Are public credit guarantees worth the hype?

Public credit guarantees have become a popular instrument to expand lending to small and medium enterprises (SMEs). More than 30 percent of credit guarantee schemes around the world have some form of state ownership. Public credit guarantee schemes are particularly important in developing countries, where they are the main type of guarantee scheme.

Although public guarantee schemes are widely popular, two important questions regarding state intervention in these schemes still linger. Is state intervention needed for credit guarantees to be sustainable over time? Have public credit guarantees been effective in expanding finance to constrained firms and enhancing their performance? In a new policy brief, we attempt to provide answers to these questions based on theoretical and empirical discussions.
 
From a theoretical standpoint, it is not clear whether public intervention in credit guarantees schemes is always warranted. For example, supporters of public schemes argue that the state has an informational or enforcement advantage over private agents, but this is not necessarily always true. They also argue that public schemes can act as subsidies to cover the initial costs of learning about new groups of borrowers. But this argument would only support a temporary use of public schemes.
 
On the empirical front, the evidence on the impact of public credit guarantee schemes has been mixed. In some countries, public schemes increased credit to targeted firms. Moreover, there is also evidence that, in some cases, firms that received guaranteed loans enhanced their performance. However, in other countries, public schemes have imposed costs, with their net effect being unclear. Varying success of public schemes could depend on whether the scheme is addressing a market failure or not, and differences in their design across countries.
 
Further work is needed to accurately assess the impact and long-term sustainability of public credit guarantee schemes. This work could focus on why private schemes might not develop on their own, when public schemes are warranted, and which factors can promote a sound performance of public schemes.