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Home Category / Columnists / A single guarantee corporation?

A single guarantee corporation?

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Published July 10, 2017, 10:00 PM

By Benel P. Lagua

Government recently announced plans to consolidate all

guarantee corporations into one unit. Ostensibly, the main

reason is e ciency as government noted that most, if not all, of
the governments guarantee operations technically were losing
money. Fund raising through bond issuances could be easier
with one big solid institution instead of having several small
ones.
The revived concern for the guarantee business is most Benel P. Lagua

welcome, but is the policy direction addressing the root causes

bugging the e ectiveness of the Philippine government
guarantee initiatives. Perhaps a more extensive review is warranted. We need to learn from the rich
lessons of operating guarantee institutions especially in Asia. The news reports discuss the need to add
new funds of P500 million into the consolidated entity and while the new money is most welcome, the
quoted sum looks paltry.

Lets start by reviewing how our neighbors handle this business. In Japan, they have appropriated and
transferred a huge funding of billions of Yen to their 52 credit guarantee corporations (CGC) in each
prefecture (local government subdivisions headed by a governor) throughout the country. These CGCs
in turn reinsure their exposure with the Japan Finance Corporation, which is wholly owned by national
government. Japan has used its guarantee system to respond to various nancial crises and to the
countrys recession. They have saved tens of thousands of enterprises from bankruptcies, kept intact
hundreds of thousands of jobs. And yes, the guarantee corporations are not making money but their
key result areas are more de ned by the macro-economic externalities.

South Korea has two major guarantee companies, the Korea Credit Guarantee Fund and the Korea
Technology Credit Guarantee Fund, employing around 4,000 sta and maintaining a network of
branches throught the country, and even overseas.

Taiwan not only enlarged its credit guarantee coverage and capacity for economic recovery, but has
e ectively used it to rebuild from like in the devastating earthquake of 1999. This was made possible
through policy decisions creating new guarantee facilities focused on strategic sectors such as
construction, SME development, agricultural automation and industrial development.

In other words when our Asian neighbors built their guarantee systems they realized it was an
investment and not a cost. And they poured funds into the system so it works as desired to catalyze
industrial growth and job creation, not as income generating ventures that earn money for their
government co ers. Historically, all those agencies receive regular funding support from their
governments.

This is the mindset that must govern any move to modify the structure of guarantees in our country. It
needs full comprehension of the policy objective of setting up guarantee funds and institutions.

The nancial system works well when it is able to channel funds from those labeled as surplus units
(the savers) to those that have a de cit (the borrowers). Ideally, the ow of funds should be to those
with the best use of funds, or to the borrowers which have an excess of investment opportunities. A
large part of the funds ows are handled by intermediaries which, in this instance, are our private
nancial institutions like banks, nance companies and micro- nance conduits.
Unfortunately, the funds ow does not happen automatically. To illustrate, people deposit money in a
bank which in turn use the fund to entertain a borrower. The depositors claim on the loan is not a
direct one. The deposit has a risk and liquidity feature di erent from the banks loan to the borrower,
which by the way is now an asset of the bank. The depositors fund is theoretically safe and liquid; but
the banks asset is now subject to risk and uncertaintly, especially of default. It is likewise not so liquid.
Here lies the major mismatch.

The characteristics of the funds ow changes the risk and liquidity feature of nancial instruments
utilized. Someone has to absorb the risk of loans. Banks normally do this as part of their risk taking
activity. In the normal course of business, the bank makes a lot of loans and not all loans will be good
ones. Some borrowers will eventually default on its obligations. The losses out of these classses
constitute the cost of the asset transformation and the risk.

If the banks are rationale wealth maximizers, certain sectors critical to the economy will be rationed
out. Given these issues, the presence of guarantees are intended to reduce the cost of administration
as well as the risks involved for the identi ed priorities. Loan losses are e ectively reduced, even if the
guarantee is not 100%. The banks should nd it less di cult to address the concern of the sector with
the incentives provided by the guaratee system. The guarantee mechanism represents a policy
intervention to direct funds ow to important but unattractive sectors.

We need to have strong guarantee institutions to make this functional to the system. Oftentimes, the
private nancial sector institutions are concerned about the nancial and administrative strength of the
government guarantee institutions. Hence, the guarantee institution must have a strong capital base
and must be professionally managed. Freedom from political intervention must be assured. Loan
guarantees help funds ow to the priority sector while it reduces the cost and risk of banks. We have to
make better use of this important resource for the nancial system to e ciently allocate scarce
resources from savers to borrowers.

At its core, the guarantee is an insurance product and since it is designed to address a priority concern
that is by de nition of higher risk class whether SMEs, agriculture or disaster recovery it must not
be viewed as an income generator per se. Many times, premium pricing will not follow actuarial

realities lest it becomes unattractive . Other economices have accepted this persective. It is about time
we focus on its impact, its leveraging e ects and its e cacy in achieving the target additionality
outcome.

(Benel D. Lagua is Executive Vice President at the Development Bank of the Philippines. He is an active
FINEX member and a long time advocate of risk-based lending for SMEs. The views expressed herein
are his own and does not necessarily re ect the opinion of his o ce as well as FINEX.)
benel_dba@yahoo.com
Tags: administration, Asian neighbors, Benel P. Lagua, government, institution, investment
opportunities, Philippine government, policy

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