Credit guarantee schemes in Bangladesh and other countries

Most small and medium enterprises (SMEs) have encountered poor access to finance globally. Adequate access to finance is crucial for the survival and growth of SMEs. SMEs often lack the collateral for loans from financial institutions (FIs). Adequate financing of SMEs is often constrained by their relatively high credit risk and the conservatism of FIs. As a result, credit guarantee institutions established in many other countries to help enterprises obtain funds from banks.

According to a survey in some countries, 80 per cent to 90 per cent of companies would not have been able to access credit without a guarantee.

In the absence of credit from FIs, SMEs borrow from informal private lenders and small investment companies at a very high-interest rate. In a situation where the FIs was reluctant to lend money to SMEs, credit guarantees contributed in a very significant way to ensure that credit financing was channelled to the real economy.

Credit guarantee contracts require the issuer to make specified payments to reimburse the holder for a loss when a debtor fails to make payment when due. Credit guarantee schemes facilitate access to credit for SMEs that would otherwise be unable to obtain it, transforming the role of these players from 'risk mitigators', which reduce the banking system's information asymmetries, to 'risk underwriters'.

Governments around the world have taken initiatives to establish credit guarantee schemes (CGSs) for SMEs, to help them absorb/share the associated risk and reduce the dependence on collateral. These schemes encourage FIs to lend more to SMEs and at a competitive rate. The guarantee is provided at a cost, but the cost of the guarantee is relatively lower than the private credit services. CGSs also include other services to promote SMEs.

The operating structures through which credit guarantee institutions do business around the world are quite diverse. There are players with widespread regional networks and those with a single centralised office, which relies on the operating structures of the promoting entities or partners (banks, trade associations, SMEs, member and approved bodies) for their sales activities.

Most of the guarantee providers in a perfectly-designed CGS operate as state and publicly held companies, mainly through public capital or central bank of the countries. A few of the CGS operate at a national level and, in some cases, at a regional level. In addition to the government, some FIs, chambers of commerce and, in some cases, state-owned funds may come up with the guarantee. The governments of those countries are, therefore, act as a regulator of such a scheme. There are a few players that are privately held, and public bodies might hold only minimum or residual interests.

These guarantee providers have an internal network regionally having associations mainly located in Europe, Asia and South America. They include AECM (Association Européenne du Cautionnement Mutuel) operating in 18 European countries; ACSIC (Asian Credit Supplementation Institution Confederation) operating in 11 Asian countries; REGAR (Red Iberoamericana de Garantìas) operating in 22 countries, mainly South American but also European; and ALIGA (Asociaciòn Latinoamericana de Instituscionès de Garantìa), which operates at a regional level and includes countries in South America.

They have an inter-organisation relationship and exchange idea and experience to upgrade their services to SMEs.

The relationship between banks and guarantee provider is apparently very close. For the banking system, these players are important intermediaries, not only because of their role as guarantors but also because of their relationships with the SMEs' network. They can bridge the information gap and the trust gap.

CGSs are for SMEs, but not all SMEs are eligible for the guarantee scheme. Therefore, the customer selection process is very crucial. Institutions gather information and gain experience of the region, market and entrepreneurs. They provide training for some particular business, support them with a guaranteed source of raw materials, and help market finished products at a reasonable price.

Institutions around the world provide three main types of CGS.

Under a normal guarantee, a guarantor provides a guarantee on the non-collateralised portion of a loan. However, the policy may fix a maximum limit of guarantee of the total loan.

For automatic guarantee, a pre-approved credit guarantee is given to participating FIs. It facilitates faster guarantee approval with less paperwork. It is a revolving scheme for a maximum guarantee amount on the unsecured loan of certain FIs.

Risk participation is a newly launched scheme, which allows Small Business Credit Guarantee Corporation to share the guarantee risk with FIs.

As a standard practice, if a guarantee provider denies the guarantee request, FIs are unlikely to issue the loan, or they tend to impose harsher conditions by increasing interest rates and to seek further guarantees. They even extend consumer credit services. Such diversification provides useful services to customers, enabling them to improve their business culture and financial management techniques.

Guarantee schemes represent one of the most powerful tools SMEs can use to access credit financing at appropriate price and terms and conditions. Thus all the actions the industry can take concerning the exchange of best practices, benchmarks, technical assistance and other actions such as institutional lobbying and marketing are of great importance to ensure the business community knows about the guarantee scheme and can make the best of it.

The three main guarantee organisation models may be summarised as follows: the public guarantee model reflects a guarantee scheme, which is typical of Asian players; the mixed model and private guarantee model reflect European cases. It has been observed that the greater the private component in the player's ownership structure, the greater the ability for it to provide a range of complex and structured additional services in addition to guarantees.

In most of countries, the laws governing guarantee market players regulate many aspects, including their scope of operations, legal status and governance, capital and operating requirements, and their access to state-owned funds. The supervision and control of guarantee organisations are assigned to the ministries of the governments in many cases.

In Bangladesh, the central bank issued a Manual of Credit Guarantee Scheme (CGS) for Cottage, Micro and Small Enterprises (CMSE) on November 3, 2020. The proposed CGS is different from those offered by other economies. There is the involvement of state authority, but the Bangladesh Bank will operate the scheme.

The guarantee shall have three limits on the portfolio of loans or investments of participating FIs. The limits are portfolio guarantee limit; guarantee portfolio cap, and loan/investment guarantee coverage ratio. The CGS is intended to be a risk-sharing facility. A guarantee coverage ratio sets a maximum 80 per cent of the loan principal. There will be no interaction between the CMSEs and the CGS unit other than through the FIs. The BB will not evaluate the feasibility of SMEs to extend the service. FIs will study the feasibility and identify the SMEs to extend service.

The proposed programme of the BB is different from other countries. The central bank, the CGS and FIs will perform their responsibilities in an independent manner. There will be hardly any intention of close cooperation between them. Bangladesh may evaluate the CGS of other countries to modify its own model.

The author is a legal economist. He can be reached at [email protected].