The Guarantee System & The Role of GFSME
Credit guarantee is a form of insurance against default in loan repayment. It is a risk sharing arrangement between the guarantor, which is the GFSME, and the lenders, which are the accredited banks and other Financial institutions.
For example, the loan of an SME from an accredited bank may be guaranteed by GFSME by as much as 85% of the total loan amount for term loans, and 90% for credit lines. This means therefore that the bank and GFSME share in the risk of lending to an SME. In this case, the GFSME shares in the greater portion of the risk by as much as 90%, while the bank shares in just a small portion, which may go as low as 10% of the total loan amount.
In the event the borrower fails to repay the loan and the account is declared in default, the bank may "call" on or claim the guarantee. The GFSME then pays the bank the amount covered by the guarantee. Upon receipt of payment of the guarantee claim, the bank assigns its rights over the guaranteed portion of the account effectively transferring the liability of the borrower to the guarantor. Nonetheless, the banks still retain part of the risk and usually continue to manage the account in view of their remaining 15-20% share in the account.
Under the guarantee system, borrower liability for a loan is not extinguished, but merely transferred to the guarantor. The guarantor now has two options: to restructure the loan if the enterprise is still viable, or to foreclose on its assets if the business is terminated. As a service agency the guarantor will be more liberal in granting conditions favorable to the recovery and further development of the enterprise.
In the Philippines, an SME borrower first goes to the bank and applies for a loan. The bank exercises the option to have the account guaranteed once the loan is approved. It is the bank that applies for the guarantee, not the borrower. It is also the bank that conducts primary credit evaluation on the loan application. The guarantor, on the other hand, does secondary credit evaluation which is more a validation process of the banks credit evaluation report. Lending decisions are made by the bank.
The guarantee is often used by the banks as a collateral substitute or supplement. In a few cases the guarantee is resorted to even if the loan is already fully secured. The reason is the banks wants additional comfort, and faster recovery on defaulted accounts. A guarantee call is paid in less time compared to a real estate mortgage which allows for a one year redemption period.
As guarantor, the GFSME can only encourage the banks to lend to SMEs, but cannot compel them to do so. Its role is more of a catalyst in the development of SMEs. As a boon to SMEs, the guarantee system encourages the flow of credit to them. Industry practice allows guarantee agencies to guarantee accounts three times (technically referred to as leveraging ) the value of their guarantee fund. So for instance, a guarantee agency with a fund of P1 million may be able to guarantee P 3 million worth of projects, or caused the flow of P 3 million in loans to SMEs.