in the case of long-term loans. The uncertainty increaseswith
the length of time for repayment.
 -3-

In theory, recourse to collateralor other assets provides an

element of security to a lending institutionthat, even in the event of a
default, it will not incur serious loss. In practice, however,banks tend
to regard collateralchiefly as a means of exertingpressure on the borrow-
er to make maximum efforts to repay. Foreclosingon collateralis a long
drawn-out process that often involvescostly litigation. In many cases,
assets pledged as collateralrealize substantiallyless than estimated,in
part because of the time and manner in which they are disposed of. In some
countries there are legal problems and restrictionsthat make the process
even more difficult. Generally, it is the hope of lending institutions
that recourse to collateralwill only have to be used as an ultimate
measure and that fear of foreclosure,togetherwith the process of pressure
and renegotiation,will lead to repayment. For this reason, banks often
rescheduledebt payment and make other sorts of financial arrangements
rather than forecloseon a loan.

Commercialbanks generally like to build long-term relationships

with clients and prefer to rely on their own judgementsin assessing the
creditworthinessof a borrower and his business prospects. They are often
reluctant to rely on another organization,even one that is willing to
share the risk of default, to interpose itself between the bank and the
client. Banks also feel that a borrowerwho defaults reflectspoor
judgement on the part of the bank, even if the loan is guaranteedand the
actual loss turns out to be low. There have been cases where commercial
banks have foregone the right to claim reimbursementfrom a guarantee fund
rather than admit the details of a default, especiallywhen the sum
involvedwas not large.

Some commercialbanks who look with disfavoron guarantee schemes

claim that, in many cases, those who receive guaranteesare often borrowers
who would have been able to obtain loans under normal procedures. Even
when a guarantee fund is in operation,lending institutionsoften prefer to
obtain pledges of collateralfrom borrowersrather than relying exclusively
on guarantees. Nevertheless,many countries have been attractedto the
idea of introducingguarantee schemes in the belief that they encourage
commerciallending institutionsto be less stringent in demanding
collateraland so make them readier to lend to small enterprises.

OPERATION OF SCHEMES

Design of Schemes. A guarantee scheme can work in different

ways. Typically,a potential borrowerwho cannot meet a bank's lending
criteria--whichusually means the borrower cannot provide satisfactory
collateral-is referredby the bank to a credit guarantee organization. In
theory, this organizationwill investigatethe borrower'screditworthiness,
the use to which the loan is to be put, and his prospectiveability to
service the debt. If it is found that the case is suitable for a guaran-
tee, the borrower returns to the bank with appropriatecertificationthat
he has been accepted for a guarantee. Usually, the guarantee involves the
payment of a premium, whose amount depends on the size of the amount being
guaranteed.
 -4-

The above is the general descriptionof the usual process, but ink
practice there are substantialvariations. In particular,schemes differ
in the manner in which the tasks of investigationand appraisal are apport-
ioned. Although most schemes, including the more successfulones, provide
for independentinvestigationby the guarantee institutionor some indepen-
dent group, this is often no more than a cursory review. Sometimes,the
task is given over entirely to the lending bank, and approval of the gua-
rantee becomes automatic. This seems to be one of the key issues in the
operation of guarantee schemes. Clearly, in cases where investigationand
appraisal of loan applicationsare handed over completelyto the bank and
the guarantee becomes automatic,there is a real danger that the banks will
transfer all loans they perceive as risky to the guarantee scheme, even if
they have obtained adequate collateral. When this happens, the whole pur-
pose of the scheme is defeated. On the other hand, independentinvestiga-
tion of applicationsfor guarantees, it is claimed, makes the system more
bureaucratic,introducesdelays, and raises costs.

Experience has shown that each request for a guarantee should be

investigatedindependently,even if the investigationconsistsmainly of a
review of the bank's appraisal of the loan request. It is significantthat
one of the better known schemes in a developingcountry, that of the Korean
Credit GuaranteeFund, relies heavily on independentappraisal of loan
guarantee applications. In fact, there is evidence that in this case, as
in some others in developed countries,the banks tend to rely on investiga-
tion and approval by the guarantee institutionfor satisfyingthemselves
that the loan should be approved. But it takes time and a competent staff
for a guarantee organizationto build up this degree of credibilitywith
commercialbanks. It cannot be stated too often that credibilitycannot be
achieved solely by insistingon formal procedures.

Many schemes in developingcountries have placed limits on the

size of firms that will be allowed to benefit from the scheme in order to
limit guarantees to small enterprisesonly. Limits are often placed on
how much of any single borrower's loan will be guaranteed. The practice of
excluding institutionswith poor portfoliomanagement and high levels of
defaults is sometimes taken a step further through the introductionof a
system of accreditation. Lending institutionsthat have good records on
appraisal, loan screening,and debt collectionare given accreditation,
meaning that their loans are guaranteedautomatically. If such a system is
introduced,it is important to monitor these institutionscontinuously.

Risk Sharing. A key issue that arises in designing a guarantee

scheme is determininghow the risk will be shared between the lending
institutionand the guarantee fund. Loans in Japan and France are
guaranteed 100% in some cases and the bank assumes none of the risk. The
more general situationin Europe and some developingcountries is to assign
between 20 and 50% of the risk to the lending institution. There is some
indicationthat where the risk of the lending institutionis 30% or more,
the institutionsare less interestedin guarantee schemes because they must
go through the process of appraisal and obtaining collateralto cover,their
 -5-

part of the risk and the costs do not justify adhering to the formalities
necessary to obtain a guarantee. In schemes where the risk of the lending
institutionis lower than 20%, there is a danger that more risky loans are
sent for guarantees since the lending institutionhas little to lose.

Most countries are reluctant to establish a guarantee system

where the banks assume no part of the risk. But evidence from such schemes
in Japan and France seems to show that such guarantee schemes are more
widely used and do not seem to result in excessivelyhigh losses. If
requests for guaranteesare carefully screened and investigated,and the
scheme operates in an environmentwhere loan default may seriouslyaffect
further business and credit prospects,and where financial institutionsmay
jealously guard their reputationfor good judgement, there may be no
greater risk in a program that provides a 100% guarantee than one guaran-
teeing 75% or less. Such is, apparently,the situation in Japan.

Some schemes allow banks to decide what proportionof a loan--

up to a specifiedmaximum--willbe made at their own risk and what propor-
tion will be lent against the government'sguarantee. When a scheme makes
it possible to vary the proportionof the risk, most loans tend to be gua-
ranteed to the maximum allowed. To safeguard against abuse, most schemes
require banks to bear at least a certain minimum portion of the risk-that
is, between 20 and 25%. There are other safeguardsas well. In the
Netherlands,for example, the government reserves the right to reject a
claim and refuse payment against a guarantee if it can show that the bank
has not taken all reasonableprecautionsagainst default, includinga tho-
rough check of the creditworthinessof the applicant. Another type of
safeguard is found in the Canadian scheme, which is forbiddenby law to
provide guaranteesfor loans for working capital. On the other hand, 85%
of all Japanese guaranteesare given for working capital loans.

The conditionsfound in Japan do not generally exist in develop-

ing countries. It is important,therefore,to make sure the banks use
guarantee schemes prudently,and it is appropriateto require the banks
themselvesto cover some of the risk. But there is also the problem of
making guarantee schemes attractiveenough to encourage banks to partici-
pate. The evidence collected from most developing countries--andalso to
some extent from developed countries-indicates that banks are never very
enthusiasticabout guarantee schemes. They may either lack confidencethat
their claims will be met if default takes place, or they may fear that
satisfactionof their claims will involve considerabledelay and costly
administrativework. As mentioned above, they also tend to regard any
increase in their default rate as an indicationof poor banking practice
even if the defaults are covered by credit guarantees,and they generally
prefer more conservativelending practices..For these reasons, it is
necessary to encourage banks to participatein guarantee schemes by
reducing their share of the risk. If it is felt that it is desirable to
establish safeguardsagainst imprudent use of the scheme by particular
institutions,it may be advisable to impose limits on how much of a bank's
loans will be eligible for guaranteesand to provide that lending institut-
 -6-

ions which make a disproportionatelyhigh level of claims can be excluded.

Furthermore,if the claims rate rises unduly there may be a case for
raising the proportionof the risk to be covered by the lending bank.

Guarantee Fees. Most guarantee systems require the payment of a

fee, or premium, for the guarantee. This fee is assessed in various ways.
Sometimes the fee includes payment for the investigationby the guarantee
organizationalong with a 1 or 2% fee to the bank. Some schemes take a
one-timepayment of 2 to 4% when the loan is arranged,but most schemes
prefer an annual premium of between I and 2% on the guaranteedportion. At
one extreme,one finds situationswhere no premium or investigationfee is
charged. At the other extreme are fees of 4%, which are found in the
United Kingdom and Indonesia. When a guarantee scheme was launched in the
United Kingdom in 1981, it was believed that the fee (then 3%) would be
adequate to cover not only administrativecosts but also the payment of all
claims. This view soon proved too be over-optimistic.

The argument for imposing a one-time payment for a guarantee is

that this insures greater equity--thatis, that all borrowerswill contrib-
ute to the cost of the scheme. In cases where an annual fee or premium is
charged on the guaranteedportion, a borrowerwho repays a long-term loan
on time makes a much greater contributionthan either an early defaulter or
a short-termborrower. Those who favor annual payments, on the other hand,
point to the disproportionin the total paymentsmade by short-termborrow-
ers who are charged a one-time front-end fee. A more equitable arrangement
might be a small front-end payment and an annual fee on the guaranteed
portion.

In a few schemes, such as those in India and in certain Latin

America countries,the fee is charged on the total loans, not just the
guaranteedportion. The argumentused in India was that this made larger
borrowers contributemore, thus making the scheme more viable. Such an
arrangementmakes the guaranteemore costly in some cases (e.g., where the
guaranteedportion is small) and is feasible only where banks participating
in the scheme are required to obtain guarantees for all of their loans.

Annual fees in developingcountriesusually run about 1%. It is

believed that higher fees would discouragebanks as well as borrowers,to
whom the charge is usually passed on. However, since many schemes,partic--
ularly in developingcountries,carry low subsidizedlending rates, the fee
can be absorbedwithout making the loan unduly expensive to the borrower.
A proposalwas made in Indonesia in 1983 to raise the front-endpremium to
4% from 3%. This would appear to be high, but in light of the subsidized
interestrate for small borrowers in Indonesia,and the fact that the Bank
of Indonesia and the lending bank absorb most of the fee (they each pay
1.5% of the premium), the 4% rate does not impose a hardship on borrowers.

The fee or premium charged in r,aost

schemes is insufficientto
cover both administrativecosts and claims for default, although, in all
schemes, it should be adequate to cover the former. Some schemes have had
 -7-

very low administrativecosts because there has been little or no investig-

ation or review of requests for guarantees;decisionshave been based
almost entirely on the recommendationof the lending institutions. Low
administrativecosts may also mean delays in handling claims, with total
reliance for debt recovery placed on the lender after the guarantee claim
has been settled. There is usually much less incentive for a lending
institutionto pursue debt recovery [Link] a guarantee claim has been
settled, although the lender may be motivated to do so if the institutions
own share of the loss for which there is no guarantee is substantial,or if
failure to take steps to pursue a defaultermay result in being barred from
further participationin the guarantee scheme. Developingcountries should
not try to cut administrativecosts by following such practices. It should
be possible to cover administrativecosts with an annual fee of 1% on
guaranteed amounts. In the United States the Small Business Administration
assesses a fee of 0.7% to pay the administrativecost of each guarantee.

In schemes where claims are low the fees may cover claims as well
as administrativecosts, but when this happens the reason is likely to be
an overly conservativeappraisal of loans or continuationof demand for
collateral,so that the guarantee scheme is not really fulfillingits
objective. In some funded schemes, such as that in Korea, returns on
investmentof accumulatedreserves have provided a substantialrevenue,
particularlyin the early period of operationwhen claims are usually low.

Handling Claims. Experienceshows that a guarantee scheme builds

up its credibilityprincipallyby how claims are handled. A scheme that
has the best chance of succeedingis one that clearly lays down regulations
on when a claim will be paid. A commitmenton the part of a guarantee
organizationto settle claims quickly also helps its credibility. The
regulationsshould specify the period of arrears after which the guarantee
may be invoked and what specific steps the lending institutionis required
to take to satisfy the guarantee organizationthat it has made efforts to
obtain repayment. Once a guarantee has been approved, responsibilityrests
with the guarantee organization,and the question of whether the lending
institutionprocessed the loan applicationwith due care can only be
reopened if there is clear evidence of misrepresentationwhen the loan
documentswere submitted. Even then, if confidencein the scheme is to be
maintained, the review should be after payment has been made against the
claim. In settling claims the guarantee organizationshould reserve the
right to reopen the case if further informationis forthcomingindicating
gross negligenceor misrepresentationwhen the guaranteewas requestedor
in collectingthe debt.

Every guarantee scheme must be operated efficientlyto deal

quickly with claims. Excessive red tape and delays in payment act as major
deterrents to the readiness of lending institutionsto participatein
guarantee schemes.

All schemes should lay out an agreed process for recoveringfrom

the borrowerwhatever can be recovered towards repayment of a loan, even
 - 8-

after settlementof a claim. In some schemes this task is imposed on the

lending institution;in other cases the guarantee organizationhas this
responsibility. Questions have sometimes been raised as to whether lenders
are likely to proceed vigorouslyagainst debtors once they have been reimb-
ursed. It should be remembered,however, that guarantee funds usually
reimburselending institutionsfor only part of the loss. Furthermore,
most guarantee schemes only guarantee the loan principal and do not include
reimbursementof lost interest. A lender will ordinarilyincur some loss
on the unguaranteedpart of the loan and usually on all, or part, of the
unpaid interest. This should, in most cases, stimulatethe lender to
recover whatever amount it can from the defaulter. A guarantee organiza-
tion can, and should, take steps to exclude lending institutionsthat do
not live up to their obligations to seek recovery of debts. It should also
be understood that invoking a guarantee is a last resort, and that every
attempt should be made to obtain repayment,either through loan recheduling
or through other means. Sometimes,however, the question arises of whether
to proceed against a defaulter where the unpaid portion of the loan is
small and the loss incurredby the lender is insignificant. In practice,
such situationsare rare. Maintaininggood credit relationswith the bank
usually acts as a potent motivation to a borrower to repay the last part of
a loan or to reach some agreement on reschedulingrepayment. Nevertheless,
circumstancesdo arise where decisionshave to be made as to whether the
costs of proceeding against a defaulter are justified in light of the smalL
amount involved.

Giving the guarantee organizationthe task of recoveringlosses

can only be effective if the guarantee organizationis strong enough to
take on the task. Usually, lending institutionswill have more means for
carrying out this task. As the operationsof the Small Business Adminis-
tration in the United States show, debt collectioncan be a heavy adminis-
trative burden.

All repayments,amounts recovered,and losses incurred should be

divided between the lending and guarantee institutionsin proportionto
their degree of risk on the original loan. The question of how recovered
amounts will be shared needs to be spelled out carefully. Some schemes
recognize that the lending institutionshould be compensatedfor lost inte-
rest and for legitimateexpenses involved in debt recovery. To encourage
lenders to vigorouslypursue willful defaulters,some schemes are generous
in allowing the lending institutionsto make prior claims on the amounts
recovered.

Financing of Schemes. Schemes should be designedwith the inten-

tion that the fees and other incomes (e.g., return on investments)will
cover all costs arising from both administrationof the schemes and from
claims. It has been suggested that a guarantee scheme can be treated
statisticallyor actuarialiyin the manner used by insurance firms to set
the appropriatepremiums. Such statisticalanalysis could also help to
determine the appropriaterelationshipbetween the resourcesavailable
(i.e., amount in a guarantee fund) and the amount of guarantees that could
 -9-

reasonablybe given out. It might also provide valuable informationfor

setting the level of the guarantee fee if it is so that the fee (along with
return on capital invested) should cover costs due to claims paid out as
well as administrativeexpenses.

Unfortunately,credit guaranteesor credit insurancecannot be

equated with other insuranceoperations. One needs at least ten years'
records on loan repayment behavior under similar conditionsto reach any
valid statisticalconclusions. Experiencein developed countriesshows
that loan defaults (and payout of guarantee claims) vary significantly
depending on economic conditionsand the quality of evaluations. In a
difficult business environmentwith high unemployment,defaults are usually
higher. Higher interest rates increase loan defaults,while lower interest
rates increase early repayments. It is virtually impossibleto take into
account all the factors in any statisticalprojection of what loss rates
might be.

Nevertheless,some statisticalprojectionsare possibleand

desirable. Using an estimated loan loss rate (which could be a rate deter-
mined as an acceptableobjective based on available data) the cost of
administeringthe scheme, the extent of risk sharing and the guarantee fee
or premium could be set, as could the total amounts of guaranteesthat
could be given for different levels of the guarantee fund. Changes could
then be introducedto take account of any changed pattern revealedby later
data. If defaultswere higher than estimated,a decision could be made to
increase the size of the guarantee fund (either by raising fees or other
means), or to limit the total amount of guarantees. Some such statistical
monitoring of a guarantee scheme is essential for effectivemanagement.
Account would have to be taken of the discountedvalue of loss amounts and
investmentincome accruing from reserve guarantee funds. Such revenuesare
not available to a non-fundedguarantee scheme.

Many schemes in both developed and developingcountries are

funded by governmentsand the amount of guaranteesshould be related to the
size of the fund. The total amount of guaranteesmay be limited, as in
Canada, by legislation,or the limit on the amount of the guaranteesmay be
specified as a multiple of the resources available in the guarantee fund.
In general, there seems to be a tendency in advanced countriesto permit
guaranteesup to a sum of 20-25 times the amount in the fund. In some
cases, however, the limit may be more than 30 times the size of the fund;
it is 36 times the fund size in Germany. In other cases the multiple is
lower than 20. In Barbados the limit was 10 times the sum in the fund. In
Chile a scheme was operating in 1984-85which only permitted guarantees
equal to the total resources in the fund. This was later deemed to be
overly conservative,and the total amount that could be guaranteedwas set
at five times the amount in the fund. After some years of operation,
well-run schemes in developed countries with claims rate of 2 to 4% are
able to give out guarantees for 20 to 25 times the amount in the reserve
fund without undue risk. In the early stages of a guarantee scheme in a
developingcountry,when loans are being made to smaller and less
 - 10 -

establishedborrowers,guaranteesup to 10 times the amount in the fund

would seem to be reasonable. Lending of less than 10 times the amount in
the guarantee fund raises the question of whether the guarantee scheme
serves any real purpose in increasingthe access of small enterprisesto
institutionalfinance. It is better to combine a higher leveragerate with
a higher fee to make the fund financiallyviable rather than to keep the
fee low and structure the fund conservatively.

If claims increaseunduly, steps must be taken either to reduce

the guaranteevolume or to increase the amount in the guarantee fund, and
also to increase the fee. As an indicationof the conservatismof some
schemes, one may cite the guarantee fund in Cameroon-one of the few ope-
rating in Africa--whichwas permitted to guarantee up to seven times the
amount in the fund but after five years of operation had only given guaran-
tees of up to 1.6 times the fund. Such risk aversion on the part of gua-
rantee organizationssoon becomes a major factor in producing a reluctance
on the part of the banks to using the scheme.

There are many other ways in which guarantee schemes can be

financed. In the Philippines,for example, the resourcesof the Industrial
Guarantee Loan Fund (IGLF) come directly from the central bank of the
country (along with some internationalfinancial inputs),which provides
finance for the loans and covers the guaranteesfrom the same fund.
Schemes in the Federal Republic of Germany and Japan are funded through
local or regional credit guarantee associations. These credit guarantee
associationspay the claims against defaults from a fund financedby
contributionsfrom financialinstitutions,local authorities,trade
associations,chambers of commerce, and state, regional, or national
treasuries. In Japan there is a double guarantee system. The guarantees
given by credit guarantee associationsare then insured up to two-thirdsby
the state-financedSmall BusinessCredit InsuranceCorporation.

The credit guarantee scheme in the Republic of Korea is funded

primarily by a levy on the profits of all banking institutionseligible to
participate in the fund. Efforts have been made in some developing
countries,to finance guaranteesschemes through levies on commercial
banks, as in the case of Rwanda, where a guarantee scheme--sofar
inactive-has been financed in this way. German institutionshave
contributed to a guarantee fund in Peru and are working to create an
internationalguarantee fund based in Switzerlandwhich would reguarantee
(or reinsure) guaranteesof schemes in developingcountries,mainly in
Latin America. Some schemes are unfunded-that is, there is no specific
guarantee fund, merely a pledge by the government to cover the guaranteeon
any loan on which there is a default. One of the oldest credit guarantee
schemes,that of the Netherlands,operates in this way. Claims are met
directly from the governmentbudget. "Unfunded"schemes,which also
operate in the United States and Canada, simplify the operation of the
scheme in that the governmentsimply assumes financial responsibilityfor
the operation and meets claims out of revenues. In developingcountries,
however, it would be advisablenot to adopt such an arrangementbut rather
 - 11 -

to establish a fund from which claims are settled. The lack of such a fund
in Morocco caused a major crisis in the scheme there. Furthermore,lack of
a fund deprives the guarantee organizationof revenuesobtained from
investing the organization'sreserves.

The credit guarantee schemes operated in the United States by the

Small Business Administrationthrough the commercialfinancial system have
the interestingfeature that the banks are permitted to discount a portion
of the guaranteed loans in the secondarymoney market. This means they can
sell the loan applicationsin secondarymarkets as government-backedsecu-
rities. In this way, capital is released for further lending. Since these
loan obligationsare usually bought by insurance companies and pension
funds, the guarantee scheme provides a means for channelingfunds from
large financial institutionsto small businesses.

ASSESSMENT OF GUARANTEE SCHEMES

Scope and Impact. It is worth noting that the proportionof all

bank loans which are subject to guarantees in all countries is small. In
France, 11.3% of all medium- and long-term loans raised by French companies
of all sizes carry a guarantee. In Japan, where one million new guaranteed
loans are made annually,nearly 5% of all lending to small firms is covered
by the guarantee system. In other countries it is lower, often less than
1%. In Germany there is concern that there is not wide enough use of guar-
antees schemes. The NMB (NederlandischeMiddenstandBank), the principal
bank that provides guaranteedloans for small firms, and originally the
only bank operating such a scheme in the Netherlands,stated early in 1983
that only 0.5% of its long-term lending was covered by guarantees. Despite
the low percentageof lending covered by such guarantees, the sums some-
times have representeda significantincrease in the amounts available for
business start-ups by individualswho lacked collateraland any record of
creditworthiness. These schemes have been particularlyhelpful in provid-
ing long-term lending to small business.

Additionalityof Lending. For guarantee schemes to meet their

objectives,it must be shown to have created additionallending to the
finance that would normally be made availableby the banking system to the
small business sector. This will occur not only if loans are made without
any collateralbut also if collateralrequirementsare lowered. It is, in
fact, desirable that lending institutionsavail themselvesof whatever
collateralborrowerscan provide since this will ultimatelyease loan
recoveries. But it has proved difficult to show whether, in fact, any
guarantee scheme has resulted in additionalcredit for small business.

A scheme introducedin 1981 in the United Kingdom was an attempt

to ensure additionalitybut has operated merely with bank declarationsthat
loans would not have been made without the existing guarantees. Other
schemes try to insure that banks are not passing on to the guarantee scheme
what would be acceptablerisks for the lender. This is usually done by
having requests for guarantees reviewedby a body independentof the banks
 - 12 -

responsiblefor the appraisaldecision. In the Netherlands,attempts are

made to go even further by stating that "paymentwill be withheld under the
guarantee scheme if an investigationreveals that there was acceptable
security for a normal bank loan at the time the guarantee was granted."
The U.S. Small Business Administrationrequires evidence that normal bank
loans are not available to the borrower before it gives a guarantee.

In virtually all countrieswhere credit guarantee schemes exist,

there are those who claim that banks shift riskier loans away from their
normal lending to the schemes. Such a danger exists in all schemes,but a
greater problem in developingcountries seems to be how to get commercial
banks to participatein the program and to be less risk-aversein their
lending to small firms. Also, there is a great mistrust in developing
countries of all publicly-supportedschemes. Many commercialbanks in
developing countries express disbelief that guarantee schemes supportedby
the governmentwill meet claims if the number of claims begins to
increase. In some countrieswhere this has been true, commercialbanks
have refused to continue to participatein the schemes. The passing on of
risky loans to guarantee schemes seems therefore to be a major problem only
in developed countries. In developingcountries a bigger problem is how to
convince commercialbanks to participatein the schemes.

Creating Confidence. It cannot be stressed too often that the

operation of guarantee schemes involves resource costs. If a scheme is to
achieve its objective,some risks must be taken and some borrowerswill
default. Some claims will then have to be paid, with minimum bureaucratic
complications. It is also essential that the rules and regulationsare
clearly spelled out so that there are no arguments about whose responsibil-
ity it is to pursue defaults, about when claims can be made, and about the
conditionsunder which the guaranteewill not be paid.

A debt will not normally be fully recoverablefrom the realiza-

tion of whatever assets, collateral,or guaranteesare availableafter a
default. It is thereforenecessary to specify clearly how amounts reco-
vered will be apportioned. There are also administrativecosts in the
appraisal of guarantee applications,in the processingof claims, and in
pursuing debt recovery. Again, it is important to state clearly how these
costs will be met. If attempts are made to lower administrativecosts
unduly, there is a danger that the scheme will be inadequatelysupervised
and that there will be long delays in paying claims. Successfulschemes,
mostly in developed countries,have shown that payment of claims is carried
out without undue delay when proceduresare suitablydesigned and effec-
tively implemented. Efforts to recover from defaultersalso benefit from
suitabledesign and good implementation.

Loss Rates. An accurate indicationof the loss rate will only

emerge after five or more years of operation. The loss rate on most of the
schemes that have been in existence for some time, at least in developed
countries,is not unduly high. In Japan, where the mortality rate of small
business is consideredhigh, the loss rate is just over 2%. The loss rate
 - 13 -

is defined as total claims for default paid out as a percentageof loans

guaranteed. In Canada the loss rate in 1981 was only 0.6%, but it was sub-
stantiallyhigher in the United States. Internal studies by the Small
BusinessAdministrationhave found that, on a discountedbasis, the total
costs of the SBA's guarantee program were 8.3% of the originalguaranteed
amounts. This cost included a statisticalprojectionof future losses
based on past records. Other interestingfindingswere that the "purchase"
of loan guarantees (i.e., the invokingof guarantees)peaked in the second
year of loan repayment,and that there were significantdifferencesin loan
default rates in different regions of the U.S. The first report on the
United Kingdom scheme suggestsa relativelyhigh loss rate--probablyabove
5%.

The loss rate, to some extent, is a function of policy-namely,

the policy on how far to extend the "risk frontier." In general, it can be
said that the "risk frontier"has been enlarged in the United States to
make finance available to minority groups, first-timeborrowers,firms hit
by natural disasters,and others who are being encouragedto start busines-
ses. In some other countries the guarantee scheme has a lower loss rate
because other programswith much higher default rates are available. These
include the special minority business program in the U.S, the subordinated
loan program in the Netherlands,and the credit program of the Federal
Business DevelopmentBank in Canada (FBDB),which operatesas a last resort
public financial institution.l/ If other schemes to deal with more risky
ventures are maintained,loss rates can be kept low, but there is always
the danger that excessive-concernover the loss rate may defeat the very
purpose for which the scheme was originallydesigned. Finally, there is
the question of the total cost of operating a scheme. Most schemes in
developed countries have relativelymodest costs that representonly a
small part of the total costs of all support programs for small business.

CONCLUSION

Credit guarantee schemes appear to be an attractiveform of

support for small enterprisedevelopmentin developingcountries,where
non-availabilityof finance has been a serious constraintin developingthe
small business sector. However, guarantee schemes only have meaning to the
extent that the commercialbanking system is ready to participatein the
scheme. Schemes in which the only participantsare publicly-funded
development finance institutionshave little meaning, since ultimatelythe
losses of these institutionsmust be made good from the public treasury.
The evidence from developed countries is that the government, the business
community,and the banking system must all assume some part of the risk.
Credit guarantee schemes cannot and should not completelyabsolve banks
from taking a normal level of risk as such risk-takingis acceptable
banking practice. Similarly,credit guarantee schemes should not be
expected to provide finance for projects of doubtfulviability. Credit
guaranteesbacked by public funds should not eliminate the need for the
lender where possible, to obtain some form of personal guaranteeor
collateral.

1/ FBDB had a loss rate of 2.1% in 1981 against 0.58% of the Small
Business Loan Act (SBLA).
 - 14 -

Finally, credit guarantee schemes should be launchedonly when it

is recognizedby all concerned-and specificallythe guarantee organization
that the scheme will entail costs. The guarantee organizationmust accept
that it is entering into contracts on which paymentswill have to be paid.
Guarantee schemes should be monitored constantlyand changes made when
necessary in the proportionof risks, participation,premiums,etc. These
changes, of course, should apply only to future commitmentsas any attempt
to change the rules on guaranteesalready approvedwould seriously
undermine confidencein the scheme.

Mutual Guarantee Associations. All that has been written so far

refers to publicly funded guarantee schemes, including some which are
partially financedfrom fees or other payments from banks or associations.,
There are certain limited guarantee schemes which operate more like mutual
guarantee associationsor cooperatives. In these schemes a number of
enterprisesmake payments to a cooperativeor associationwhich will then
be prepared to guarantee loans taken out by any member, up to certain
amounts. Such arrangementshave worked reasonablywell in both developed
and developingcountries among farmers,artisans, and tradesmen. Their
impact on the total volume of lending to small enterprisesis very small,
but this does not mean that such initiativesare not worthy of support.

Independenceof Guarantee Organization. Summing up, it can be

stated that guarantee schemes can represent an important financialinstru-
ment available to compensatefor market imperfectionswhich may result in
the small business community being deprived of access to institutional
finance. As a financial instrumentwhich can play an importantrole in
redistributingcredit, a guarantee scheme, and the organizationthat
operates it, should aim at self sufficiencyand financial independenceover
the course of time. The fund will need to be capitalizedadequatelyto
meet its obligationparticularlyover the first years of its operation.
The scheme should be designedwith a financialplan which should set down
the capital needed for the guarantee fund and the estimated level of claims
expected to be paid out. This should determine the total amount of guaran-
tees that can be undertakenat the projected level of claims, and of the
fund available. This provides the basis for setting the fees, in light of
other revenues available and the administrativecosts needed to achieve the
estimated level of operations.

If managed efficiently,with a realistic level of fees and

revenues from investments,and if operated with a business approach and
assuming only prudent risks, guarantee schemes should be able to achieve
financialautonomywhile fulfillingits main purpose in assisting small and
medium enterprisesto obtain the finance they need for their development.
 I~~~~~~~~~~
un
I a~~~I
int

AI
 - 17-

CHAPTER 2

NORTH AMERICA

UNITED STATES

Section 7(a) of the $mall Business Act, introducedin 1968,

empowered the Small Business Administration(SBA) to guarantee loans made
by participatinglending institutionsto eligible small businesses. The
objective of this program was to assist independentsmall business concerns
in the United States by increasingthe institutionalfinance available to
them by reducing the risk of financial institutionsthat made loans to
small businesses. A blanket guarantee agreement between the participating
bank and the SBA covers all loans guaranteedby the bank (except line-of-
credit loans with maturitiesof one year or less) and specifies the terms
under which the bank and the SBA will cooperate to issue and administer
these loans.

Eligibility. Loans are eligible for guaranteesunder this

program only if other methods of financing are unavailableon reasonable
terms and the loans are expected to be of sound value or so secured as
reasonably to assure repayment. The loans may be used for a variety of
business purposes, includingexpansion or relocation,construction,
machinery and equipment,working capital, etc. The applicantis expected
to be able to document the likelihoodof a cash flow of at least
one-and-a-halftimes the amount of debt service. Applicantsare also
expected to make a substantialcapital commitmentthemselves. Equity to
debt ratios of 1:1 are normally required, although in some cases ratios as
low as 1:4 are accepted. Borrowersmust have an unquestionablecredit
reputationand records showing several years of profitableperformance.
New ventures do not normally qualify, nor do ventureswith inexperienced
management. In order to qualify, a firm should not employ more than 500 to
1,500 persons, depending on the industry. Guaranteesfor business loans
have a maximum maturity of 25 years, while guaranteesfor working capital
loans are generally limited to seven years.

Risk Sharing. The scheme guaranteesup to 90% of the loan

amount. In theory, 90% is supposed to be the maximum guaranteedportion,
but in practice it is virtually the norm for all guaranteedloans. The
total amount guaranteedcannot exceed $500,000 per borrower.

Guarantee Fee. In return for the guarantee,an initial fee of 1%

of the guaranteedamount is collected by the SBA from the lender when the
loan is disbursed. This fee may be transferableto the borrower. The
program's interest rates have been only slightly higher than normal bank
lending rates and have generally been lower than interbusinessand other
sources of financing. Regulated rates have varied from 1/2% over prime to
2-1/4% over prime for loans of less than seven years and 2-3/4% over prime
for loans longer than seven years.

Claims Procedure. Lenders are required to notify the SBA of the

status of each loan on a quarterly reporting form provided by SBA. If
non-paymentof a guaranteedloan persists for 60 days after the due date,
the lender may demand that the SEA "purchase"the guaranteedportion of the
outstanding loan balance, including any accumulatedinterest. It is at
 - 18 -

this time that funds are paid by the SBA to the lender. The amount paid is
the guaranteedportion of the principal,plus interest, to the date of loan
"purchase." Usually, the SBA then proceeds to take over servicing of the
loan. From that point on, future payments by the borrower are made direct--
ly to SBA. Occasionallythe SBA will purchase the guaranteedportion of a
loan while the bank agrees to continue administeringthe loan. When a loan
is in default and remedial actions have been unsuccessful,the SBA and the
lender may agree to initiate liquidationproceedings. The SBA or lender
proceedswith liquidation,which either results in the loan being paid in
full or the remaining loan balance being written off. The guaranteed
portion of the outstandingunpaid balance is considereda loss to the SBA.

Operation of the Scheme. The SBA loan guarantee program has been
relativelysuccessfulin inducing commercialbanks to lend funds to small
businesses. Annual loans approved rose from $385 million in 1969 to $1.9
billion In 1973, then declined somewhat before rising to $2.7 billion in
1977 and to $3.4 billion in 1980. However, by 1983, annual loans approved
fell to $2.5 billion. The total number of loans disbursedrose from 6,240
in 1969 to 24,106 in 1980 before dropping to 17,053 in 1983. The total
amount actually disbursed to small borrowers in 1983 was $1.8 billion. As
of September 1983 there were 81,473 loans outstandingtotaling $7.1
billion. The total number of banks certified under the scheme was 580 as
of 1983. These operationswere supportedby an SBA staff of around 2,000
persons in Washington,D.C., and in 10 regional and about 100 branch
offices.

The SBA thus appears to be reaching a small but significantshare

of what is defined as small business in the United States. A detailed
breakdown of loans approved in 1983 is given in Table 2-1.

Table 2-1. SBA LOANS APPROVED IN 1983

% of Amount % of
Category No. Loans Total Loans (US$ million) Total Amount

Retail 5548 36.1 733.8 29.8

Services 3957 25.7 558.7 22.7
Manufacturing 2262 14.7 498.9 20.2
Wholesale 1617 10.5 324.6 13.2
Construction 727 4.7 121.5 4.9
Transportation 454 3.0 92.3 3.7
Agriculture 472 3.1 78.7 3.1
Flinance 160 1.0 24.8 1.0
Mining 61 0.4 14.5 0.6
Other 128 0.8 17.6 0.7

TOTAL 15,386 100.0 2,465.4 100.0

-l __
 - 19 -

Evaluationof the Scheme. Although there are approximately14

million business establishmentsin the United States, only 5 million of
these had gross receipts of more than $25,000, and only 2 million had gross
receipts of between $100,000 and $1,000,000. It is not known if all SBA-
guaranteedloans go to businessesthat would not otherwise receive bank
finance. Each time they make a guaranteed loan, banks do certify that the
loan would not be made without such a guarantee. SBA regulationsand
review proceduresappear adequate to prevent the substitutionof guaranteed
loans for other modes of finance. Finally, and most persuasively,the
additionalityof these loans is suggested by an average default record
greatly in excess of the general average for commercialbanks (net losses
in guaranteed loans of 4.95% in 1983, versus less than 0.5% of all loans).

The SBA program is also a success in the sense that the guarant-
eed loans are term loans, with 80% ranging from 5 to 10 years. Term loans
are not readily available to U.S. small businessesfrom other sources,
although they are commonly associatedwith expansionor improvementsin
productivity. Although term lending has become a common practiceamong
U.S. commercialbanks, lending especiallyfor small enterprisesis usually
for periods of less than five years.

Finally, the program has been a success from the point of view of
offering a relativelyhigh guarantee rate--thatis, up to 90%, at the
lender's option. Compensationor repurchaseof defaultedportions of guar-
anteed loans has been nearly automatic,with investigationnormally occur-
ring after rather than prior to compensation.

The SBA loan guarantee program has been criticizedon several

accounts. From the taxpayers point of view its prime deficiencyis the
large subsidy required to support the administrativecosts and losses of
the program. Some observersquestion whether the guaranteedlending is
sufficientlyselective in view of the 12.9% ultimate loss rate (the sum of
net losses plus projected losses) and the 4.95% loss rate of 1983. In
addition to net losses not covered by the guarantee fee, annual
administrativecosts average about 0.7% of the portfolio outstanding.

From the borrower's and the lender'spoints of view, the initial

required procedureshave involved excessivepaper-workand delay. Thus, a
pilot program was institutedin 1978 to test the transferof responsibili-
ties for loan evaluationand for the liquidationof defaulted loans to
accreditedbanks. It was expected that the time required for an accredited
bank to receive SBA approvalon a loan would be reduced from around 20 days
to 3 days. Some banks reported in the early 1980s that approvalrequired 6
to 10 days. It was also hoped that transferringresponsibilityfor collec-
tion and liquidationwould reduce the net loss rate and total administra-
tive costs. It is not certain,however, that banks will be willing to take
over these responsibilitiesunless they are compensated. Compensation
formulashave yet to be worked out, however. In the past, banks have been
allocated3/8% of outstandingbalances when they have been asked to admi-
nister recoveryon defaulted loans.
 - 20 -

Small business leaders have frequentlycomplainedthat SBA

guaranteed loan procedureswere complex and rigid, and that loan standards
were too conservative. Since the average loan is approximately$160,000,
the program is clearly not directed at the 12 million business establish-
ments with gross sales below $100,000,but rather at the 2 million with
gross sales between $100,000 and $1 million. The upper limit for some
types of firms, such as wholesalers,is gross sales of $10 to $20 million,
although no loan guaranteemay exceed $500,000. In practice, loan guarant-
ees have not benefittedfirms that can provide very little collateral,
although minimum collateralrequirementsof 75% are moderate. Banks are
free to establish higher collateralrequirements,and normally require the
pledging of all available assets. Whether banks lower their normal collat-
eral requirementsin the case of guaranteed loans is not known, but the
recovery ratio of only 30% on defaulted loans suggests that such require-
ments have been lowered. It also appears, however, that borrowers without
any collateralwould not be granted guaranteedloans.

Conclusions. The SBA loan guaranteedprograms should be judged

in light of the U.S. environmentbefore any attempt is made to adapt it to
developing countries. The SBA program has four fundamentaladvantagesnot
often found in developingcountries. Reliable nationwidecredit rating
services allow low-cost verificationof applicants'credit standing. Most
applicantshave reliable accountingand other records that make it possible
to judge their past performancequickly. Most commercialbanks have staff
with experiencein evaluatingterm loans on the basis of projected
performance. And there are enough small business in the United States to
interest commercialbanks in meeting their financialneeds.

Other advantagesare the relative ease and moderate degree of

loss with which collateralmay be liquidated,and the relativelylow cost
and expediencywith which legal procedurescan be used to protect the
lender'slegitimate interestsor recover defaulted loans. The great amount
of low-cost informationon conductingall types of small businessesalso
differentiatesthe situationin the United States from that in developing
countries. Since the coming to power of the Reagan administrationin 1981,
efforts have been made to abolish the SBA and to eliminate the loan guaran-
tee program but so far the strong reaction to these moves from the business
community have prevented this being carried out.
 - 21 -

CANADA

Guaranteesfor lending to small enterpriseswere initiated in

Canada under the Small Business Loan Act (SBLA) of 1961. The objective of
the Act was to encourage lenders in the private sector to make term loans
available to small businesses. The Act was originallylimited to a period
of three years but has been extended from time to time. To qualify for a
guarantee,loans must meet certain criteria specified in the legislation.
These relate, among others things, to the maximum amount of security to be
taken, the maximum rate of interest to be charged, the maximum term of the
loan, the purposes for which loans may be made, and the persons eligible to
receive them. A number of changes have been made in the legislationsince
1961.

Eligibility. All small businessesengaged in manufacturing,

trade, services, construction,and transportationare eligible, but
guarantees are given only on loans for fixed investment,which includes
purchase or constructionof premises and purchase of land for factory
construction. The regulations specificallyexclude all forms of working
capital. In 1977 a small business was defined as one with annual revenues
of less than C$1,500,000. Borrowers were required to provide equity of at
least 20 percent of the total cost of any project or 10 percent of the cost
of purchase of land or the constructionor purchase of premises. All
credit assessmentsare made by the lending institution.

Participationin Scheme. Under the originalAct, all chartered

(commercial)Canadianbanks are designatedas lenders. The Act was later
amended to include credit unions, caisse populaires,and trust, insurance,
and finance companies.

Guarantee Fee. There is no charge for the guarantee,either to

the lender or to the borrower but the maximum interest rate permitted to a
lender is 1% over the prime rate.

Risk Sharing. Approved loans are guaranteedto 90% by the

government, the other 10% being at the lender's risk. The maximum loan
size was increasedfrom C$75,000 to C$100,000 in 1980. The Canadian scheme
has a special feature in that it imposes a global ceiling on outstanding
guaranteesand also a limit on the amount guaranteedfor loans to any
single institution. In 1981 the global ceiling was C$1.5 billion.

Funding of the Scheme. The loan guarantee system in Canada is

unfunded. The arrangementis centralized,and the national government
meets deficiencypayments from budgetary resources.

Operation of the Scheme. From inceptionof the program to the

end of 1982, 117,343 guaranteeshad been given for loans totallingC$2,415
million. In 1982 alone, a total of 17,044 guaranteesfor loans amounting
to C$440 million was given. The annual report of the guaranteeprogram for
1982 states that there was a marginal decrease in the number of guaranteed
loans compared to the previous year and the dollar values of loans made
decreased by 14.9%. The average loan in 1982 was C$25,837.
 - 22 -

Up to the end of 1982, a sum of C$28.14 million was paid on 1,880

defaulted loans. Recoveriesfrom defaulterscame to only C$367,211. The
loss rate on the scheme was estimated at about 0.58% for 1980.

The number of participatinglenders stood at over 1,350 by the

end of 1982 (not includingthe new Schedule B banks charteredunder the
revised Bank Act). Service businesseswere the leading group of borrowers
in 1982, accountingfor 42.2% of all loans, followedby retail establish-
ments (24.7%), transportation(10.1%),manufacturing(10.0%),and construc-
tion (8.6%).

Evaluationof the Scheme. The guarantee scheme under the Act and
direct lending by the Federal BusinessDevelopmentBank (FBDB) are the main
types of Canadiangovernmentsupport for small business. The FBDB grew ouit
of an IndustrialDevelopmentBank set up in 1944 and renamed and restruct--
ured in 1975. The FBDB's role is to provide long-term finance to small
firms that cannot obtain funds on reasonableterms elsewhere. The FBDB has
103 branches to carry out its lending. It is government-ownedbut operates
outside the Small BusinessLoan Act.

A study was carried out during 1981 to assess the effectiveness

of the FBDB and the SBLA, and whether these programsprovided a net benefit
to the country. The report concluded that while the FBDB "expandedthe
pool of financing available to small business, particularlythose that are
marginal or start up enterprises,the SBLA (guaranteescheme) seems to have
duplicated, in large part, the term-lendingfacilitiesalready available at
the chartered banks...." The report found that bankers had mixed atti-
tudes toward SBLA guaranteedloans and the effectivenessof the program.
The report goes on to say that "Most bankers have granted very few SBLA
loans and have argued that high risk lending is imprudent...thebanks'
regular lending programs are more than adequate to finance small business'
needs." Some bankers doubted whether the scheme had added to the volume of
bank loans to marginal small business; others thought that some banks were
lending under SBLA to businesses that could have obtained loans through
normal channels. The bankers also claimed that SBLA loans were going to
creditworthyclients,who were thereby in a strong position to demand the
lower SBLA interestrate. Sometimes,the report adds, SBLA guarantee loans
were offered to potential customers to attract them away from a competitor.

The study concludes that the FBDB was more successfulin making
financingavailable to small businesses than the SBLA. However, the FBDB
had a loan loss ratio of 2.10% for 1980 (high by Canadian standards),as
against 0.58% for SBLA loans. The average ratio of loan losses to all
loans outstanding,both to large and small firms, for the five largest
charteredbanks was 0.40%.
 - 23 -

CHAPTER 3

EUROPE

FRANCE

Loan guaranteesin France are of two kinds, one for medium-term

loans and the other for long-term loans.

Guarantees for Medium-TermLoans

Medium-term "Article 8" bank loans, which are generally refinan-

cable by the central bank, can be guaranteedeither by one of the 15 regio-
nal developmentsocieties (SDRs, or Societesde DeveloppmentRegionale)or
by one of the 59 or so mutual guarantee organizations(OCMs, or Organisa-
tion de Credit Mutuel), which are sectoralbodies. The SDRs are private
institutions(thoughwith public law status and special borrowing privil-
eges) whose shares are listed on regionalexchanges. Both SDRs and OCMs
are under the control of a governmentbody, the Credit d'Equipementdes
Petites et Moynue Enterprises (CEPME),which was formed in 1980 to merge
the functionsof three previousorganizations. CEPME provides a second
rank guarantee to lending banks.

Additionalitydoes not seem to be a specific aim of the French

system. Also, the scheme has not been restrictedto small enterprises
(PME--Petitesat Moyennes Enterprises). Subsidiariesof large firms have
been able to take advantageof Article 8 loans, particularlythrough the
SDR.

Eligibility. The credit appraisal for a guarantee is done by a

committeeof the SDR or OCM, on the basis of a dossier preparedby the
bank, but final approval by CEPME is required. The latter'srole is
to make sure that the loans qualify under refinancingrules, which require
them to be for specific equipment or fixtures. Working capital is
excluded. OCMs and SDRs are able to approve guarantees for loans of less
than F 0.5 million on delegated authority,with CEPME examining the
applicationsafter the fact.

The OCM credit committee is appointedby the sectoraltrade

associationsand would normally include directorsof firms. This sometimes
leads to problems of conflict of interestwhen an applicationfrom a friend
or a competitoris being considered. Similar problems arise on SDR
committees,which include local businessmen. On the other hand, trade or
local knowledge has proved useful in appraisals. A CEPME representative
also sits on the credit committees.

Guarantee Fee. The OCMs and SDRs charge borrowers a flat fee
of 1-2% which is reimbursableat the end of the loan, plus a running
commissionof 1.2% per annum on the outstandingbalance, half of which is
passed to CEPME. Guaranteed loans, not subject to any of the numerous
interest subsidy schemes, carry a rate that is 1-2% below commercial
levels. Banks have an additional incentiveto use the guarantee system
since half of their guaranteed loans are excluded from the total used to
calculate solvencymargins being transferredto CEPME's account.
 - 24 -

Risk Sharing. In theory, the guarantee is for 100% of the loan,

but in many cases (and particularlyfor smaller loans) the banks provide a
counter-guaranteeof 50% to the OCM or SDR. Borrowershave to provide
security,where available,and a personal guarantee. The loan amount is
limited to 70% of the asset cost, and the loan term must correspondwith an
agreed depreciationschedule. The SDRs and OCMs' total guarantee
obligationsare limited to various multiples of their funds.

Claims Procedure. When a default occurs, the claims procedure is

favorable to the banks in that they receive reimbursementof the whole loan
as soon as a payment is missed, even when they have given a counter-
guarantee. CEPME is responsiblefor debt recovery.

When a default occurs, the bank's first claim is on the funds of

the OCM or SDR. Only when these are exhausted does the CEPME guarantee to
the bank operate. Some SDRs' rules allow them to supplementtheir guaran-
tee funds from their other resources,up to 20% of the fund. However, the
OCMs' funds are limited to their retainedearnings from commissionsand the
returns from investing the funds. There have been times when OCM funds
were exhausted by claims, but they can recommenceoperationsby building a
new fund. There has been considerablerationalizEttion among OCMs in recent
years, with mergers creatingmore powerful organizations. In certain
weaker sectors, including textiles, shoes, and furniture,OCM funds have
been supplementedby governmentallocationsfrom sales tax revenues.

Operation of the Scheme. Up to now, the medium-term system has

been self-financingfrom the governmentpoint of view. CEPME and its
predecessor,Caisse Nationale des Marches de l'Etat, have been in surplus
on their guarantee business and have paid dividends to the state. Deterio-
rating economic conditionsin the early 1980s strainedresources,however,
particularlysince many of the OCMs had to draw on funds accumulatedover
many decades to meet claims. It appears that the banks now bear most of
the cost of the loan guarantee scheme.

The scheme is widely used. In the years 1979 to 1981, about

35,000 new guaranteeswere given annually. In 1931 the new commitments
amounted to F 8.6 billion,and the total outstandingat the end of that
year was F 420.1 billion. These figures include a small proportionof
guaranteesgiven under certain special programmes,includingenergy
conservation,technical innovation,and export development. In all,
Article 8 guaranteedloans accounted for 11.3% of all funds raised by
French companies of all sizes on the medium and long-term capital market.

On a much smaller scale, two government-supported Fonds Nationale

de Guarantie administeredby CEPME provide support to the subordinatedloan
program and to the creationof new enterprises. These funds have only been
operating since 1980. In 1981 the two funds provided guarantees,respect-
ively, for 300 loans amounting to F 358 million, and for 50 loans amounting
to F 30 million. The new enterprisefund is used mainly by the SDRs.
 - 25 -

Guaranteesfor Long-TermLoans

Guaranteesfor long-term loans are given by the SDRs. These

loans are for terms of between 5 and 15 years, whereas Article 8 loans
range from 2-1/2 to 7 years. The loans themselvesare also made by the
SDRs, using funds raised through public bond issues. SDRs apparently
receive a governmentsubventionequivalentto a spread of 2% on this
program. A condition of obtaining a loan of this type is participationin
a borrowers mutual guarantee fund.

Borrowers of long-term loans pay a flat fee of between 3 and 5%

of their loan into the fund. These fees are then invested and claims are
met first from investmentreturns, then from retained fees, and finally
from SDR reserves. The fee is refundablefrom the eighth year of the loan
onwards, less that proportionwhich has been allocated to meeting claims.
At the liquidationof loans of 12 years or more, accumulatedinterest is
also paid. The SDR long-term loan program had F 17 billion in outstanding
loans at the end of 1981 and provided F 2.8 billion in new lending in that
year. The authoritativeMayoux report (1979) described the program as
a crucial mechanism for institutionalinvestmentof long-term funds in
small businesses.

Up-to-datedata on loss rates were not available as of late 1983,

but an estimate given in 1978 suggested that, on average, borrowers lost
about half their guarantee fee.

Problems of division of responsibilitybetween banks and

guarantee institutionsdo not arise in this scheme, since only the SDRs are
involved. Additionalityis also less relevantbecause a major aim is to
provide long-termmoney without requiring personalguarantees. Presumably,
some borrowerswould have been willing and able to give sufficientpersonal
guarantees to banks in return for cheaper loans.

The loan guarantee system in France is well integratedinto the

institutionaland policy framework for the small business sector.
 - 26 -

FEDERAL REPUBLIC OF GERMANY

Credit guarantees in the Federal Republic of Germany are provided

under a decentralizedinstitutionalframeworkwhich reflectsboth the
federal political structureand the main economic divisions of Handwerk
(skill-intensivemanufacturing,repair and service trades),Handel
(distribution),and Industrie (larger scale manufacturing).

The operationof the credit guarantee system varies from Land

(region) to Land, but the basic principlesare common throughoutthe
Federal Republic. Guarantees are given by 34 locally based private credit
guarantee associations(usually called Kreditgemeinschaften, or KGa's) to
commercial,savings and cooperativebanks on medium and long-termloans.
KGa's are limited companies establishedby the business community as mutual
assistanceorganizations. Chambers of commerce, trade associations,banks,
insurancecompanies,and other private sector organizationscontributedthe
initial capital and are representedon KGa boards. Additionalityof lend-
ing was the express purpose of the KGa's, and this purpose is built into
the appraisal procedure. Each KGa has a credit committee composedof charm-
ber of commerce, banking, and governmentrepresentativeswhich decides on
applicationsfor guaranteesprepared by banks. The KGa staff usually makes
direct contact with the borrower to assist in the appraisal. Often, a
guaranteed loan is in addition to other loans.

Eligibility. Small firms in all sectors are eligible to receive

guaranteed loans. Equity percentagerequirementsusually stipulate a mini-
mum of 20% after the new loans are included. These requirementswere en--
forced more rigorouslyafter 1980 because of recession. Further safeguards
are personal guaranteesfrom borrowers and any available securityon
second-rankbusiness assets not acceptablefor normal bank lending. In the
case of new businesses,the chamber of commerce for Handwerk or Handel must
provide an independentand positive recommendationwhich covers both an
assessmentof the entrepreneur'scapabilityand a market analysis of his
project. The entrepreneurmust be qualified in his trade before being
allowed to start his own firm.

Guarantee Fee. Small businessmenapplying for guaranteedloans,

are charged an applicationfee of DM100. The fee is refunded if the gua-
rantee is granted. A non-refundableflat fee of 0.5% of the amount guaran-
teed is also charged to the borrower, in addition to the normal 2% bank
arrangementfee. Despite these charges, the screeningprocess is so tho-
rough that both the banks and the KGa's claim that they do not recover
their full costs. This fact is given as one explanation for the limited
demand from banks for KGa guarantees. Borrowers apply for the guarantees
through the banks. The weak demand, in turn, explains why the interest
rates charged on guaranteedbut otherwise unsubsidizedloans are not signi-
ficantly below normal market rates. The borroweralso pays a running fee
of about 0.25% quarterly on the diminishingbalance of the guaranteed
amount.
 - 27 -

Risk Sharing. The amount of the guarantee varies from 50 to 90%

of the loan; the average is 75%. Counter-guarantees are provided in a
ratio of 3:2 by the Federal and Land governmentscovering 60% of the gua-
ranteed amount, and a further 12.5% is covered by the European Recovery
Programme guarantee fund administeredby the government-ownedbank, Kredi-
tanstalt fur Wiederaufbau(KfW). Hence, the KGa's are responsible for only
27.5% of the risk on the guarantees themselves.

Funding of the Scheme. Funding for the scheme consists of

capital subscribedby KGa shareholders,accumulatedreserves, and borrow-
ings from the European Recovery Programme at a special interest rate of
5.5%. These borrowings are restrictedto between one-third and one-half
of the total fund. The KGa's fund is invested,and the return on this
provides the major source of income. The volume of guaranteesis theoreti-
cally limited on the supply side by regulationson the KGa's. In recent
times they have been allowed to guarantee up to 36 times their funds, the
former multiple being 18. Generally,however, the regulationslimitingKGa
commitmentsdo not in reality constrain the system.

Claims Procedure. Banks are obliged to inform KGa's that a

borrower has failed to meet a capital repayment. A decision to treat a
loan as in default appears to be a joint one between the bank and the KGa.

When a borrower in difficultieswishes to extend the term of his

loan, permissionmust be given by the bank, by the KGa, and by the govern-
ment counter-guarantors. When a default occurs, it is the bank that is
responsiblefor recovery. The KGa normally reimbursesthe bank only at the
end of the recovery process, although sometimes (to save accumulating
interestcosts) the expected final deficiencyis paid over fairly quickly,
and a time limit is set for the realizationof security and personal
assets. The KGa keeps watch over this. For example,KGa staff attend
auction sales to ensure that the bank is acting in the KGa's best
interests. The bank also has to demonstratethat the credit was used for
its intendedpurpose before the deficiencypayment will be approved.

Some KGa's allow banks the option of first call on assets taken
as security for guaranteedloan, in return for which capital repayments are
allocated first to the guaranteedportion of the loan. Otherwise,the
capital repaymentsand recoveriesfrom security are allocated according to
the risk-bearingproportions.

Operation of the Scheme. The total amount guaranteedby the

KGa's and still outstandingat the end of 1978 was DM 1.2 billion (US$450
million). On average,about 3,000 new commitmentsare made every year,
amounting to about DM 300 million (US$115million). This representsa very
small proportion (less than 0.5%) of loans to the whole of the Mittelstand
(small and medium-sizedbusiness sector). Even for Handwerk the proportion
is probably only 1%. Loss rates have been low, but rose a little in the
early 1980s. From the inception of the KGa's in the 1950s to the end of
1978, there had been 1,100 guarantee deficienciestotalingDM 31 million,
representing1.9% of the total number of guarantees and 0.9% of their total
value. However, the figures for the five years 1977 to 1981 were an
 - 28 -

average 120 defaultsa year and average annual losses of DM 8.5 million.
In the Handel (distribution)sector, the deficienciesof at least one KGa
in 1980 would have prevented any new commitmentsin 1981 had the
shareholdersnot subscribednew capital.

The costs of the system in Germany appear to be borne mainly by

the government,which effectivelysubscribesto 72.5% of the losses and
also subsidizesthe administrativecosts of some KGa's through Land
budgets. The banking sector carries very little of the burden, its main
contributionbeing occasionalcapital inputs to the KGa's. Borrowers pay
only a little more, overall, for guaranteedloans.

Evaluationof the Scheme. Generally,the credit guarantee system

in Germany should be regarded as a way of putting moral pressure on larger
economic and financial institutionsto play a part in helping the
Mittelstand (SME). The KGa's themselves,however, are widely regarded as
being both overcautiousand bureaucratic. The banks, which are responsible
for 25% of the risk, considerguaranteedloans to be high-riskventures,
and they dislike the high costs they incur in participatingin the scheme.
 - 29 -

ITALY

There are three loan guarantee systems in Italy-one for the

artisan sector, another for the agriculturalsector, and a third for the
small industry sector.

Artisan Scheme

The artisan scheme has been operated since 1964 by the Artisan
Cassa, a public body that provides a channel for various government
programs to the sector, the most notable being a substantialinterestrate
subsidy. The guarantee operation is supportedby a central guarantee fund
which was establishedwith a capital grant from the government.

Eligibility. Small enterpriseswith less than 15 employeesare

permitted to participatein the artisan scheme. Appraisalsof loan
guarantee applicationsare carried out by local credit committeesoperated
by branches of the Artisan Cassa. Additionalityis an objectiveof the
scheme and is investigatedas part of the appraisal. Prospective borrowers
normally have to provide their bank with a personalguarantee.

Guarantee Fee. The charge to borrowers is a one-time flat fee of

0.5% of the loan amount.

Risk Sharing. Loans are guaranteedup to 70% of the loan amount.

Funding of the Scheme. The central guarantee fund receives

additionalrevenue through an allocationof the subscriptionincome paid by
member firms of the Artisan Cassa and is also subsidizedby central
government subventions. Although full figures are not available,it
appears that the major source of fund revenues is the central government
subventionsand that guarantee fees are not intended to cover losses.

Claims Procedure. When a default occurs, the fund reimbursesthe

bank promptly and then acquires rights to any security and personal
subrogation. In the case of a bankruptcy, the courts realize assets on
behalf of the fund. Otherwise the fund's own staff carries out this
function. If the bank waives a repayment,it loses its right to make a
claim under the fund's guarantee. Generally,however, the bank decides
when a loan is to be treated as in default.

The Small Industry Scheme

A completelydifferent system is in operation for the small

industry sector. There are approximately80 mutual consortia funds, one or
more for each province in Italy. These are private bodies, but they are
subject to general statute law governing the activitiesof consortia. On
average, 150 local enterprisesconstitutea consortium. Each enterprise
guaranteesa sum of Lit 1 million (US$560 approximatelyin 1984) and
thereby acquires a consortiumguarantee on a loan from a bank with which
the consortiumhas an arrangement.
 - 30 -

Guarantee Fee. A borrowing firm pays an annual fee of between

0.5 and 1.0% on the outstanding balance of its loan to the consortium.

Risk Sharing. The percentageguaranteed and the limit of the

guarantee sum are decided case by case by the board of the consortium.
This board normally has representationfrom the local branch of the
national small industryorganization,from the local chamber of commerce
and similar bodies, and from member firms. On average,guaranteesare
given for 50% of loan amounts.

Funding of the Scheme. The scheme is funded by accumulatedfees

and commitmentsfrom consortiummembers. The consortium'sobligations
cannot exceed the sum of its liquid resources. Each consortiumhas its own
constitutionlimiting individualloan guarantee obligations. The consort-
ium may be able to call upon its members to increase their guarantee
amounts if it wishes to increase its obligations. In the event of a
default, the consortiumhas recourse first to its liquid assets (usually
invested in local bank deposits) and then may call on members for
additionalcommitments.

Operation of the Scheme. The number of loan consortia rose from

39 in 1971 to about 1,980 in 1982. The system is widely used and there
have apparentlybeen no spectacularfailures. Banks are often anxious to
be chosen to work with the local consortium. In 1977, the most recent year
for which data were available,the total volume of outstandingguarantees
was Lit 216 billion (around US$200 million then).

The loan consortiahave begun to offer management consultant

services to their members. In general, the mutual nature of the consortia,
and their freedom from political interference,suit Italian businessmen
very well.
 - 31 -

NETHERLANDS

A loan guarantee scheme has existed in the Netherlandsfor more

than 40 years. Under this scheme, loans granted to small and medium-sized
businessesare guaranteedby the Ministry of Economic Affairs. Until 1977
only one bank, the NederlandscheMiddenstand Bank (NMB), had the preroga-
tive of granting loans under the scheme, but since then the scheme has been
extended to a group of ten banks. Even after 1977 the NMB retainedabout
70% of the guaranteedloans market. The next largest participantis the
Union of CooperativeBanks (RABO).

Eligibility. Small and medium-sizedenterprisesin commerce,

manufacturing,crafts, and services are eligible to receive guarantees.
An enterpriseis classifiedas a small or medium-sizedenterpriseif the
number of employeesdoes not exceed 100 people, and, in the case of an
industrialenterprise,if sales do not exceed f. 7.5 to f. 10 million ($2.5
to $3.3 million in 1985).

Appraisal of a guarantee applicationis thorough. An application

from a new businessmust be accompaniedby a recommendationfrom the Dutch
small firm agency (CIMK) or the governmentadvisory body (RND). This often
causes delay, since neither organizationis under pressure to produce
reports on prospectiveborrowers quickly. All borrowers must have a
relevant trade qualificationcertificate. The applicationscreening
includes a check on the history of any previous applicationsto any
participatingbank. An important criterion for the appraisalcommittee is
the overall gearing of the business. Guaranteed loans are appraised by
reference to the whole business and are not linked to a specificproject or
equipment purchase. The equity percentagerequiredvaries from 5 to 30% of
the total net assets after the loan, though the requirementtends towards
the higher percentage. Independentvaluations are made of equity assets
where appropriate.

Additionalityin the Netherlandsis achievedmainly through the

screening process, under which the banks are effectively subject to govern-
ment control. For guarantee commitmentsabove f. 300 thousand (about
$100,000),approvalmust be obtained from the guarantee departmentat the
relevantMinistry. For smaller commitments,from NMB, the departmenthas a
representativeon its internal credit committee who can veto a loan by
insisting that it be referred to the full department. Other banks jointly
fund the operation of a single credit appraisalcommittee consistingof
representativesof small firm organizations,accountants,retired bankers,
and a governmentnominee who again has the power of veto through mandatory
referral. One principle applied in the appraisal of guarantee applications
is that the Bank should have obtained all availablecollateralbefore
applying for a guarantee.

Guarantee Fee. No guarantee fee is charged to the borrower. As

in some other countries,it was expected that market forces would drive
down interest rates on guaranteed loans, but in practice the reductionwas
 - 32 -

marginal, (about 0.25%). The reason given for this was that credit
controls are generally fairly restrictivein the Netherlands. But
according to the NMB, guaranteedloans are excludedwhen the bank's
solvencymargins are calculated. A more plausible explanationis that
there has been a good deal of cooperationbetween the participatingbanks,
for example, and that competitiverelationshipshave yet to develop.

Risk Sharing. The design of the scheme is very simple. A

special departmentof the Ministry of Economic Affairs guaranteesloans
made by NMB and the other participatingbanks to 100% in the case of
general business loans, including subordinatedloans, and up to 47% of
loans secured by a mortgage on business premises.

The guarantee takes the form of a "deficiencyguarantee." That

is, the governmentwill indemnify the banks for any net loss they suffer as
a result of a default on a guaranteedloan, once all recoveriesfrom
security and personal guaranteeshave been taken into account. The scheme
reimbursesloss of interest to the date of indemnification. Personal
guaranteesgiven to the bank are a standard requirement,as are any
available security in the form of second-rankbusiness assets (e.g.,
furniture and fittings). The governmentpayments are known as
"declarations."

Funding of the Scheme. The Credit Guarantee Scheme in the

Netherlands is unfunded. The governmenthas an open-endedbudget
commitmentto cover liabilitiesarising from claims.

Claims Procedure. Another control on additionalityis provided

through the claims procedure. Before a "declaration"is accepted, the
guarantee departmentat the Ministry reviews the history of the loan. The
departmentcan, and occasionallydoes, exercise its right to withhold
acceptanceif the review shows that the rules of the scheme were not
observed by the lending bank.

From the government'sviewpoint, the default procedurehas

several problems. One is that because the bank continues to earn interest
on the loan while it is realizing on collateral,there is sometimes
insufficientpressure on them to forecloseon loans quickly, and to the
maximum extent. This applies particularlywhere the unguaranteedlending
portion is small.

One approach to this problem being consideredis to agree on a

time limit for the realizationof security. In principle,the banks are
obliged to pursue the recovery of any outstandingdebt for five years after
their claim has been satisfiedby a "declaration"payment.

Another problem is that there is an administrativebacklog in

approving "declarations." The staff of the departmentnumbers 17.
Additional staff might achieve savings if "declarations"could be approved
more quickly, thereby reducing interest charges.
 - 33 -

Operation of the Scheme. The proportionof lending to small and

medium business that is guaranteedis roughly estimated at about 5%.
Outstandingcommitmentsamounted to f. 1242 million (US$415 million) at the
end of 1981. There were about 9,300 outstandingloans under guarantee at
the end of 1980. About 3% of all retail businesseshad a guarantee loan at
that date.

Recent data (to 1983) indicate a sharp increase in the amount of

claims paid. Declarationsrose from f. 6.3 million in 1978 to f. 43.4
million in 1981, and the trend in 1982-83 was still upward. This
represents a rise in the loss rate from less than 1% to about 4%.

A particularproblem in the Netherlands has been the sharp fall

in property prices after 1980, which substantiallyreduced the securityon
many loans and resulted in higher losses. By early 1983 there was serious
concern on how to modify the system to reduce the cost to the government.
Various possibilitiesthat were being consideredincluded increasingthe
equity percentagerequired and asking the banks to bear some of the risk on
non-mortgageloans.

A differentproblem has arisen in cases where the NMB has used

its own authority to grant new small guaranteedloans to an existing
borrower, thus reducing its own exposure by effectivelyrefinancingat the
government'srisk. Since 1981 the banks have also tended to reduce the
percentage of buildingvalues on which they will accept a mortgage. This
leaves the governmentto pick up a correspondinglyhigher percentageunder
its business loan guarantee window. Although restrictedto guaranteeing
40% of the bank's mortgage under the building loan guaranteewindow, the
government in principlewill guarantee a loan on the unmortgagedportion of
the building value under its business loan scheme. To deal with this, the
government has begun to require banks to take a first mortgage (insteadof
the usual second-rankmortgage) to cover their exposure. Practices like
these, however, tend to nullify the purpose of the guarantee scheme.
 - 34 -

PORTUGAL

After the revolutionof 1974, far-reachingchanges took place in

the Portugueseeconomy which compelled the government to save small enterp-
rises in danger of collapse. An Institute for Small and Medium Enterprises
(IAPMEI)was created in 1975 in the Central Bank and was given responsibil-
ity for the operation of a guarantee scheme. Most of the loans guaranteed
were short-termand for working capital,mainly to enable firms to purchase
raw materials or to finance confirmed orders.

Eligibility. Short-termloans which prefinancedconfirmedorders

or financed the purchase of raw materials, and long-term loans which
financed fixed and working capital investment,or expendituresincurred In
restructuringoperations,are eligible to receive guarantees.

Risk Sharing. For short-termloans the maximum guarantee in 1980

was Esc 1.5 million (US$33,000equivalentat that time) or 50% of the loanm,
whichever was less. For long-term loans the maximum guaranteewas Esc 5
million (US$100,000equivalentin 1978) except in cases of mergers, joint
ventures, or projects located on industrialestates,where the ceiling can
be raised.

Funding of the Scheme. IAPMEI was given control of a guarantee

fund of 2 million contos (then about US$60 million).

Claims Procedure. The Guarantee Fund provides that in the event

of default the creditormay request IAPMEI to pay the percentageof the
amount in arrears equivalent to the percentageof the guarantee. Unless It
can arrange a rescheduling,IAPMEI will honor the guarantee. The agency
and the creditormust then initiate court proceedingsagainst the firm in
default.

Operation of the Scheme. As of June 30, 1978, IAPMEI had

guaranteed 555 loans totallingEsc 510 million under the short-term
facilitywith the total amount guaranteedequalling Esc 291 million
(Esc 154 million outstanding). Of loans granted up to June 30, 1978, 46
loans (9%) had defaulted,and IAPMEI had to pay Esc 27 million (9.3% of the
total amount guaranteed) to the lenders. During the same period IAPMEI had
provided guaranteesfor 435 long-termloans amounting to a total of Esc
1,205 million, with the total amount guaranteedby IAPMEI equalling Esc 562
million (Esc 484 million outstanding). Defaults of loans granted up to
June 30, 1978, numbered 10 (3%), and IAPMEI had to pay Esc 16 million (2.8%
of the total amount guaranteed)to the banks.

Evaluationof the Scheme. The Guarantee Fund proved to be the

most important financial service offered by IAPMEI in the early years of
its operation. After 1979, however, the IAPMEI started acting as a
promotionalagency for lines of credit available to small and medium
industry (SMI) from the World Bank and other internationalinstitutions,
and the Guarantee Fund declined in importance. Commercialbanks that
 - 35 -

onlent the lines of credit preferred to take collateralfor the loans they
made. TAPMEI continued to offer guaranteesfrom the Fund in cases where
the collateraloffered was insufficient,but such guaranteeswere provided
only in a limited number of cases and in smaller amounts after 1980. In
retrospect,however, it can be said that the GuaranteeFund played an
important role in rehabilitatingthe small and medium industry sector after
the changes of the mid-1970s in Portugal.
 - 36 -

UNITED KINGDOM

The United Kingdom's Loan Guarantee Scheme was introducedin June

1981. The scheme is administereddirectly by the small firms division of
the Departmentof Industry in London, using a staff of 2-3 people. Thirty
financial institutionswere participatingin the scheme in early 1983,
including the "Big Four" clearing banks. Applicationsfor guaranteesare
made through the banks, which carry out the screeningand appraisalof loan
applications. One of the objectivesof the UK scheme, and an objectivenot:
found in other countries,was to end the usual requirementof personal
guarantees from small businessesseeking bank finance.

Eligibility. The decision to give a guarantee is formally the

responsibilityof the small firms division. Applicationsforwarded by
banks have to be accompaniedby a declaration that the loan is additional,
in the narrow sense that without the scheme the bank would not have offered
finance on the same terms to the small firm. With this declaration,and as
long as the applicationmeets the criteria laid down as to the business
sectors to be included and the size and term of the loan, approval is
automatic. The maximum amount (there is no minimum) which can be borrowed
is i75,000. Loan terms range from two to seven years, and applicantsmust
be prepared to pledge all available assets.

Guarantee Fee. In return for a guarantee, the borrower original--

ly was required to pay a premium of 3% of the guaranteedamount, quarterly
in advance, on the outstandingbalance. This premium was designed to make
the U.K. scheme self-financing. But the failure rate has proved greater
than anticipated,and as a result it was decided early in 1984 to raise the
guarantee fee to 3.5%. In addition to the guarantee fee, borrowers in most
cases have to pay the bank a 1% arrangementfee. Initially,the interest
rates on guaranteedloans were no lower than those on unguaranteedloans to
small firms, in most cases 2.5% over base. In July 1982, however, one of
the banks reduced its rate on these loans by 0.5%. Early acceptanceof the
scheme was far greater than anticipated,and it seems that the banks recog-
nized the scheme as providing them with a relativelyrisk-freeand profita-
ble market. After reports appeared on high failure rates, the premium was
raised to 4% in 1985 and subsequentlyin April 1986 lowered to 2.5%. The
proportionof the guaranteewas also reduced from 80% to 70% of the loans.
Interest in the scheme dropped appreciablywhen the premium was raised to
4% and the proportionguaranteedreduced.

Risk Sharing. The scheme provided for a guarantee cover of 80%

of the loan but, as stated, in early 1984, this was reduced to 70%. Since
the maximum amount which can be borrowed is t75,000, the maximum claim
liabilityper borrower after 1984 was t52,500. The exclusionof personal
guaranteesapplies both to the guaranteedportion and to the portion on
which the bank bears the risk. It was thought that this would be
sufficientto prevent unsound loans. In many cases, however, personal
assets (usuallyhouses) were used to obtain secured overdraft finance for
the business along with a guaranteedloan. Under these circumstances,the
proportionof total bank lending at risk is of course smaller than 30%.
 - 37 -

Claims Procedure. The Banks have discretionin decidingwhen a

claimable default has occurred. Their claims are met automaticallywithin
14 days, and they are then obliged to cover as agents what is available
from the realizationof any securityand forward the appropriateshare (80%
or 70%) to the small firms division. Although formally the guarantee
applies only to the loan principal, in practice banks have in some cases
been reimbursedfor a proportionof one quarter's interest loss.

Operation of the Scheme. By mid-1986, 16,500 guaranteecommit-

ments had been made on loans totalling b530 million, an average of t32,000
per loan. About half of these were for new businesses. The scheme was
originally designed to be self-financing,but the governmentadmitted in
1983 that claims for the previous financialyear were expected to exceed
premiums by around t8 million. Outside estimates of the failure rate have
varied from one in five to one in 20,2/ it being argued that early
experiencewas not typical. A major source of equity and loan capital for
small and medium enterprises,the Industrialand CommercialFinance
Corporation(ICFC), points out that one in three of the new businesses
which it backs fails within the first five years.

An assessmentof success in terms of additionalityis difficult

to measure. Counting loans to businesseswhich could have raised alterna-
tive finance by giving personalguaranteesas additional,the government's
preliminaryreview of the scheme found that only 60% of the loans sampled
(both in number and value) were in fact additional. A further 20% could
have obtained bank finance if the borrower had given personalguarantees.
The remaining 20% could only have been financedby non-bank finance,which
would have been more expensive and therefore less attractiveto the
borrower.

Evaluationof the Scheme. At the time the scheme was introduced

there was criticism that the 3% guarantee fee was too high since the banks
were also charging a standard 1% arrangementfee in most cases. The 3%
premium, though generally higher than most of the schemes studied in this
report, is not unreasonableif the aim is to cover the total cost of the
scheme. No other funding or revenue sources were provided to meet claims,
and the loans guaranteedare essentiallyunsecured, so that there is little
offset from recoveryof security. Only unencumberedbusiness assets not
consideredadequate for security against a normal bank loan can be used.
However, the problem appears to be that the banks are not actuallylowering
interestrates to compensatefor the additionalburden of the guarantee
fee, as had been hoped would be a result of relieving the bank of a
substantialpart of the risk on loans. The subsequentloweringof the
premium in 1986 to 2.5Z after raising it to 4% in 1985 seems to indicate
that there was a recognition that a 4% premium was too high and a deterrent
to use of the scheme.

2/ A later report (April 1984) stated the failure rate appeared to be as

high as one in three in the early period of operation of the scheme but
one in five seems to be the accepted figure after three years of
operation.
 - 38 -

The banks were accused of not screening applicationswith

sufficientcare and of using the scheme to provide finance for firms in
difficulties. A review of the scheme was carried out in 1983 by a firm of
accountants,who reportedon the first 50 cases where the borrower
defaultedon the loan and the guaranteewas called. The accountantsalso
tried to establishwhether there had been a shift from ordinarybank
lending to lending under the scheme, and whether the screeningprocedures
had been adequate.

The 1983-84 review drew attention to the increasinguse of the

scheme as a "toppingup" facility in a package of structuredfinance
(equity, term loans, and overdraft). It observed that "capitalgearing
(the proportionof loans to equity) and, in particular income gearing or
debt servicingratio (the amount of net income taken up in repaying loans
and interest)were astonishinglyhigh in a very large number of the
failureswhich we studied." The review also seemed to indicate that many
borrowers were inexperienced.

Some other interestingfacts that emerged from the above report

were that the average loan size was then tf33,000that 60% of loans were
obtained by new enterprises,and that around 50 to 60% of the loans could
be classifiedas additional,based on the indicator that the borrower had
been refused normal bank financing. The report also stated that the loans
were mainly used for working capital. This may help to explain the finding
that jobs were being created at the remarkablylow cost of around t1,350
each.
 - 39 -

CHAPTER 4

ASIA AND THE PACIFIC

JAPAN

The credit guaranteesystem in Japan has existed for about 50

years and is widely used by small firms. The institutionalarrangements
are quite complex. There are 52 local Public-lawCredit GuaranteeCorpora-
tions (CGC) which provide guaranteesto banks lending to small firms. The
banks in turn reinsure70-80% of their commitmentswith the Small Business
Credit InsuranceCorporation(SBCIC). The entrepreneurseeking a guaran-
teed credit usually approacheshis bank but may apply directlyto the CGC,
which will then refer him to a suitablefinancialsource. The loan appli-
cation is generally appraisedby the CGC, and if collateralis requiredthe
CGC will handle the details of this as well. Appraisalsare thorough,
often involvingpersonalvisits. Because the guaranteeapplicationsare
screenedand the decisionto approve an applicationis made by the credit
guarantee corporationswho are at risk, the loans tend to be sound. About
5% of the applicationsare rejected.

Eligibility. Enterpriseswith less than 300 employeesin manu-

facturing,less than 100 in wholesaledistribution,and less than 50 in
retailingare eligiblefor guarantees. Separatearrangementsexist for
farming,fishing,and forestry. The great majority of guaranteedloans
require the borrower to give his personalguarantee to the bank. Colla-
teral is also requiredin more than half of the cases, althoughit is gene-
rally secondarybusinesscollateral(stock,for example).

GuaranteeFee. The borrowerspay an annual guaranteefee of 1%,

of which 0.37% is passed on by the guaranteecorporationsto the (SBCIC)as
a reinsurancepremium. The banks, competingfor risk-freebusiness,have
driven the interestrate down by about 0.9 percentagepoints, significantly
reducingtheir spread. They tend to use the scheme only where they cannot
make a loan otherwise.

Funding. CGCs receive contributionsfrom local governmentand

local financialinstitutions,and they receive low interestloans from the
national governmentvia the SBCIC. There is a ceiling on the total obliga-
tions which can be assumedby each CGC. This ceiling is a multipleof
reserve assets. The system is inherentlyresilientto higher loss rates,
since the liquidityof the CGCs is underpinnedby substantialborrowings
from central and local government. At the end of 1981 the total borrowings
amountedto approximatelynine times the net paymentsin subrogationfor
that year.

Risk Sharing. The Credit GuaranteeCorporationsprovide 100%

guaranteesto the banks. The CGCs in turn reinsure70-80% of their commit-
ments with the Credit InsuranceCorporation. Therefore,the CGCs bear
20-30% of the risk, while the remaining70-80% risk is borne by the SBCIC.
The banks bear no risk.

Claims Procedure. If a repaymentis missed there is generallya

cooling-off"period before the CGC actuallymakes its payment in subroga-
tion, during which time the borrowerhas extra time to make the repayment
 - 40 -

(interestcontinues to accrue, however). In the case of a single missed

installmentpayment, the presence of the guarantee is usually sufficientto
allow the bank to carry the missed repaymentuntil the end of the loan
period. For a single repayment loan, up to 90 days may be granted before
subrogationis called for by the bank. The CGC offers managementadvice
where it has become a creditorto small firms through subrogationpay-
ments. A contractualrelationshipbetween the CGC and the borrower appears
to arise only after the former has indemnifiedthe bank and acquired its
rights over securityand guarantee in subrogation. Recoveries are pursued
vigorously,and the borrower may well continue to pay off his outstanding
debt from his salary in the years following his bankruptcy. The CGC first
tries to realize the collateral;if this proves impossible,it will finally
claim the personalguarantee. When losses cannot be fully recovered,70 or
80% of the loss is borne by the Small Business Credit Insurance Corporation
and 20-30% by the CGC.

Operation of the Scheme. Since 1974, approximatelya million new

loan guarantee commitmentshave been made annually. The amount outstanding
reached V7 trillion,or about US$30 billion,at the end of 1981. This is
about 5% of all lending to small and medium-sizedbusinesses. The wide-
spread use of credit guaranteesin Japan is primarily due to the system's
decentralizedoperation. All the 52 CGCs have strong links, formal and
informal,with local governments,and with local branches of major nationa]L
financial institutions,and with all local credit groups. Political
influenceis brought to bear in negotiatingannual contributionsto the
Guarantee Funds.

The costs of the Japanese system are difficult to determine,

since the credit guarantee corporationshave other sources of revenue
besides guarantee premiums. One study estimated that the actual cost of
the system to the government,including the administrationcosts of the
guarantee institutions,was 2.0% of the guaranteedamount in 1978. The
banks contributea further 0.9% through their lower interestrates, while
the borrowersmake a marginal contributionof 0.1%. Loss rates actually
fell slightly in the years 1979-81,since the absolute value of payments itn
subrogation(net of recoveries from borrowers)increased less rapidly than
total obligationsoutstanding.
 - 41 -

NEW ZEALAND

A loan guarantee scheme for small-scaleindustrieswas introduced

in New Zealand in November 1978 by the Small Business Agency (SBA), a divi-
sion of the DevelopmentFinance Corporationof New Zealand (DFCNZ). The
object of the scheme was to enhance the borrowing capacityof small busi-
nesses which were unable to provide adequate collateralfor regular loans.
In addition to administeringthe guarantee scheme, the SBA provides advi-
sory and referral services, develops small business education and training
programs, and produces publicationson specific topics for small busines-
ses. The main features of the guarantee scheme are as follows:

Eligibility. SBA loan guarantees are available to small firms

engaged in manufacturing,processing,tourism, craft development,and tech-
nology development. Companies providing serviceswhich contributeto New
Zealand's foreign exchange earnings or savings are also eligible. While
the guaranteesare primarily issued for fixed capital loans, they are occa-
sionally issued for working capital also. The maximum amount of the loan
must not exceed NZ$200,000 (NZ$1 = US$0.50 in December 1985). There is no
minimum amount, but firms seeking less than NZ$5,000 are normally encour-
aged to seek bank assistancewithout a guarantee.

Guarantee Fee. The guarantee fee is normally 2% of the guarant-

eed amount, but may be higher in cases of greater risk. If the period of
guarantee coverage exceeds twelve months, an annual charge of NZ$100 or 2%
of the remaining liability,whichever is greater, is levied.

Risk Sharing. The guarantee covers 100% of the loan amount, to a

maximum of NZ$200,000per borrower. There is an overall exposure limit of
NZ$10 million for the whole scheme.

Operation of the Scheme. From the beginning of the scheme in

November 1978 up to December 1985, 450 guarantees amounting to
NZ$15,389,000were approved. The average size of a guaranteewas approxi-
mately NZ$34,000. During the same period, 13% of the approvedguarantees
were invoked because of default, and a total of NZ$1,996,700was paid out
in claims on these guarantees. The administrativecosts for the scheme
were NZ$58,562 for the year ending March 31, 1985, while the amount
received in guarantee fees was NZ$63,847.
 - 43 -

PART II

SCHeMESIN OPERATIONIN DEVELOPINGCONTRIES

 - 45 -

CHAPTER 5

ASIA

INDIA

A credit guarantee scheme for small-scaleindustrieswas intro-

duced by the governmentof India in 1960 in 22 selected districts as an
experimentalmeasure. The scheme was later (1963) extended to the whole
country. The object of the scheme was to increase the supply of institu-
tional finance to small-scaleindustrialborrowers by reducing the risk of
such lending to financial institutions. The original scheme, operated by
the Reserve Bank of India, was modified several times to make it more
flexible. It was eventuallydecided that all credit guarantee schemes
should be brought togetherin one organization,the Deposit Insuranceand
Credit Guarantee Corporation,with a view to improving coordinationand
operational flexibility. In 1981 the corporationwas given the responsi-
bility of dischargingobligationsarising from the previous guarantee
scheme. The corporationintroduceda new credit guarantee scheme of its
own on April 1, 1981.

The main featuresof the scheme are as follows:

Eligibility. The guarantee scheme covers credit for both invest-

ment and working capital for small-scaleindustrialunits and small scale
ancillary units engaged in the manufacture,processing,of goods, or ser-
vicing and repair workshops. Small-scaleindustrialunits are defined as
those whose investmentin plant and machinery does not exceed Rs 3.5
million ([Link]$291,666). Investmentin ancillaryunits cannot exceed
Rs 4.5 million. This definition set in March 1985 representsan increase
in asset size on the previous limit of Rs 2 million.

Participationin Scheme. Participationin the guarantee scheme

is voluntary, and guaranteesunder the scheme are availableonly to insti-
tutions that enter into agreementswith the corporation. Once a credit
institutionjoins the scheme, however, the guarantee cover is automaticand
covers all credit granted to specifiedcategoriesof borrowers. Parti-
cipating credit institutionsare not free to exclude any eligible borrowers
from the guarantee cover.

Guarantee Fee. The guarantee fee is 0.5% per annum on aggregate

credit up to Rs 25,000 (about US$2,083) and 0.75% for credit above
Rs 25,000. The guarantee fee is determinedon the outstandingbalance and
is payable half-yearlyin advance.

Risk Sharing. The scheme provides for reimbursementof 60% .!

of the amount in default for credit extendedup to Rs 0.2 million. In the
case of advances in excess of Rs 0.2 million, a reduced guarantee cover of
50% is provided except in the case of small scale industriesin the back-
ward areas where guarantee cover continues to be available at 60%. The
maximum claim liabilityper borrower is Rs 1 million. Thus, in the event
of a loss on a large loan made by a bank, a major share of the loss would
have to be borne by the bank itself.
3/ The proportionwas 75% up until 1984 when it was reduced to 60%.
 - 46 -

Funding of the Scheme. The credit guarantee scheme is operated

by the Deposit Insurance and Credit Guarantee Corporation,which is a
wholly owned subsidiaryof the Reserve Bank of India with a paid-up capital
of Rs 500 million (US$41.7million) invested in [Link]
share capital of the corporationis held in a general fund.

The administrativeexpenses of the corporationare met entirely

from intereston investmentsof the general fund. Resources from another
fund called the credit guarantee fund are used solely for meeting credit
guarantee claims. Funding for this credit guarantee fund comes from the
fees received for guaranteesgiven by the corporationand the interest on
investmentsof this fund. It is the hope of the Credit Guarantee Corporaw-
tion to be able to cover all claims from the credit guarantee fund.

Claims Procedure. The guarantee is not invoked merely because

of default if there is a chance that the defaultingborrower can be rehabi-
litated. Such rehabilitationusually requiresadditionallending, and in
the event of a later default the guarantee organizationmay question the
judgement of the bank in advancing further credit. This naturally leads to
differing opinions as to whether a particulardefaulter can be rehabilitat-
ed. Institutionsare expected to take effective steps against the availa-
ble collateralof any defaulter and only then to invoke the guarantee for
the balance outstanding. There is no time limit fixed for invoking a
guarantee.

The conditionsto be compliedwith before a claim can be invoked

are: (1) the loan under guaranteehas not been repaid within one month
from the date on which a notice of demand for repaymentof the entire
amount due was served on the borrower; (2) the loan is treated by the
credit institutionas a "doubtfuldebt' and it has been provided for as
such in the accounts of the credit institution. At the time they invoke a
guarantee, credit institutionsare required to certify that the loss has
not arisen due to negligencein appraisal,supervision,and follow-up of
borrowers. This sometimesleads to disagreementas to whether in fact
there has been any negligence.

Operation of the Scheme. Outstandingguarantees increasedfrom

approximatelyRs 30 million in 1960-61 to Rs 21.9 billion in 1976-77 to Rs
58.4 billion (close to US$4.9 billion)at the end of 1985. The number of
participatingcredit institutionsstood at 449 on January 1, 1986. These
included the State Bank of India and its subsidiaries,all the nationalized
commercialbanks, most of the other smaller private banks, state financial
corporations,regional rural banks, other State developmentagencies, and
cooperativebanks.

As of December 31, 1984, 7,360 claims amounting to Rs 804.2

million (around US$67.0 million) were pending under the Government's
previous scheme. These claims are not paid from the credit guarantee fund
but from funding receiveddirectly from the central government. During the
year 1985, 5,259 claims with an aggregateamount of Rs 140.7 million were
received,while 8,597 claims amounting to Rs 319.6 million were disposed of
(i.e., paid out, rejected, or withdrawn). Of this, 5,325 claims amounting
 - 47 -

to Rs 129.2 million were paid out, 3,085 claims amounting to Rs 172.4

million were withdrawn and the remaining 187 claims amounting to Rs 18.0
million were rejected. As on December 31, 1985, 4,022 claims amounting to
Rs 625.3 million were pending.

Under the corporation'sscheme (new scheme), 12,991 claims for an

aggregate amount of Rs 689.1 million were pending as of December 31, 1984;
these are the corporation'sliability. During the year 1985, 22,048 claims
with an aggregate amount of Rs 719.9 million were received,while 22,791
claims amounting to Rs 250.8 million were disposed of. Of the claims dis-
posed of, 18,264 claims amounting to Rs 120.6 million were paid out, 4,116
claims amounting to Rs 116.1 million were withdrawn and 411 claims
amounting to Rs 14.1 million were rejected. As on December 31, 1985,
12,248 claims amounting to Rs 1,158.2million were pending.

The average size of a claim was Rs 30.9 thousand (US$2,575)under

the corporation'sscheme, and Rs 20.2 thousand (US$1,683)under the govern-
ment scheme. Under both schemes the average size of the claims paid out
was much smaller than the average size of the claims withdrawn or rejected,
which in turn was smaller than the average size of claims still pending.
This indicates that the financial institutionsare encounteringdifficulty
in collectingon their larger claims. Under the corporation'snew scheme,
the average size of claims paid out was only Rs 7.8 thousandas compared to
an average claim size of Rs 30.9 thousand and an average size of claims
still pending of Rs 94.6 thousand. Under the previous governmentscheme,
the average size of claims paid out was Rs 13.5 thousand as compared to an
average claim size of Rs 20.2 thousand and an average size of claims still
pending of Rs 155.5 thousand.

The Credit Guarantee fund had a balance of Rs 1.18 billion at the

end of 1984 and had receipts totallingRs 1.06 billion in 1985. Income in
1985 by way of guarantee fees and interestamounted to Rs 1.35 billion.
The claims paid out under the various schemes operatedby the corporation,
as well as the estimated liability in respect of claims submitted to the
corporationbut not yet admitted at the end of 1985 amounted to Rs 1.21
billion (over US$101 million). At the end of 1985 the Credit Guarantee
fund had a balance of Rs 1.25 billion. This serves as a reserve for future
claims.

The data on receipt, claims and outflowsof the credit guarantee

fund for 1984 indicates that claims submitted to the corporationfor the
first time exceededreceipt of guarantee fees (claims totalledRs 1.05
billion, while fees only added to Rs 879 million). This trend is likely to
increase in the near future due to the large and growing percentageof bank
credit tied up in loans to sick industries. This situationraises doubts
on the long-term financialviability of the scheme.

Evaluationof the Scheme. The voluntarynature of the guarantee

scheme has been questionedby several financial institutions(most notably
the commercialbanks and state financing corporations)that are required to
 - 48 -

offer guarantees to make their loans eligible for refinance from IDBI.4 /
This, in effect, virtually makes the guarantee cover compulsoryfor a large
number of financial institutions. Several financial institutionshave
urged IDBI not to insist on the guarantee cover. Also the nationalized
commercialbanks believe that they have little choice but to use the
guarantee cover because the guarantee scheme is operated by a "sister'
public sector institution.

The major complaint of the financial institutionshas concerned

the acceptanceand settlementof claims. Under the original scheme, claims
were to be settled within a month of filing. In practice it takes much
longer; some banks state that in the past many claims were not settled for
2 years or longer but the CGC has reported more recently that claims are
now settled with less delay. The amount of the pending claims also lends
credence to complaintsabout slow settlement. This in turn reduces the
appeal of the guarantee scheme to financial institutions. While conceding
delays in the settlementof claims, representativesof the Credit Guarantee
Corporationargue that banks do not always adhere to the conditionslaid
down in the guarantee agreement. Branch banking leads to further delays,
since the head office of a bank must serve as an intermediarybetween a
particularbranch and the Credit Guarantee Corporationwhenever a question
is raised. There have also been disagreementsbetween banks and the Credit
Guarantee Corporationon the interpretationof certain clauses in the
guarantee agreement. Some of the questions involvedinclude: (I) whether
the firm to which the bank granted credit falls under the definitionof a
small-scalefirm; (2) whether overdue interestshould have been included in
the amount in default; (3) whether due control was exercised by the bank on
the end-use of funds by the borrowers; (4) whether there was negligenceon
the part of the bank in appraisal,supervisionand follow-up.

While admitting to some lapses, officials of the financial

institutionspoint out that from a practicalpoint of view it is very
difficult to fulfill all the required conditionsfor all loans. They think
that the guarantee corporationshould go by the spirit of the agreement
rather than by the letter, especiallyin the case of smaller loans.
Arguing that the guarantee corporationhas often rejected their claims on
flimsy grounds, thereby reducing the credibilityof the guaranteecorpora-
tion. The lending institutionsclaim that this results in loss of
confidencein the scheme.

The Credit GuaranteeCorporationsome years ago changed the

procedurewhich the financial institutions'complain has caused lengthy
delays in the settlementof claims. Earlier issue of a recall notice by a
bank was sufficientto lodge a claim but under the changed procedure a
claim could be made only after exhaustingall possible courses of action
which in some cases could take years.

Another issue of concern to financial institutionshas been the

method for computing the guarantee fee. The guarantee fee is payable on
the entire outstandingloan, whereas the guarantee cover is limited to a

4/ IDBI - IndustrialDevelopmentBank of India.

 - 49 -

ceiling of Rs 1,000,000. The financial institutionsfeel that this proce-

dure in effect makes the guarantee fee very high in relation to the amount
of guarantee coverage provided. Guarantee corporationofficialsjustify
this procedure by saying that this is one way to collect enough fees to
make the scheme fully self supporting,without raising the guarantee fees
for all borrowers.

Conclusions. Two questions arise in relation to the operationof

the credit guarantee scheme in India, namely, whether the introductionof
the scheme has increased the flow of credit to small scale industries;
and whether the guarantee cover is still needed. The introductionof the
credit guarantee scheme was additionalto other major programs and measures
designed to provide credit to small-scaleindustries. One cannot therefore
attribute the increasedflow of credit to small scale industriesover the
years only to the credit guarantee scheme. Policy decisions of the
government had much to do with the increase. However, the impression
gained from several commercialbanks is that the existence of the guarantee
scheme has had a favorablepsychologicaleffect on branch managers by
persuading them to provide credit to small-scaleindustrieswhich would not
or could not provide adequate collateral.

To answer the second question, one must go back to the original

objective of the guarantee scheme, which was to encourage increased credit
to small-scaleindustriesby reducing the higher risk consideredto be part
of such lending. This objectivemay no longer be valid. Today, by virtue
of their charter, financial institutionsmust lend to small-scaleindus-
tries. The major banks in the public sector are mandated by law to lend a
substantialportion of their loanable funds to this sector as well.
Therefore,it may be that no further inducementsare needed to increase
lending to small-scaleindustries.

Participationin the credit guarantee scheme by financialinsti-

tutions has been fairly widespread. However, several features of the
scheme may need to be reexamined,such as its so-called "voluntary"charac-
ter, the manner in which the guarantee fee is levied, and the procedures
for invoking the guarantee by the financial institutions,and for settle-
ment of claims.
 - 50 -

INDONESIA

In 1971 the Indonesiangovernment set up Askrindo, a publicly

financedcredit insurancecorporation,to provide coverage against defaults
on business loans to both large and small enterprises. After the
introductionin 1974 of the KIK/KMKP lending program, through which Bank
Indonesiamade small credits available for fixed asset investmentand
working capital for indigenoussmall enterprises,Askrindo insurance
coveragewas provided also for loans under this program. The loans, given
mainly through banks (mostly state-owned),are rediscounted75% by Bank
Indonesia.

Guarantee Fee. Askrindo charges a one-time guarantee fee of 3%

for 3 to 5-year loans. Ralf of the cost is borne by the administering
bank, and half by the Central Bank. The fee is 1% for loans of a year or
less.

Risk Sharing. Askrindo provides a guarantee for 75% of each

loan. As of 1983, loans under KIK/KMKPwere limited in amount to the
equivalent of about $15,000.

Operation of the Scheme. The annual volume of loans insured

under the program rose from $60 million in 1974 to $270 million in 1978.
In 1981-82,over 56% of KIK/KMKP credit went to trade, 9% to agriculture,
13% to services, 12% to manufacturing,and the remainder to other sectors.

In 1980-82, efforts were made to strengthenAskrindo'sorganiza-

tional structure and management in order to support the expandingKIK/KMKP
lending program more effectively. While these measures appear to have been
successfulin speedingup the claims procedure for KIK/KMKP losses, it was
felt by 1983 that the role of Askrindo needed to be reexaminedfurther to
determinewhether Askrindo'soperating policies cause it to assume a dis-
proportionateshare of the repayment risk, given the premiums it receives,
and whether the terms and conditionsof Askrindo'scoveragegive banks less
incentive to pursue loan repaymentsvigorously. Claims for losses on loans
insured by Askrindo have been rising steadily since 1979; claims on KIK/
KMKP losses rose from Rp 6.0 billion in 1981 to Rp 13.2 billion (around $13
million) in 1982.

At the end of 1983 it was claimed that Askrindo'sover-generous

terms had contributedto a high arrears and default rate in the KIK/KKKP
programs, and it was proposed that the proportionof loans insured by
Askrindo be reduced from 75% to around 60% and that the premium be raised
from 3% to 4%. The additional1% was to be paid by the borrower. As of
mid-1985 the proposed changes were still being studied.
 - 51 -

REPUBLIC OF KOREA

The Korea Credit Guarantee Fund (KCGF) was establishedas a

special public corporationby the Credit Guarantee Fund Act of June 1976.
Its major activitiesinclude a credit guarantee service, the provision and
management of credit information,as well as technicalassistancefor small
and medium-industry. The declared purpose of the KCGF is to make finance
available for business firms by guaranteeingpayment of the liabilitiesof
these firms.

KCGF has 16 departmentsin its head office and 24 branches

throughoutthe country; at the end of 1982 it had close to 1,300 employ-
ees. The board consistsof 15 members including the president of the KCGF,
who is also the chairman of the board, one person from the Ministry of
Finance,8 executivesof financial institutions,and 5 representativesof
private enterprises.

The following are the major featuresof the KCGF's operation:

Eligibility. KCGF extends guarantees for loans issued by banks

for bonds, for payment of taxes and duties, for bills, for loans by non-
banking financial institutions,and for leases. Guaranteesfor taxes and
duties are designed to relieve a company of immediate cash expendituresby
deferring the payment of taxes and duties. Guaranteesfor leases can be
used as required collateralwhen a business firm leases productionfacili-
ties. Guarantees for bills can be used as a guarantee for payment of notes
payable or receivableand collateralbills. Creditworthybusinessfirms
which lack sufficientcollateralcan make use of KCGF when they borrow
money from banks, short-termfinance companies,and insurancecompanies by
furnishinga letter-of-creditguarantee from KCGF. Before the issuanceof
a letter-of-creditguarantee,KCGF reviews the application,interviewsthe
entrepreneurs,and conducts a credit investigationand analysis. Guarant-
ees are approved only after thorough screening. KCGF covers all types of
enterprisesexcept forestry, fishing, agriculture,and real estate. KCGF
also provides informationon the credit rating of enterprises.

The maximum guarantee depends on the scale of the business. The

maximum for large business is W 1 billion 5/, for small and mediumr-sized
businessW 800 million, and for very small business 100 million Won.
However in sectors designatedas of special importanceto the development
of the economy, the maximum limit of guaranteehas been set at W 5 billion
for large businessesand W 3 billion for SMI. An enterpriseis considered
a small and medium-sizedbusiness if it employs less than 300 persons and
is classifiedas very small if it employs less than 50 persons.

GuaranteeFee. The guarantee fee is 1% per annum of the amount

guaranteed, for all types of guarantees.

5/ US$1 - W 750 (1982)/W 870 in June 1985.

 - 52-

Risk Sharing. The guarantee covers 80% of the loan amount.

Funding of the Scheme. KCGF is funded by the governmentby means

of a levy imposed on the profits of all banks and by the 1% per annum
guarantee fee. The initial capital was W 33.2 billion (approximatelyUS$73
million) and had grown to W 139 billion (approximatelyUS$190 million) as
of December 31, 1981. The total of all guaranteesavailable for business
firms is 15 times the capital of KCGF. When the KCGF was establishedin
1976 the ratio of 15 times was consideredadequate to cover the demand for
guarantees. But during the next 6 years the scale of business activity
exceeded expectations. As a result, the total guaranteedbalance jumped
from approximately3 times the capital of KCGF in 1976 to more than 11
times the capital in 1981 but dropped again to 7 times in 1985. The total
guaranteesreached a peak of 12.09 times the capital funds in 1982.

Claims Procedure. When a company defaults,KCGF subrogatesthe

amount of the balance on its credit guarantee accounts to the banks. The
organizationsconcerned are compensatedfor their loss directly by KCGF.

Operation of the Scheme. As of December 31, 1981, the outstand-

ing balance of guaranteesissued reached the sum of W 1,544 billion (US$2
billion approximately),an increase of 23% over that of the previousyear.
In 1985, it reached W 1,895 billion (around US$2.3 billion)b/ Credit
guarantees for small business stood at 40.9% of all guarantees in 1976,
56.8% in 1979, 63.1% in 1981, 81.6% in 1983, and 90.6% in 1985. Meanwhile,
the proportionof credit guaranteesfor large businesshas been steadily
declining. A breakdown of KCGF guaranteesby type of industryand by type
of guarantee is given below.

Evaluationof the Scheme. By all accounts the KCGF has been

effective in providing guaranteesto small and medium firms seeking loans,
although there is evidence that its main activityhas been the guaranteeing
of loans given by the three governmentowned banks--the Small and Medium
Industry Bank (SMIB), the Citizens National Bank (CNB), and Korean Develop-
ment Bank (KDB) rather than guaranteeingloans given by commercialbanks.
Detailed figures are not available on claims made against guarantees,but
it is known that there were very few before 1979. After 1980, due to more
difficult economicconditions,defaults and claims against KCGF increased
considerably. The profit and loss statementsfor 1984/85 (see Table 5-1)
show that there were significantnet losses on operations. It is also
evident from the statementthat due to large reservescreated during the
initial funding of KCGF, the fund earned substantialintereston its
holdings. Income from the guarantee fee covered "Generaland
AdministrativeExpenses" up to 1982 but by 1984-85 the fees no longer
covered these costs.

6/ There was a decrease to W 1,310 billion in 1983.

 - 53 -

Credit Guarantee by Economic Sectors

(as of end 1981) - (Unit: 100 mil. Won)

Type of
Business Amount Ratio

Manufacture 11,122 72.0

Wholesale & Retail 1,192 7.7
Mining 98 0.6
Construction 2,402 15.6
Transportation& Storage 481 3.1
Others 147 1.0

Total 15,442 100.0

Credit Guarantee by Type of Guarantee

(as of end 1981) - (Unit: 100 mil. Won)

Type of Guarantee Amount Ratio

Guarantees for loans 8,582 55.6

Guaranteesfor payment
issued by banks 1,615 10.4
Guaranteesfor loans of Non-
Banking Financial Insti-
tutions 795 5.2
Guarantees for Leases 252 1.6
Guaranteesfor Bonds 3,707 24.0
Guarantees for Bills 428 2.8
Guaranteesfor Taxes and Duties 63 0.4

Total 15,442 100.0

 554-

MALAYSIA

The Credit Guarantee CorporationMalaysia Berhad (CGC) was

establishedby Bank Negara Malaysia in 1972 with the primary objective of
encouragingcommercialbanks to extend more credit to small-scaleenter-
prises. It was establishedas a limited company with a paid-up share
capital of M$2.5 million. Shares were held jointly by Bank Negara and all
the other commercialbanks licensed to operate in Malaysia.

The CGC has undertakentwo credit guarantee schemes;(1) the CGC

General Scheme (CGC/GS)which was started in January 1973, and (2) the CGC
Special Loan Scheme (CGC/SLS),which was started in January 1981.

CGC General Scheme

The general features of the CGC/GS Scheme are as follows:

Eligibility. Companieswith paid-up capital and reserves not

exceeding M$100,000 are eligible, provided they are registered,operated,
and owned by Malaysian citizens. The maximum loan limit that can be
guaranteed is M$100,000 and M$200,000 for Bumiputras (ethnic Malays), with
the ceiling per loan at M$30,000.

Guarantee Fee. The guarantee fee is 0.5% per annum of the

outstanding loan amount. The interestrate for loans is set at 1% below
the base lending rate.

Risk Sharing. The risk covered by the guarantee is 60% of the

outstanding loan amount.

Claims Procedure. The CGC has the right to reject claims if the
quality of loan appraisaland follow-up by the individualbank is found to
have been poor. It is the responsibilityof the participatingbanks to
ensure that the loan is actually used for its intended purpose,and also
for recoveringamounts due under the guarantee scheme. Before submittinga
claim to CGC the banks must take all possible legal steps to recover the
loans. The costs of legal action must be borne by the banks themselves.
To alleviate some of the burden of legal costs on the banks, the CGC waived
requirementof legal actions on claims for loans below M$5,000, provided
that legal action is taken on one out of every five such cases.

CGC Special Loan Scheme

The Special Loan Scheme (CGC/SLS)was introducedby the CGC in

January 1981. The CGC/SLS differs somewhat from the CGC/GS.

Eligibilitywas widened to include all registeredbusinesseswith

net assets of less than M$250,000 or limited companieswith eligible share-
holders funds of less than M$250,000,with a loan limit in both cases of
M$250,000. The maximum loan under the CGC/SLS is M$50,000 for each borrow-
er, which can form part of total borrowingsup to the M$250,000 limit.
 - 55 -

The CGC/SLS guidelinesalso state that the loans may be made without secur-
ity unless the loan is used to buy fixed assets. No penalties are levied
on banks for taking additionalsecurity. In practice, therefore,the banks
in many cases have obtained additional securityagainst their SLS loans.

Another differencebetween the two schemes is the interest rate

charged. Under the CGC/SLS the interest rate is 7.5% per annum, as compar-
ed to 8.5% per annum under the CGC/GS.

Operation of the Schemes. In 1973, the CGC's first year of oper-

ation, 2,292 loans amounting to M$11.8 were approved,of which M$5.9 mil-
lion was disbursed. In 1976, there was a sharp increase in the total
amount of loan approvals to M$164.3 million. By 1981 the loan approvals
increased to M$523.9 million on a total of 18,309 applications. Since
then, however, loan approvals dropped to M$519.3 million in 1982 and
M$298.3 million in 1983.

The corporation'sportfolio as of December 1982 included71,288

loan accountswith an approved value of M$1,374.98million. Loan cancella-
tions (includingloan repaymentsand loans reclassifiedoutside the schemes
for a variety of reasons) totalled 7,330, with an approvalvalue of
M$150.31 million during the year. Deducting these, and adding on the new
loans approved, net outstandingloans accepted for guarantee at the end of
1983 totalled 74,521 and were valued at M$1,522.99million. The outstand-
ing value of these loans amounted to M$964.85 million as of December 1983,
giving a utilizationrate of 63.4%. By end 1985 there was a total of
approximately80,000 accountswith CGC, coveringa total outstandingloan
amount of M$850 million.

Loans guaranteedby the CGC were directed at three broad sectors

-business, agriculture,and industry. Lending to the general business
sector accounted for the largest share (80%) while agricultureand industry
each received 10%.

The handling of claims has been very poor, as the figures show.
Up to December 31, 1981, a total of 1,342 claims amounting to M$4.39
million had been lodged with the CGC. Of these, only 132 claims for
M$277,787 had been paid out, while 760 claims for M$2.17 million had been
rejected. In 1983 a total of 254 claims amounting to M$1.9 million were
considered. Total settlementsmade by the corporationin 1983 amounted to
M$117,122 on a total of 94 loans, comparedwith M$77,000 on 45 loans in
1982. By end 1985 a cumulativetotal of 1,935 claims had been processed,
with an additional127 involvingan amount of M$1.45 million still out-
standing. Of the claims processed only 429 were paid out, involving a
total sum of M$1.27 million. Of the remainder, 1,186 claims were rejected
(for M$6.44 million) and 320 were withdrawn by the banks. Most of the
claims consideredwere rejected or found not eligible for compensationon
the ground that they did not comply with the terms and conditionsof the
guarantee cover. These figures explain some of the loss of confidenceof
the commercialbanks in the scheme.
 - 56 -

The Malaysian scheme seems to have been poorly planned in that

inadequateprovisionswere made for handling claims. Five years after the
central bank guidelinesfor CGC guarantee loans were introduced,the CGC's
capital fund (includingprovisions for claims) amounted to only 4.4% of its
guaranteeobligations,while doubtful accounts reportedby the participa-
ting banks amounted to 20% of the outstandingguaranteedcredits. The
scheme seems to have been introducedwith the aim of helping Bumiputrasor
indigenousMalays-without real thought as to what the costs of the scheme
would be. Perhaps the most disturbingfeatures of the CGS is that even
after 10 years of operation,it has not yet a clear picture of the risks
associatedwith small-scalebusinessesin Malaysia. Although CGC issued
guidelines (in 1985) to commercialbanks relating to the credit analysis of
their small-scaleclient, it remains a passive institutionwhich tries to
keep its liabilitiesto a minimum by rejecting claims on grounds of
"administrativeirregularities."

In 1982, at the request of the Malaysian government,the World

Bank sent a consultantto Malaysia to review the scheme. One of his find-
ings was that the scheme was grossly underfunded in light of the volume of
guaranteesgiven. The consultantalso recommendedraising the guarantee
fee to 1% and the share capital to M$40 million, and pointed out that these
measures alone would not make the CGC solvent unless the manner of its
operationwas changed.
 - 57 -

NEPAL

The "Credit Guarantee Corporation"was establishedin Nepal in

1974 with the purpose of guaranteeingthe loans advanced by commercial
banks to the agriculture,industry,and service sectors. In addition to
the Governmentof Nepal, Ministry of Finance which owns 40% of the shares
of the corporation,the other shareholdersare Nepal Rastra Bank (i.e., the
Central Bank of Nepal, 44%), Nepal Bank Limited and Rastriya Banijya Bank
(8% each). The Board of Directors of the Corporationconsists of one
representativeeach from the Governmentof Nepal, Nepal Bank Limited,
Rastriya Banijya Bank, and three from Nepal Rastra Bank. The objective of
the scheme was to increasethe supply of credit to generate income to low
income groups and create employmentopportunities. Prior to the establish-
ment of the Credit Guarantee Corporation the share of commercialbank
lending to small enterpriseswas minimal because of their perceived higher
risk and their inability to provide adequate collateral. It was felt that
commercialbanks were in a position to increaselending to the high priori-
ty small enterprise sector since they controlledmost of the financial
resources and had extensive branch networks. The main featuresof the
guarantee scheme are as follows:

Eligibility. Credits advanced by members institutionsup to

NRs 0.2 million (US$10,000)per loan in the agricultureand service sectors
and NRs 1 million (US$50,000)per loan in the industry sectors is automati-
cally guaranteedunder the scheme. The banks are required to send quarter-
ly statementsto the CGC giving all the details of loans such as name of
borrower, purposesof the loan, amount, maturity date, etc.

Guarantee Fee. The guarantee fee is fixed at the rate of 1% per

annum or 0.25% per quarter on quarterly balance outstandingon the total
amount of loans advanced. This fee was raised to the present level from
0.75% in early 1986.

Risk Sharing. The corporationreimburses the member institution

after scrutinizingthe claim documents. The reimbursementprovided is 75%
of the outstandingloan, and of this amount CGC pays out 50% as advance
compensationupon receipt of a claim and the remainderonly after receiving
the report of an auditor identifyingthat the loan is unrecoverable.
Recently, CGC has made some changes in the filing of claims. In some
instancesa member institutioncan now file a claim before the due date of
the loan if there is a default due to natural calamitiesor reasons beyond
control of the borrower. It is the responsibilityof the member
institutionto proceed with recovery of the loan from the borrower. The
member institutionis to take actions against the borrower to recover the
loan within six months of receivingcompensationfrom CGC.

Funding of the Scheme. The CGC was initiallyestablishedwith an

authorized, issued and paid-up capital of NRs 3 million. At present
(1986), the authorizedcapital stands at NRs 60 million, the issued capital
at NRs 30 million and the paid-up capital at NRs 15 million. Out of the
 - 58 -

paid-up capital of NRs 15 million,NRs 7.5 million is owned by the

Governmentof Nepal, NRs 5.5 million by Nepal Rastra Bank and NRs I million
each by the two commercialbanks, Nepal Bank Limited and RastriyaBanijya
Bank. Additional funding for the guarantee scheme comes from the guarantee
fees and the interestearned on investmentof this fund. After operating
under the central bank's priority sector lending guidelines for seven
years, the CGC's capital fund amounted to 8.6% of its guarantee
obligations,while reported overdue loans amounted to 52% of outstanding
guaranteedcredits; the situation had not improved significantlyup to 1986
despite a 3.6 times increase in the CGC's capital fund.

Operation of the Scheme. The central bank lending guidelinesfor

the priority sector were introducedat the same time as the establishment
of the CGC; all priority sector loans below a certain size were to be auto-
matically guaranteedby the CGC. As a result it is difficult to determine
to what extent the commercialbanks would have used the servicesof the
credit guarantee organizationif they had been provided on a completely
voluntary basis. One immediateresult of the impositionof the central
bank guidelineswas that, because the commercialbanks were completely
unpreparedfor lending on a large scale to the small-scalesector, many of
the guaranteedsmall loans made for the first 5-6 years were not properly
appraised,and supervised. The situationwas further exacerbatedby
interest rate ceilings imposed on guaranteedloans which did not allow the
commercial banks a large enough spread to take into account the higher
administrativecosts of lending to this sector. The overall result was
that a large number of guaranteedloans went to small enterpriseswhich
were not viable. The loans were not properly utilized, went to ineligible
enterprisesor for ineligiblepurposes, and in most cases fell into
arrears. Since guaranteeswere provided virtually on an automatic basis,
the volume of guaranteedobligationsgrew rapidly in line with the central
bank lending guidelines;however, CGC had no control over the quality of
the credits which they guaranteed. Also, as credits were accepted for
guarantee without any screening,deficienciesin meeting the guarantee
guidelineswere usually not discovereduntil claims were scrutinized;at
which point the claims were rejected. The commercialbanks then realized
they would have to improve their loan processingproceduresin order to be
able to have their claims approved. However, the inadequateinterest
spread they received for loans under the central bank guidelinesdid not
allow them to take steps to improve the situationwithout affecting their
profitability. Accordinglythey resorted to other means to reduce their
risk, such as taking full collateralcoverage against guaranteedloans, or
allowing the loans to be used improperlybut with less risk for such
purposes as making fixed deposits,which essentiallydefeated the purpose
of the guarantee scheme. A World Bank adviser reviewed the scheme in April
1986 and made recommendationsfor changes.
 - 59 -

PHILIPPINES

The IndustrialGuarantee and Loan Fund (IGLF) establishedin 1952

under an agreementwith the predecessor to USAID is not really a guarantee
scheme in the pattern of the others described in this paper. The main
function of the IGLF was to provide credits to the small and medium indus-
tries (SMI) by refinancingloans made by financial institutionto SMI
borrowers. To provide an incentive to financial intermediariesto use the
loan fund, part of the loan made was guaranteed. The IGLF had only very
limited success in its first years of operation and was little used by
banks.

The World Bank became associatedwith IGLF in 1975, when changes

were introduced,particularlyin the compositionand role of the Inter-
agency Review Committee (RC) which advises and supervisesIGLF on policy
matters. Previously, each loan submitted for rediscountingand for guaran-
tee had to be reviewed and approved by the RC. On the Bank's advice, a
system of RC accreditationof financial institutionswas adopted; after
such accreditation,any loans from the institutionto SMI conformingto the
directivesof the IGLF were automaticallyrediscountedand guaranteed to a
maximum of 60%. Since 1976, therefore,accreditedfinancial institutions
have taken full responsibilityfor appraisingand approving projects submi-
tted for financing. This has reduced the time taken to approve loans from
months to a few days, once appraisal is completed.

The RC originallyincluded representativesof the National Econ-

omic DevelopmentAuthority (NEDA), the Central Bank (CB), the Universityof
the PhilippinesInstitute of Small Scale Industries(UP-ISSI),and the Min-
istry of Industry (MOI). In 1978 the membershipwas broadened to include a
representativefrom the Ministry of Finance (MOF), and the level of rep-
resentationwas upgraded to give the RC greater influenceon the formula-
tion and implementationof policies and programs. Since investmentdeci-
sions are now made by the accreditedlending institutionsand merely
reported ex-post to the RC, the latter can pay more attention to policy
issues.

The IGLF program is administeredby the Central Bank's Department

of Loans and Credit (DLC). This unit now engages mainly in promotional
work to increase the use of the IGLF, which involves identifyingand eval-
uating institutionsfor accreditation,and monitoring of their operations.
It was found that some financial institutions,mainly rural banks, were not
able to meet the requirementsfor accreditation,but they were allowed to
use the IGLF on an 'ad hoc' basis, submittingeach case for approval; these
applicationsare processedby a special division in the IGLF unit of the
DLC. The professionalstaff of this unit grew from 18 in September 1975 to
23 in November 1978, to 43 in 1980 and 66 in 1982.

The main featuresof the guarantee scheme are as follows:

Eligibility. Loans made to cottage small and medium-scale

industriesin the manufacturingand service sectors by participating
 - 60 -

intermediaries,are eligible to receive guarantees. Cottage industries

refer to enterpriseswith assets of not exceeding-P250,000(US$12,500in
1986), small-scaleindustrieshave assets above *250,000 but not more than
F2.5 million. Medium-scaleindustriesare those whose assets are in excess
of P2.5 million, but not more than f10 million.

Participationin the Scheme. In order to have access to the IGLF

both for rediscountingand guarantee coverage, financial institutions-
commercialsavings banks and non-bank financial intermediaries--must be
accreditedby the Central Bank. To meet accreditationrequirements,a
financial institutionmust have a specifiedminimum net equity, a loan
portfoliowith arrears below a given level, and sufficientstaff for loan
appraisalsand efficientdisbursement. In all 34 institutions7/ were
accreditedby 1985, 18 of them being commercialbanks, 7 were non-bank
financial intermediaries(NBFI) 2 were savings/mortgagebanks and 7 were
ptivate developmentbanks (PDB). In general, the accreditationscheme
has worked quite well, despite a slow response of the institutions,but the
view has been expressed that the performanceof;the accreditedinstitutions
should be more closely monitored. In recent years the DLC has withdrawn
accreditationfrom institutionswhen the arrears ratio of the portfolio
passed 15%.

Guarantee Fee. The fee charged is 2% of the guaranteedpercent-

age of the loan outstanding. The fee for a collateral-shortguarantee is
passed on to the borrowerwhile the fee for a credit-riskguarantee is
absorbed by the financial institutionmaking the loan.

Risk Sharing. The IGLF originallyoffered two types of guaran-

tees. The first type--collateral-slhort guarantee--wasavailable for small
loans to cover collateraldeficiencyup to an amount equivalentto 25% of
the loan amount. This would be a fixed absolute amount guaranteewhich
covered first losses to the extent of the guarantee or the loan outstanding
whichever was lower. The second type was a credit-riskguarantee for small
and medium loans for an amount not exceeding 60% for small loans and 40%
for medium loans. In practice,no use was made of the "collateral-short"
guarantee until late 1982 and then only in a small number of cases.
Lenders preferred to take collateraland accept the guaranteeas extra
coverage for 40 to 60% of the loan. The IGLF also originallyoffered
accreditedinstitutionsa straight guaranteeup to a maximum of 80% of
loans if the lending institutionsmade use of its own funds, but no insti-
tution has made use of this arrangement.

In 1982, total lending through IGLF reached P188.3 million (US$26

million)-about 26% was through commercialbanks and 62% through non-bank
financial intermediaries. Two of the latter (PDCP and MANPHIL) probably
accounted for around 50% of all IGLF lending in 1982. The commercialbank
IGLF portfolio at end of 1984 was P530 million (approximatelyUS$30
million). In the beginning of 1983, some private developmentbanks dropped

7/ Following the grave financial crisis in the Philippines in 1985, 10 of

these institutionswere under receivershipand only 21 were active
participantsof the IGLF.
 - 61 -

out of IGLF and started lending to small and medium-industries(SMI)

through an arrangementwith DBP (DevelopmentBank of the Philippines)which
makes loans directly to SMI and not through IGLF.

Settlementof Claims. The time period taken for settlementof

claims has been a point of dispute between IGLF and the commercialbanks.
The commercialbanks claim that it takes IGLF over 3-4 months to settle
claims. IGLF denies this generally,but states that in specificcases this
may be so; it claims the commercialbanks are to blame for providing
insufficientdocumentationwhich causes delays. As virtually all loans
through IGLF are made by lending institutionsagainst collateral,in the
case of default the lenders are required to take steps to forecloseon all
such security to recover what they can before the IGLF will agree to settle
claims for outstandinglosses. This process takes time.

As of end 1984 there were 79 cases of foreclosure,18 of these in

the year 1984. Based on the claims of the financial institutionsinvolved,
IGLF stood to share losses to the amount of P1,170,430.20(about
US$70,000). However, all the claims were in various stages of processing
and had not been settled by the end of 1984. Total guarantee fees collect-
ed for 1984 amounted to #3.440 millions (around US$200,000). The amount
provided for losses against guaranteed loans for 1984 was i4,695 millions.
The actual amount written off during 1984 was 1.048 million (around
US$62,000) to cover IGLF's share of the losses on 8 foreclosedaccounts.

One point that emerged from a Universityof the Philippines/

Institute for Small-ScaleIndustriesstudy in 1980 of a sample of IGLF
borrowerswas that the long processingtime distorted the calculations
submitted,because allowancesfor inflationwere inadequate,and the SMI
thus faced financialdifficultiesfrom the start. The tendencyof the
lending institutionto approve only part of the amount requestedfurther
aggravated the situation.

The data show a diversity of experienceamong the accredited

institutions. Some used IGLF occasionallyand selectively,and found it
profitable; in the best case the number of arrears has been kept to less
than one in twenty. Other institutionshave been less discriminating,and
have had 50 to 90% of loans in arrears. Clearly, the former group applied
stricterstandards and investedmore effort in loan appraisal,investiga-
tion of credit records, supervisionand collection. This subtantially
reduced losses from arrears and defaultsbut also raised administrative
costs. Some banks managed to minimize these costs while still keeping
risks low by concentratingonly on borrowerswith very good credit stand-
ing. But this greatly reduced their overall use of IGLF and largely
defeated its purpose.

In order to increaseuse of the IGLF, operationalchanges were

introducedin 1979. The changes raised the effective interest rate to the
 - 62 -

final borrower by 1984 from 11% to 21% 8/ and increased the spread allowed
the participatingintermediariesfrom 5% to 8% for small industryloans and
to 6% for medium industry loans. This helped to cover the high transaction
costs, and made IGLF more attractivethus encouragingmore institutionsto
seek accreditation. As of 1984, the maximum limit on loan size was raised
to 10 million (then around US$600,000)making the program more attractive
to commercialbanks.

Review of Fund. The scheme appears to have achieved the objec-

tive of expanding institutionallending to SMI. Since all lenders continu-
ed to require collateral,however, the scheme did not do a great deal to
widen access to finance for small industriesthat could not provide colla-
teral.

As stated earlier the prime objective of the IGLF was to provide

credits through a variety of institutionsfor onlending to small and medium
industries. The guaranteeof 40-60% of losses was meant to induce banks to
lend to under-collateralized borrowers. As most of the financialinstitu-
tions were unwilling to accept less than 100% collateralbefore approvinga
loan, the guarantee through the IGLF only served to increasethe cost of
borrowing to fully collateralizedborrowers since the 2% guarantee fee was
passed on to the borrowersby the [Link] 1982 the gua-
rantee coveragebecame optional and borrowers could use the IGLF without
paying for a guarantee. One report shows that during November 1985 out of
33 disbursementsfrom IGLF from a World Bank loan, only 7 borrowers took
guarantees. One was for a collateralshort guarantee amounting to 20% of
the subloan, three others were credit-riskguaranteesfor 60% and three for
credit-riskguarantees for 40%.

In general the IGLF can be consideredto have succeededmore as a

loan fund and less as a guarantee scheme. Slowly after 1983 some financial
institutionsdid make limited use of the guarantee part of the IGLF to
reduce collateralrequirements. Still, the IGLF in 1986, after over ten
years active operation,refinances 100% of the onlending under IGLF and has
not yet succeeded in inducing the financial institutionsincluding the
commercialbanks to use some of their own funds.

8/ In November 1984 the interest rates were raised to 16 to 23%. The

spreads were 7% for small industriesand 5% for medium-scale
industries.
 - 63 -

SRI LANKA

Sri Lanka introduceda Small IndustriesCredit Guarantee Scheme

in the 1970s, administeredby the Central Bank. This scheme was modified
in 1979 to provide guaranteesfor loans made to SMI through the World Bank
line of credit to the National DevelopmentBank (NDB), which was channelled
through four commercialbanks.

Guarantee Fee. A 1% premium on the outstandingamount was

payable by the lending institution. Applicationsfor guarantee coverage
were made separatelyfrom loan applications,but approval of loans by the
SMI Fund facilitatedrapid review of guarantee applicationsby the Central
Bank. Early in 1984 it was decided to pass on the charge for the premium
on the guarantee to the borrower.

Risk Sharing. Generally, these loans to small enterpriseswere

guaranteed through the Central Bank fund to a maximum of SL Rs 400,000 9/
or 60% of the loan, whichever was less. SL Rs 400,000 representedat that
time 40% of the maximum loan size allowed under the World Bank credit
line. In 1981, under a second credit line from the World Bank, the maximum
was raised to SL Rs 800,000,which was 40% of the increasedmaximum loan
size of SL Rs 2 million.

Evaluationof the Scheme. Even on loans for which guarantees

were undertaken, the commercialbanks continued to demand collateral,
fearing that claims for payment from the fund would run into bureaucratic
problems. By early 1983 there were 15 SMI loans against which the Central
Bank guarantee had been invoked for an amount equalling SL Rs 5.38 million
(about $240,000). The NDB reported at that time that SL Rs 1.017 million
($57,000) had been paid out. Also, it was reported in April 1983 that the
Central Bank was claiming that insufficientor inconsistentdocumentation
from the banks was holding up payment on claims under the scheme. The
banks, in their turn, were losing interest in the guarantee scheme and were
demanding collateral. There was also a fall-offin lending to SSE by the
banks, but it was not clear to what extent this was linked to dissatisfac-
tion with the guarantee scheme.

9/ US$1 - SL Rs 25.00.
 - 64 -

THAILAND

In May 1985 the Asian DevelopmentBank (ADB) approved a technical

assistancegrant to Thailand to help the IndustrialFinance Corporationof
Thailand (IFCT) set up a new financial facility, the Small IndustryCredit
Guarantee Fund (SICGF). This was designed to promote direct lending by
financial institutionsto the small-scaleindustry sector through provision
of loan guarantees to enterpriseswhich did not have sufficientcollateral
to borrow from financial institutions.

SICGF will be part of IFCT for the first five years of its opera-
tions, after which if successfulit will become a statutory credit
guarantee corporationto be establishedunder a special act of Parliament.

SICGF's guidelineswere only finalizedin May 1986 after the

first set introducedin November 1985 drew a negative reaction from the
bank and small scale entrepreneurs. The SICGF first wanted the banks to
undertake an appraisalof each project similar to one done by a development
bank. As this was unacceptableto the banks, consideringthis too time
consumingand administrativelycostly, the SICGF agreed to rely on the
commercialbanks' own credit screeningprocedures.

In general SICGF will guarantee 80% of the collateral-short

portion of loans but may in exceptionalcases cover 100%. In order to
simplifyprocedures the SICGF agreed to accept the banks' estimate of the
collateralavailable. SICGF only requires as a minimum that the fixed
assets financedunder the project be pledged as collateral.

Guarantee Fee. The SICGF's guarantee fee is 1.5% per annum

payable in advance on the guaranteedamount.

Guarantee Fund. The SICGF was formallyestablishedin April 1985

with a capital fund of B 200 millions (US$7.6 million) contributedby the
Thai Government (Ministryof Finance), all the Thai banks and the IFCT.

Eligibility. SICGF guarantees are available on loans to firms

with total net fixed assets of less than B 10 millions. The loan size
should be not greater than B 5 millions nor less than B 200,000.
Guaranteesare available on loans for fixed assets and working capital.

Operations. Initially the SICGF proposed that claims be paid

only after the bank has taken all steps to forecloseon all the security
pledged against the loan. The shortfall between the loan amount, including
accrued interest, and the recovered amount would be the collateralshort
amount of which the SICGF would reimburse 80%. As the SICGF now accepts
the collateralvalue as estimated by the bank all the claim is settled
after the legal proceedingshas resulted in a final judgment against the
borrower. If afterwards the bank recoversmore than the collateralcovered
portion of the loan from liquidationof the security, it has to share this
amount on a pro rata basis with the SICGF.
 - 65 -

In the initial months the scheme moved slowly and commercial

banks were still reluctant to use it. Only a few guaranteeswere given out
in the first three months.

SICGF may extend guaranteesup to 100 percent of each loan made

to a small-scaleenterprise,but total outstandingguaranteesare not to
exceed SICGF's total capital funds. It is envisaged that SICGF's opera-
tions will be financed by income from guarantee fees and from the
investmentof SICGF's capital funds in the financialmarket. The fund is
to be a tax-exemptservice-orientedentity and is expected to earn enough
revenues to make the guarantee scheme self-sustainingin the course of
time.
 - 66 -

CHAPTER 6

AFRICA

CAMEROON

In Cameroon,a credit guarantee fund (FOGAPE - Fonds d'Aide et de

Garantiedes Credits aux Petiteset MoyennesEnterprises)was established
in 1975 to guaranteeloans providedeither by commercialbanks or by Banque
Camerounaisede Developpement(BCD) for SME investmentprojects. FOGAPE is
funded partly by subventionsfrom the governmentand partly througha 10%
annual levy on the profits of commercialbanks. The guaranteeceiling is
set at CFAF 30 million per borrower (equal in 1985 to US$66,700)or 80% of
the loan, whichever is lower.

By November 1981, after six years of operation,the fund had

given 159 guaranteesand had only four claims of loan defaults,two of
these on BCD loans. FOGAPE was allowed to give guaranteesup to 7 times
its asset base but only had commitmentsfor 1.6 times by June 1980, about
five years after startingoperations. By June 1984 a total of 268
guaranteeshad been providedby FOGAPE. Total FOGAPE guaranteesamounted
to CFAF 3.9 billion (mostlyfor term loans) as comparedwith outstanding
term credits from the banking sector of CFAF 226 million. These figures
put FOGAPE'soperationsinto perspective. FOGAPE'soperationswere essen-
tially aimed at smaller SMEs, with the averageFOGAPE guaranteecovering
65% of a loan; in practice,the average loan guarantee amountedto CFAF 14
million (aroundUS$30,000). Approximately60% of FOGAPE'sguarantees
covered loans made by BCD, which also provided the largest loans for which
FOGAPE providedguarantees. The smallestloans guaranteedby FOGAPE were
extendedby the BIAO Cameroon,a commercialbank. For the period from 1975
until June 1983 FOGAPE reimbursedthe banks a total of CFAF 51.6 million
(US$114,700)for losses on guaranteedcredit and interest,which correspon-
ded to only about 1.4% of the guaranteedamount.

FOGAPE has been criticizedby the commercialbanks as being 'too

risk-averse'and for delays in processingguaranteeapplicationsthrough
prolongedexaminationof each request. The drop in the number of guaran-
tees in the 1980-84period appears to reflect disappointmenton the part of
banks in FOGAPE. Accordingto reports,the banks continuedto require
collateralbefore approvinga loan, claimingthat they had to wait about
six months for FOGAPE to approve a guarantee. They also complainedthat
they had to wait a very long time, often three to four years before FOGAPE
paid the guaranteedsum followingborrowerdefault.

The difficultiesin obtainingapprovalof guaranteesand settle-

ment of claims seem to have caused the banks to stop using the scheme. In
principle,accordingto the guaranteeagreement,the banks were requiredto
pay a commissionof 1.5%, but in many cases this commissionwas either not
requestedor not paid, accordingto an internalstudy of FOGAPE'soper-
ations.

The number of operationsof FOGAPE (268 over a nine-yearperiod)

seems small, since the organizationhad a staff of 35. Staff costs in one
year (1981/82)were CFAF 61 million,considerablyhigher than total repay-
ments over an eight-yearperiod. FOGAPE never seemed to have reached
 - 67 -

anywherenear the amount of guaranteesit could have given according to its

statutes, and the conclusionis inevitablethat it followed an excessively
cautious approach in processingrequests for guarantees.

In 1984 FOGAPE was upgraded into an independentfinancial

institution,but it was not clear by 1985 what this new status signified.
Since its establishment,FOGAPE was supposed to have the functionof
upgrading SMEs through the provision of training, information,and advisory
services,but there was little evidence that it had been active in these
fields.
 - 68 -

GHANA

A Credit Guarantee Scheme (CGS) for small borrowerswas

establishedby the Bank of Ghana in 1969 with the objective of increasing
the flow of credit to small enterprises. The responsibilityfor its
administrationwas entrusted to a departmentof the Bank of Ghana.

Eligibility. All enterprisesengaged in extraction,processing,

or manufacturingof goods, repairs and services, and road or water
transport,with investmentin plant, machinery accessories,and other
capitalizedexpenses not exceeding 10O,000 1W/were eligible for
guarantee coverage. The value of assets was to be based on the original
price paid. The duration of the guarantee ranged from one year for
short-termcredit to term loans of 10 years maximum for acquisitionof
fixed assets.

Loans to small borrowers in agriculture,livestock,poultry

farming, and trade were also eligible under this program. In the years of
operation of the scheme, 50% of the credit amount guaranteedand 75% of the
number of guaranteesissued went to trade. The number of guarantees for
small traders dropped as governmentsupport for this sector was withdrawn.

In order to achieve the maximum possible coverageof loans to the

small-scalesector, it was made obligatorythat participatingbanks cover
all eligible loans to small borrowers after December 1, 1969, under the
guarantee scheme. However, this requirementwas never strictlyenforced by
the Bank of Ghana.

Guarantee Fee. The guarantee fee charged to the credit institu-

tions was 1% per annum, calculatedon the maximum amount of the guaranteed
advance sanctionedfor short-termborrowing and on the outstandingamount
for which a guarantee has been issued for term loans. The guarantee fee
was paid by the credit institutionand came out of the 6% spread between
lending and borrowing rates.

Risk Sharing. The Credit Guarantee Scheme provided a guarantee

cover of 66-2/3X up to a maximum of {50,000 per borrower (i.e., from all
banks, in the event that an enterprisehad several guaranteed loans). This
meant that the maximum guarantee of 66-2/3% was reached with a g75,000
loan.

Funding of the Scheme. At the time the fund was created it was
creditedwith sum of $500,000 by the Bank of Ghana. The maximum for total
guaranteesoutstandingallowed under the scheme was fixed at 10 times the
balance available in the fund. As a promotionalmeasure the Bank of Ghana
decided to bear the administrativeexpenses of the scheme out of its own
revenue. The balance available in the fund as of February 1980 was p7.2

10/ At that time (1969) the cedi was on par with the U.S. dollar. By
1986, the rate was 90 cedis to 1 U.S. dollar.
 - 69 -

million. Over the ten-yearperiod of operation of the scheme (1970-80),

the Bank of Ghana contributedan additional4 million cedis out of its own
resources. Revenue from the one percent guarantee fee was 2.14 million
cedis, and income from interestbearing accounts was 1.56 million cedis.
Claims paid out over the period 1970-80were reported to be 1.1 million,
cedis.

Claims Procedure. A decision to invoke the guaranteewas based

upon the credit institution'sassessmentof the status of the borrower's
account, but temporarydefaults were not a sufficientbasis for a bank to
invoke the guarantee. A bank was supposed to make 'normal"efforts to
regularizethe account and, only if this did not succeed,was expected to
submit a claim to the CGS. While a bank was allowed to submit a claim
before any legal proceedingshad been entered into, it was expected to
follow through with efforts to collect the amount in default. Any recover-
ed amount was to be shared with the guarantee fund on a 2:1 basis in favor
of the CGS.

Operation of the Scheme. The credit guarantee scheme seems to

have operated reasonablywell in the early 1970s. Operationspeaked in
1975/76,when the annual number of guaranteesissued reached 7,000 (includ-
Ing renewals,enhancements,and new loans submitted)with a total amount of
over t42 million. In the next three years, however, the use of the scheme
declined sharply in both numbers of guaranteesoutstandingand the amount
of loans covered. In 1979, only 514 guaranteeswere issued to cover about
t10.5 million in loans. The official explanationgiven for the sharp
decline in the use of the CGS was the state of the economy, but this did
not fully explain the situation. A contributingfactor could be that some
of the large participatingbanks--amongthem the Ghana CommercialBank,
which in 1976 accounted for 57% of the total amount of guarantees
given-abandoned the scheme after becoming disenchantedwith it.

Claims paid out over the period 1970-80were reported to be 01.1

million, or 0.5% of the total amount of guarantees issued in that period.
Such a low payout rate over a 10 year period of great economic difficulty
raises questions about the operation of the scheme. An explanationcould
be that the administratorsof the fund were slow in paying out claims, a
complaintmade by some of the participatingbanks.

Evaluation of the Scheme. The Ghana Credit Guarantee Scheme

suffered from two kinds of problems. First, it failed to increase the cedi
limit on amounts guaranteed so as to reflect inflationand real costs more
accurately. Participatingbanks did suggest in 1980-81 that the maximum
value of investmentdefining a small enterprise should be raised to
¢300,00O and the liabilityof the CGS should be a straight 66-2/3% of the
amount advanced,with no maximum of ~50,000imposed. The second problem
pertained to settlementof claims. Participatingbanks claimed that the
Credit Guarantee Scheme was reluctantto settle claims. They believe that
the managers of CGS were under the misconceptionthat the measure of
success of a guarantee scheme was a low pay-out rate.
 - 70 -

The DevelopmentFinance Departmentwhich administersthe CGS

within the Bank of Ghana saw the situation differently. They reported
serious problems in two areas which they claim disrupted the operationsof
the CGS: (i) participatingbanks submitteddoubtful loan accounts for
coverageunder the CGS and then tried to invoke the guaranteesquickly, and
(ii) once the CGS paid out claims the banks did not pursue recovery of any
part of these funds from their defaultingclients. According to the
regulations,CGS had the right to refuse applicationsfor guaranteesfor
borrowerswith deficient accounts. In practice, the CGS did not exercise
the right of refusal since it did not have the staff necessary nor access
to informationto properly assess the applications. During the 1980-84
period the participatingbanks evidentlydid not find it financiallyworth
their while to pursue small borrowers in default.
 - 71 -

LIBERIA

A Credit Guarantee Scheme was set up at the National Bank of

Liberia (NBL) in 1979 to provide a degree of protectionto commercialbanks
and credit institutionsagainst possible losses on loans and advances. It
was hoped that this would lead to an increase in the volume of institu-
tional finance to small and medium business enterprisesowned by Liberians.

Eligibility. In order to be eligible for a guarantee,advances

have to satisfy the followingconditions:

(a) they must be granted to Liberian individualsor to organizations

wholly owned by Liberians;

(b) they must be granted to enterprisesengaged in agricultureand

industry (excludingthe entertainmentindustry) and utilized for
acquiring fixed assets or for working capital;

(c) they must not exceed L$100,000 to a single borrower,or L$250,000

to a group of related interestswhere a borrower trades under
differentbusiness names or has substantialholdings in more than
one enterprise.

Guarantee Fee. The guarantee fee is 1% per annum. The fee is

determinedon the maximum amount of the advance as approved for the first
year; for subsequentyears the charge is calculatedon the outstandingloan
amount. There is currently (March 1986) a proposal to increase the fee to
2% per annum.

Risk Sharing. The scheme provides for reimbursementof 66-2/3%

of the amount in default (includingprincipal and interest)or the amount
guaranteed,whichever is less. In the case of advancesgranted under any
special scheme (such as IDA credit, etc.), the extent of guarantee cover
may differ from this figure.

Funding of the Scheme. The guarantee scheme was startedwith an

initial funding of L$500,000. By January 1986 this fund had been reduced
to around L$206,000 through payment on claims. A promise by the government
to increase the fund to L$1,000,000had not materializedby January 1986.

Claims Procedure. The conditionsto be compliedwith before a

claim can be invoked by a credit institutionare: (1) the guarantormust
be informed of said default as soon as possible and in any case not later
than 15 days after the date of expiry of the guarantee;and (2) the credit
institutionmust furnish a certificateto the guarantor to the effect that
the borrowing unit and the sureties, if any, have been called upon to pay
to the full extent of their liabilityand that the amount in default cannot
be realizedwithout resorting to legal remedies.
 - 72 -

Operation of the Scheme. The scheme, which was still in

operation in early 1986, has performed poorly since its inception. By
early 1986 NBL's exposure on guaranteesissued was L$997,000. Confidence
in the scheme was low, and commercialbanks were skeptical about receiving
payment after they filed claims. There have been complaintsthat the
instructionsgiven by NBL were unclear, resulting in confusion and misun-
derstandings. Another complaint has been that the process of making a
claim is lengthy and tedious. The Liberian Bank for Developmentand Indus-
try (LBDI) was recently engaged in a dispute with NBL on the settlementof
claims. LBDI wanted NBL to pay the guaranteedamount as soon as legal
proceedingsfor recoveryof debt are initiated. NBL's positionwas that
all remedies, including legal procedings,had to be exhaustedbefore
settlementof a claim. When NBL finally agreed to settle the dispute with
LBDI, it proposed to do so by taking personalguarantees from the defaul-
ters before paying out the claims. For the period January to December
1985, total guaranteesin the amount of L$206,344 were invoked by LBDI.
NBL paid to the extent of 66-2/3% on an aggregate amount of L$118,240. For
the same period, guaranteesamounting to L$344,762 were revoked by N8L
because of non-paymentof guarantee fees by LBDI.
 - 73 -

MOROCCO

The Caisse Centrale de Garantie (CCG) set up in Morocco in the

early 1970s provides a governmentguarantee for eligible loans and supplier
credits to Moroccan enterprises. A committeewith members from the
Ministry of Finance, the Bank of Morocco and the technicalministries
concerned is responsiblefor reviewing guarantee applications. The
committee meets five or six times a year to review a dozen or so applica-
tions and is chaired by the Director of the Treasury, who also serves as
managing director of the CCG.

Guarantee Fee. The guarantee fee charged to the credit

institutionvaries according to the term of the guaranteedloan. The fee
structure is presented below.

Below 5 years 1.25%

Between 5 and 7 years 1.80%
Between 7 and 9 years 2.25%
Between 9 and 12 years 3.25%

Claims Procedure. A loan must be in default for two years before

the guarantee can be invoked. Also, before invokingthe guarantee, the
credit institutionmust demonstrate it has made all reasonableefforts to
collect on the defaulted loan.

A major problem that requires immediateattention is that CCG

cannot meet its obligations. There is no guarantee fund and therefore the
governmentmust settle claims. As of August 31, 1983, CCG owed more than
DR 163 million on local and foreign loan. No action on these obligations
has been taken. CCG's own resources fall short of meeting even its
administrativeneeds. Payments on claims are decided on an ad hoc basis by
the Treasury.

Other problems are poor evaluation criteriaand the limited and

poorly qualified staff. CCG has only five professionals,who are unable to
properly appraiseguarantee applications,and there are no clearly
specified eligibilitycriteria for guarantees.

Due to lack of staff, large parts of the fees due remain unpaid.
Unpaid fees at the end of 1982 amounted to 154% of those paid in 1981 (DH
50 million).
 - 74 -

Tables showing the total guaranteesgiven and the sectoral

breakdown are given below:

December 31, 1981 December 31, 1982

- --- (DH million)

Total guarantees 8,334 9,593

of which: foreign exchange 4,388 4,106
dirhams 3,946 5,487
Public sector 6,364 6,151
Private sector 1,970 3,442

The sectoral distributionof CCG guaranteeswas as follows at December 31,

1982:

Public Sector Private Sector

--- (DH million)

Energy 1,765
Mining 384
Communications 1,820 -
Fisheries 1 1,899
Agriculture 480 75
Industry 1,701 1,191
SHE - 277
Total 6,151 3,442

6.33 Among the reforms recommendedfor CCG by a World Bank mission in

1984 were these:

(1) CCG's current financial positionmust be strengthenedby a

treasurygrant to create a fund to give CCG a sound financial
base. Past claims must be separated from new commitmentsin
CCG's accounts and funds for settling past claims must be made
available.

(2) CCG's commissionsshould be set at a level that enable CCG to

meet reasonableoperating costs. A reasonablefee level would
also discouragerecourse to CCG guaranteeswhere there is no
need for them.
 - 75 -

(3) CCG's guarantee cover should be reduced from 80% to 60% of the
loan for the project appraised. The current guarantee,which may
be 100% and unconditional,increases the risk that financial
institutionswill relax their appraisal criteria and transfer the
entire risk of projects to CCG.

(4) A total annual limit on CCG commitmentsshould be set, taking

into account the resources available and the quality of the loans
guaranteed.

(5) Payment of claims should be acceleratedthrough faster processing

by CCG.

(6) CCG should hire enough qualified staff members to develop ade-
quate appraisalcapability.
 - 76 -

TUNISIA

A guarantee fund, the Fond National de Guarantie (FNG), was

establishedby law in Tunisia on December31, 1981. The law provides for
guaranteesfor small and medium agricultural,industrial,and artisanal
productionunits,1 l/ primarily in connectionwith credits to finance the
establishmentof new units or the expansion of existing units and their
export operations.

Risk Sharing. The FNG guaranteesbetween 50 and 75% of the

outstandingprincipalof such loans. The guarantee covers 75% of the loan
amount if the loan is less than 10,000 dinars and 50% of the loan if it
exceeds 10,000 dinars. The banks making the loans assume the rest of the
risk.

Funding of the Scheme. The FNG derives its funds from the
following sources:

(a) a 5/8% levy on short-termbank overdraftsnot representing

rediscountablecredits;

(b) a one-time levy of 1/8% on investmentloans not eligible for an

FNG guaranteegranted by banks out of their equity resources to
non-agriculturalsectors,and a 1/8% one-time levy on the total
amount of guarantee credit backed by the beneficiariesof such
guarantees.

Claims Procedure. A guarantee can be invoked two years after a

loan is in default. Before invoking the guarantee,however, the insti-
tution must demonstratethat it has taken all reasonableefforts to collect
on the defaulted loan.

Operation of the Scheme. Since FNG only began its activitiesin

1982, it is too soon to make a reasonedjudgment on the appropriatecommis-
sion rate to be paid by beneficiariesof guaranteedcredits.

Also, FNG's sphere of activity is limited to small- and medium

enterprises. The percentagecoverage given by FNG guarantees to these
beneficiariesis often consideredtoo low by these, and they complain of
the additionalcollateralrequirementsof banks for the portion of the
credit not covered by FNG. At the same time, there is a risk in increasing
the coveragewithout a considerationof the bank and beneficiariesattitude
towards recovery.

As of May 1986, there were no claims against the FNG although it

was expected that there may be a number of such claims towards the end of
1986 when the two-yearwaiting period expires. The FNG has not been widely
used by the commercialbanks.

11/ According to the Tunisian definition,small and medium enterprisesare

those in which up to 500,000 dinars has been invested. A proposal to
increase this ceiling is under consideration.
 - 77 -

CHAPTER7

LATIN AMERICAAND THE CARIBBEAN

BARBADOS

The Central Bank of Barbados, in an effort to promote the growth

of the small business sector, introduceda credit guarantee scheme for
small businesses in September1979. The Central Bank Act (Amendment1977)
authorized the Central Bank to operate and fund the scheme, and the Credit
Insurance and Guarantee Departmentof the bank was entrustedwith the
responsibilityfor its administration. The object of the scheme is to
enable small businessesto obtain finance from commercialbanks and other
credit institutionswithout having to provide security from their own
sources. The commercialbanks are responsiblefor evaluatingproject
proposals and submittingthe necessary applicationsto the Central Bank.
These applicationsare reviewed by the Central Bank primarily to ensure
that the terms and conditionsof the scheme have been compliedwith. A
bank's assessment is generally accepted by the Central Bank without further
detailed investigation. Commercialbanks are required to notify the
Central Bank, on a monthly basis, of any applicationsthat are rejected.

Eligibility. To be eligible for a credit guarantee,the borrower

must qualify as a small business borrower in one of the following
categories:

(a) An agriculturalenterprisewhich meets any two of the criteria

listed below:

(i) Total capital - less than BDS$100,000;

(ii) Acreage available for cultivation- not more than 25 acres;

(iii) Annual sales - less than BDS$300,000;

(iv) Number of employees - less than 25 persons.

(b) An enterpriseengaged in manufacturing,retail trade,

construction,hotel industry,or cateringwhich meets any two of
the criteria listed below:

(i) Total capital - less than BDS$100,000;

(ii) Annual sales (or value of completed contracts in the case

of constructionenterprises)- less than BDS$500,000;

(iii) Number of employees- less than 36 persons.

(c) An enterpriseengaged in transportationwhich:

(i) owns vehicles with total original cost of less than

BDS$250,000;and

(ii) has annual receipts of less than BDS$150,000.

 - 78 -

(d) An enterpriseengaged in medical, health or educationalservices

which:

(i) owns fixed assets and equipment with total original cost of
less than BDS$100,000;and

(ii) has annual receiptsof less than BDS$250,000.

(e) An enterpriseengaged in other professionalserviceswhich

(i) has annual receiptsof less than BDS$100,000.

The guarantee limits are BDS$50,000 for credit in excess of one

year (mostly for fixed assets) and BDS$25,000for credit facilitiesgranted
for one year or less (mostlyworking capital). Guaranteesare not granted
for periods in excess of the useful life of an asset acquired, and in no
case will a guarantee be granted for a period in excess of 10 years.

Guarantee Fee. The commercialbanks are charged a fee of 1% per

annum, payable quarterly,based on the highest outstandingamount of the
guarantee during the quarter. The banks are allowed a spread of 3% to
3.5% for such guaranteedloans over and above the bank rate, which includes
the one percent guarantee fee. The spread of 3% is for guaranteesgranted
for one year or less, while the 3.5% spread is applicable to longer term
guaranteedloans.

Risk Sharing. All advances made under a guarantee are covered.

The risk sharing between the guarantee institutionand the commercialbank
is 80% to 20% for guaranteesof one year or less and 70% to 30% for
guaranteesof over one year. The guarantee covers both borrower insolvency
and protracteddefault.

Funding of the Scheme. The Central Bank Act authorizedthe

Central Bank to operate and fund the Credit Guarantee Scheme. The scheme
is backed by a special fund created out of the Central Bank's profits. At
the end of 1980 the funding for the scheme was BDS$300,000. The scheme's
maximum liabilitywas fixed by the Central Bank's board of directors at 10
times the amount of the fund (i.e., BDS$3.0 million in 1980).

Operation of the Scheme. Within the first year of operation

(1980), 14 guaranteeswere issued on behalf of 10 small businesses to four
banks operating locally. Of the 14 guarantees,5 were for one year or
less. The liability coverageranged from BDS$3,200 to BDS$22,400. The
remaining9 guaranteeswere for periods of more than one year, and maximum
liabilitycoverage ranged from BDS$4,000 to BDS$20,000. Small manufactur-
ing operations,retail operations,auto mechanics,handicrafts,and stereo
assemblywere among the small businessesthat took advantageof the guaran-
tee facility. In most cases, credit guaranteeswere used as additional
security and did not replace collateral.

Evaluationof the Scheme. The Central Bank has gone a long way
towards simplifyingits applicationforms and proceduresand reducing
 - 79 -

record-keepingby the commercialbanks. Despite these efforts, the commer-

cial banks have not been very receptive to the scheme, and only four of the
seven local banks have participatedin it. Even when the guaranteewas
used, this was done only to give additionalsecurityto the collateral
provided. It is almost certain that no additionalfunds to small business-
es were generated by the scheme. Some banks, even though they gave a
commitmentto participatein the scheme, have consistentlyturned away
potential users of the scheme by claiming ignoranceof how it works. This
attitude is primarily due to the fact that the commercialbanks regard the
scheme as a way of making them approve loans to very risky small business-
es. In addition, the commercialbanks are not very enthusiasticabout
granting small loans on which the risks are high and the profitabilityis
low. They prefer to make larger loans where the risks are high but the
profitabilityis higher.

The commercialbanks also felt that lending to small businesses

was administrativelytoo costly. Obtaining guaranteesonly made the admin-
istrative problems worse, they claimed.

Many of the credit officers of the commercialbanks lack

experiencein lending to small businessand thereforeavoid making such
loans even with the guarantee. Even if the credit guarantee scheme assumed
100% of the risk, it is doubtfulwhether this would significantlyincrease
the use of the scheme, since commercialbank managers believe that it would
show poor judgement on their part if too many claims were made. Small
businessmen initiallywelcomed the scheme, but that early optimism soon
disappeared. They are now of the opinion that the scheme will be of little
help unless the Central Bank is given special powers to force the commer-
cial banks to use the scheme. The Central Bank of Barbados,while realiz-
ing the limited effectivenessof the scheme, still believes that it can
play a positive role.
 - 80 -

COLOMBIA

A credit guarantee fund under the title Fondo Nacional de

Garantia (FNG) started operating in Colombia in January 1983. The FNG was
originallyestablishedby Institutode Fomento Industrial(IFI) and Corpo-
racion FinancieraPopular (CFP) in 1981. Later, PROEXPRO (the Export Pro-
motion Organization),CARBOCOL (a national mining corporation),and ACOPI
(Associationof Colombian Small Industries)also became shareholders.
FNG's total paid-in capital amounts to Colombian pesos 100 million (around
US$0.52 million in mid-1986).

Eligibility. Eligible for guarantees are loans to legally

constitutedfirms with up to 80% local ownership and assets below 100
million pesos (US$520,000approximatein June 1986). Such firms receiving
guaranteesshould not have sales above Col$150 million (US$780,000)and
employ less than 150 workers.

Guaranteesare provided through a certificateof guarantee for

loans for construction,for purchase and installationof equipment,and for
working capital.

Guarantee Fee. The guarantee fee charged is 2% per annum, based

on the guaranteedportion of the loan (the fee is payable at the beginning
of the year).

Risk Sharing. The guarantee originallycovered 80% of the loan

amount. In 1986 this was changed and in some cases the FNG can guarantee
up to 100% of the loan. The maximum value of a guarantee certificatein
June 1986 was Col$6 million (approximatelyUS$31,250)and the minimum value
was set at Col$100,000(approximatelyUS$520). Guaranteecertificatescan
be renewed yearly.

Claims and Procedure. In the event of a default in payment, the

financial institutionthat made the loan can claim reimbursementup to the
amount of the guarantee certificate,but only after it has recovered the
maximum amount possible from the available securitiesand collateral. The
repaymentby FNG would then be reduced by the amount recovered. The FNG
would then accept the obligation to pay up to the value of the guarantee
certificate(after allowing for amount recovered)within 30 working days.

In the first years of operation, the FNG decided on a special

manner of payment of claims. For certificatesof guarantee between
Col$100,000-500,000, the amount were paid out in full immediately. When
the amount remaining to be paid on the guarantee certificateis between
Col$500,000and Col$1 million, the fund is reimbursedup to 75%
immediately. When the amount covered by the guarantee certificateis
between Col$1 million and Col$2 million the fund paid out only 50% of the
value of the certificate,and when between Col$2 million and Col$4 million
the fund limited its payment to 25%. In practice, this means that the fund
made a maximum first payment of Col$1 million, irrespectiveof the size of
the guarantee. The remainder of the amount owed under the guarantee
certificatewould be paid out when the financial institutiondemonstrated
 - 81 -

that it had taken legal proceedingsagainst the defaulter and when it can
show that the debtor has been declared in bankruptcy. The guarantee
certificateonly covers principal. The FNG does not reimburse loss of
interest, nor legal or collectioncosts. Since early 1986 the FNG has
changed its manner of paying out claims. 50% is now paid out immediately
on receipt of the claim and the remaining50% within 90 days after evidence
that the financial intermediaryhas taken steps to foreclose on the
borrowers. Guaranteesup to Col$500,000are still paid out in full
immediately.

Operation of the Scheme. The first guaranteeswere given out in

March 1983. By the end of December 1983, 316 requests for guaranteeshad
been received, of which 276 were approved, 20 were denied and 20 were being
studied. The total value of the guaranteedamount was Col$112.6million
(approximatelyUS$1.2 million). By end April 1986 the number of approved
guaranteesreached 1065 for a total amount of Col$1,132million
(approximatelyUS$5.86 million).

The FNG is run by a staff of around 20 persons from one office in

Bogota. Although steps were taken to try to establishbranch offices in
main towns, it was found that this was not justified economically. Of the
guaranteesgiven out in the first 9 months, 44% of the clients were in
Bogota, the capital, and 27% were in Cali.

As of April 1986, FNG had paid out 117 claims to CFP for a total
amount of Col$38 million (about US$210,000). Although the FNG was
available to all institutionsin the banking system to end 1985, 70% 12/
of the guaranteesgiven out were for loans given out by the Corporation
FinancieraPopular (CFP), the government-owneddevelopmentbank for small
and medium enterprises. The FNG is making efforts to get requests for
guaranteesfrom commercialbanks to use the guarantee scheme.

There have been complaintsof delays in obtaining approval for

guarantees from FNG. One recent study 13/ of CFP's subprojectprocessing
time shows that it takes, on average, a total of 165 days to process a
subloan and of this 52.5 days were taken to obtain the guarantee. However,
it is claimed by FNG that since early 1986 a reorganizationhas reduced
this time to no more than 3 weeks.

12/ This figure dropped to 59% in the first five months of 1986.

13/ By ACOPI - Associationof Colombian Small Industries.

 - 82 -

HAITI

In Haiti an IndustrialDevelopmentFund (IDF) was set up in early

1983 under the board of directors of the Central Bank of the Republic of
Haiti. The objective of the fund was to provide credit and guarantees to
productiveprivate enterprises. The fund is supposedto administertwo
basic operations: (1) discountingof loans, and (2) guaranteesfor loans
to priority industrialsubsectors. The fund was expected to be self-
supporting. IDF credits were to be offered through participatingfinancial
intermediaries,mostly commercialbanks.

Eligibility. Registered small and medium-sizedenterpriseswhich

are 51% owned and controlledby Haitian citizens, and operating in handi-
crafts, manufacturing,agro-industry,fisheries,mining, tourism, trans-
port, industrialconstruction,or ancillary servicesrelated to such sub-
sectors are eligible to receive guarantees. Eligible enterprisesmust meet
the following criteria:

(1) be receiving a discount operationof G 1,250,000 or less;

(2) have a maximum debt/equityratio of 3:1;
(3) have an estimated debt-servicecoverageratio of at least 2:1;
(4) have no overdue financial obligations.

Participation. All financial intermediariesin good standing

with the Bank of the Republic of Haiti qualify to participate. However, a
financialintermediarywith portfoliosaffected by arrears of more than 25%
is not eligible to participate. It will have access to such operations
only after reducing arrears to less than 25%.

GuaranteeFee. IDF charges a guarantee fee of 2% per annum on

the guaranteedportion of the outstandingloan, payable on the anniversary
date of the loan.

Risk Sharing. For discountoperationsup to G 500,000 the risk

covered is 75%, while for discountoperationsof larger amounts (i.e.,
between G 500,000 - G 1,250,000),the risk covered is 60%. It should be
noted that the guaranteescover only the risk of non-paymentof outstanding
principal,not of interest due. The interest spread allowed to a
participatingintermediaryis 6% for discount operationsup to G 500,000
and 5% for discount operationsin the G 500,000 - G 1,250,000range.

Funding of the Scheme. IDF was funded from resourcesmade avail-

able by the government,resources from other national or international
agencies, and from any net operatingrevenue.

Claims Procedure. Participatingintermediariesare responsible

for periodicallyreporting to IDF the status of their loans and, in parti-
cular, loans which are delinquent- that is, more than 30 days overdue in
payment. IDF then examines each delinquentaccount and conferswith the
participatingintermediaryon the action to be taken. IDF will consider
 - 83 -

claims under the guarantee scheme only after a loan is 90 days or more
overdue, except in cases where the enterpriseinvolved is declaredbankrupt
or dissolved. The participatingintermediarymust file a claim for payment
not earlier than 90 days and not later than 120 days after the repayment
falls due; otherwise, the guarantee is invalidated. A claim request must
contain informationon the actions taken and follow-upduring the delinqu-
ency period, financialconditionsof the enterprise,expected recovery, and
proof that the participatingintermediaryhas initiatedlegal proceedings
against the delinquentclient. According to the polity statement,IDF will
settle such claims within 30 days from the date received. However, the
participatingintermediaryis required to continue collectionefforts
against the defaulted borrower.

Any sums recoveredwill first be used to defray legal and collec-

tion costs incurred by the lending institutionand/or the IDF and will then
be distributedbetween the lender and the IDF in appropriate proportions.
In the event collectionefforts are unsuccessfuland further attempts
appear unwarranted,the participatinginstitutionwill confer with IDF on
when to suspend collectionefforts. In such instances,IDF will write off
the outstandingbalance.

Operation of the Scheme. Through the end of 1983, only four

projects took advantage of the guarantee scheme. In all cases, however,
the guarantee was used only as added protectionfor the intermediary,since
the loans were well collaterized. (In one case the fixed assets offered as
collateralwere several times the value of the loan itself.) So far, there
is no evidence that additionallending has taken place because of the
existence of the guarantee scheme.

Evaulation of the Scheme. The commercialbanks have shown little

confidencein the guarantee scheme and are continuingto lend only to well
establishedclients who can provide collateral. They considerlending to
other small clients as very risky even with the guarantee. They point out
that the guarantee does not cover 100% of the risk and also that the
guarantee applies only to the principal. They also fear that they would
have to wait for a long time before they are able to collect on a guarantee
in the event of a default.
 - 84 -

JAMAICA

Until 1982, a credit guarantee scheme was administeredby the

Premier InvestmentCorporation (PIC), which was operated as a subsidiaryof
the Bank of Jamaica (BOJ). In 1981, political changes took place in
Jamaica, as a result of which existing credit operations- includingPIC -
were closed down. A new institutioncalled the National DevelopmentBank
(NDB) was then created to replace the previous institutions.

After some revisions,the earlier scheme had provided for the

Bank of Jamaica through PIC to guaranteeup to 50% of the amount of a loan
against a one time fee of 2% to be paid by the borrower. The maximum
guaranteeper loan was originallythe equivalentof US$20,000,but this was
later raised to US$50,000 or 50% of any loan eligible for rediscountunder
the PIC scheme, whicheverwas lower.

According to reports, the credit guarantee scheme was not very

successfulin that the five commercialbanks in the country did not give
it real support, claiming that they did not trust the Central Bank (BOJ) to
redeem guarantees. In an interview conducted in 1984, the largest commer-
cial bank participantsin the program stated that the guarantee scheme,
even after the revisions,had not been a decisive factor in their making
loans. One reason the banks gave for not believing that the guarantee
scheme would pay any claims was that the Central Bank already owed the
banks about $40 million for claims under another scheme, the Export
DevelopmentFund.

Another reason given for the failure of the scheme was that the
proof required of the commercialbanks to show that they had made their
best efforts to collect on delinquent loans was too stringent. The
objective of the scheme--tocreate additionalityof funds available to
small firms--wasthwartedby the banks' requiring very high collateralin
spite of the guarantees.
 - 85 -

USAID-SPONSOREDGUARANTEE
PROGRAMS

These programswere initiated in 1975 under the 1974 Amendment to

the US Foreign AssistanceAct of 1961, which authorizedUS assistanceto
small businessguarantee programs abroad. In all, US$12 million was
authorizedby USAID under the ProductiveCredit Guarantee Program (PCGP)
for a guarantee authority for four Latin American countries-Paraguay ($3.5
million) Costa Rica and Nicaragua ($3.0 million each), and Bolivia ($2.5
million). The programs initiated in Paraguay,Bolivia, and Costa Rica were
designed to guarantee private loans, i.e., from commercialbanks to small
enterprises. The most developed scheme was implementedin Paraguay. By
1983, however, all schemes under the PCGP were discontinueddue to dis-
agreementsbetween USAID and the governmentsas to whether all conditions
for reimbursementof claims had been met. Total guaranteesgiven under the
PCGP schemes amounted to $23 million. USAID paid out US$100,000to settle
claims.

The scheme in Nicaragua,introducedin 1978, differed in various

way from the other schemes. The Nicaraguangovernmentmade an equivalent
contributionof US$3 million to the Fund. Small-scaleenterpriseswith
total assets up to US$33,000 and without enough collateralwere eligible to
apply for the guarantee. The loan was not to exceed US$25,000 and the
guarantee covered 75% of the principal amount of the outstandingand up to
120 days of interest. Financial institutionscould invoke the guarantee
after a loan was in arrears for 120 days. The front-endfee was 3% of the
loan, and a small annual payment was levied on the guaranteedportion. The
scheme became operational,guaranteeingover 300 loans through various
banks, but collapsedbecaused of political changes in 1979 before handling
any claims. The majority of the loans guaranteedby the fund had a repay-
ment period of between 3-5 years. The average amount guaranteedper loan
was approximatelyUS$6,000. For the entire period that the scheme was in
operation there was only one case of no repayment by the borrower,and
arrears were below 1% of the total portfolio,but the scheme was in opera-
tion for too short a period to obtain a true picture of the viability of
the scheme.

The programs in the other countries--Paraguay, Costa Rica,

Bolivia-provided governmentguarantees to motivate lending institutionsto
make loans to small enterprises and made the services of private consul-
tants simultaneouslyavailable to small businessesunder the supervisionof
a government agency. The aim was to widen the access of small business and
small farmers to institutionalfinance to reduce their dependenceupon
high-costmoney lenders. It was expected that small businesswould be
assisted in obtaining these loans despite more stringentproceduralrequir-
ements through the availabilityof consultingstaff, who would assist in
preparing and evaluatingprojects for a fee of 3 to 4% of the value of the
loan. The consultantswere expected to provide follow up assistance,if
required, at reasonablerates. The effective cost of the loans, including
the guarantee premium and the support assistance,was 16% or 17% per annum,
which was still much lower than other sources of finance for small
business.
 - 86 -

Eligibility. In order to be eligible for guarantees,borrowers

by and large were expected to be businessesemploying less than ten workers
and requiring less than US$50,000 in credit (the limit was US$25,000 for
enterprisesowned by individuals).

Guarantee Fee. A one-time fee of 5% was charged for the guaran-

tee. An unusual feature was that the 5% premiumwas charged on the total
loan amount, and not on the guaranteedportion only. The programswere
intended to be self-supportingout of revenue generated by the 5% guarantee
fee plus some initial administrativesupport donated by the Central Banks
administeringthese programs. Training, manuals, and advisory service were
contributedby USAID. Data availabledid not permit full actuarial asses-
sment of the probable range of defaults, but some general calculations
indicated that a 5% premium would cover the likely losses from defaults.

Risk Sharing. The risk covered by the scheme was 75% of the
loan, with 50% covered by US AID and 25% by the banks collectively. The
lending institutionthen was responsiblefor the remaining 25% of the
risk. It was hoped that the 75% guarantee,along with lending rates rang-
ing from 8 to 14% and a plan to allow discounting the guarantee portions at
6% (which never materialized),would make lending to small enterprises
financiallyattractive.

Claims Procedure. The guaranteedpart of the loan was to be paid

from the ProductiveCredit Guarantee Program (PCGP) fund within 30 days
after a default period of 180 days.

Operation of the Schemes. Total lending under the three programs

(Costa Rica, Paraguay, Bolivia) in the period 1978-80 amounted to $16 mil-
lion in loans averaging around US$120,000 each. Repayment periods averaged
five years. In Costa Rica, the ProductiveCredit GuaranteeProgram started
operationsin January 1979. In the agreement it was laid down that the
credit guarantee system would have the capacity to guarantee a total port--
folio of loans equal to US$6.0 million. AID's assistancewould consist of
a guarantee of US$3.0 million. It seems that the size of the guarantee
portfoliowas dictated more by the availabilityof funds for lending than
by the amount of the guarantee fund. The amount approvedfor guarantees
during 1980 was equal to US$1.1 million, against an originalprojection for
that year of US$2.4 million. The projectionfor the whole five-yearprog-
ram was US$24.4 million. After one year's operationof the scheme in Costa
Rica, the results were consideredacceptablein three of the four banks
that participatedin the system. However, due to problems in the fourth
bank, which alone accounted for 59% of the total amount approved, 19% of
all guaranteedloans in the scheme were more than 90 days in arrears by
1981. The problem seemed to arise from inadequatesupervisionand poor
project evaluation. The technical assistanceseems to have been carried
out by inexperiencedconsultants. The bank with the problemswas suspended
from the system for surpassingthe allowed percentageof bad debts. The
whole scheme was discontinuedin 1982.
 - 87 -

The credit guarantee program in Paraguay grew rapidly, surpassing

initial projections. The Central Bank of Paraguay reported that during the
initial 15 months, 534 guaranteedloans were made for a total amount of
US$9.9 million. During a review in October 1980, complaintswere made
about the quality of projects approved for guarantees,about the work of
the consultants,and about the supervisionof the Central Bank. Lending
was suspended in 1981 due to the non-availabilityof further funds for
making loans, but not before some controversyhad arisen about the payment
of some claims. The Central Bank refused to pay on grounds that the
lending banks had not taken adequate precautionsin approving the loans.
By that time, total guaranteesamounted to US$17.5 million.

The PCGP in Bolivia never developed into a large program,

although some very small loans were given out to small scale farmers under
the scheme before it was discontinuedin 1983.

The PCGP suffered in all the countries in that the scheme

provided only guaranteesand not the actual financing of loans. Shortage
of funds for lending became a constraint.

Although the ProductiveCredit Guarantee Program more or less

ceased to operate after 1982, another departmentof USAID, the Bureau of
Private Enterprise, set up in 1981, has revived the idea of USAID financing
of guaranteesfor loans made by commercialbanks for small-scaleenter-
prise. Such guarantee funds have been set up recently (1984-85)in a few
countries (Thailand,Morocco), but they have not been in operation long
enough to draw any conclusions.
 - 89 -

SELECTED BIBLIOGRAPHY

Anderson,D., and F. Khambata. Small Enterprises and DevelopmentPolicy in

the Philippines: A Case Study. World Bank Staff Working Paper No. 468,
Washington,D.C., 1981.

Bank of Ghana. Papers on Credit Guarantee Schemes. undated.

Bank of the Republic of Haiti, IndustrialDevelopmentFund. "Statementof

Policies." January 1983.

Bannock, Graham. "The Promotion of Small Business: A Seven-Country

Study." Vol. 1. EconomistsAdvisory Group, Ltd., U.K., December 1980.

Banque Centrale de Tunisie. DocumentNo. 84.04: "Fonds National de

Garantie." February 1984.

Credit Guarantee CorporationMalaysia Berhard, Malaysia. Annual Report

1983.

Cristi, Enrique. "GuaranteeMechanism for Small-ScaleEnterprises."

Inter-AmericanDevelopmentBank. Internaldocument, Washington,D.C.,
March 1981.

Davenport,Robert W. "Credit Guarantee Scheme for Small Scale

Enterprises." Paper prepared for World Bank, March 1981.

Deposit Insurance and Credit Guarantee Corporation,India. Small Loans

Guarantee Scheme. 1981.

__________ _,_ 21stAnnual Report. Bombay 1982.

_23rd Annual Report. Bombay 1984.

. 24th Annual Report. Bombay 1985.

Doran, Alan. "Credit Guarantee Schemes for Small Firms: Operations in

Selected Countries." Paper prepared for IndustryDepartment,World Bank,
November 1982.

_ "SomeAspects of Public Policies towards Small Business

in Japan." Paper prepared for EconomistsAdvisory Group, Ltd., U.K.,
August 1980.

FinancialTimes, U.K. Articles on U.K. Government'sLoan Guarantee Scheme,

August 24, 1984; May 3, 1983; April 5, 1984.

Fondo Nacional de Garantias SA. "ReglamentoGeneral." January 1986.

 - 90 -

Kongsiri, Aswin. "Credit Guarantee Scheme in DevelopingCountries: Some

Observationsfrom Experience in Malaysia, Nepal, and Thailand." Paper
presented at the InternationalWorkshop on CommercialBank Lending to Small
Enterprisesand the Operationof Credit Guarantee Schemes,London, July
1986.

_ "Nepal: A Report on the Credit Guarantee System." Paper

prepared for the World Bank, May 1986.

_ 'A Study of the Credit Guarantee Corporationof

Malaysia." Paper prepared for the World Bank, April 1982.

Korea Credit Guarantee Fund. Annual Report. Seoul, 1985.

Levitsky, Jacob. "Financingof Small-ScaleIndustriesand Enterprisesin

SelectedAsian Countries." Paper prepared for ThirteenthSEANZA Central
Banking Course, Indonesia,November 1980.

Lim, C.P., M.C. Puthucheary,and D. Lee. A Study of Small Entrepreneurs

and EntrepreneurialDevelopmentProgrammesin Malaysia. Universityof
Malaya Press, Kuala Lumpur, 1979.

Mathena, Vijaya Ram. 'Credit Guarantee System in Nepal." Paper presented

at the InternationalWorkshop on CommercialBank Lending to Small
Enterprisesand the Operation of Credit Guarantee Schemes,London, July
1986.

Ministere des Finance, Caisse Centrale de Garantie. Circulaire. undated.

Ministeriode DesarrolloEconomico. "Decreto por la Constitutiondel Fondo

Nacional de Garantias."Colombia, 1983.

Ministry of IndustrialDevelopmentand InternalTrade, India. Credit

Guarantee Scheme for Small Scale Industries. 1979.

Schmidt,ReinholdH. Small Scale Financing and Credit [Link],

Eschborn, 1985.

Research Institute for Management Science. "Case Study for Korea Credit
Guarantee Fund." Delft, Netherlands,January 1983.

_ "A Few Remarks About theGranting of

Government-Guaranteed Credits in the Netherlands." Text delivered by Rob
Roeder, NMB Bank Netherlands,September 1980.

_ "High Risk Ventures by SSIP, Problems and Suggested

Solutions Set within Long-term and Short-termPerspectives." January 1983.

._ "Industrial
Guarantee and Loan Fund Philippines."
January 1983.
 - 91 -

"Korea Credit Guarantee Fund and Industrial GuarantEe and

Loan Fund (A Comparison)."January 1983.

Saksena, K. 1'. Credit Guarantee Schemes - The Indian Experience." Paper

presented at the InternationalWorkshop on CommercialBank Lending to Small
Enterprisesand the Operationof Credit Guarantee Scheme, London, July
1986.

SGV & Co., Management ServicesDivision, Indonesia. Credit Insurance

Study, Vols. 1-2. P.T. AsuransiKredit Indonesia (ASKRINDO),1980.

Small Business Agency, DevelopmentFinance Corporation,New Zealand.

Loan Guarantee Scheme, October 1983.

Small Business Credit InsuranceCorporation,Japan., Outline of Small

BusinessCred:.tInsuranceCorporation,September 1977.

US. A.I.D. Project Paper for a ProductiveCredit Guarantee Project in the

Republicof Ccsta Rica. Internaldocument,Washington,D.C., 1977.

Wynant, L., J. Hatch, and M. Grant. CharteredBank Financing of Small

Business in Canada. Universityof Western Ontario Press, 1982.
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