# 1. Introduction

Partial Credit Guarantees (PCGs) are a preferred instrument to support companies with limited access to finance, as well as to de-risk bank portfolios and support the flow of credit to companies in periods of large market swings, such as those seen during the COVID-19 pandemic. Historically, the use of PCGs has responded primarily to one market failure: lack of financial access by small and medium-size enterprises (SMEs). PCGs offered indirect support to these firms by providing third-party credit risk mitigation to financial intermediaries. A second related objective of PCGs has been the development of longer-term credit for the SMEs, building on the relations established between financial intermediaries and the firms that have gained access to credit. PCGs acquired new importance in the response to the economic consequence of the COVID-19 pandemic, as governments all over the world have relied on them to prevent disruptions in the flow of credit to vulnerable companies, many of which are in the SME sector. Leveraging on existing public guarantee institutions, governments have devised COVID-19-oriented programs to scale up resources for supporting borrowers. In many cases, PCGs were the instrument of choice due to their resource efficiency, their role in risk distribution and their longstanding relationship with SMEs and SME organizations. However, they might be only a piece of a bigger picture, complementing a comprehensive policy response, as discussed below.

The aim of this paper is to describe the challenges of PCG schemes in supporting lending to the SME sector in the Latin America region (LAC) during the COVID-19 pandemic, and to share lessons with policy makers. The assessment is based on a series of surveys carried out by the World Bank (WB), covering the majority of operating PCGs in the region. These surveys offer useful information about the relative allocation of guarantees and the governance of different schemes, while they also highlight the opportunities for shaping up these schemes in terms of pricing, capitalization and supporting the environmental agenda.

The paper notes that, while PCGs in LAC have been an efficient mechanism to assist the SME sector during COVID-19, there are opportunities for improving their design in order to optimize their impact and ensure their sustainability over time. The paper finds that the bolder COVID-response programs have used PCGs as part of a broader support package. However, the majority of PCG schemes in the LAC region are still too small to have a meaningful impact on the business model of the financial sector, in the sense that some of potential “public goods” created by PCG schemes, including creation of SME platforms by financial institutions; SME loan standardization; and climate and gender related issues still have ample room for further development. Unlike schemes in advanced economies, PCGs in the LAC region have made relatively modest use of the toolbox available in terms of parametric changes to boost interest from financial institutions. Moreover, PCGs in advanced economies may provide cues on how to return operations back to “normal” after the change in priorities due to the COVID-19 related market swing. In addition, the pricing of guarantees and solvency indicators in the LAC region remain largely statutory, and not driven by fair pricing methodologies that ensure long-term sustainability of PCG funds. While it is understandable that during periods of turbulence, governments may want to use price subsidies (of PCG schemes) to support the SME sector, it is important to understand the impact of these subsidies on the sustainability of PCG funds. An adequate risk assessment becomes key to gauging PCG solvency, particularly in the post-pandemic environment, as the expected process of insolvencies unfolds. In this context, PCGs in LAC should consider sharpening the use of solvency indicators, considering the limitations of the maximum leverage allowed by local laws.

2