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Credit Guarantee Schemes

The objective of the scheme is to improve credit guarantee small enterprises' access to credit and assist the integration of small enterprises in the formal financial. This will ultimately translate into improved business performance and job creation. One of the main roles of guarantee schemes is precisely to compensate for the lack of collateral hindering SME access to finance. The scheme are allowed to require whatever collateral is available up to reasonable limits. For example, in France and in Canada, the schemes are allowed to require personal guarantees but these guarantees are capped respectively at 50% and 25% of the loan value.
The guarantee scheme calls for change in mind-set of the bankers, which should consider it as a financial instrument, as it is ‘an opportunity’ to extend collateral-free credit in support of viable projects requiring higher quantum of loan assistance.

The successful schemes are measured by the outreach, which refers to the scale of the guarantee scheme, as measured by the number of guarantees issued to eligible SMEs and the amount of outstanding guarantees. The greater the outreach, the stronger is the impact of the scheme on the SME sector. However, the impact of the guarantee scheme will also depend on whether guarantees are extended to firms that are credit constrained, and not to firms that would be able to obtain a loan anyway. This is why additionality is another key outcome that is taken into account. Furthermore, reaching firms that are credit constrained involves risk-taking and financial losses. Even if the objective of a guarantee scheme is not to make a profit, the scheme should still be financially sustainable through sound rules, effective risk management, and regular funding.

Information asymmetry is a core reason commercial banks are generally reluctant to provide loans to SMEs. In most instances, SMEs are unable to provide information on their creditworthiness they tend to lack appropriate accounting records and collateral. This leads to uncertainty on the project’s expected rates of return and the integrity of the borrower. Gathering such information on SMEs can be challenging and costly. It is only through a 'learning process' in assessing the risk involved in small clients that banks will acquire the skill to make appropriate lending decisions

It is advisable, therefore, that in every guarantee scheme the lending institution should assume some of the risk. It might be concluded that loan guarantees should be introduced cautiously, and that no more than 50 per cent of the loan amount should be guaranteed at the start. However, the relatively low level of 50 per cent guarantee means the lending bank has to obtain collateral to cover a significant part of the risk, which could be administratively costly for banks and would inevitably make the scheme less attractive.
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