provision of partial guarantees is an alternative way of giving direct support to lending operations in targeted sectors.

- Lines of credit with subsidized interest rates. Lines of credit are a powerful funding mechanism when no other alternatives are available. However, they create a critical distortion in the risk management structure of SFIs.  SFIs that depend on lines of credit have the incentives to lend what they receive and to limit their operations by the amounts that the government is willing to offer depending on the budget. Lines of credit may create a dependence relationship between the government and the final destination of the funds, which creates room for political interference and mismanagement of the SFI portfolio.

- Erosion of the SFI’s capital together with regulatory and supervisory forbearance. Some SFIs might be able to finance unprofitable projects with a softer regulatory and supervisory framework compared to other financial institutions.  This mechanism allows for inefficiencies and political interference in the company. Poorly regulated SFIs are likely to be request periodic recapitalizations, which creates dependence on the owner and may compromise the independence of the board.  SFIs should be subject to the same regulatory framework as other banks and therefore this approach should be avoided.

- Allowing SFIs to take deposits from the public.  Due to lack of government funds, many governments allow SFIs to take deposits from the public.  The decision about allowing SFIs to take deposits from the public should depend on the objectives of the SFIs and should be driven by the need to meet those objectives than the funding requirements of the bank. Only SFIs that have an objective related to the development of savings market should be allowed to take deposits from the public.  It is necessary to take into consideration that deposit taking institutions require a more comprehensive supervisory framework than banks that only take wholesale funding.  Most importantly, funding of an unprofitable business with deposits is unsustainable, and will require permanent recapitalization of the business.  Consistent with the previous alternative, this mechanism should also be avoided.

In the Canadian case, BDC is less risk averse than the private sector, and therefore willing to finance projects with higher risk. BDC has shown to be as efficient as the privately owned commercial banks, and has been able to create a profitable business from its target sector (Canadian SMEs). BDC has been maintaining a detailed database of its commercial relationship with Canadian SMEs since 1980. This has allowed BDC to understand better the risks inherent in these types of companies. In addition, BDC has developed sophisticated risk management system that has allowed them to price by risk and to run a sustainable business with SME.

The management board of BancoEstado requires all business units of the bank to be operationally profitable, including its targeted sectors (e.g. micro and SME lending, and mortgage lending for low income people). However, these business units do not cover the fixed costs associated with the distribution channels, the back office, risk management systems, etc.

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