«by MICHAEL GUDGER FAO AGRICULTURAL SERVICES BULLETIN 129 The designations employed and the presentation of material in this publication do not imply ...»
The Agricultural Credit Guarantee Scheme (ACGS) was launched in 1977. This author reviewed its annual reports up to 1988 when it ceased publishing detailed data. Additional data were subsequently obtained at a conference attended by Nigerian officials. From this information we can construct a reasonable picture of its operations.
ACGS was intended to facilitate small farmer access to bank loans as a means of stimulating agricultural production. A capital fund of Naira 100 million was authorized and placed in the Central Bank. ACGS guarantees up to 75% of losses of principle and interest on loans of up to N 50, 000 for individuals and N 1 million for loans to cooperatives. Banks using the guarantees were required to lend at highly concessional nominal interest rates of 4 - 6 %.
The financial results are dismal. Between 1978 and 1994, ACGS wrote 183,875 loan guarantees against loans of N 1,035.3 million (approximately US$ 46 million at N 23 = US$ 1 in 1994 when the data was collected). Through June 1994, ACGS had settled 653 claims for N 0.4 million, amounting to less than 0.4% of the value of the loans guaranteed. However, the ACGS had claims due for settlement of N 127 million, or about 12.3% of the total volume of guarantees issued. When asked about the volume of pending claims, an official of ACGS noted that paying them would more than exhaust the scheme's net worth!
A rough estimate of the claims cost is 12.3% of the loans guaranteed: ACGS guaranteed 75% of the loan amount, so the claims cost was about 9.2% of the amount guaranteed. The administrative costs of ACGS were N 20 million from 1978 to 1988, roughly 5 times the amount of claims paid and about 16% of the amount of claims pending. With expenses at these levels, total operational costs are likely to be between 13% and 15% of the amount guaranteed. The data do not permit a precise calculation of administrative costs on the overall costs of operations. But, what is the rationale for a guarantee scheme that costs N 20 million to pay only N 0.4 million in claims, and that would be insolvent if it paid all claims due?
The result of not paying claims in order to preserve the capital of the scheme was that banks made fewer guaranteed loans. The number of operations declined from a peak of 34,000 in 1989 to only 2,895 in 1994. The available information suggests that the scheme was almost totally moribund by 1996. In many ways the Nigerian scheme resembles the Malaysian programs. In both cases, the Central Bank directed concessional credit to target groups and in both cases, guarantee funds issued guarantees to protect banks against default risks only to deny claims when they arose. The result in both cases was that the volume of guarantees contracted to an insignificant volume and the fund could survive only by defaulting on its claims.
LATIN AMERICAUSAID Supported Guarantees Latin America is rich in guarantee fund experiences but quite poor in carefully conducted analysis, although occasionally a program is reported by its manager to have produced successes. Guarantee funds, as an instrument to promote development in Latin America seem to have had its origins in USAID initiatives in the mid-1980s. The only systematic attempt to review these programs was conducted by FUNDES, a Swiss NGO. FUNDES reports that of the 12 programs that they identified in 11 countries, only two remain in existence "after having been bailed out repeatedly by shareholders."_ The reasons cited for the failure of all but two funds are: a) politically motivated payments, b) lack of confidence on the part of banks in the willingness of the funds to pay, and c) iIll-advised investments and/or inflation.
USAID also operates a central portfolio of guarantee funds to provide portfolio guarantees for certain classes of loans made by banks. To date, no information is available in the public sector on the volumes of guarantees, the results and the expenses of this central facility.
FUNDES was founded in 1984. It is a Swiss-based NGO which created programs to guarantee 50% of SME loan amounts in Costa Rica and Panama. The organization later expanded to Bolivia, Guatemala and Colombia. Guarantee programs scheduled for Argentina, Venezuela and Mexico were not undertaken due to adverse economic developments in the region.
In 1995, after 10 years of experience, FUNDES undertook a fundamental review of its operations and the concept of using guarantees to bring SMEs and banks together to fund
viable enterprises. The findings of that review are quite revealing:
FUNDES had guaranteed 2,400 loans totaling US$ 54 million for more than 1,400 customers.
Average annual losses were only 0.7% through 1994, but rose to 4.1% as the result of claims in Guatemala and Colombia. However successful overall FUNDES was in keeping losses to acceptable levels, the organization was unable to break even because of very heavy administrative costs. Most of these costs were in the small business advisory and monitoring services, not in the guarantee operations. From 1991 onward, it became clear that the gap between income and expenses was widening. As the result of this review, FUNDES concluded that as an institution operating with private donor funds, it would sift its emphasis to nonfinancial services, including training and management consulting. Existing guarantee programs in Bolivia, Colombia, Panama and Costa Rica were to be restructured accordingly.
While the FUNDES guarantee operations did not cover costs, according to FUNDES officials they were instrumental in producing several positive impacts on the SMEs. These include: a) longer loan terms and less collateral, b) internal changes at the companies in quality and administration, and c) increased employment and growth at the companies receiving loans and guarantees.
However, even given that these changes did occur, it is difficult to determine whether they arose from the guarantees or instead from the intensive consulting, advising and monitoring services that FUNDES provided its clients. As we will see below, FUNDES itself determined that these services were more valuable than the guarantees.
The expectation of FUNDES was that banks' interest in the SME market would increase significantly with guarantees. Instead, the decade-long experience led FUNDES to conclude
• Banks remained uninterested because of the high cost of information and transactions.
• Banks were uninterested in SME lending even when their risk was limited to 50%.
• Banks did not want to work with "small, often simple and informal, customers."
• Banks were not driven by competition to seek out new markets among SME borrowers.
The "healthy competition required for banks to become more interested-and competitivein an increasingly attractive small business segment can be found only in open economies and financial markets."
These findings based on field experience confirm the criticism of guarantee funds in Chapter One.
ACCION International ACCION International created a Bridge Fund in 1984 to enable its affiliates to obtain loans from local banks by offering credit guarantees as partial collateral. The Bridge Fund was capitalized with loans from USAID for US$ 1.0 million in addition to donations from individuals and institutions. These funds were deposited in a bank and invested in bonds, which were used as collateral for guarantees made under standby letters of credit issued by Citibank in favor of local banks. These letters of credit currently support guarantees of 20 to 90% of the loans extended by local banks. Local banks use the letters of credit as security for loans to ACCION affiliates which in turn on-lend the funds to micro borrowers at market rates of interest.
This mechanism achieves substantial leverage. Each dollar in the Bridge Fund supports a letter of credit by Citibank to a local bank for $1.30. Based on a letter of credit for $1.30, the local bank issues a line of credit for $2.25 to $2.90. As the loans are short term, averaging four months' maturity, leverage can reach $8.80 per year.
At the end of 1994 the Bridge Fund had issued US$ 6.25 million in guarantees in nine Latin American countries: Argentina, Bolivia, Chile, Colombia, Costa Rica, Ecuador, Mexico, Paraguay and Peru. ACCION affiliates had issued a total of 400,000 loans totaling US$ 209.5 million. The assets of the Bridge Fund had grown significantly to almost US$ 6 million.
Repayment rates were reported to be about 98% and no claims had been made on the guarantees. There is no information on the operating costs at the central level or of the national affiliates.
Colombia’s Fondo Nacional de Garantia:
The largest guarantee programme in Latin America is the FONDO NACIONAL DE GARANTIAS (FNG) in Colombia. The FNG was established in 1982 with about US $21million of capital from government entities, principally the export promotion programme PROEXPO and an industrial development bank, the Instituto de Fomento Industrial (IFI) along with several other small government shareholders. The FNG was designed to support the export sector as well as SMEs, mining, and commerce with guarantees to facilitate credit.
Between 1982 and 1995 when this writer finished the data analysis of the FNG, the volume of guarantees rose from 47 per year in 1982 to almost 900 in 1992 and declined sharply to about 400 guarantees in 1996. In total, about 5,900 guarantees were issued. On average across the 15-year period, about 395 guarantees per year were issued.
The guarantee income generated was about 1,161 million 1990 Colombian Pesos on total guarantees issued of 30,930 million Pesos. The operating expenses were 1,845 million 1990 Pesos or 5.97% of the value of guarantees issued. The guarantee payments net of recoveries were 1,095 million 1990 Pesos, or 3.54% of the value of guarantees issued. The FNG across the 15 year period suffered losses and costs of 2,940 million 1990 Pesos, or 9.51% of the value of guarantee issued. Guarantee income was 1,161 million pesos or 3.75% of the value of guarantees issued. Guarantee income covered just under 40% of the cost of operations and losses. Thus, FNG paid out 2.5 Pesos in losses and administrative costs for each Peso of income. The cost of operating the FNG was met by the investment income on the capital it obtained from government. These totaled almost 8,000 Million 1990 Pesos.
As seen above, the rates that the FNG charged were far too low to meet losses and operating costs. On average FNG charged guarantee fees of about 3.75% but required fees of 9.5% to meet losses and operating expenses. Despite the large implicit subsidy, the market for guarantees averaged fewer than 400 per year.
The cost per loan guaranteed was quite high. In fact, administrative costs were considerably larger than the fees generated by the guarantees. Furthermore FNG achieved a very low volume of guarantee and consequently very low leverage of their capital. On average, the capital was leveraged at about 2-to-1 over the 15 year period. In 1995, the capital was about 9 billion current Pesos or some US $9 million. Total guarantees outstanding were about 12.8 billion current Pesos and thus the leverage was about 1.4 to-1. In 1995, 386 guarantees were issued at a cost of 1.3 billion constant Pesos or about US $1.3 million. Thus, it cost the FNG about $3,370 to issue a guarantee whose average value was about US$ 25, 000. The low volume of high cost guarantees and the low leverage of the reserves however protected the FNG from a rapid decapitalization. “The loss ratios of the FNG clearly are worrisome but with incentives so perverse … it is surprising that losses are not greater. The reality is that the low level of activity by the FNG was its major protection and prevented a more serious loss of capital.” 20 Beatriz Marulanda de Garcia, “Fondo Nacional de Garantias de Colombia” in Sistemas. These data are partially derived from this writer’s research and supplemented by additional information.
SUMMARY OF THE LATIN AMERICAN EXPERIENCELatin America has had a broad range of experiences with guarantee funds. On balance, the largest of these, the FNG, clearly is not a model to be duplicated in other countries. The FNG was characterized by low volumes of guarantees, very high operating costs, inadequate guarantee fees to meet costs and utilization of the income derived from earnings on capital to sustain the operation. The FUNDES experiment is in many ways the most interesting in that the organization at the end of 10 years of operations in Latin America came to the conclusion that they would not be able to meet the costs of operating guarantees. Even with guarantees, FUNDES concluded that banks had limited interest in working with the SME and micro market. As a result, FUNDES is restructuring operations to emphasize non-financial services for these sectors.
By far the single example that holds out hope of being duplicated in other regions is that of ACCION International. The Bridge Fund has achieved a substantial leverage of the capital, a significant volume of micro loans and apparently a low default ratio. The wholesale guarantee approach would appear to also have the added advantage of very low costs, although no cost data are available to permit a definitive judgement. Retail level guarantees clearly have not been successful. The ACCION bank guarantee approach seems to hold promise and should be carefully studied, as it develops, with a view to replication in other regions.
INTRODUCTION TO THE GUARANTEE INDUSTRY IN THE U.S.A.The commercial guarantee industry in the USA is quite different from the state-supported schemes in Europe, Latin America, Canada, and Asia. It is first and most importantly a completely private sector industry comprised of stock companies selling financial guarantees for profit. Second, the volume of operations is very large and the industry's range of products is expanding rapidly as it seeks new markets domestically and abroad.
Do these commercial guarantee insurance companies offer a useful model for providing guarantees to SMEs and micro borrowers in developing countries and as a model for development finance practitioners promoting lending to SME and micro enterprises? Are there products, useful lessons or best practices that can be derived from the highly developed U.S. markets and applied in developing countries?