Linking Financial Service Providers to Commercial Capital: How Do Guarantees Add Value?

May, 2008     Alexia Latortue, Jasmina Glisovic-Mezieres

In microfinance, experimentation with loan guarantees began largely as an attempt to demonstrate to local banks that microfinance institutions (MFIs) are creditworthy. Though loan guarantees are far less common than other funding instruments, such as debt, equity, and grants, they are beginning to be used more often. This Brief is based on a joint CGAP/USAID study of 96 transactions executed by eight guarantor agencies between 1988 and 2005, with most transactions made after 2000 (Flaming 2007).

In this Brief, “loan guarantee” refers to a type of credit guarantee that backs up a loan to a single MFI from a bank or other lender. Such loan guarantees are a form of insurance that covers a lender—typically a commercial bank—against default on its loan to an MFI.

Most MFIs can reach significant scale in the long term only by tapping into local deposits and bonds and by borrowing from local banks. However, many MFIs are prohibited from taking deposits, and many local bond markets are underdeveloped. Funders hope that issuing loan guarantees will facilitate MFIs’ access to commercial funding—mainly local bank loans. Most guarantees are issued by organizations, or departments within funding agencies, that aremandated and funded specifically to provide loan guarantees.

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