Description

Guarantees are a powerful credit-enhancement tool that can provide investors with the ability to leverage more capital to address social and environmental challenges. Lowering the risk profile of investment to decrease the cost of infrastructure project finance: city governments can ensure the infrastructure project against commercial, political and environmental risks or reduce the interest rates through credit enhancements and guarantees. Different international organisations provide credit enhancement and guarantee instruments. One example is subordinated debt, often provided as convertible loans (mezzanine finance). Another example is credit guarantees by multi-lateral development banks, for instance, to national financial institutions, that can provide credit enhancement to infrastructure project bonds, which in turn achieve a higher credit rating and can thus mobilise cheaper money from investors with mandated lower risk profiles, such as insurance or pension funds.

Instrument category

Risk mitigation instruments

Implementation status

Moderate - tried and tested

Enabling conditions and success factors

• Investment capital is needed alongside the guarantee to fund the projects.

Instrument benefits

• Improves access to finance.
• Deploy institutions' risk-taking capacity where they do not have funding capability.
• Generates better financing terms and conditions.
• Enhanced mobilization of resources by enabling debt financiers to get a risk transfer.
• Lower operational costs.
• Expand and enhance financial sectors in developing countries.

Challenges and risks to implementation

• It is often difficult to estimate the probability of default and, therefore, the pricing.
• Increased transaction costs could deter the use.
• Inadequate (too low) pricing could generate moral hazard behaviour.

References

Case studies

Risk guarantee to enable the public-private partnership for the Kigali Bulk Water Supply Plant in Rwanda

Scaling-up energy efficiency for industrial enterprises via a guarantee instrument in Vietnam