Linking Financial Service Providers to Commercial Capital: How Do Guarantees Add Value?

In microfinance, experimentation with loan guarantees began largely as an attempt to demonstrate to local banks that MFIs are creditworthy. Though loan guarantees are far less common than other funding instruments, such as debt, equity, and grants, they are beginning to be used more often.

Most MFIs can reach significant scale in the long term only by tapping into local deposits and bonds and by borrowing from local banks. However, many MFIs are prohibited from taking deposits, and many local bond markets are underdeveloped. Funders hope that issuing loan guarantees will facilitate MFIs’ access to commercial funding—mainly local bank loans. Most guarantees are issued by organizations, or departments within funding agencies, that are mandated and funded specifically to provide loan guarantees.

This Brief is based on a joint CGAP/USAID study of 96 transactions executed by eight guarantor agencies between 1988 and 2005, with most transactions made after 2000 (Flaming 2007).