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Credit Guarantees: Challenging Their Role in Improving Access to Finance in the Pacific Region

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Credit Guarantees: Challenging Their Role in Improving Access to Finance in the Pacific Region Credit Guarantees Challenging Their Role in Improving Access to Finance in the Pacific Region The Pacific Private Sector Development Initiative—a regional technical assistance facility cofinanced by the Asian Development Bank (ADB), the Government of Australia, and the Government of New Zealand—has undertaken landmark secured transaction reforms in eight Pacific Island countries. These reforms have unlocked the value in “movable” assets such as machinery, inventory, and accounts receivable for use as collateral in borrowing. They have the potential to benefit businesses and financial institutions that offer business loans. Yet, despite these reforms, financial institutions remain unwilling to lend. Businesses still find it hard to access the credit they need to grow, which in turn creates jobs and drives the economic activity so desperately needed in the Pacific. Credit guarantees are often proposed as an instrument to overcome this problem. However, as this publication demonstrates, there is no strong theoretical justification for their use. About the Asian Development Bank ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to half of the world’s extreme poor. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. CREDIT GUARANTEES CHALLENGING THEIR ROLE IN IMPROVING ACCESS TO FINANCE IN THE PACIFIC REGION ASIAN DEVELOPMENT BANK 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines ASIAN DEVELOPMENT BANK www.adb.org CREDIT GUARANTEES CHALLENGING THEIR ROLE IN IMPROVING ACCESS TO FINANCE IN THE PACIFIC REGION ASIAN DEVELOPMENT BANK Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) © 2016 Asian Development Bank 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines Tel +63 2 632 4444; Fax +63 2 636 2444 www.adb.org Some rights reserved. Published in 2016. Printed in the Philippines. ISBN 978-92-9257-571-7 (Print), 978-92-9257-572-4 (e-ISBN) Publication Stock No. RPT168376-2 Cataloging-In-Publication Data Asian Development Bank. Credit guarantees: Challenging their role in improving access to finance in the Pacific region. Mandaluyong City, Philippines: Asian Development Bank, 201_. 1. Trade credit. 2. Finance sector. 3. Credit guarantees. I. Asian Development Bank. The views expressed in this publication are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. The mention of specific companies or products of manufacturers does not imply that they are endorsed or recommended by ADB in preference to others of a similar nature that are not mentioned. By making any designation of or reference to a particular territory or geographic area, or by using the term “country” in this document, ADB does not intend to make any judgments as to the legal or other status of any territory or area. This work is available under the Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) https://creativecommons.org/licenses/by/3.0/igo/. By using the content of this publication, you agree to be bound by the terms of this license. This CC license does not apply to non-ADB copyright materials in this publication. If the material is attributed to another source, please contact the copyright owner or publisher of that source for permission to reproduce it. ADB cannot be held liable for any claims that arise as a result of your use of the material. Attribution—You should always acknowledge ADB as the source using the following format: [Author]. [Year of publication]. [Title of the work in italics]. [City of publication]: [Publisher]. © ADB. [URL or DOI] [license]. Translations—Any translations you create should carry the following disclaimer: Originally published by ADB in English under the title [title in italics]. © ADB. [URL or DOI] [license]. The quality of the translation and its coherence with the original text is the sole responsibility of the translator. The English original of this work is the only official version. Adaptations—Any adaptations you create should carry the following disclaimer: This is an adaptation of an original work titled [title in italics]. © ADB. [URL or DOI][license]. The views expressed here are those of the authors and do not necessarily reflect the views and policies of ADB or its Board of Governors or the governments they represent. ADB does not endorse this work or guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. Please contact [email protected] if you have questions or comments with respect to content, or if you wish to obtain copyright permission for your intended use that does not fall within these terms, or for permission to use the ADB logo. Notes: In this publication, “$” refers to US dollars. Corrigenda to ADB publications may be found at http://www.adb.org/publications/corrigenda iii CONTENTS Abbreviations iv About The Pacific Private Sector Development Initiative v 1 INTRODUCTION 1 Secured Transactions: Solving the Problems of Collateral 1 Questioning the Case for Credit Guarantees 2 2 THE CHALLENGES OF LENDING 4 Revolutionizing business lending through secured transactions 4 3 GUARANTEES IN PRACTICE 6 A Critique of the Rationale for Credit Guarantees 6 Types of Credit Guarantees 7 Coverage, Cost, and Risk Allocation 8 The Inherent Risk of Guarantee Schemes 10 4 COULD GUARANTEES INCREASE BUSINESS CREDIT IN THE PACIFIC? 11 Pacific Experience with Guarantees 12 The Limits of Increasing Private Sector Credit in the Pacific through Guarantees 13 5 INTERNATIONAL EXPERIENCE WITH CREDIT GUARANTEE SCHEMES 14 6 TRADE CREDIT AND BUSINESS ENVIRONMENT REFORM FOR SMALL AND MEDIUM-SIZED ENTERPRISES 17 Business Environment Reform and Small and Medium-Sized Enterprises 17 Trade Credit: A Preferable Alternative to Guarantees 18 7 CONCLUSION 21 Appendixes 1 Lending and Profitability Indicators for Seven Pacific Countries 22 2 Credit Guarantee Schemes in the Pacific 23 REFERENCES 33 iv ABBREVIatIONS ADB Asian Development Bank BSP Bank South Pacific CBSI Central Bank of Solomon Islands IDA International Development Association IFC International Finance Corporation GDP gross domestic product MSEs micro and small-sized enterprises PNG Papua New Guinea RBF Reserve Bank of Fiji SFLG Small Firms Loan Guarantee Scheme SMEs small and medium-sized enterprises CURRENCY EQUIVALENTS (as of 21 January 2016) Unless otherwise stated, “$” refers to US dollars. Currency unit = Fiji dollar/s (F$) F$1.00 = $0.46 $1.00 = F$2.18 Currency Unit = kina (K) K1.00 = $0.33 $1.00 = K3.02 Currency Unit = tala (ST) ST1.00 = $0.38 $1.00 = ST2.65 Currency Unit = Solomon Islands dollar/s (S$) S$1.00 = $0.12 $1.00 = S$8.17 v ABOUT THE PACIFIC PRIVATE SECTOR DEVELOPMENT INITIATIVE The Pacific Private Sector Development Initiative (PSDI) is a regional technical assistance facility cofinanced by the Asian Development Bank (ADB), the Government of Australia, and the Government of New Zealand. Since 2006, PSDI has been working with ADB’s 14 Pacific developing member countries to improve the enabling environment for business and support inclusive, private sector-led economic growth. Its expert team provides support services in policy and program development, advocacy, legislative and administrative reform, and capacity building. All PSDI publications can be downloaded from www.adbpsdi.org. This paper draws on the background research by Saumya Mitra. PSDI thanks Erik Aelbers for preparing Appendix 2: Credit Guarantee Schemes in the Pacific, and Melissa Dayrit and Amanda Lucas-Frith for helpful comments and editorial support. 1 1. INTRODUCTION Banking sectors across Pacific island countries have to pledge moveable assets, making it easier for not yet reached the point where they effectively banks to take on additional forms of collateral as an intermediate between savers and borrowers. alternative to real property and reducing the risks of Despite adequate liquidity, commercial banks are losses in the event of default. often reluctant to extend business credit, which is a serious constraint to business operations and Credit guarantees are often promoted as an broader economic development. In quantitative instrument to overcome the lack of lending. Credit terms, the ratio of private sector credit to gross guarantee schemes have existed for over two domestic product (GDP) in Pacific countries is less centuries, having emerged first in Europe. Today, than 50%,1 with the exception of Fiji and Vanuatu. they are widely prevalent in both the developed In faster growing and more developed economies, and developing worlds.3 Credit guarantee schemes this ratio typically approaches or exceeds 100% can take several forms, with the main variants being (Appendix 1). guarantees of individual loans and guarantees of a portfolio of loans. Within these variants, there are many alternatives for allocating risk, ranging from SECURED
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