Paper
Capital Enhancement Guarantees and Risk Management by Capital-Constrained Lenders
Examining techniques that can encourage lenders to make loans they wouldn't otherwise make
22 pages
The paper states that commercial lenders require capital to bear risk. The capital enhancement guarantee (CEG) encourages lenders to make loans they would not otherwise make, such as microenterprise loans.
The CEG is auctioned and awarded to bidders who promise the greatest amount of new lending for a given increment of permanent capital. Whether the incremental lending causes losses or gains for the lender, the incremental capital is free. The CEG subsidizes innovation in risk management by:
- Placing analytical focus on risk and its cost;
- Supporting the key party to the lending decision;
- Promoting skill in risk management;
- Emphasizing transparency;
- Minimizing moral hazard with trivial transaction costs.
The paper concludes that overall, the CEG should be attractive to donor agencies and the guarantee supports the key party to the lending decision who requires support to make the loan.
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