The assessment of credit guarantee schemes for SME's: valuation and cost

Abstract

Small and medium enterprises (SME' s) have important limitations from the financial viewpoint. Their reduced capability to generate resources (self-financing) and their high financial costs as compared to the profitability of investments, makes them highly dependent of short-term bank financing. Among the different mechanisms used to solve these financial problems we find credit guarantee schemes as the Loan Guarantee Associations (LGA). These (mutual or government granted) credit insurance systems were set to facilitate the access of SME ' s to the credit market covering part of the loss incurred when borrowers default on a loan. In spite of some legal differences, LGA in most European Union countries function in a fairly similar way, making therefore easier to compare their operational cost and impact on business. This study provides a model for the valuation of the costs and implicit benefits associated with the loan guarantee programs. Empirical results indicate that the use of LGA is likely to differ among SME' s depending on company size and debt financial cost. The relatively high cost of the loan guarantee, is not always fully compensated with a similar reduction of the interest rates of the financing entity, hindering, in many cases, the full development of the schemes.