Instrument Overview
Partial and/or full risk guarantees are tools used by lenders to reduce risk, particularly in projects or countries where the perceived risk is high, but the potential impact is significant. These guarantees are a powerful credit-enhancement 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 these guarantee instruments. One example is credit guarantees by multilateral development banks, for instance, to national financial institutions, that can lead to a 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 [1].
Why it matters for cities
Given the developing capacity of local governments in obtaining access to repayable finance on commercial terms, investors and lenders can rely on credit enhancement mechanisms, such as guarantees, to substitute for municipal creditworthiness, reduce credit and other types of risk, and secure more favorable lending terms. Guarantees work to de-risk and, therefore, unlock private investment. They also facilitate better financial terms for individual projects. Guarantees may, for instance, lower collateral demands, secure long-tenured financing facilities, encourage lenders to waive deposit requirements, and reduce the cost of borrowings. These outcomes are achieved by providing assurance to the lender that all or part of the losses will be covered in the event the borrower defaults [2].
Key features
- Risk Reduction: Lowers commercial, political, and environmental risks to attract investors.
- Improves Financing: Enables generally better loan terms—lower interest rates, longer maturities, less collateral.
- Credit Enhancement: Supports entities with limited creditworthiness to access commercial finance.
- Encourages Private Investment: Makes projects more attractive to lenders and private capital.
- Offered by MDBs and Agencies: Commonly provided by multilateral banks and export credit agencies.
- Supports Sustainable Projects: Often used for green infrastructure and climate-related investments.
How It Works
The key stakeholders include borrowers or developers seeking financing, lenders or financial institutions providing loans, guarantors such as governments or financial entities assuming credit risk, and regulatory bodies overseeing guarantee programs [3].
City government may provide credit guarantees to support green infrastructure projects. This can involve guarantees for developers or individuals seeking mortgage loans for constructing green buildings. Moreover, cities can promote policies and initiatives that encourage the use of credit guarantees to stimulate investments in green buildings [3].
Benefits & Challenges for Cities [1]
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
- 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.
Use Cases
Bita Water Project in Luanda, Angola, with a World Bank Guarantee
The World Bank has provided a loan guarantee to the government of Angola for a commercial loan to finance a water supply investment project for the city of Luanda. The Bita water project, executed by Luanda’s water utility, extends potable water services to 2 million people in Luanda, using the proceeds of an IBRD-guaranteed commercial loan to finance investments in water production, transmission, and distribution systems. IBRD provided a partial loan guarantee of US$500 million to commercial lenders, based on which the national government secured US$910 million in sovereign commercial loans for the project. The African Trade Insurance Agency and the French export credit agency BPI France Assurance Export provided complementary financing products to mobilize the overall financing requirement of US$1.1 billion [2].
The IBRD loan guarantee has a duration of fifteen years, a significant extension of the maturity of Angola’s previous commercial loans that sets a precedent for future long-term financing. The loan’s interest rates, which are substantially lower than Angola’s standard borrowing costs, improve the financial viability of the project. The guarantee is designed to alleviate the risk of debt service default by the government by ensuring the payment of both principal and interest. It also incorporates a cash reserve account, established with funds from the loan, to provide initial loss protection [2].
The Bita project represents the first investment in the water sector to leverage a World Bank guarantee and serves as an example of how guarantees can attract private investment into municipal water infrastructure, a sector traditionally less appealing to private financiers than other infrastructure domains [2].
When to Use It
- To mobilize private capital in projects with high upfront costs or risks.
- In emerging markets with political or financial uncertainties.
- For sustainable infrastructure needing long-term, affordable financing.
- When borrowers lack creditworthiness or public budgets are limited.
- To secure better loan conditions (longer terms, lower costs).
- To reduce investor risk in complex or uncertain regulatory environments.
References
[1] https://citiesclimatefinance.org/financial-instruments/instruments/partial_or_full_risk_guarantee
[3] https://ccfla-netzerobuildings.org/database/instrument/full-or-partial-credit-guarantee
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