SME loans covered by government credit guarantee schemes

Much SME lending by finance companies in the region is covered by government-backed guarantee programmes that reimburse a large share of the loss on default, in exchange for a fee. Whether the guarantee is considered integral to the loan decides whether expected recoveries from the guarantor reduce ECL directly or whether the finance company must book the full ECL and recognise any reimbursement separately, under a stricter recognition threshold. The difference can be most of the allowance on a guaranteed book. The scheme's claim conditions, the treatment of fees and the effect of the guarantee on staging all affect reported profit and capital.

Was the guarantee obtained at origination as part of the lending decision, and is it referred to in the loan terms, or was it bought later for a portfolio already on the books? Does the guarantee transfer with the loan if the loan is sold? Who pays the fee: the borrower, passed through by the finance company, or the finance company itself? What percentage of loss is covered, is it calculated on principal only or also on accrued profit, and is it capped per borrower or per portfolio? What conditions must the lender meet to claim (timely notification, enforcement steps, compliance with scheme eligibility rules), and what is the historic rate of rejected claims? Is the guarantor's own credit quality reflected?

1. Determine whether the guarantee is part of the contractual terms of the loan or is otherwise integral to it, for example because it was required by the lending decision at origination and would transfer with the loan; if so, it is not recognised separately and its expected cash flows are included in measuring ECL.
2. If the guarantee is not integral (for example portfolio cover bought after origination that stays with the lender if the loans are sold), measure ECL on the loan without the guarantee and account for the guarantee as a separate right; a reimbursement asset is typically recognised only when recovery is virtually certain, by analogy to IAS 37, unless the contract is itself a derivative measured at FVTPL.
3. Assess SICR and staging on the borrower's own default risk; the guarantee reduces loss given default, not the probability of default, and does not prevent a loan moving to Stage 2 or
4. 4. Reflect claim conditions: if the lender is unlikely to meet a condition, or a claim is expected to be rejected, exclude the cover for that loan.
5. Guarantee fees paid by the finance company for an integral guarantee are a cost of the credit protection; upfront fees directly attributable to originating a specific loan are generally included in the effective interest rate, while periodic fees on the outstanding balance are recognised in profit or loss over the period of cover.
6. Fees collected from borrowers and passed to the guarantor are not revenue of the finance company.
7. Consider whether a below-market fee charged by a government guarantor is government assistance that needs disclosure.

For integral guarantees, ECL is measured using cash flows expected from the borrower, from collateral and from the guarantor, net of the costs of claiming, and adjusted for the probability that the claim is rejected and for the guarantor's own credit risk where relevant. Where the scheme pays a percentage of the outstanding principal or of the loss after recoveries, the model follows the scheme formula. Without discounting, ECL on a defaulted guaranteed loan is the loss before the guarantee less the expected guarantee recovery.

Disclose: (1) the nature of credit guarantee schemes used and the share of the SME book covered; (2) the policy for deciding whether a guarantee is integral and how guarantees are reflected in ECL; (3) the effect of guarantees on the loss allowance, for example ECL with and without guarantee cover; (4) claims lodged, paid and rejected; (5) guarantee fees paid and how they are recognised; (6) government assistance received, if any.

• Keeping a guaranteed loan in Stage 1 because the guarantor is the government
• deducting the guarantee from ECL when it is not integral, or ignoring it when it is
• assuming 100% claim success despite a history of rejected claims for late notification
• applying the guarantee percentage to the whole exposure when the scheme covers principal only
• recognising fees collected from borrowers as fee income
• presenting guaranteed and non-guaranteed exposures together in credit risk disclosures without showing the effect of the cover