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Guaranteed Loans to Microfinance Institutions: How Do They Add Value?

Topic : Insurance, Microfinance, Risk Management

This Focus Note looks at recent experience with guarantees of commercial loans to microfinance institutions (MFIs). Such loan guarantees are a form of insurance that covers a lender – typically a commercial bank – against default on its loan to an MFI. If the MFi defaults, the guarantor pays the bank the guaranteed portion of the loan. The MFI pays for this insurance in order to get a loan from a bank that will not lend without some additional security for payment.

This Focus Note discusses the results of a study that draws on data provided by guarantee agencies, publicly available financial reporting by MFIs, and telephone and email exchanges with selected MFI managers and guarantee staff. The study itself

reviews the specific benefits loan guarantees are meant to produce;
describes guarantor agencies, transaction volumes, cost structures, and guarantee mechanisms; and
examines the results of a set of 96 loan guarantees issued by eight agencies and draws conclusions about the effectiveness of loan guarantees.

The paper begins by setting out key findings before discussing reasons that funders use loan guarantees and the profile of MFIs that use loan guarantees. The bulk of the paper then provides an analysis of measuring the impact of guaranteed loans to MFIs. Before remarking on factors for the future, the paper also provides a view on whether schemes are successful in that MFIs are eventually able to borrow from their local banks without a loan guarantee. A brief review of the role of guarantees in international lending to MFIs and the sustainability of guarantee agencies is also offered.

The Focus Note states that its central observation is that loan guarantees are superior to a direct loan from an international donor or funder only if the guaranteed loan helps the MFI build a competitive funding structure. The conclusion also follows that guarantors will realise their greatest potential by focusing on lenders that use guarantees to structure loans to MFIs in conditions that are competitive with other funding options. In this role, the paper suggests, guarantee facilities could become specialised, permanent, and possibly profitable components of an emerging MFI funding industry.