A credit guarantee scheme (CGS) provides third-party risk mitigation to banks or lenders where a percentage of lenders losses due to payment default by the borrowers are absorbed. The Common Fund for Commodities (CFC) and the Rabobank Foundation set up a mechanism worth USD 2.25 million to provide loans to coffee farmers in Ethiopia to buy processing equipment and guaranteed 50% losses incurred. The project also provided technical assistance to follow processing best practices. Farmer cooperatives that facilitated the processing, purchase, and export of coffee were also eligible.
Stage of Implementation
More than 23 cooperatives in Ethiopia have received commercial loans using the credit guarantee mechanism. The scheme has enabled better access to commercial loans for smallholder coffee farmers, helped to scale up of agricultural best practices and better access to markets. The technical facility has improved access to production and processing information
- DFI and Philanthropic Foundation: Common Fund for Commodities (CFC) provided USD 2m as a collateral to support a risk sharing solution between local lending banks, Rabo Rural Fund and CFC and USD 1,240,210 in grants, USD 600,000 of which was financed by OFID. The Foundations have a high-risk appetite and a strong climate change mandate and therefore have a critical role to play in de-risking and covering a share in case of default.
- Financial Institutions: Banks are the lending Institutions that are the participating lenders in the risk-sharing facility and who have loan exposures to individual farmers, cooperatives, or SMEs. The lending institutions often have a low-risk appetite, and no climate change mandates.
- Fund Manager: The Rabo Rural Fund is the fund manager who is responsible for screening the lending institutions’ portfolio and extending the guarantees accordingly. The Facility Manager also verifies the risk claims submitted by Lending Institutions in case of a default and releases funds thereafter.
- Technical Assistance Provider: CABI and Rabobank International Advisory Services are providing technical assistance for grants and loan-related activities respectively. They have a critical role to play in capacity building, pipeline development and project preparation assistance for beneficiaries to access the credit guarantee. They also help the lending officers to understand the value chain of the business and familiarize them with governance best practices.
Credit guarantee schemes can be of many types, public, mutual (private) or Public-Private Partnership (PPP) model. Public CGS would be useful when there is strong public sector culture. Budgetary grants are available for providing guarantees while mutual (private) CGS can be undertaken when the expertise in the government is lacking and there is a growing private sector. The PPP model can be useful in building additional sources of funds and expertise to complement government capacity.
- Project pipeline: Countries with significant pools of investable project pipeline in the agriculture businesses and SMEs are strong candidates for CGS. There should also be transparency and fairness in selection criteria. Additionally, the borrowers should be carefully screened to assess the potential of creating long-term value and ability to sustain themselves once the guarantees are not available.
- Strong legal and regulatory framework: The legal and regulatory framework for the schemes should be in place, with the CGS as an independent legal entity with effective oversight. Enabling regulatory framework is especially critical for mutual guarantee funds concerning minimum capital requirements, the appropriate solvency ratio and transparency criteria.
Programme for Rural Outreach of Financial Innovations and Technologies in Kenya or Financing Ghanaian Agriculture Project (FinGAP) in Ghana are examples of credit guarantee schemes that have a strong potential to deploy risk mitigation instruments for smallholder farmers.