Practice Advice on Public Financial Management
Loan Guarantees (OCED)
Summary Advice: The OECD advises that the use of explicit contingent debts, such as loan guarantees, should follow sound principles of valuation and reporting.
Main Points: The OECD notes that there are sound reasons for employing explicit contingent debts but there is a risk that guarantees can be used for unsound reasons; for example, because they are given less transparent treatment in budgets and debt reporting than regular expenditures and on lending. Debt managers have a key role in risk management involving guarantees, as contingent debt is effectively a latent form of government debt. This calls for defining measures of cost and risks that encompass both the guarantee portfolio and the regular debt portfolio. Debt managers are well positioned to manage this joint portfolio, using their expertise in financial risk management and access to flexible financial instruments, including derivatives.
The paper makes the following recommendations:
- Guarantees are contingent expenditure decisions and should be treated analogously to regular expenditure decisions in the budget process.
- Fees corresponding to at least the expected cost of each guarantee should be charged for all government guarantees.
- The fee should be paid either by the recipient of the guarantee or by budget funds, so as to ensure that guarantees are in line with sound principles on state aid and are fully accounted for in the state budget. If the recipient of the guarantee is a commercial enterprise, the fee should correspond to the market value of the guarantee to prevent competitive distortions.
- Fees should be used to build up actual or notional reserve funds so that the government has resources to cover future losses.
- Fees should be set based on careful analyses, preferably made by entities not directly involved in the decision to issue the guarantees. Debt managers are candidates for this task.
- Guarantees should be reported consistently based on their expected cost and in a way that gives a complete picture of the government’s total debt position.
Source: OECD (2005). Advances in Rick Management of Government Debt at http://www.oecd-ilibrary.org/finance-and-investment/advances-in-risk-management-of-government-debt_9789264104433-en (accessed 13 November 2012).
Page Created By: Matthew Seddon on 13 November 2012. Updated by Ian Clark, 4 January 2013. The content presented on this page is drawn directly from the source(s) cited above, and consists of direct quotations or close paraphrases. This material does not necessarily reflect the official view of the publishing organization.