Distr.

LIMITED

November, 2013

Original: ENGLISH

COMMON MARKET FOR EASTERN

AND SOUTHERN AFRICA

11th Meeting of the Monetary and Exchange Rates Polices

Sub-Committee

11 – 13 November 2013
Nairobi, Kenya

A PROPOSAL FOR PARTIAL CREDIT GUARANTEE SCHEME IN COMESA

By

Ibrahim A. Zeidy

Director of CMOESA Monetary Institute

Dr. Berhane Tewolde

FEMCOM Imdistria; Cluster Develppment/MSMEs Finance Expert

 A Proposal for a Partial Credit Guarantee Scheme in COMESA

Table of Contents
Introduction................................................................................................................................................4
1. The Rationale for Partial Credit Guarantee Schemes.....................................................................4
1.1 Overcoming Information Asymmetries........................................................................................4
1.2 Diversifying or Transferring Risk..................................................................................................5
1.3 Reducing Collateral Requirements..............................................................................................5
2. Design Issues of Partial Credit Guarantee Scheme........................................................................6
3. The Different Forms of Partial Credit Guarantee Schemes............................................................7
A. Public Guarantee Schemes.........................................................................................................8
B. Corporate Guarantee Schemes..................................................................................................9
C. International Schemes..................................................................................................................9
D. Mutual Guarantee Schemes......................................................................................................10
4. Proposal for the Design of Partial Credit Guarantee Scheme in the COMESA Region...........11
4.1 Risk Sharing..................................................................................................................................11
4.2 Fees...............................................................................................................................................12
4.3 Types of Loans.............................................................................................................................12
4.4 Defaults..........................................................................................................................................13
4.5 Risk Management........................................................................................................................13
4.6 Regulatory and Institutional Framework....................................................................................13
5. Model Proposal for Partial Credit Guarantee Scheme..................................................................14
5.1 Establishment of the Scheme.....................................................................................................14
5.2 Funding..........................................................................................................................................14
5.3 Objectives......................................................................................................................................14
5.4 Managing Agent...........................................................................................................................14
6. Definition of MSMEs...........................................................................................................................15
7. Eligibility Criteria for Participation in the Scheme..........................................................................15
7.1 Participating Bank (PB)...............................................................................................................15
7.2 Borrower........................................................................................................................................15
8. Modalities of the Scheme..................................................................................................................16
9. Acceptable Collateral........................................................................................................................16
10. Loan Tenor........................................................................................................................................16
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11. Procedure for Applying for the Guarantee....................................................................................16
12. Verification and Monitoring of Projects..........................................................................................17
13. Responsibilities of Stakeholders....................................................................................................17
13. Discontinuation of a Credit Facility.................................................................................................18
14. Amendments.....................................................................................................................................18
Bibliography.............................................................................................................................................19

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Introduction

1. For the better part of the last decade, due to the combination of a generally stable
macroeconomic environment, global liquidity, better banking practices and improved
technology across the globe, domestic credit to the private sector in most developing
has been growing countries at a very high rate. However, there is anecdotal and
increasingly statistical evidence that small and medium enterprises (SMEs) have not
benefited from this financial deepening to the same extent as other borrower groups.

2. The limited access to finance faced by SMEs, is mainly associated with the high
administrative costs of small scale lending, the underdeveloped financial system, the
high risk perception attributed to small enterprises, asymmetric information and the
inability of SMEs to provide adequate collateral.

3. In order to lessen the financing constraints faced by SMEs, governments, non-

governmental organizations (NGOs) and the private sector, have developed access
to finance programmes such as Partial Credit Guarantee Schemes (PCGSs).
PCGSs first emerged in Europe in the 19 th and early 20th centuries. Currently, there
are over 2250 schemes implemented in different forms in almost 100 countries
(Green, 2003). PCGSs provide guarantees to groups that do not have access to
credit by covering a share of the default risk of the loan. In the case of default, the
lender is able to recover the value of the guarantee through the PCGS.

4. In view of the above, the COMESA Committee of Central Bank Governors in their
18th meeting, held in Kigali, Rwanda instructed the COMESA Monetary Institute to
develop a guideline for implementing PCGSs based on international good practices
in PCGS design and management.

5. Section one of the paper discusses the rationale for PCGSs. Section two describes
the design issues that needed for the operationalization of a PCGS. Section three
highlights the different forms of PCGSs based on international best experiences.
Section four make proposals for appropriate PCGS designs based on international
best experiences. Section five presents a guideline for the establishment of a Partial
Credit Guarantee Scheme for the COMESA region.

1. The Rationale for Partial Credit Guarantee Schemes

1.1 Overcoming Information Asymmetries

6. Information asymmetry is a core reason commercial banks are generally reluctant to

provide loans to SMEs. In most instances, SMEs are unable to provide information
on their creditworthiness because they tend to lack traditional bank appropriate
accounting records as well as inadequate collateral. All these factors combined
make gathering the prerequisite information on an SME challenging and costly, thus

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 decrease the attractiveness of engaging an SME credit, cast doubt on the projects
expected rates of return and increases the risk associated with lending an SME.

7. Lending administrative costs tend to be higher for smaller firms. Obtaining sufficient
information requires more resources as a percentage of the underlying loan. Visiting
borrowers, conducting due diligence and monitoring their activities is expensive and
not economically rational when a loan size is small.

8. Adverse selection is another problem stemming from information asymmetry. In this

context, adverse selection starts with the market phenomenon whereby the
probability of default increases with the interest rate. As interest rates increases,
safer borrowers are driven out of the lending pool while riskier borrowers remain.
This leads to an increasingly riskier portfolio of loans. This leads banks to increase
interest rates. Increasing interest rates prevents many SMEs, which are typically
riskier investments, from obtaining loans even if they are able to service the higher
interest rates and loans. The result is credit rationing.

9. Both adverse selection and lending administrative costs can result in a

discriminatory selection process focused only on firm size, history, and the size of
the available collateral. Consequently, potentially profitable SME’s, that do not meet
these conditions are unlikely to obtain financing, resulting in a suboptimal allocation
of credit. PCGS can help banks overcome information asymmetries by aiding
accurate identification of lending risk, reducing the financial risk associated with
lending to SMEs and improving bank’s ability to make appropriate lending decisions.
1.2 Diversifying or Transferring Risk

10. Commercial banks often have a difficult time assessing SME risk due to a lack of
information. Moreover, SMEs are more vulnerable to sudden economic shocks and
sustained harsh conditions, and as such their mortality rates can be relatively high.
Weak creditor and property rights, the informal economy, and nonexistent or ill-
enforced collateral registration, likely compound the situation in developing
economies. Thus, lending to SMEs typically does carry higher risks, however
PCGSs are can be a mechanism of risk transfer and diversification. A lender’s risk is
lowered by a PCGS, which guarantees repayment of all, or parts of the loan in case
of default. In essence, PCGSs are capable of absorbing an important share of
borrower’s risk, while also compensating for such factors as insufficient collateral,
weak creditor rights, and information asymmetry.
1.3 Reducing Collateral Requirements

11. Lending decisions by commercial banks tend to linked to the amount of available
collateral. Property, assets, and other form of collateral offered by the borrower
reduce the risks faced by the lender by allowing them to recover part of all of the
value of the defaulted loan. . In theory, a borrower who is willing to offer additional
collateral, particularly personal collateral such as a house, has a higher incentive of
repaying the underlying loan. However, many SMEs do not possess enough assets
to cover the collateral requirements of banks. Thus, deficient collateral is one of the

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 main reasons SMEs are unable to obtain the necessary credit. PCGSs can alleviate
the high collateral requirements necessitated by banks.

12. PCGSs are designed to lessen the risk associated with lending to SMEs, by
reducing information asymmetry and alleviating the high collateral requirements. In
doing so, PCGSs can improve loan terms and facilitate access to formal lines of
credit for SMEs. Additionally, by allowing loans to borrowers that would otherwise be
excluded from access to traditional forms of financing, these firms are now able to
establish a good credit history and reputation, in the future, will provide financial
credibility to the SME. Finally, by extending more loans to smaller businesses,
lending institutions gain experience in managing these types of loans, encouraging
further development, innovation in addressing this market segment and expanding
their client base.

2. Design Issues of Partial Credit Guarantee Scheme

13. The central function of a PCGS is to share the risk of a potential loss between a
lender and the guarantee organization, on previously agreed terms. Ideally, the
borrower is a firm with a viable project or investment but is unable to satisfy a bank’s
usual criteria for lending due to either a lack of collateral or an established credit
rating. In this situation, and subject to some investigation of the borrower’s
creditworthiness, a third party guarantee is made available to alleviate the lender’s
exposure to any potential risk. This insurance is likely to attract a premium over and
above the lender’s standard interest charges and a fee may be charged for
processing or investigating the guarantee application.

14. The following highlights a number of important design issues for PCGSs, which are
central to their acceptability - to both lenders and potential borrowers - and their
subsequent rate of success.

15. First, there is the question of which organization has the responsibility for conducting
due diligence on the potential borrower and ensuring their eligibility for any
guarantee. In some situations, this is undertaken by the lender subject to pre-
determined criteria, in other situations this may be the function of an independently
mandated entity. Both approaches have some advantages. An independent
investigation separates eligibility and any risk assessment by the lender and may
help to avoid any conflicts of interest. On the downside, a scheme with such a
system may, introduce delays into the process while additionally increasing
overheads to the PCGS. Eligibility assessment by lenders on the other hand raises
issues of moral hazard with lenders potentially using the scheme to guarantee loans
that would otherwise not qualify but with the involvement of a PCGS they act riskier,
knowing that all costs and risks associated with failure are guaranteed by the PCGS.

16. Second, there is the question of which lenders are eligible to provide guaranteed
loans. Again, scheme designs vary from those, which are available only through a
small number of accredited lenders to those where guarantees are more
widespread.
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17. Third, a decision must be reached on the extent of risk sharing - that is the
proportion of a loan that the PCGS will guarantee. Relatively few schemes cover the
whole value of the loan with most providing coverage up to mandated limited
depending on the applicable criteria. Typically, according to the World Bank, PCGS
will cover 75 to 80 percent of the value of a loan limiting the lenders liability to 20 to
25 percent.

18. Fourth, most PCGSs require the payment of a fee or premium for guarantee. The
premiums are assessed in different ways but generally range from 2 to 4 percent for
those based on an initial payment only or a 1 to 2 percent premium on the
guaranteed proportion of the loan.

19. Fifth, there is the question of how PCGS handles claims. Experience shows that a
guarantee scheme builds up its credibility principally by how claims are processed. A
scheme that has the best chance of succeeding is one that clearly lays down
regulations on the process involved for qualifying the duration of the process, when
and how a claim will be paid. Efficiency and expediency are of vital importance to the
success and attractiveness of a PCGS. Excessive red tape and delays in payment
are a major deterrent to both the willingness of lending institutions and SMEs to
participate in guarantee schemes.

20. Sixth, there is the question of eligibility. Some PCGSs have a specific focus on
smaller firms while others have a more thematic or industry focus. For example, The
UK Small Firms Loan Guarantee Scheme provides broadly based support for SMEs
which are less than five years old and have turnover of less than USD 9.3 million;
the French Fonds de Garantie des Investissements de Maîtrise de L’Energie or
Energy Management Investment Guarantee Fund (FOGIME) is focused specifically
on energy management such as energy efficient production equipment, use and
storage, energy saving modifications to equipment and renewable energy
investments.

21. Finally, there is the question of who will fund the guarantees. In the vast majority of
cases, either the national or the regional governments are in charge with the
establishment of guarantee funds – depending on their priorities or focus areas.
Ideally, the schemes are designed to run in a self-sustaining manner, that is to say
the fees and any investment income should cover the costs of operating and any
claims against the scheme/guarantees provided by the fund. Experience suggests
that achieving sustainability and self-sufficiency may take a number of years
depending on the focus goals of the scheme. Adequate capitalization of schemes
during their initial phases of development will be important, however, to provide an
indication of intent to both borrowers and lenders and ensure adequate reserves to
counter any losses.

3. The Different Forms of Partial Credit Guarantee Schemes

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22. There are four major types of guarantee funds: (i) public guarantee scheme (ii)
corporate funds (iii) international schemes and (iv) mutual guarantee associations.

A. Public Guarantee Schemes

23. Established by public policy, this scheme is funded/resourced/supported by the

central bank or direct state subsidies. One primary advantage of this system is that,
in the event of default, the guarantee is paid out directly from the central bank or
government budget. This provides the scheme with a level of infallible credibility with
in the banking sector.

24. The following are some successful Partial Public Credit Guarantee Schemes:

I. Slovenia
In 1992 the Government of Slovenia, established the Slovenia’s Small Business
Development Fund (SBDF) to promote the establishment and development of
small business units. In collaboration with banks, it guarantees both long-term
and short-term loans. All forms of support are provided based on a public
invitation to lenders to participate in the programme. First, a loan must be
approved by a bank. Thereafter the board of directors, consisting of
representatives from banks and governments, comes to the final decision on
which applications to accept into the fund.

II. Nigeria
The N200 Billion Small and Medium Scale Enterprise Credit Guarantee Scheme
was established by the central bank of Nigeria in 2010. The scheme aims to
facilitate access to credit by SMSs in Nigeria by guaranteeing loans by banks to
SMEs in order to absorb some of the risk elements that inhibit banks from
lending to SMEs. The activities covered under the scheme include the
manufacturing and agricultural value chain, SMEs processing, and the packaging
and distribution of primary products. The maximum amount that can be
guaranteed is N100.0 million for working capital and term loans for
refurbishment, equipment upgrade, expansion, and overdraft. The guarantee
covers up to 80 percent of the amount borrowed and is valid up to the maturity
date of the loan, with a maximum tenor of five years.

III. Chile
The Fund of State Guarantee for Small Industrialists (FOGAPE) in Chile is
administered by a government agency. In 2014, FOGAPE had a total equity of
USD 52 million. The number of guaranteed loans has risen from 200 in 1998 to
approximately 34,221 in 2004. In 2004, the total amount of loans covered by the
guarantee fund was USD 472 million and the average coverage ratio was 65
percent. The success of the FOGAOE is due to many factors, including the
following:
 A strong regulatory and supervisory system
 Transparency and Fairness

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  An intensive publicity and promotional campaign launched by the
Government to explain the utility of the programme
A study on the impact of the fund indicate that FOGAPE not only removed the
restrictions to finance increasing the volume of available credit by 40% but also
had measurable economic results with companies involved increasing turnover
by 6 percent.

IV. South Korea

The Korean Technology Credit Guarantee Fund (KOTEC) was founded in 1989
by the Korean Government as a nonprofit guarantee institution under the new
“Korea Technology Finance Cooperation Act”. KOTEC provides credit
guarantees to new technology based enterprises. It also promotes the growth of
technologically strong SMEs. Since its foundation, KOTEC has provided a total of
USD 99.7 billion in guarantee. Evidence has shown that KOTEC has had a
positive effect on sales growth, productivity, the adoption of new technologies,
resulting in a substantial the increase in standards of living throughout the
country.

B. Corporate Guarantee Schemes

25. Corporate Guarantee Schemes are primarily funded, administrated, and operated by
the private sector, e.g. banks and chambers of commerce. Corporate guarantee
schemes have the advantage of both being managed by experienced private sector
leaders, and benefiting from the direct involvement of the banking sector.

26. The following are examples of Corporate Guarantee Schemes:

Egypt
Egypt has a well-established Credit Guarantee Corporation, which has operated
since the early 1990s. Established as a partnership between the Egyptian
Government, which holds around a quarter of the equity in the company, nine banks
and insurance companies the aim is the development of microenterprises, in
addition to small and medium enterprises in Egypt. The scheme supports
investments in both physical and working capital with loan level guarantee approval
by the company on each application. This programme guarantees a maximum of 75
percent of the loan provided by the banks, both short and long-term loans, where the
loan amount does not exceed LE 10 million (USD 1.8 million) and the guarantee
does not exceed LE 2 million (USD 0.4 million). Firms pay a premium of around 2
percent of the value of the loan in return for the guarantee and the scheme now
guarantees loans by most banks operating in Egypt.

C. International Schemes

27. International schemes are typically bilateral or multilateral government or non-

governmental (NGO) initiatives, for example the ILO, UNIDO or the European

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 Investment Fund. In most cases, international schemes combine both a guarantee
fund with technical and knowledge assistance to firms.

28. The following is an example of such scheme:

NEPAD-COMESA-AfDB Credit Guarantee Fund Initiatives

This initiative was developed with the explicit aim of supporting women
entrepreneurs in the COMESA region. It is implemented through the Federation of
National Associations of Women in Business in Common Market (FEMCOM) and
funded by the NEPAD Spanish Fund. The fund aims to support women
entrepreneurs and their businesses. There are ongoing discussions on the
possibility of PTA Bank to manage the fund.

USAID’s Loan Portfolio Guarantee Schemes

USAID’s Loan Portfolio Guarantee Scheme (LPG) does not provide funding to any
particular organization. Instead, the focus of the scheme is on facilitating public
private partnerships, through a series of international bilateral commercial guarantee
arrangements between USAID’s Centre for Growth and privately owned commercial
banks.

USAID uses the Development Credit Authority (DCA) to stimulate lending using
credit guarantees. Established in late 1999 DCA has grown to currently having more
than 225 partial credit loans and bond guarantees. The DCA has facilitated the
movement of approximately USD 1.8 billion in private capital loans to over 60
contries, in addition to technical assistance. The DCA offers guarantees, which
cover up to 50 percent of the default risk. Loan amounts typically range between
USD 5 to 10 million.
D. Mutual Guarantee Schemes

29. Mutual Guarantee schemes (MGS), also known as mutual guarantee associations,
societies, or funds - are private and independent organizations formed and managed
by borrowers with limited access to bank loans. Although they largely funded
through membership fees, in many instances, they operate with some form of
government support. MGSs benefit from the active involvement and experience of
their members. A 2008 World Bank study of 76 guarantee schemes across 46
developed and developing countries has shown that mutual guarantee funds tend to
operate in high-income countries while most middle and low income countries have
publicly operated funds. The study also suggests that mutual guarantee schemes
tend to be financially more sustainable due to the member ownership structure and
interpersonal relationships at the basis of MGSs.

30. The following is an example of such scheme:

Italy
Confide of Italy is one example of such a scheme. Confide, the first Italian Mutual
Guarantee Association was created in late 1950s. . Today it operates over 700
individual Mutual Credit Associations (MGAs) in many different sectors and has over
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 940,000 SMSs as members (De Gobbi, 2002). The membership structure is based
on the principle of equality. Confide has also benefited from government assistance
as well as financial support from the European Union.

4. Proposal for the Design of Partial Credit Guarantee Scheme in the COMESA
Region

31. The following proposal has been made based on the good practices studied from
other countries in order to design an appropriate PCGS for the COMESA Region.
Based on the proposed appropriate design a model guideline for operationalization
of the scheme will also be recommended.

32. The most important questions to be considered when designing a PCGS are
whether the scheme should be self-sustainable and whether it should focus on
creating financial and economic additionally. In the following proposal, we put forth a
potential design of PCGS based on good practices that aims for both sustainability
and economic development.

4.1 Risk Sharing

33. An improperly designed guarantee scheme can increase moral hazard among
borrowers by reducing the default risk they would otherwise incur (i.e. by providing
part of the collateral required to obtain the loan). This can lead to more “strategic
defaults” from borrowers-because part of the collateral does not belong to the
borrower, they have a higher incentive to default. However, a properly designed
guarantee scheme can limit moral hazard. For this to occur, it is important that the
loan risk be shared among the lender, the borrower, and the guarantors.

34. The extent to which each party should share in the risk is a delicate balancing act.
The Guarantor should accept enough risk to be able to persuade banks to
participate in the scheme. In fact, 100 percent coverage exists in countries such as
Canada, Japan, and Luxembourg. A World Bank study in 2008 revealed that among
the 76 schemes in 46 developed and developing countries, 40 percent of them offer
this option. However, a 100 percent coverage rate is subject to greater moral
hazard. Not only does it increase the strategic default option of borrowers, but it also
reduces banks’ incentives to properly assess and monitor risk.

35. Coverage rates below 50 percent reduce the potential for moral hazard and
encourage steadfast assessment, monitoring, and evaluation of loans. On the other
hand, a coverage rate below 50 percent reduces banks’ incentives to participate in
the guarantee programme, especially because loan administration costs can be
quite high. Some countries with low coverage rates have been able to maintain the
attractiveness of their scheme by using other financial incentives. The national
guarantee fund in Egypt, despite having a low coverage rate, still managed to
guarantee USD 85 million in loans in 1995 after only four years in operation. This

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 achievement was partly possible by offering other financial incentives in addition to
guarantees.

36. Such experiences suggest that coverage rates should generally be between 60 to 80
percent (Levitsky, 1997). Rates in this interval are high enough to encourage lender
participation and yet low enough to limit moral hazard. From the 76 schemes studied
by the World Bank, the median coverage rate was 80 percent.

37. Some countries offer more complex coverage rates. For example, Italy and Mexico
offer an array of guarantee rates. Rate levels depend on the risk assessment and
the nature of loan.
4.2 Fees

38. The fees charged by PCGSs are an important consideration in designing an

appropriate guarantee scheme. The fees form the incentives lenders and borrowers
have in participating in the programme, but moreover they are key factor in
determining the financial sustainability of the fund. The fees must be high enough to
cover administrative costs, but low enough to remain attractive to lenders and
borrowers. Experience has shown that it is unrealistic to expect a PCGS to cover its
full costs through fees, but it can still cover at least the administrative/operational
costs of running the scheme.

39. In general, the percentage and the way fees are applied vary among different
schemes. There are schemes where a registration fee for processing the application
is required. In Europe, as well as in developing countries, the fee is typically about 1
percent of the loan amount. Other schemes usually impose an annual or a per-loan
fee that ranges from 1 to 2 percent.

4.3 Types of Loans

40. An important element to a PCGS is the decision as to whether a scheme should

provide individual or portfolio loans. On a loan level or in an individual model, the
guarantor approves applications. In this case, there is a direct link between the
borrowers and the lenders, since the application assessment is conducted on a
case-by-case basis. This review process allows for more diligent risk management
and likely reduces the probability of moral hazard. Such a scenario probably results
in a higher quality loan portfolio. According to the World Bank, 72 percent of credit
guarantee schemes use this selective or individual loan approach.

41. If the objective of the scheme is to increase guarantee and credit volume, the
portfolio model is well suited to these objectives. Under this approach, the guarantor
negotiates the criteria of the portfolio. For example, a fund can specify that loans
made with its guarantees target to the SMSs sector. However, the portfolio model
does have some disadvantages. In focusing on a specific segment of the market,
versus the viability of one specific loan, the screening process is less meticulous and
default rates tend to be higher. Moreover, since the portfolio is based on specific

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 lending objectives, there is less risk diversification. Managers/Administrators are
thus confronted with a tradeoff between lending volume and portfolio quality.
International experience has shown that only 14 percent of the 76 schemes studied
by the World Bank use the portfolio model.
4.4 Defaults

42. The default rate is an important indication of a scheme’s sustainability. When

applications are appropriately assessed and monitored, an adequate default rate is
possible. Levisky considers that a sustainable scheme should aim to have a default
rate of between 2 to 3 percent. Newly established schemes in developing countries
might consider a higher default rate (i.e. over 5 percent) in their early years of
operations.

43. A scheme’s credibility is also based on how defaults are handled. Guarantee pay out
should only be used as a last resort. In the case of a default, guarantors or lenders
should renegotiate payments schedules. This requires experienced staff in the
guarantee scheme, that are capable of subjectively restructuring and renegotiating
payment plans.

4.5 Risk Management

44. In order to reduce the exposure of scheme to default and diversify risk, funds might
use risk management mechanisms such as reinsurance and portfolio securitization.
However, these mechanisms require relatively well-developed local capital and
financial markets. The World Bank study revealed that 76 percent of the schemes
studied use risk management tools, 20 percent purchase some form of loan
insurance, 10 percent securities the loans portfolio and 5 percent use risk
management strategy.

45. An example of a reinsurance mechanism is a counter or co-guarantee. The

government or an international financial entity provides counter guarantees. They
provide indirect protection-the counter-guarantor assumes part of the risk associated
with guaranteeing a loan. One negative consequence of a counter-guarantee system
is that moral hazard increases. For this reason, it is advisable to have a counter-
guarantee cover only a limited amount of the risk. However, a positive consequence
of the counter guarantee system is that it helps increase private sector confidence in
the guarantee scheme.

46. Counter guarantee systems are mostly found in developed countries. Applying
counter guarantees in developing countries has proven to be difficult due to
inadequate financial system development and legal frameworks.
4.6 Regulatory and Institutional Framework

47. Governments need to put in place conditions that enable the growth Mutual Credit
Guarantee Schemes. In particular, they need to minimize obstacles to their creation

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 and growth, while actively promoting their use between the financial sector and the
public. One of the more important aspects is to make sure that these guarantees are
operating within a well-regulated legal framework. This can be done by establishing
minimum capital requirements, and a strict commitment to transparency. Such
guidelines and controls help improve banking sector confidence in the guarantee
schemes but additionally can help prevent any major crisis stemming from poorly
issued guarantees.

48. Guarantee scheme regulation contributes to the credibility of the schemes,

particularly in the case when public resources support the scheme, regulators can
ensure the protection of those resources. In countries, where the private financial
market is well developed, regulation can be achieved, in part, with the active
participation of private sector actors. However, when this is not the case, public
entities such as central bank, should play a central role in the regulation and
monitoring of the schemes.

5. Model Proposal for Partial Credit Guarantee Scheme

49. The following model guideline is recommended based on the suggestions and
concepts, detailed above. The guideline is derived from the Nigerian SMECGS.
5.1 Establishment of the Scheme

50. As part of its developmental role, the central bank of country X has established the
Small and Medium Enterprise Partial Credit Guarantee scheme (SMEPCGS) for
promoting access to credit by SMSs in country x.
5.2 Funding

A. The Scheme shall have a fund of USD ---- Dollars to be financed by the following;
B. National Central Bank of country X
C. Donor Funding, etc.
D. International Development Finance Institutions
5.3 Objectives

51. The main objectives of the credit guarantee scheme include the following:

A. Fast-track the development of the SME sector of country X by providing guarantee

for credit from banks to SMEs and manufacturers;
B. Set the pace for industrialization of country X;
C. Increase the access to credit by promoters of SMEs and manufacturers;
D. Increase output, generate employment, diversify the revenue base, increase foreign
exchange earnings, and provide inputs for the industrial sector on a sustainable
basis.
5.4 Managing Agent

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52. The Central Bank of country X shall be the managing agent and be responsible for
the day-to-day administration of the scheme.

Activities to be covered Under the PCGS:

A. Industrial development activities
B. Agro – food and value addition/ Value Chain
C. Capacity building
D. Any other activity as may be specified by the Managing agent from time to time

Trading shall not be accommodated in this scheme

6. Definition of MSMEs

53. The definition of MSMEs varies from country to country, as it should reflect the
existing socio-economic objectives, realities, and the suitable parameters of
promoting MSMEs in each country. COMESA defines MSMEs based largely on
SME’s employment levels, as this is the only indicator, which can be used to
effectively define MSMEs across all member states. The table below provides the
general categorization of MSMEs in the COMESA region.

Type of Enterprise Number of Employees

Micro 2-9
Small 10-50
Medium 51 - 150

7. Eligibility Criteria for Participation in the Scheme

7.1 Participating Bank (PB)

All Deposit Money Banks and Development Finance Institutions (DFIS) shall be eligible
7.2 Borrower

The borrowers shall meet the following criteria to be eligible:

- Have a clear business plan.

- Any entity falling within the definition of an SME;
- A wholly owned and managed Country X private limited company registered
under the Company Act;
- A legal business operated as a sole proprietorship;
- A startup with satisfactory cash flows indicating fixed asset cover ratio of
100:150.
- A Franchise
- Have no non-performing or delinquent loans with any financial institution;

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 - Be a member of the organized private sector bodies such Association of Small &
Medium enterprises, the Manufacturers association etc.
- Provide up-to date records on business operations, if any; and
- Satisfy all requirements specified by a Participating Bank
- A Borrower shall have on loan under the scheme at any point in time

8. Modalities of the Scheme

A. Loan Amount

Maximum Loan amount is USD 250,000, which can be in the form of working capital,
term loans for refurbishment/equipment upgrade/expansion, overdrafts, etc.; - all of
these conditions will differs from country to country.
B. Guarantee Cover

1. The guarantee cover shall be 80% of principal and interest and shall be valid up
to the maturity date of the loan with a maximum tenure of 7 years inclusive of a
2-year moratorium. The Guarantee shall be executed at the point of the loan
disbursement by the Bank to the customer and shall be redeemed when the
facility becomes non-performing and classified under the loss category of the
Prudential Guidelines.

2. In the event of recoveries after payment of claims by the central bank of country
X, such recoveries shall be shared in the ratio of 80:20 for central bank of country
X and Participating Banks respectively.

3. Interest Rate
The lending rate under this Scheme shall be at Prime Lending Rate (PLR) of the
participating Banks.

9. Acceptable Collateral

The security to be offered to a bank for the purpose of any loan under the Scheme shall
be one realizable and acceptable to the participating bank(s).

10. Loan Tenor

A. Loans shall have a maximum tenor of seven (7) years and/or working capital
facility of one year with provision for roll over.
B. The Scheme allows for moratorium in the loan repayment schedule.

11. Procedure for Applying for the Guarantee

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 A. All loan applications by SMEs promoters under the Scheme shall be made
directly to the Participating Bank accompanied by the necessary documents as
per normal loan processing requirement and the PBs applying the same degree
of due diligence and professionalism as in the normal course of banking
business.

B. Applications received by Participating Banks should be processed promptly and

the period elapsing between the submission of an application and requisite
documents for appraisal under the Scheme and its approval or otherwise will not
exceed 60 days. Banks may call for information that has not been sufficiently
provided by the applicant. Officials of the Managing Agent may call on banks that
have not acted within a reasonable time on any application submitted to them.

C. Participating Banks should submit application for guarantee using a standard

application form, on behalf of their clients to the Managing Agent.

D. The application for a guarantee should be accompanied with Offer Letters.

12. Verification and Monitoring of Projects

A. Projects under the Scheme shall be subject to verification by the Managing

Agent. Acceptance or rejection of an application for a guarantee by Central Bank
of country X shall be communicated to the Participating Bank and the borrower
within 10 working days after verification.

B. The project shall be subject to monitoring by the Managing Agent (Countries

central Bank) during the loan period.

C. The Countries central bank has the right to reject a request from any
Participating Bank if it contravenes any section of the Guidelines.

13. Responsibilities of Stakeholders

For the effective implementation of the Scheme and for it to achieve the desired
objectives, the responsibilities of the stakeholders shall include:

A. The Central Bank shall:

- Provide Fund for the Scheme
- Act as the Managing Agent of the Fund.
- Determine the limits of guarantee of the Scheme
- Carry out verification/monitoring of projects under the Scheme.
- Process Applications for guarantee from Participating Banks within 21 days of
receipt of application.
- Request PB(s) to render periodic returns as may be specified from time to
time.

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 B. The Organized Private Sector Associations (MAN, NASME, etc.)

The Organized Private Sector Associations shall:

- Accredit would-be beneficiaries of the Scheme
- Ensure prompt repayment of loans by members

C. The Participating Banks (PB)

The PB(s) shall:

- Grant credit facilities to SME Promoters at prime lending rate;
- Approve loan requests under the Scheme based on normal business
consideration exercising appropriate due diligence;
- Render periodic returns under the Scheme as may be specified by the Central
Bank of Country X from time to time.
- Monitor the projects during the loan period.

D. Borrower

The borrower shall:

- Utilize the funds for the purpose for which it was granted.
- Ensure the charged assets being financed.
- Adhere strictly to the terms and conditions of the Scheme.
- Make the project and records available for inspection/verification by the Central
Bank of country X.

13. Discontinuation of a Credit Facility

Whenever a credit is repaid or the facility is otherwise discontinued, the Participating

Bank shall advise the Central Bank of country X immediately, giving particulars of the
credit facility.

14. Amendments

These guidelines shall be subject to review from time to time as may be deemed
necessary by the Managing agent.

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Bibliography
OECD “Facilitating Access to Finance” Discussion Paper on credit Guarantee Schemes

Youssef Saadani, ZSofia Arvai and Roberto Rocha” A Review of Credit Guarantee

Schemes in the Middle East and North Africa Region” The World Bank 2010

Central Bank of Nigeria “N200 billion Small and Medium Enterprises (SME) Credit

Guarantee Scheme (SMECGS)

Beck Thorsten, klapper Leora, Mendoza Juan “ The typology of Partial Credit

Guarantee Funds Around the World, policy research Working Paper, The World Bank

Credit Guarantee schemes: A tool to Promote SME Growth and Innovation in the Mena

region: MENA-OECD Investment Programme Working Paper, 2010

Green A, (2003): Credit Guarantee Schemes for Small Enterprise: An effective

Instrument to Promote Private sector Led-Growth, UNIDO Working Paper No.10, august

2013

Levitsky J.: SME Guarantee Scheme: A summary, the Fincier, Vol. 4, No. 1&2,

February / May 1997, =

Levitsky. J. (1997); Best Practices in Credit Guarantee schemes; the Financier, Vol. 4,

No. 1

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