Instead of providing direct financing to its clients, IFC can leverage its triple-A (AAA/Aaa) rating and provide unfunded guarantees to lenders or investors, ie. while the lender or investor provides the funding, IFC absorbs a portion, or all, of the credit risk of the pre-identified borrower under the guaranteed debt.
This can be interesting in cases where a local lender has better access to local currency funding than IFC; or where IFC wishes to partner with a financial institution for operational aspects; or where an IFC guarantee can provide the necessary credit enhancement to lift the rating of an issuance and allow an issuer to access a wider investor base.
Partial/Full Credit Guarantees for Loans
A partial or full credit guarantee for a loan is an irrevocable commitment by IFC to make a payment to the lender of a specified loan after the borrower has defaulted on its payment obligations and the loan has been accelerated. The payment is typically a pre-agreed percentage (or in the case of a full credit guarantee, 100%) of outstanding principal of the guaranteed loan.
IFC’s credit guarantees provide the highest possible comfort to the beneficiary of the guarantee. Subject to local regulations, IFC’s guarantees are often provided with a 0% risk weighting, in line with Basel guidelines.
A partial or full credit guarantee therefore can result in a significant reduction of expected losses to the lender of the guaranteed loan and help the lender increase its credit exposure to the borrower beyond its relevant exposure limit.
Partial and full credit guarantees can be denominated in either hard currency or local currency. Local currency denominated credit guarantees can be offered as a substitute to direct lending by IFC to the borrower. Rather than IFC providing a loan to the client, a local lender (typically a bank) provides the loan and IFC absorbs (a portion of) the credit risk of the borrower. This can be a useful way to provide local currency financing in a situation where a local lender has an advantage in sourcing local currency funding but is limited in its ability to absorb the credit exposure of the borrower.
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Partial Credit Guarantees for Bonds
Partial credit guarantees for corporate bonds are a credit enhancement mechanism for corporate debt securities, representing an irrevocable undertaking by IFC to pay principal and/or interest due to bond holders, up to a pre-determined amount. In certain circumstances, the partial credit guarantee can be structured to cover 100% of debt service payments, for a pre-agreed period of time and up to a maximum cumulative amount (typically expressed as a percentage of outstanding principal). As long as the amounts drawn under the guarantee are repaid within a prespecified period, the guarantee is reinstated. In essence, this feature acts like a liquidity facility for the guaranteed debt instrument that can help to avoid a default during short periods of illiquidity (and hence help to not only reduce the expected loss but also the probability of default of the guaranteed debt).
IFC’s partial credit guarantees can be denominated in either local currency (for local currency issuances) or hard currency (typically for cross-border transactions). The partial credit guarantee allows IFC to use its triple-A (AAA/Aaa) credit rating, to help an issuer enhance the credit worthiness of its bond issuance. Especially for first time issuers and during periods of uncertainty, partial credit guarantees can provide access to debt capital markets and diversify funding sources. They also help issuers establish their name in the market and integrate capital markets into their core financing strategy, potentially paving the way for future issuances without the need for credit enhancement.
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Unfunded Risk Participations
Unfunded risk participation is a financial arrangement where IFC assumes a specified portion of the credit risk associated with a loan or debt facility issued by a financial institution to a single borrower, or to a portfolio of pre-approved debt facilities, without providing upfront funding. In this arrangement IFC, as the risk participant, conducts its own due diligence on the credit quality of each underlying borrower.
Following a default or credit event (and typically the acceleration of the underlying loan), the lender can request payment from IFC that corresponds to the portion of the risk participation.
By entering into an unfunded risk participation with IFC, the lender therefore transfers a portion of its credit exposure to IFC and reduces its credit exposure and capital allocation (subject to local regulations); this allows the lender to offer larger amounts of financing to projects with a higher risk profile.
At the same time, by offering unfunded risk participations, IFC can leverage its triple-A (AAA/Aaa) credit rating to facilitate financing and take exposure to relevant target segments while relying on the resources and expertise of a financial institution for the day-to-day management and funding of the underlying facilities.
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These are some of several World Bank Group guarantee products. For comprehensive information on the suite of all World Bank Group guarantee products, please visit the World Bank Group Guarantee Platform.
