Development Credit Authority
The partial loan guarantees of the United States Agency for International Development (USAID) allow it to use credit to pursue any of the development purposes specified under the Foreign Assistance Act (FAA) of 1961, as amended.[1] The Development Credit Authority (DCA) is the tool that provides USAID Missions the authority to issue loan guarantees to private lenders, particularly for loans of local currency. These guarantees cover up to 50% of the principal in loans to projects that advance USAID’s international development objectives. However, they do not cover lost interest income.
In addition to mobilizing the financing of specific projects, partial guarantees help demonstrate to local banks that loans to underserved sectors can be profitable. This fosters self-sustaining financing, because lenders become willing to lend on a continuous basis without the support of guarantees from USAID or other donors. Partial guarantees are a powerful catalyst for unlocking the resources of private credit markets to spur economic growth while advancing development objectives.
Benefits of using a credit guarantee
Credit assistance is particularly useful in areas such as microenterprise and small enterprise, privatization of public services, infrastructure, efficient and renewable energy, and climate change. Credit projects offer several distinct and very attractive advantages over other forms of assistance:
- They promote private sector investment: Large reserves of untapped private capital are present in the private sector of developing countries. To encourage financial institutions to lend that capital for developmentally beneficial projects, credit guarantees can be used to cover part of the risk on new loans where financing had been unavailable or inaccessible.
- They encourage lending by reducing risk: USAID guarantees up to 50 percent of the net loss on principal for investments covered by a guarantee, sharing the risk with the private-sector partner.
- They enhance banks' lending capacities: Guarantees provide local financial institutions with the security to extend credit and expand into new sectors. In this way, banks can develop their capacity to lend into new and potentially profitable markets while increasing the credit available to developing areas. These guarantees are often coupled with training and professional assistance from USAID to strengthen a financial institution’s long-term involvement in local credit markets, beyond the coverage of a partial guarantee.
- The value of U.S. Government funding is maximized: By using credit from local sources to finance development activities, one dollar from the U.S. Government leverages an average of 28 dollars in loans.
Criticisms of DCAs
- DCAs offer only marginal value in protecting the loan principal: The loan principal can already be guaranteed via credit default swaps. DCAs do not help and offer only marginal value, given that banks are already able to insure their loans.
- DCAs do not cover interest income lost: In a country that has, for example, a 30% interest rate, the interest income would represent almost 50% of the total loan value and is not insured via the DCA. In this case, the DCA covers 50% of the principal, but only 25% of the total loan exposure.
- Banks do not like waiting on U.S. Government bureaucracy to be repaid: Since the asset must be liquidated in order to calculate the repayment, banks must wait for an extended period to collect on the guarantee.
References
2. http://www.usaid.gov/what-we-do/economic-growth-and-trade/development-credit-authority-putting-local-wealth-work (Nov 13 2013)