metadata: authors: 0: author: Rudolph,Heinz P.
1: author: Diaz Kalan,Federico Alfonso
2: author: Miguel Liriano,Faruk
count: Latin America
docna: 0: docna: Challenges of Public Credit Guarantee
            Schemes in Latin America during the Pandemic
docty: Policy Research Working Paper
subtopic: Financial Sector Policy,Legal Institutions of the Market Economy,Access to Finance
teratopic: Public Sector Development,Finance and Financial Sector Development
abstracts: cdata!: Partial credit guarantees have been a
            central tool in countries&#x2019; strategies to support
            firms through the COVID-19 pandemic. This paper presents the
            results of a set of surveys covering 19 partial credit
            guarantees in 12 countries in the Latin America region,
            which were repeated at different stages of the pandemic
            crisis. The paper finds that most partial credit guarantees
            in the region are not large enough to foster change in the
            way the local financial sectors conduct business, how they
            engage with small and medium-size enterprises, and how they
            assimilate climate and gender considerations. Moreover, the
            response to the pandemic shows that most partial credit
            guarantees in the region have made limited use of the
            toolkit of parametric changes for boosting participation
            among financial institutions. Finally, the paper stresses
            the need for fair pricing methodologies and risk-based
            capital adequacy that may ensure the long-term
            sustainability of partial credit guarantee schemes.
repnme: repnme: Challenges of Public Credit Guarantee
            Schemes in Latin America during the Pandemic
display_title: Challenges of Public Credit
            Guarantee Schemes in Latin America during the Pandemic
listing_relative_url: /research/2022/01/33700446/challenges-public-credit-guarantee-schemes-latin-america-during-pandemic
topicv3: Environment, Natural Resources and Blue
            Economy m1327391 566,Access to Finance m1327464 1249,Financial Sector Development m1327681 1920,Financial Institutions m1505015 3797,Coronavirus (COVID-19) m1939478 4828
publishtoextweb_dt: 2022-01-10T00:00:00Z
dois: 10.1596/1813-9450-9895
historic_topic: Public Sector Development,Finance and Financial Sector Development
origu: EFI-LCR-FCI-Finance (ELCFN)
no_of_pages: 43
author_keys: 0: author_key: 862651
1: author_key: 1598599
2: author_key: 1753502
model_extractions: Policy Research Working Paper 9895 Challenges of Public Credit Guarantee Schemes in Latin America during the Pandemic _Heinz P. Rudolph Federico A. Diaz Kalan Faruk Miguel Liriano_ Finance, Competitiveness and Innovation Global Practice January 2022
Policy Research Working Paper 9895

# **Abstract**

Partial credit guarantees have been a central tool in countries’ strategies to support firms through the COVID-19 pandemic. This paper presents the results of a set of surveys covering 19 partial credit guarantees in 12 countries in the Latin America region, which were repeated at different stages of the pandemic crisis. The paper finds that most partial credit guarantees in the region are not large enough to foster change in the way the local financial sectors conduct business, how they engage with small and medium-size enterprises, and how they assimilate climate and gender considerations. Moreover, the response to the pandemic shows that most partial credit guarantees in the region have made limited use of the toolkit of parametric changes for boosting participation among financial institutions. Finally, the paper stresses the need for fair pricing methodologies and risk-based capital adequacy that may ensure the longterm sustainability of partial credit guarantee schemes.

This paper is a product of the Finance, Competitiveness and Innovation Global Practice. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at hrudolph@worldbank.org, fdiazkalan@worldbank.org, and fmiguelliriano@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Challenges of Public Credit Guarantee Schemes in Latin America during the Pandemic**<sup>**1**</sup>

Heinz P. Rudolph, Federico A. Diaz Kalan and Faruk Miguel Liriano JEL classification codes: G32, G21, G28 Keywords: COVID-19, partial credit guarantees, SME finance Authors’ Email Address: hrudolph@worldbank.org, fdiazkalan@worldbank.org, <u>fmiguelliriano@worldbank.org.</u> 1 The authors work with the World Bank. We are grateful to the Red Iberoamericana de Garantías (REGAR) for facilitating the information exchange with PCGs in the Latin American region, and to FIRST Trust Fund for generous financial support. We are also indebted to Yira Mascaró and Zafer Mustafaoglu for their guidance; and to Pietro Calice, Eva Gutierrez and Tony Randle for their comments and suggestions. This paper’s findings, interpretations, and conclusions are entirely those of the authors and do not necessarily represent the views of the World Bank, their Executive Directors, or the countries they represent. All errors and omissions are the authors’ sole responsibility.
# 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
The paper is structured in four sections. Section 2 presents a brief literature review. Section 3 describes the methodology used in the three surveys that provided the basis for this work. Section 4 is an overview of the PCGs operating in LAC and their characteristics, differentiating between pre- and post-pandemic periods, and presenting the main challenges faced by PCGs in the latter. Section 5 concludes with a discussion of the main lessons and conclusions.

# 2. Literature Review

SMEs are usually credit constrained, particularly during periods of economic turbulence. Existing literature points to market failures associated with information asymmetries between the credit providers and the firms as the underlying driver for SMEs’ access to credit (Cusmano, 2013; Mullins and Toro, 2018). In the presence of asymmetric information banks face difficulties distinguishing creditworthy borrowers, and may opt to credit ration or even deny credit to entire market segments. The sole reliance on pricing could lead to problems of adverse selection (Stiglitz and Weiss, 1981). SMEs' inherent characteristics, such as limited credit history and incomplete financial information and limited collateral, restrict their ability to access finance. As the SME lending, in the initial stages, is largely based on collateral availability, banks remain reluctant to actively participate in this market. In addition, due to fixed loan origination costs, SME lending is relatively costly for banks compared with more sizable loans. Given SMEs’ complexities, scoring systems are less frequently used as in the case of household lending. Furthermore, smaller enterprises are prone to lose access to credit in periods of large market swings. DeYoung et al. (2015) provide evidence of changes in banks’ lending behavior during the 2008 Global Financial Crisis (GFC), where they become less tolerant to risk and rationed supply of credit to SMEs.

PCGs are a widely used risk mitigation tool to support SME financing. PCGs reduce the need for SMEs to post collateral for accessing to credit, as these schemes pay the lender a portion of the loan in the case of default. According to Beck et al. (2008a), 50 percent of developed countries’ banks and 55 percent from developing countries consider PCGs are the most influential government program to support bank financing to SMEs (compared programs include interest subsidies, directed credit programs, and regulatory subsidies). During the GFC, public guarantee schemes played a central role in countering the effects of the recession by enhancing credit allocation to SMEs. Back then, PCGs substantially expanded both in terms of operating schemes and guarantee volumes. For instance, OECD countries saw a threefold increase in the share of guaranteed loans in the total loans stock between 2008 and 2010 (see Cusmano, 2013 and OECD, 2020).

Some studies have empirically assessed the performance of PCGs. In the case of Chile, Mullins and Toro (2018) find that by accessing to new credit via PCGs, SMEs significantly scale up their sales, employment, and input purchases. The authors also find that SMEs increase borrowing from other banks following a loan guarantee. For the United States, Hancock et al (2007) show evidence of stabilizing effects of the SBA-guaranteed loan program on SME outcomes, as this program’s loans were less pro-cyclical and less affected by bank capital than non-guaranteed loans. Additionally, Craig et al. (2008) find a positive and significant correlation between the average level of employment in a local market and the level of SBA guaranteed lending in that local market, with the intensity of this correlation being relatively larger in low3
income markets. Lelarge et al. (2010), provide evidence indicating that the obtention of a loan guarantee helps newly created French firms grow faster and pay a lower cost for their capital, though it also increases their probability of default.

Inadequate pricing of guarantees has been identified in the literature. A study covering 76 PCGs across 46 developed and developing countries finds evidence that while governments have a crucial role in funding and management of PCGs, their involvement in risk assessment and recovery is limited (Beck et al., 2008b). Risk-based pricing and limited use of risk management mechanisms have been largely absent in the design of the PCG schemes. This finding is also confirmed in this paper.

The World Bank Principles for Public Credit Guarantee Schemes for Small and Medium Enterprises offer a sound approach for assessing the soundness of the PCG schemes. Following the launch of the _World Bank Principles for Public Credit Guarantee Schemes for Small and Medium Enterprises_ , Calice (2016) reviewed its implementation across the globe. The paper found the space for reform and actions in terms of the accountability of funding sources, corporate governance and risk management, prudential regulatory recognition of guarantees, program/product calibration, and reporting and disclosure. More recently Goffe and others (2021) provide a set of good practices for policy makers in the design of PCG schemes.

# 3. Methodology

The paper is largely based on information from three surveys of PCG schemes in LAC, conducted by the World Bank in the second half of 2020. The surveys cover almost all the operating PCGs in LAC by examining 19 PCGs in 12 countries: Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, El Salvador, Honduras, Mexico, Paraguay, Peru, and Uruguay.<sup>2</sup> In that regard, the project benefited from a network that brings together PCGs in the region and programs in Spain and Portugal: _Red Iberoamericana de Garantías_ (REGAR).<sup>3</sup> The information was collected over three survey periods, in June, September and December of 2020. See Table A1 in the Appendix for a full list of the programs and the details of the periods during which they were surveyed. The surveys generated information on a set of characteristics of the schemes that will be presented in this paper, including their objectives, scope, governance and COVID-19 response programs. The design of successive surveys was enriched both by the policy discussion held with the PCGs that participated in the survey and the operational work the WB has undertaken with governments in supporting such schemes. A summary tabulation of the responses is available in Table A2 in the Appendix.

> 2 The Caribbean PCG is expected to be included in future surveys. Jamaica and the Organization of Eastern Caribbean States have recently launched PCGs, which will be surveyed as they increase their volume of operations. The Development Bank of Jamaica (DBJ) has revamped its Credit Enhancement Facility with support from the World Bank (P152307) and began operations in January 2020. The Eastern Caribbean Partial Credit Guarantee Corporation (ECPCGC) operates in Antigua & Barbuda, Dominica, Grenada, St. Kitts & Nevis, St. Lucia, and St. Vincent & the Grenadines. The project is being supported by the World Bank. It was launched in October 2020 and it began operations in January 2021.

> 3 In addition, non-affiliated PCGs were also contacted in an attempt to increase the survey coverage.

4
The paper builds on some of the WB Principles for Public Credit Guarantee Schemes (PPCG) for SMEs.<sup>4</sup> While this paper does not attempt to assess the PCG schemes in the region based on the PPCG principles, it does build on some of them. Examples of this can be found in the areas of objectives, governance, and supervision, which reflect on principle 5 (“[PCGs] should have a clearly defined mandate supported by strategies and operational goals consistent with policy objectives.”), principle 1 (“[PCGs] should be established as an independent legal entity on the basis of a sound and clearly defined legal and regulatory framework to support the effective implementation of the CGS’s operations and the achievement of its policy objectives.”) and principle 4 (“[PCGs] should be independently and effectively supervised on the basis of risk-proportionate regulation scaled by the products and services offered.”).

This paper also benchmarks the characteristics and performance of PCGs in LAC vis-à-vis advanced countries during the COVID-19 pandemic. Advanced economies have also relied heavily on PCGs to provide support to their local enterprises as they dealt with the COVID-19 pandemic. While several advanced economies had well-established institutions in place, many had to introduce special programs, which included significant parametric changes, as they also brought in new public funding in order to maximize the impact of their policy measures. A presentation of these changes, along with an overview of their performance, are important for policy makers in LAC to explore future policy options for their own use.

# 4. PCGs in the LAC region

PCG schemes that support the SME sector serve different purposes in normal times and during market swings. While in normal times, PCG programs typically focus their efforts on supporting access to finance by SMEs, during market swings the programs become a valuable instrument to channel the government support for viable companies to weather the storm and de-risk bank portfolios to help in smoothing the credit flow towards the SME sector. Increasing the use of banking services by companies during crisis periods might be a difficult endeavor. Banks and other financial institutions protect their capital, by becoming more risk averse, that means curtailing their lending to riskier segments of the markets, such as SMEs. Notwithstanding, during market swings, PCG schemes may grow as a proportion of total lending to SMEs. This is because PCG schemes may help to de-risk banks’ loan portfolios and facilitate smoother lending to the SME sector, thus avoiding the possibility of a credit crunch.

# a. PCGs in the LAC region in pre-pandemic times

While PCGs in LAC have clear objectives, economic additionality is not one of them. In the absence of economic additionality as an objective, the incentive structure of PCG schemes runs the risk of misguidance. The lion’s share of surveyed PCGs (14)<sup>5</sup> has an explicit annual objective: either the volume

> 4 World Bank (2015).

> 5 Refers to the number of PCGs. The same notation is used henceforth.

5
of guarantees to be granted or the number of borrowers to be served.<sup>6</sup> As for their target economic sectors, the COVID-19 pandemic has given more prominence to the need to maximize the number of firms covered by the scheme in order to increase the chances of their financial survival. Before the pandemic, the majority of PCGs had an explicit objective, usually governed by specific parameters within each PCG, economic sector (14), with the majority being focused on MSMEs. Few of them (3) include exporting firms and firms operating in the agriculture sector within the target. It should be noted that no PCG considered financial or economic additionality as an explicit objective.<sup>7</sup> Although having an explicit objective is positive, and consistent with principle 5 of the PPCG, the fact that PCGs do not target additionality may create perverse incentives. For example, financial institutions may want to use these guarantees for overcollateralizing credit to low risk companies.

**_Figure 1_** _– PCGs characteristics: Existence of an explicit annual objective_

<!-- Start of picture text --> Yes / No ...If it does, the objective is defined as:<br>Volume of guarantees* 8<br>No ; 2;<br>13% Volume and number of<br>6<br>guarantees*<br>Number of guarantees 0<br>Economic or financial<br>0<br>Yes; 14; additionality<br>87%<br>0 2 4 6 8<br>Number of answers<br><!-- End of picture text -->

**Source:** Own elaboration. **Note** : *In terms of guarantees granted or credit covered by PCGs programs

Other elements that may exacerbate perverse incentives within PCG schemes include subsidized fees, an elevated percentage of guarantees and insufficient scale. If the cost of guarantees is subsidized, financial institutions may opt to use these subsidies to protect their portfolios, and in the absence of competition, they can easily pass the cost of these guarantees to the borrower. Moreover, moral hazard increases with the percentage of guarantees offered by PCG schemes. Banks are less likely to screen the risk of their loans to the extent that the overall amounts of loans are guaranteed. Furthermore, to the extent that PCGs in the region remain small within the overall SME lending market, their programs are likely to be

> 6 The sample composition of the surveyed PCGs varies by wave (Table A1 – Surveyed Programs). To take into account this and the non-responses to certain questions, in Table A2 we specify the number of responses for each survey outcome.

> 7 The WB Principles recommend taking into account additionality both in terms of PCGs delivery approach (Principle 10) as well as part of their performance evaluation (Principle 16). Additionality could be either financial or economic. Financial additionality refers to incremental credit volumes granted to eligible SMEs due to PCG activities, whereas economic additionality to incremental credit volumes granted to eligible SMEs as a result of PCG activities. For further details, see the Glossary.

6
less effective. In other words, PCGs would largely be used to protect the balance sheet of banks’ SME portfolios, but the selection of companies is likely to be similar with or without guarantees. This is a consequence of the presence of information asymmetries between the bank and the PCG administrator.

In the pre-pandemic environment, most PCG schemes had subsidies embedded in their fees. Aimed at gauging whether PCGs in the region present embedded subsidies in the fees charged per covered loan, we compared their operating costs and incomes before the pandemic.<sup>8</sup> We defined operating income as income from fees and loan loss recovery, and operating costs as credit losses, as a simplified approach. Both variables were normalized by the credit covered (see Figure 2).<sup>9</sup> We found that, as of December 2019, most PCGs reported operating income that was insufficient to offset the cost of credit losses, signaling a subsidized pricing policy. While capital investment returns from the PCG fund helped finance the gap, the size of the fund was also a dynamic variable (Figure A1). During the pandemic, some COVIDspecific programs were further subsidized by governments through co-financing (i.e., _Fondo Nacional de Garantías_ -FNG- in Colombia) or by eliminating fees (i.e., BNDES – Brazil) paid by financial institutions. In contrast, some PCGs in advanced economies have self-sustainability as part of their mandates. These include the Finnish state-owned financing company Finnvera<sup>10</sup> and the Small Business Administration (SBA) scheme in the United States.<sup>11</sup>

**_Figure 2_** _– PCGs characteristics: Fees, loan loss recovery, and credit loss_

<!-- Start of picture text --> Fees Loan loss recovery Income Credit loss<br>12<br>10<br>8<br>6<br>4<br>2<br>0<br>BRA ARG URU MEX SLV CHL COL ECU<br>BNDES SGC Garantizar FOGACH FOGABA SIGA NAFIN BMXT FIRA FSG FOGAPE FNG CFN<br><!-- End of picture text -->

**Source:** Own elaboration.

8 Nafin in Mexico has aimed to price the guarantees by risk.

9 Note that this is not a solvency measure, which is better captured by risk management frameworks and leverage ratios as discussed below.

10 Finnvera periodically reports on its performance relative to the policy goals established by the Government of Finland. One of these goals is that the income from the company’s operations covers the expenses of the operations over a period exceeding a business cycle (in the case of SME financing, the review period is 10 years). The company aims to achieve this goal through a combination of risk-based pricing and risk management tools.

11 The SBA sets its front-end fee based on estimates of the program losses for its guarantee scheme over the life of the loans made in a given year. While the SBA has the backing of the US government to cover any shortfall, the upfront fee and an ongoing fee are, in principle, set with the objective of making the scheme self-funding.

7
The coverage ratio, that is the percentage of the underlying loans being guaranteed, has seen changes in PCGs across the world. The guarantee coverage ratio should strike a balance: on the one hand, it should be high enough to be an incentive to financial intermediaries to participate and to provide credit to borrowers which otherwise would have no access; on the other hand, the ratio should place a meaningful share of credit risk on lenders in order to keep their incentives aligned with those of the PCG (so-called ‘skin in the game’). Different coverage ratios have implications on the risks of their schemes and are expected to have effects on the provisioning of PCG funds as well as their fee structures. This increase in risk provides further motivation for schemes in LAC to implement a risk management framework.

In 2019, the coverage ratio differed significantly across countries in the region. Region-wide the median coverage in 2019 stood at 59 percent. Programs in Argentina are the only ones in LAC that offer full guarantees on SME loans. At the other end, the effective coverage ratio in the programs in Bolivia, Colombia, El Salvador, and Mexico reached approximately half of the related loans in 2019. As described in the next section, most of these PCGs have increased the coverage ratio in the face of the COVID-19 pandemic.

While access to finance is a significant constraint for micro, small and medium size companies (MSMEs) in the LAC region, only three countries have relatively large PCG programs to support the sector. The International Finance Corporation (IFC) estimated that 1.1 million firms, or 27 percent of formal MSMEs in LAC, have unmet financing needs of USD1,209 million every year (see Figure 3). This finance gap in LAC is especially large when compared with the current credit volume to MSMEs of only USD 185 million.<sup>12</sup> With the exception of Mexico, Colombia and Chile, the lending portfolio covered by PCG schemes is less than 10 percent, which appears to be insufficient and poses a question concerning the additionality of the PCG schemes in the region. As of 2019, more than 30 percent of the total credit granted to SMEs was covered by PCGs in Mexico, followed in relevance by Colombia and Chile with 22.6 and 10.9 percent, respectively (see Figure 4). Mexico is one of the countries in the region with more history and concentration of PCGs, with three schemes currently operating. On the flip side are Peru, Brazil, and Paraguay, with a ratio of PCGs’ guarantees to total credit to SMEs well below 1 percent. The small size of the PCG in Paraguay ( _Fondo de Garantía del Paraguay_ , FOGAPY) –0.02 percent of guarantees to total credit to SMEs– speaks of its recent creation and low capitalization. Nonetheless, this overall picture changed, as most programs increased their allocation of guarantees during 2020. Many of them still remained small, reflecting a considerable potential for growth.

12 IFC (2017).

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# Microenterprises

<!-- Start of picture text --> Small and Medium Enterprises<br><!-- End of picture text --> <!-- Start of picture text --> = Partly Constrained = Fully Constrained = Unconstrained<br><!-- End of picture text --> <!-- Start of picture text --> De® s S oh © Ss >)<br>eS & eS & eS s eK & S<br>2 ©) OS Ss Sy RO Q ny<br>rs fF Sf S Bs<br><!-- End of picture text -->
<!-- Start of picture text --> Yeses / N _..ifit does, it relatesto: ... of which standarizedgrace periods and/or<br>/ NO maturity(up to):<br>TM Grace period TM Maturity<br>Grace period ay ax Re een! ls 7<br>2 NAFIN/BMxT SST<br>ga BNDES EEN<br>—<br>—<br>Maturity |] 8 Z3Oo —_FOGAPEFNG NNNENN<br>a<br>a coribe fi<br>><br>>3 FocaPY fj<br>0 2 4 6 8 10 Fa<x scc J<br>Number of answers ) 60 Months 120 180<br><!-- End of picture text -->
**_Figure 6_** _– PCGs characteristics: Environmental standards requirements by scheme_

<!-- Start of picture text --> Yes / No ...If it does, they apply to:<br>Ultimate beneficiary 3<br>Yes; 6; Ultimate beneficiary and<br>2<br>37% financial intermediary<br>No ; 10;<br>Financial intermediary 1<br>63%<br>0 1 2 3<br>Number of answers<br><!-- End of picture text -->

**Source:** Own elaboration.

PCGs can be instrumental in implementing well-defined specific objectives such as supporting female entrepreneurs in the region. Across the region, four PCGs reported having programs targeted at women in Mexico, El Salvador, and Argentina. For instance, the _Fondo Salvadoreño de Garantias_ (FSG) launched in 2014 was the first guarantee program intended to provide financial access to women entrepreneurs, called _“Banca Mujer”_ .<sup>14</sup> This program has the largest outreach in terms of number of women-led firms served across LAC, and represented 10 percent of the total number guarantees granted by FSG during 2020. _Banca Mujer_ offers a coverage rate of 70 percent, which is almost 20 percent higher than the average of other FSG programs. Other PCGs with women-targeted programs are _Nacional Financiera_ (NAFIN, Mexico), _Banco Nacional de Comercio Exterior_ (Bancomext, Mexico), and _Garantizar_ (Argentina). When dealing with targeted programs with enhanced guarantee terms, it is essential to have in place sustainable pricing policies, and in the case of subsidies they should be transparent to ensure a clear source of funding.<sup>15</sup> These subsidies may come, for example, directly from the government budget.

A positive feature in all PCG schemes in the region is that their supervisory accountabilities are separate from their own ownership and management. All PCGs surveyed are independently supervised. With the exception of the guarantee fund administered by BNDES in Brazil, the supervisor of banks conducts the supervision of PCGs in LAC. However, room for improvement remains, as, for example, this type of supervision is not supported by sound solvency metrics, including the use of risk-based measures.

14 As in other women-targeted programs in the region, the eligibility criteria for women led-businesses is more than 50 percent of the shareholders’ funds belonging to women. NAFIN in Mexico additionally considers another eligibility criterion: more than 50 percent women on the firm’s board.

15 The WB Principles stress the importance of having adequate capital and government financial support to ensure effective implementation of its operations, and recommend that the sources of funding, including any reliance on explicit and implicit subsidies, should be transparent and publicly disclosed (Principle 2).

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# b. PCGs in the LAC region during the pandemic

The governance structure is an important element at the time of deciding how to use the PCG schemes during periods of market swings. PCG schemes need to have in place a governance structure that offers flexibility to expand in periods of market swings. The majority of PCG schemes that have had success in mobilizing credit during the pandemic modified their parameters by law, a decree, or executive order. While it seems intuitively obvious that those PCGs operating in countries where the governance structures were set internally would be more reactive to market swings, the opposite was observed. The more reactive PCGs were in countries where the main structures were set in law. These were the cases of PCGs in Paraguay, Brazil, Uruguay, and Chile. The programs were not only supported in terms of massive resources,<sup>16</sup> but also in terms of parametric changes. The apparent contradiction is largely explained by the magnitude of the crisis and the recognition by the authorities of the need to take bold measures to support SME financing. The political support associated with approvals based on the law has allowed the programs to gain visibility and enabled them to implement bolder changes. In terms of the parameters that can be revised, the board of directors or internal committees of most programs can modify the fees on the guarantees granted (15), the percentage of guarantees allocated to loans (11), or the type of firms to serve (12).

While most of the public discussion on PCGs focused on the coverage of guarantees, the menu of potential parametric changes to improve effectiveness is broader. It includes the extension of COVID-response programs, economic sector coverage, guarantee maturity, grace periods, as well as caps on fees and interest rates. As shown in Figure 7, the United States and European Union have undertaken several parametric changes to sustain access to finance of firms during market turmoil, while countries in LAC have only partially used the options at their disposal. In the US, the SBA Paycheck Protection Program (PPP), launched to provide a direct incentive for small firms to keep their workers employed had a design that differed from the standard guarantees provided by the agency. The new program had a predetermined interest rate, a fixed maturity, eliminated fees (both by the government and the lenders) and, most importantly, gave the possibility for clients to apply for loan forgiveness in case employment and compensation levels were maintained.<sup>17</sup> The entities eligible for PPP also went beyond the SBA definition of a small business concern.<sup>18</sup> Similarly, the European Union also had to undergo parametric changes to face the pandemic crisis, which required them to adapt the EU state aid rules with the Temporary Framework (TF, see Box 1). Though most economies are finding their way out of the pandemic, the experience of advanced economies may also provide guidance for developing countries in their efforts to reestablish SME access to finance as their main priority.

> 16 For instance, The Ministry of Finance of Chile approved a capitalization of FOGAPE of up to USD 3,000 million, COFIDE (Peru) received a capitalization of around USD 7,500 million, and FOGAPY (Paraguay) recapitalized from USD 8 million to USD 276 million.

> 17 A grace period of 10 months would be granted to those firms that did not apply for loan forgiveness.

> 18 PPP admitted, among others, sole proprietors, independent contractors, and self-employed persons. It also had a more ample definition for firms in the Accommodations and Food Services sectors.

12
<!-- Start of picture text --> Figure 7 - PCG adjusted parameters during the pandemic<br>(In percentage of programs)<br>LAC US EU<br>Maturity<br>100<br>80<br>Program extension 60 Grace period<br>40<br>20<br>0<br>Economic sector Interest rate ceiling<br>Coverage Fees<br><!-- End of picture text -->

**Source:** Own elaboration. **Note** : For the US and the European Union (TF, individual countries ruled on grace periods and interest ceilings<sup>19</sup> ), the radar takes the maximum value (100) if the parameter was modified/included in the PCG program, 0 otherwise.

Many of the COVID-19 related PCG schemes were designed for a short period, and the end of these programs coincided with the peak of the pandemic. This is at odds with the experience of high-income economies, which have been extending the programs introduced during the crisis or launching new ones. In detail, 13 of the surveyed PCGs launched COVID-19 oriented programs, most of them during April 2020 (6).<sup>20</sup> The most successful PCGs have extended their COVID-19 programs (Peru, Paraguay, Brazil, Uruguay, and Chile). As of December 2020, COVID-19 programs in Peru, Argentina, Mexico (Bancomext), Paraguay, and Brazil were closed as they met the pre-determined termination date or exhausted the available capital. This contrasts with the experience of advanced economies, as the European Union extended the TF until December 2021, the United Kingdom replaced CBILS, CLBILS and BBLS with a new Recovery Loan Scheme (RLS) that will run until December 2021 and the United States launched a Second Draw PPP in January 2021.<sup>21</sup> Successful experiences during the pandemic point to loan standardization as a key feature to facilitate the use of guarantee programs **.** Ten of the 16 surveyed schemes standardize the contractual conditions of the loans. This is a key feature, and in some instances, explains the successful implementation of some programs. This was the case of Chile, where PCGs’ loan standardization matched the central bank's liquidity facilities conditions to the banking system. The survey shows that ten PCGs set grace periods, and

> 19 The EU TF also established that the minimum all in interest rate (base rate plus the credit risk margins) for SMEs and large enterprises receiving state-sponsored guarantees should be at least 10bps per year.

> 20 During 2021 some PCGs continued to create new programs for supporting borrowers. This is the case of FOGAPE Reactiva in Chile, which is targeted to financing for working capital, investment, and refinancing for MSMEs. The program, which will be valid until December 31, 2021, considers a coverage rate of up to 90 percent with no fees for the borrower. For additional details, see <u>http://www.fogape.cl/sitio/2021/02/23/participacion-programa-fogape-2-</u>

> <u>0-reactivacion/</u>

> 21 PPP ended in May 2021 after exhausting the funds allocated to the program.

13
most of them fixed a maximum maturity length (8). Generally, one-year grace periods were granted. While there is greater heterogeneity regarding maturity, in the majority of cases it did not exceed 10 years. Besides, a significant number of schemes set interest rate ceilings (7). Usually, the conditions varied by economic sector and firm size. For instance, FNG in Colombia had differentiated parameters depending on whether the credit was for working capital or payroll financing, independent workers, formal and informal microenterprises, SMEs, and large firms most affected by COVID-19 pandemic, large firms, or mortgages.

**_Figure 8_** _– Length of COVID-19 programs_

<!-- Start of picture text --> SIGA<br>COFIDE<br>FNG<br>FOGAPE<br>FOGACH<br>FOGAPY<br>SGC<br>BNDES<br>BMX<br>FIRA<br>NAFIN<br>SAFGR<br>CFN<br>United States*<br>UK**<br>EU - Temp framework<br>PRY ARG CHL COL PER URU<br>BRA<br>MEX<br>ECUHND<br>Mar-20 Apr-20 Jun-20 Jul-20 Sep-20 Nov-20 Dec-20 Feb-21 Apr-21 May-21 Jul-21 Sep-21 Oct-21 Dec-21<br><!-- End of picture text -->

**Source:** Own elaboration. **Note** : In dark blue: programs that have been extended. In grey: programs without finalization date. * Paycheck Protection Program First (ended Aug-20) & Second Draw (started Jan-21). ** CBILS, CLBILS and BBLS were replaced with a new Recovery Loan Scheme (RLS) that will run until December 2021.<sup>22</sup>

Most COVID-19 programs leveraged their existing platforms to support large-sized firms. All PCGs with emergency programs that increased their outreach to new economic sectors (8) did it to larger-sized firms. For instance, after serving only micro and small firms in the pre-COVID period (annual sales up to USD 12 million), the _Fondo de Garantías para Pequeños Empresarios_ (FOGAPE)-Chile COVID-19 program began providing guarantees to larger firms (annual sales up to USD 30 million). Many others (5) began serving enterprises in the informal sector. FNG-Colombia created incentives for micro-enterprises and selfemployed to formalize by offering a higher coverage rate. In most advanced economies, PCGs had guarantee lines that could be accessed by larger enterprises. Though SMEs and particularly micro

> 22 PPP ended in May 2021 after exhausting the funds allocated to the program.

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enterprises had better guarantee terms, large firms were recipients of a relevant share of the total volume guaranteed during the crisis and in some cases, they had a separate facility within the scheme. For example, the Dutch RVO established the Corporate financing coronavirus guarantee (GO-C) which provided loans of up to EUR 150 million with a 70 to 90 percent state guarantee. The COVID-19 response by Finnvera (Finland) began with a focus on SMEs but later shifted to larger corporations (loans up to EUR 125 million could get up to 80 percent in guarantee) and the BBB (UK) had the Coronavirus Large Business Interruption Loan Scheme (CLBILS, providing loans of up to GBP200 million with a 80 percent government guarantee).

# Box 1. PCG actions in Europe – The EU Temporary Framework

Given the constraints imposed by the EU state aid rules, the European Commission adopted a new State Aid Temporary Framework (TF) to provide flexibility for member countries to support their economies. The EU TF expanded the scope for states to provide aid to firms in the form of guarantees on loans, with new conditions on the level of guarantee premiums, the size of guaranteed loans per beneficiary, the duration of the guarantee, the coverage by the guarantee, the types of loans (investment or working capital loans), and the type of firms that could get support. These conditions evolved over time with a series of amendments that were introduced to the EU TF as the pandemic crisis unfold (Appendix C provides a schematic presentation of these changes).

The EU TF enabled member states to use their PCGs schemes as an instrument to channel public support to firms during the pandemic. States then implemented a wide series of changes to their programs, which are presented below. A full list of the European Association of Guarantee Institutions (AECM) members and the COVID-response measures adopted is available in Appendix C.

• **Setting-up dedicated programs to tackle the immediate effects of the COVID-19 crisis** . While all the PCGs in Europe relied on their standard programs to support local firms during the emergency, a significant majority (34 out of 47 AECM members) opted also to establish temporary COVID-response programs. Some examples include: Garantiqa Crisis Guarantee Program (Hungary), Krisenbewältigungsfonds (Austria) and ICO Linea Avales COVID (Spain). • **Increasing the guarantee capacity of their schemes.** As the EU TF relaxed the state aid rules, most European PCG schemes received additional funding from their states and increased the size of their staff. One prominent example of this is Bpifrance, which implemented the COVID-response PGE ( _Prêt garanti par l’Etat_ , Loan guaranteed by the State) which had an initial allocation of EUR 300 billion. **• Broadening the spectrum of guarantees.** Several PCGs in Europe already had amplitude in terms of minimum and maximum guarantee volumes per beneficiary. Nonetheless, there were PCGs that implemented changes in this regard, mostly to support larger firms in the face of the crisis. The guarantees provided since the COVID-19 outbreak have been larger than those granted in normal times. Additionally, PCGs expanded their scope in terms of the sectors covered, typically to crisis-affected sectors such as tourism. • **Increasing the coverage rate.** Despite the risks associated with increasing the coverage rate in normal times, most European PCGs implemented very large coverage expansions, making use of the fact that the EU TF made such measure compatible with EU state aid rules. This was also facilitated by a rise in 15
counter-guarantees provided by national (or regional) governments, as well as by European Union programs. Many PCGs increased their coverage to a range of 75 to 90 percent. In cases such as AWS (Austria), Assoconfidi (Italy) or CESGAR (Spain), the guarantee coverage ratio for smaller borrowers was increased to 100 percent.

- **Providing interest rate subsidies and limiting/waiving fees.** Often under heavy scrutiny by EU

- institutions, the EU TF enabled PCGs in Europe to provide subsidies (through interest rates and fee structures), as well as to set caps on the interest rates that could be charged by lenders for guaranteed loans. The vast majority of PCGs in Europe implemented some sort of subsidy of this form. It was not uncommon for PCGs to charge no fee (either guarantee fee or processing fee) and to set a relatively low cap on interest rates, which could even be zero for the initial years of the loan.

- **Providing a fast-track for procedures.** As the health crisis unfolded, the surge in the demand for

- guarantees forced PCGs to find ways to increase their output while keeping their risk management frameworks in place. The solution included automating application procedures, delegating decisions to on-lenders and reducing documentation requirements.

- **Extending the duration of guaranteed loans.** PCGs such as the Dutch RVO decided to extend the

- duration of their COVID-related guarantees (BMKB-C). • **Extending the repayment period of guaranteed loans.** There were several cases such as the Slovene Enterprise Fund, which combined loan extensions with additional grace periods.

- **Reducing/waiving collateral requirements.** The relaxation of collateral requirements included both

- reduction of conditions asked by PCGs and limitations for financial intermediaries granting guaranteed loans. Schemes such as SBCI (Ireland), INVEGA (Lithuania) and Bpifrance provided coverage for certain types of unsecured loans.

The timeframe for receiving the guarantee in case of defaults and cumbersome procedures for claiming the guarantees are also sensitive issues for banks. The challenge is to strike a good balance between credit recovery efforts by participant financial institutions, and the probability of receiving the payment for the guarantee if those efforts are completed. Participating financial institutions should be able to claim the guarantees once these recovery procedures are fulfilled. The more complex the procedures for claiming the guarantees, the less the interest from participating financial institutions, and the easier to claim the guarantees the lower the effort on credit recovery, especially if the percentages of guarantees are high.

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**_Figure 9_** _– Claiming procedures by scheme_

<!-- Start of picture text --> Past due days (at least)<br>Type of procedure<br>FOGAPY<br>FNG<br>Judicial or extrajudicial 10<br>NAFIN / BMXT<br>FIRA<br>COFIDE<br>Extrajudicial 4 FOGAPE<br>BNDES<br>SGC<br>Judicial 2 FOGABA<br>FOGACH<br>Garantizar<br>0 2 4 6 8 10<br>Number of answers 0 60 120 180<br>Days<br>Source: Own elaboration.<br>PRY<br>COL<br>MEX<br>PER<br>CHL<br>BRA<br>ARG<br><!-- End of picture text --> In order to incentivize the participation of financial institutions, many PCG schemes have simplified claiming procedures to facilitate execution of guarantees and possession of the collateral. Mobility and face-to-face interaction restrictions during the pandemic have incentivized PCGs to relax the procedures they impose on financial intermediaries for triggering the claiming of guarantees. In 2020, schemes started to admit extrajudicial notification to the borrower as a substitute for judicial notifications. Particularly, ten PCGs reported requiring financial intermediaries to submit proof of legal or out-of-court notification to the borrower. For instance, FOGAPE (Chile) under its COVID-19 program started to accept proof of two email notifications from the financial institutions to the borrower to execute guarantees. In contrast, only two PCGs require a legal notification. The survey also shows that the overdue days to initiate the notification process vary considerably across PCGs. While most are set to at least 90 days, others can be as low as five days or as high as 180 days (NAFIN/Bancomext –Mexico and FOGAPY - Paraguay). In addition, some schemes limit the claiming period ( _Sistema Nacional de Garantías -_ SIGA- Uruguay, 15 months; _Corporación Financiera Nacional_ -CFN- in Ecuador, 12 months).

The pandemic led PCGs in advanced economies to provide higher coverage to SME loans, despite perverse incentive risks. Moral hazard increases with the percentage of guarantees offered by the PCG schemes. While extraordinary times require extraordinary measures, many advanced countries, including Austria, Croatia, Germany, Italy, UK and others, increased their maximum coverage to a range of 90 to 100 percent (typically for micro or small firms). In contrast, prior to the pandemic, the average maximum coverage ratio in Europe was in the range of 75 percent. In the United States, the PPP not only guaranteed 100 percent of the loans granted to small enterprises, but it also provided loan forgiveness to the borrowers, 17
<!-- Start of picture text --> m2019 m2020q4 TM2019 m 2020q4<br>Uruguay<br>> Uruguay)<br>Bolivia a Bolivia —EE<br>———— |<br>0 25 50 75 100 0 25 50 75 100<br><!-- End of picture text -->
COVID-19 programs reduced fees and increased coverage. As discussed in the previous section, fees charged to financial institutions before the pandemic were below break-even. During the pandemic, and consequently higher risk, fees were reduced even further. Six of the thirteen PCGs with COVID-19-oriented programs introduced fee reductions. The lowest fees (as percentage of credit amount) are in BNDES – Brazil (0 percent), FOGAPE - Chile (ranging from 0.2 to 0.4 percent), and SIGA – Uruguay (ranging from 0.6 to 0.8 percent). Along with fee reduction, many emergency programs increased the volume of guarantees assigned to loans (8). Particularly, FNG-Colombia increased the coverage ratio the most, from 50 percent pre-COVID to up to 90 percent during the pandemic. While these measures were aimed at maximizing the coverage of the guarantee programs and therefore supporting borrowers affected by the pandemic, PCGs should properly quantify the impact that such measures may have on the sustainability of their funds.

Some small PCG schemes had exponential growth in 2020, including Peru (COFIDE) and Brazil (BNDES). Figure 11 presents the PCGs’ guarantee allocation in 2019 and 2020, along with the growth rate. Programs in Peru, Paraguay, Brazil, Uruguay, and Chile are those that present the strongest relative expansion. For example, the increase in the PCG run by _Corporación Financiera de Desarrollo_ (COFIDE) in Peru from a guarantee allocation of USD 14 million to USD 15 billion between 2019 and 2020 leaves the Peruvian PCG program as the largest in nominal terms in the region. Similarly, the emergency fund employed by BNDES places its PCG as the second largest with a guarantee allocation of more than USD 14 billion as of December 2020. It also highlights the speed of resource allocation performed by BNDES, as its COVID-19 program was one of the latecomers (launched in June 2020) in the region. FOGAPY in Paraguay also presents an impressive expansion, explained by recent modification to the law that created the fund and re-capitalized it to USD 276 million. Previously the capital of FOGAPY was just USD 8 million.

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**_Figure 11_** _- Guarantee allocation in 2019 vs COVID-19 programs_

_(In USD million and as a percentage of guarantees allocation in 2019)_

|**Peru**|**Paraguay**|**Brazil**|
|---|---|---|
|16,000<br>**106,235%**|400<br>**68,498%**|16,000<br>**7,916%**|
|14,000|350|12000<br>14,000|
|12,000|300|,|
|10,000|250|10,000|
|8,000|200|8,000|
|4,000<br>6,000|100<br>150|4,000<br>6,000|
|2,000|50|2,000|
|0|0|0|
|**Uruguay**|**Chile**|**Colombia**|
|500<br>**1,982%**|10,000<br>**1,112%**|4,000<br>**160%**|
|100<br>200<br>300<br>400|2,000<br>4,000<br>6,000<br>8,000|1,000<br>1,500<br>2,000<br>2,500<br>3,000<br>3,500|
|0||500|
||0|0|
|**Mexico**|**Ecuador**|**Argentina**|
|12,000<br>**140%**|60<br>**123%**|500<br>**97%**|
|10,000|50|400|
|4,000<br>6,000<br>8,000|20<br>30<br>40|200<br>300|
|2,000|10|100|
|0|||
||0|0|

**Source:** Own elaboration, credit to SMEs obtained from the Financial Access Survey (IMF) and from the MSME Finance Gap Report (IFC) if missing.

**Note:** Heat map bar depicts the credit to SMEs covered by PPCG as percentage of the financial system credit to SMEs as in Figure 4. Two of the three PCGs in Argentina did not implement COVID-19 programs. We couldn’t compile complete information for _Banco de Desarrollo Productivo_ (BDP, Bolivia), and _Sociedad Administradora de Fondos de Garantía Reciproca_ (SAFGR, Honduras). In the case of BDP its guarantees granted by the end of 2020 totaled less than USD 1 million, and around USD 33 million in SFGR in Honduras. Besides, the guarantees granted by FSG in El Salvador stood at USD 38 as of 2019.

20
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<!-- Start of picture text --> @Micro @Small @ Medium Large m Other = Micro @Small @Medium SLarge TM Other<br>Bivia Bcivia<br>Colombia Colombia<br>Uruguay Bart<br>Ecuador Uruguay<br>Mexico pay ii _ a s<br>Chile Ecuador I Sn<br>a Chile<br>spain SOR<br>("> spain CNW<br>United statealy —— United statealy re<br>0% 25% 50% 75% 100% 0% 25% 50% 75% 100%<br><!-- End of picture text -->
the evolution of the volume of guarantee allocation presented in Figure 11 with the same plot but in terms of their number (Figure A2). In most cases, the expansion in the volume of credits was higher than the expansion in the borrowers served, meaning an increase in the average amount of guarantees granted.

Under COVID-19 oriented programs, some PCGS have started to guarantee credits to larger firms. While in normal times, the market failure affects mostly the SME sector, during market swings, a segment of larger companies might also need additional guarantees in order to access additional funding. As most companies become riskier, from the policy perspective, it is important to ensure that solvent larger companies continue receiving financing during the pandemic. In detail, eight PCGs modified the target economic sectors considered in pre-pandemic programs, all of which incorporated larger-size firms. For instance, FOGAPE in Chile expanded its program to incorporate larger firms by expanding the eligibility threshold to annual sales up to USD 20 million for large firms and USD 30 million for larger ones (before, the cutoff was around USD 12 million). Besides, COFIDE in Peru also increased the covered credit amount up to USD 2.8 million to guarantee loans to larger firms. In addition, FNG in Colombia launched the program “ _Unidos por Colombia – Gran Empresa”_<sup>_29_</sup> for firms with an annual income ranging from USD 13 million to USD 20 million depending on their economic sector.

PCGs are measuring solvency based on their leverage ratio, which has significant limitations. A measure of financial sustainability widely use by PCGs in LAC is their capitalization, typically using the leverage ratio as a proxy. Providing guarantees on SMEs loans frequently involves higher credit risk than lending to larger corporations and staying below maximum regulatory leverage defined by each country does not necessarily mean that the fund will always have capacity to honor its payments. This is particularly worrisome, given the wide diversity in the maximum allowable leverage in the region, and the fact that these legal requirements do not necessarily respond to any recent financial sustainability analysis. PCGs should assess their sustainability without factoring in further rounds of recapitalization by governments, as fiscal space may not be available in the future. Brazil has taken a cautious approach in this regard.<sup>30</sup> In detail, the maximum regulatory leverage varies from 1 percent in COFIDE (Peru) to 11 percent in FOGAPE (Chile) and FNG (Colombia). As argued by Goffe et al. (2021) and evidenced in LAC, such differences are aligned with the level of maturity of the scheme. Leverage ratios also present significant variation across PCGs (see Figure 14). The median leverage as of December 2020 stood at 3.8 percent, with many programs closing their space to keep providing guarantees (i.e., leverage close to the maximum regulatory): BNDES (Brazil), FOGAPY (Paraguay), COFIDE (Peru), and SIGA (Uruguay).<sup>31</sup>

> 29 See https://www.fng.gov.co/ES/Unidos%20por%20Colombia/Garant%C3%ADa%20Gran%20Empresa.pdf 30 In the case of Brazil, BNDES, a state financial institution, is the manager of a guarantee fund (Fundo Garantidor de Investimentos). The guarantee offered by this fund is bounded by the size of the fund. The cautious approach toward the rules of operation of the fund is explained, among other factors, by the government’s intention to limit potential contingent liabilities.

> 31 Nevertheless, the region-wide average leverage is similar to those in other regions across the globe (Calice, 2016).

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<!-- Start of picture text --> Max. regulatory leverage B@ Current leverage - Jun 2020<br>4 Current leverage - Sept 2020 Current leverage - Dec 2020<br>15<br>11.0 11.1<br>10.0<br>10 |<br>5.0<br>B<br>5.0 A he 5.0<br>5 4.0 40 ||<br>A 3.5<br>: | z A UW<br>0 “4 a | ce<br>Garantizar FOGABA FOGACH BNDES FOGAPE FNG ‘CFN NAFIM FOGAPY COFIDE $IG4<br>ARG BRA CHL COL ECU MEX PRY PER URY<br><!-- End of picture text -->
and economic sector. It also presents an opportunity to understand the behavior of financial institutions towards risks. The experience of Chile’s FOGAPE in gathering data about credit rejection (as described in Box 2) is useful to understand the types of companies that are not getting credit. From the policy perspective, that information is useful for policy makers to assess the desirability of offering other tools for supporting specific sectors of the economy. These analyses require PCG administrators to have in place adequate IT resources that allow them to process this information on a timely basis.

# c. Self-assessment of obstacles

The challenges to the operations of PCGs in the LAC region highlight the importance of learning from experiences outside the region. Not surprisingly, the complications seen in LAC also arose in several PCGs across the world as these institutions were used as a lifeline for the local firms facing the crisis. In that regard, several European PCGs have successfully addressed many of these issues, as described in Box 1.

The most salient (self-reported) difficulties faced by PCGs in the LAC region were related to the need to fast-track procedures and to streamline documentation requirements. The majority of schemes (5) mentioned the urgent need for accelerating application procedures and implementing new IT platforms to automate different procedures within their operations as a critical challenge during the implementation of COVID-19 related PCG scherms. Other elements that affected the implementation capacity of PCG schemes included the approval rate by the financial intermediaries (see Box 2), and the need to adjust either regulation or coordination between government branches in order to speed up the procedures. Moreover, three PCGs stressed the need for additional support from their governments, either through capitalization of the guarantee funds or through the provision of counter-guarantees. Finally, only one scheme highlighted the need to support the participating financial intermediaries with technical assistance.

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<!-- Start of picture text --> Requested and allocated operations Rejected operations<br>(In USD million) (In percent of allocated operations, as per<br>(lm Rejected December 25")<br>Gl Registered and under eval. mw Lack of information<br>Ell Approved but not completed Bm Not meet program requirements<br>===Mae AllocatedTotal B Non-compliance| with. the financialala institutioncaees aa policiesae<br>18,000 100<br>15,000 80<br>12,000 60<br>9,000<br>6,000 40<br>3,000 20<br>jun Jul Aug sep Oct Nov Dec Microand Medium Large | Large Il<br>small<br><!-- End of picture text -->
their guarantees to the equivalent of 7.4 and 4.5 percent of GDP, did so in the context of larger and comprehensive COVID-response packages, which had PCGs at the center of the fiscal effort to support demand.<sup>33</sup> In that sense, their strategy had similarities with their advanced country counterparts, which benefited from a degree of fiscal space that is not available to most countries in LAC.

Despite access to finance of SMEs being a significant problem in most of the countries in the region, PCG schemes are still too small to be on the radar screen of the financial sector and hence be impactful. Prior to the unfolding of the pandemic, only three countries in the region (Mexico, Colombia and Chile) had PCG schemes that covered more than 10 percent of the local banking system’s SME lending portfolio. The large fiscal stimulus implemented by the Peruvian government to fight the pandemic made COFIDE a relevant player in the local SME credit market. However, most PCGs in LAC remain relatively small. This raises questions regarding their ability to provide additionality. In concrete terms, banks will only build platforms for serving the SME sector to the extent that they see growth opportunities in it. Insufficient efforts could lead to the PCGs merely providing a vehicle for risk-sharing, with little impact on the selection of SMEs receiving credit.

The focus of PCGs in LAC during the pandemic was largely set on increasing the coverage ratio, while other parameters, including procedures for executing the guarantee, program extension, grace period or maturity, have been less exploited. The schemes in the region can benefit from the experience of advanced economies and in particular European countries, as these countries used, adapted, and expanded their public PCG programs during the COVID-19 market swing to support both SMEs as well as large enterprises. Going forward, the experience of advanced economies may also provide a roadmap for developing countries, as the focus of their schemes transitions back to the promotion of access to finance among SMEs.

The pricing of the guarantees, in most of the PCG schemes, does not seem to reflect the risk of the portfolios. The implementation of a risk surveillance framework would enable the schemes to price-byrisk and bring transparency about the subsidies that they are providing. The surveys point to evidence of subsidies embedded in the fees charged to intermediaries. The provision of fiscal support is not necessarily a negative feature of a scheme, and in fact it can be very appropriate in circumstances such as the current pandemic. Nonetheless, best practices recommend that PCGs should adopt a transparent and consistent risk-based pricing policy to ensure that the schemes are financially sustainable, and that any reliance on explicit and implicit subsidies should be transparent and publicly disclosed. The development of transparent policies on risk management and pricing would represent major steps towards the preservation of long-term sustainability of PCG schemes.

Most PCG schemes in the region measure solvency according to leverage. The latter is a handy proxy for the PCGs’ capitalization levels, though it has limitations. Moreover, PCGs in the region tend to use their statutory maximum leverage as a guide for their operations, but there is no generally accepted criterion for these legal limits, which exhibit a high variance across the region. PCGs in LAC should move towards the use of standard solvency metrics, including the use of risk-based measures. Currently, PCGs are not adequately monitoring the risk that they are taking, relying mostly on leverage indicators. Following the

> 33 FCI GP COVID-19 Financial Policy Response Compendium.

27
lead of PCGs in advanced economies, schemes in the region could work on the development of their own risk monitoring frameworks.<sup>34</sup> One step in that direction could be the use of capital to risk-weighted assets (capital adequacy ratios). This is particularly relevant for the aftereffects of the current pandemic response, which has led PCGs to increase their risk levels, either by providing a larger volume of guarantees relative to their capital (leverage) or by holding a larger share of the credit risk of the newly issued loans (coverage ratios). Additionally, the pandemic crisis is expected to have a material impact on the firms’ balance sheets, giving rise to higher default rates that could put the financial sustainability of PCGs at risk.

PCGs offer important opportunities for standardizing the SME credit market, and thus supporting further competition in the financing of SMEs. Homogeneity in terms of parameters such as grace period, maturity, and interest rates would make SME credit more attractive to lenders, as it would lower the cost of managing the portfolio while also broadening the volume of potential buyers if they decided to unload that portfolio from their balance sheet. As banks become more interested in granting credit to SMEs, companies would then benefit from more competitive pricing. PCGs in the region recognize the importance of standardization, with two-thirds of the existing PCG schemes making efforts in that direction, including as part of the implementation of COVID-19 programs. Despite these intentions, the relatively low volumes of most PCG schemes in the region have hampered the ability to bring standardization to this market segment.

PCGs offer opportunities for supporting climate and gender objectives. These issues are still in the embryonic stage in LAC, but there is large room for immersing the financial sector with good practices in these areas through PCG schemes. While the implementation of environmental standards requirements is still limited in the region, PCG schemes can be catalytic in supporting clean environmental practices in the SME sector. How big of an impact they may have will once again depend on the volume of the PCG schemes. Moreover, a few PCGs in LAC have programs targeted to women, which will be instrumental in reaching the objective of improving the gender balance in the SME sector. Given that these usually entail better guarantee terms than standard guarantees, they should be transparent in terms of any subsidy that may be provided as part of any pricing policy to ensure the sustainability of the entire scheme.

> 34 See Footnote 9 on Finnvera.

28