Overview of USAID’s Partial Credit Guarantees
Background
Banks in many developing countries are very conservative in their lending practices. Much of their capital is invested in low-risk government bonds. When banks make loans, it is typically to established customers and collateral requirements are 100% to 200%. As a result, many creditworthy borrowers are unable to access financing.
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Monthly
meeting of
Finca-Tanzania's borrowers, with their children.
This young man was named after the microfinance institution
that enabled his mother to run her own business. |
How USAID Uses Credit Guarantees
The U.S. Agency for International Development (USAID) works with the private sector in developing countries to expand investment in local development activities. Since 1999, USAID’s field offices, or “missions” have used the Development Credit Authority (DCA) to facilitate these public-private partnerships.
DCA is a tool within USAID that enables missions to provide partial credit guarantees for private-sector investments. These guarantees, which cover up to 50% of the risk in lending to projects, reduce the risk associated with lending to new sectors or new borrowers. Moreover, they help stimulate development by increasing the flow of credit to areas and activities that need it most, including specific sectors targeted by USAID. This represents a tremendous opportunity for local businesses as well as public and private service providers in sectors such aspublic health,education, finance and infrastructure.
USAID’s loan or bond guarantees are often complemented by technical assistance at three levels: partner financial institutions potential borrowers and the enabling environment. The combination of technical assistance and partial guarantees has introduced local financial institutions to new lending opportunities has given borrowers the skills to market themselves to banks, and has contributed to the legal and regulatory reforms necessary to support a vibrant financial sector.
In addition to mobilizing financing for specific projects, partial guarantees help demonstrate to local banks that loans to underserved sectors can be profitable. This fosters self-sustained financing because lenders become willing to finance projects on a continuous basis without the support of guarantees from USAID or other donors. Partial guarantees are a powerful catalyst for unlocking the resources of private credit markets to spur economic growth while advancing development objectives.
Cost of USAID Credit Guarantees
Under the Truth-In-Budgeting Act, the cost of a USAID loan guarantee is the estimated net cost of the assistance to taxpayers over the life of the guarantee, as expressed in present discounted value terms. For example, if USAID makes a $10 million loan guarantee, the true cost will be determined for the most part by the risk of default. To over simplify, if the risk of default is estimated to be 10%, the cost to USAID's budget of a $10 million loan guarantee would be approximately $1 million. This cost would be approximately the same on a direct USAID $10 million loan made at interest rates similar to Treasury's cost of borrowing, assuming again a 10% estimated risk of default.
Partial guarantees are intended to be used as a credit enhancement tool with true risk sharing on the part of private and public sector partners. Loan amounts typically fall in the $5-10 million range, but loan guarantees have been as low as $1 million and as high as $40+ million.
Benefits of USAID’s Partial Guarantees
Credit assistance is particularly useful in areas such as micro and small enterprise, privatization of public services, infrastructure, efficient and renewable energy, and climate change. Credit projects offer several distinct and very attractive advantages over other forms of assistance:
- Promotes private-sector investment - Large reserves of untapped private capital are available within the private sector of developing countries. To encourage financial institutions to lend that capital for developmentally beneficial projects, credit guarantees can be used to cover part of the risk on new loans where financing had been unavailable or inaccessible.
- Encourages lending by reducing risk - USAID guarantees up to 50 percent of the net loss on principal for investments covered by a guarantee, sharing the risk with the private-sector partner.
- Builds banks lending capacities - Guarantees provide local financial institutions with the security to extend credit and expand into new sectors. In this way, banks invest in their capacity to lend into new and potentially profitable markets while increasing the credit available to developing areas. These guarantees are often coupled with training and professional assistance from USAID designed to strengthen a financial institution’s long-term involvement in local credit markets, beyond the coverage of a DCA guarantee.
- Demonstrates benefits of credit (“the demonstration effect”) – the benefits of credit guarantees are demonstrated by providing local partners with access to less expensive credit. Subsequently, by demonstrating the sustainability and profitability of development activities using that credit, local institutions are more likely to expand financial services to traditionally underrepresented economic sectors and social groups.
- Maximizes U.S. Government funding - By using credit from local sources to finance development activities, one dollar from the U.S. Government can leverage up to 50 dollars in loans.
Legislative History
In the FY 1998 Appropriations Act, Congress gave USAID the general authority to provide credit assistance (loan and bond guarantees) for any of the development purposes specified under the Foreign Assistance Act (FAA) of 1961, as amended. In April 1999, the Office of Management and Budget (OMB) certified USAID's capacity to properly manage credit programs, i.e., to accurately assess risk and to operate viable financial management and accounting systems.
Restrictions on the Use of Guarantees
The use of partial guarantees is primarily intended for countries and regions where USAID has an active presence. Eligible projects must have positive financial rates of return so that the loans can be repaid. USAID may decline to offer credit assistance where risk analysis of a specific project demonstrates that the estimated risk is very high. There should be true risk sharing through a partial guarantee. True risk sharing requires an independent risk analysis performed by firms with a real financial stake in the outcome. This effort will tend to protect the US taxpayers.
For more detailed information about the guidelines on which USAID’s guarantees are based, please refer to the Guiding Principles.
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