Posted by Lilia Razlog, Tim Irwin, and Chris Marrison[1]
The World Bank has just published two papers on government guarantees that may be of interest to the PFM community. The first sets out a checklist of ideas to consider when reviewing a government’s framework for managing guarantees. The second shows how scenario analysis (stress testing) can help governments quantify the guarantees’ risks.
The checklist starts with steps to establish macroeconomic control of guarantees by setting limits on the issuance of guarantees and restricting the authority to grant them. It goes on to consider six ways of improving decisions about guarantees: developing guidelines on when guarantees should be used; imposing restrictions on their use; considering the conditions attached to guarantees; quantifying their costs; setting fees for guarantees; and establishing a good decision-making process. And it concludes with steps to improve the management of guarantees after they have been issued: monitoring outstanding guarantees; paying when guarantees are called; recording and reporting guarantees; and learning from experience.
These management options are best supported by having quantitative estimates of the potential guarantee payments. The second paper presents the scenario analysis (or stress testing) approach to quantifying the risk of potential payments when guarantees are called. The approach is designed to be streamlined and easily used by a wide range of governments. There are accompanying Excel template models to allow government analysts to immediately use the approach (so long as a minimal amount of financial data is available on the guaranteed entity). The approach is described in three stages of increasing complexity depending on the government’s current need.
The first stage estimates the payment on a guarantee for a single company given individual stress scenarios. This helps the government to understand its potential liability and can be used during the approvals process or, for an existing guarantee, to estimate upcoming payments on behalf of a company that is facing potential distress. The second stage estimates the average payment across multiple scenarios to estimate the expected economic fee. The third stage looks at multiple guarantees together, and it estimates the combined loss in an economic crisis. This combined loss can be used in setting reserve targets or be part of a larger project to measure the macro-economic risks to the fiscus.
This second paper describes the methodology, gives examples, and gives directions on using the accompanying Excel models. These models can be used as-is or by government analysts as the basis for making their own customized models.
[1] Lilia Razlog is Senior Debt Specialist, Macroeconomics, Trade & Investment, World Bank; Tim Irwin is a consultant and former staff member of the IMF’s Fiscal Affairs Department; and Chris Marrison is the CEO of Risk Integrated.
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