arranger in this transaction, but also as a financial guarantor providing guarantees to partially cover credit losses once the liquid guarantees from industry participants are exhausted. FIRA charges a fee for its services as arranger and also for the provision of the guarantees. FIRA requires all investors participating in this scheme, which are financial institutions, to use its second tier lending to purchase the securities issued by the SPV.

This structured finance transaction helps to solve principal-agent problems by outsourcing the screening of small producers to a large commercial firm that has an informational advantage relative to financial intermediaries. A significant problem in this type of transaction is that the originator may have incentives to include lower quality assets in the pool. Anticipating this possibility, investors who have less information about the quality of the assets may not be willing to invest or may ask for a premium to compensate them. In this particular transaction, the adverse selection problem is ameliorated by the fact that, since Ocean Garden signs supply agreements with the producers, it depends on the fulfillment of these agreements for its future sales and therefore has incentives to adequately screen and monitor producers. The adverse selection problem is further reduced by the fact that Ocean Garden provides guarantees to cover the initial credit losses. The pooling of working capital loans to several producers reduces transaction costs and also helps financial institutions to diversify their risk exposure, as they do not face the idiosyncratic risk of an individual producer. Also, financial institutions do not face Ocean Garden’s credit risk, as the supply contracts are removed from its balance sheet and their ownership is transferred to the SPV. This means that if Ocean Garden files for bankruptcy, the assets in the pool do not come under court jurisdiction. FIRA has been successful in using similar structured finance transactions to improve access to credit in several sectors (including wheat, corn, and sorghum production) by using large commercial firms as originators and the loans provided through this type of transactions now account for 5 percent of its total portfolio. See Appendix 4 for more details on FIRA’s experience with structured finance.

# **4.3 Credit Guarantee Systems**

Credit guarantee systems are mechanisms in which a third party, the _guarantor_ , pledges to guarantee loans to a particular group of borrowers. Credit guarantee systems reduce the lender’s expected credit losses—even if the probability of default remains unchanged—acting as a form of insurance against default. Public credit guarantee systems are widespread: according to a survey conducted by Graham Bannock and Partners, in 1995 there were at least 85 countries with some type of government credit guarantee program.<sup>64</sup> The largest and more established guarantee schemes are mostly in developed countries, including Canada, Japan, the U.S., and several European countries. The general experience with credit guarantee systems, especially in developing countries, has been poor to mixed, at best: most systems have depleted their reserves due to high

> 64 Graham Bannock and Partners (1997) find that in 14 countries there is no public credit guarantee system and in another 76 countries it is not possible to tell whether operating guarantee schemes exist. See also Herrero Calvo and Pombo Gonzalez (2001) for an overview of public credit guarantee systems around the world.

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