Published 02 May 2017

Loan Guarantee Schemes as a policy instrument for financing entrepreneurial businesses

The author discusses the theoretical basis for a loan guarantee scheme and describes its function and component parts. In addition, it provides some examples of how such systems can be formulated in practice.

Loan Guarantee Schemes

  • Loan guarantee schemes are operational in more than 100 countries worldwide since the first recorded schemes were initiated in the US and Switzerland in the early 1950s
  • They are the single most popular policy instrument in both developed and developing countries
  • Fundamentally, they implicitly recognise the fact that entrepreneurial talent is more widely distributed than wealth and that many talented entrepreneurs and firms with viable investment opportunities face collateral based constraints in capital markets. And this problem is more acute for younger and smaller businesses.
  • For the public policy maker the attraction of loan guarantee schemes lies in their simplicity which means that entrepreneurs and banks find them easy to understand, access, and administer. And this is important as banks have more relationships with SMEs than any other institution.

Robust evidence from the US, Canada, and UK highlights the fact that well targeted loan guarantee schemes can; (a) create jobs at a low cost over a sustained period, (b) increase productivity as labour and capital are complementary in production for smaller firms, and, (c) alleviate binding credit constraints faced by asset poor but good quality firms.

The Swedish Context

  • A more considered and in-depth investigation highlights some interesting features of the Swedish credit market.
  • SME, and in particular micro businesses and manufacturing firms, view access to finance as a pressing problem of some concern to them.
  • Take-up of short-term debt instruments (leasing, factoring, and credit lines) is particularly high given the financial preferences of firms.
  • Around 1 in 7 firms view publicly supported finance as appropriate to them, although a common perception held by Swedish SMEs is that accessing government financing is highly bureaucratic.
  • Traditional banks only serve ¾ of the total loan market.
  • Collateral requirements of debt providers have become increasingly onerous and affect around ¼ of all firms.
  • Lack of collateral is the single most important limitation on future growth affecting approx. 13 per cent of all firms, and approx. 25 per cent of those who face barriers to growth.

Recommendations

  • That the Swedish government develop a specific large-scale SME finance survey aimed at understanding and supporting potential policy interventions in smaller firm capital markets.
  • Develop a national pilot loan guarantee scheme for a trial period of 3 years with operational responsibility devolved to private sector financial institutions but ownership and monitoring responsibility retained in the public sector.
  • The focus of the proposed pilot loan guarantee scheme should be on all SMEs as finan­cing issues have been shown to be more related to firm size than firm age (i.e. more related to collateral inadequacy than lack of track record).

We estimate that a national guarantee scheme would have the potential to impact on between 2 per cent and 6 per cent of the total stock of SMEs and, within this, a much higher proportion of growth orientated firms.

Title
Loan Guarantee Schemes as a policy instrument for financing entrepreneurial businesses

Serial number
PM 2017:04

Reference number
2016/084

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