What are Credit Guarantees?
A credit guarantee provides comfort to the lender that if the borrower does not repay a guaranteed loan, the credit guarantee will cover some or all of the outstanding loan amount.
Credit guarantees are a form of insurance against non-payment of credit obligations. The structure of these guarantees differs greatly depending on the purpose of the guarantee.
A personal guarantee is a form of credit guarantee if it secures a financial obligation, such as a loan.
In international trade, a letter of credit is essentially a credit guarantee because it gives comfort to a seller that if all the conditions agreed with the buyer have been met, the bank will pay on behalf of the buyer.
Credit guarantees are usually used to encourage lending in areas that lenders are reluctant to lend because of some form of discomfort. For examples, the borrower does not have sufficient collateral to secure the loan requested, or the business is in a new or previously untested sector. The credit guarantee offers comforts to the lender that, in the event of a loan default, they will be able to recover a portion of the outstanding loans by claiming on the guarantee.
Guarantees have developed over time as lessons have been learned. For example, it has been learned from experience that guarantee programs need to cover a portion of the loan amount rather than the entire loan amount to ensure that the banks have enough ‘skin in the game’ to mitigate against moral hazard.
There are typically two types of guarantees, individual guarantees and portfolio guarantees. We have been developing hybrid guarantee products that have some attributes of the individual and portfolio guarantees in addressing the needs of the credit guarantee schemes that we work with.
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