Primer for Credit Guarantee

By Patrick Chong

A credit guarantee is a commitment by a credit guarantee agency to reimburse a lender if the borrower fails to repay a loan. The lender pays a guarantee fee for the use of the credit extended.

An export credit agency’s aim is to benefit the respective economy by helping exporters of goods and services to win business, and for firms to invest overseas, by providing guarantees, insurance and reinsurance against loss.

Typically export credit agencies are required by their respective government to operate on a slightly better than break-even basis, charging exporters premium at levels that match the perceived risks and costs in each case.

The largest part of credit agencies’ activities involve underwriting long term loans to support the sale of capital goods, principally for the export of such goods such as aircrafts, bridges, machinery and services. It helps companies take part in major overseas projects such as the construction of oil and gas pipelines and the upgrading of hospitals, airports and power stations

As part of its risk management process, the credit agency has to make a judgement on the ability of a destination country to meet its debt obligations. The credit agency or department uses a ‘productive expenditure’ test, or some other tests of a similar nature, that makes sure that the countries defined as Heavily Indebted Poor Countries and those exclusively dependent on International Development Association financing only get official export credits from the beneficiary country’s government for projects that help social and economic development without creating a new unsustainable debt burden. The credit agency is obliged to continue checking that the proposed borrowing is sustainable.

Credit guarantee agencies are normally operated by governments. There are instances where private banks, as a group, joined with the government agency to provide such credits. The reluctance of private banks stem from many factors. One such factor is the fact that SMEs are numerous in numbers and have limited skills and capability. Another factor is inability to judge if the companies are up to the task, especially if the projects are large or complex. Yet a third factor may be due to SMEs inability or unwillingness to provide financial accounts making it difficult for banks to assess the solidity of the business.

Vector believes that government agencies have to take up the cudgels to support these SMEs in their efforts to win businesses and contracts. The difficulties encountered in assessing viability of business or projects means that these government agencies have to shoulder what ought to be a vetting and assessment process best suited to commercial banks who are generally in a better position in conduct due diligence as these banks have networks of information sources not typically available to government agencies. This being the case, these credit agencies are fulfilling a social role and are not for profit entities. Such funding can often cause friction between nations as they are seen to be subsidizing exports and not playing on a level field. In this respect, these agencies are unjustifiably seen as the “bad guys”.

In a nutshell, Government credit agencies, for better or worse, are a necessity and play a critical role in keeping their economy, and by extension, the world economy growing.