Comments on: Public Initiative to Support Entrepreneurs: Credit Guarantees versus Co-Funding by Arping, Loranth and Morrison and Are Loan Guarantees Effective? The Case of Mexican Government Banks by Benavides and Huidobro Stijn Claessens Assistant Director, Financial Studies Division Research Department, International Monetary Fund Conference on Partial Credit Guarantees World Bank, March 13/14, 2008

General Comments Topic little explored, theoretical or empirical Topic little explored, theoretical or empirical Nice papers, new theory and data usage Nice papers, new theory and data usage General comments General comments Do papers consider the (unique) role of government? Do papers consider the (unique) role of government? In papers little special about government In papers little special about government Much could be done by private sector, if given a subsidy? Much could be done by private sector, if given a subsidy? What is optimal design of public support in general? What is optimal design of public support in general? Like to know what is optimal, first best design of financial and other instruments given objectives, constraints, etc. Like to know what is optimal, first best design of financial and other instruments given objectives, constraints, etc. How do partial guarantees compare to other instruments? How do partial guarantees compare to other instruments? Papers address some, but not all elements Papers address some, but not all elements

Arpin, Loranth and Morrison paper: Some corporate finance questions Liability structure is a corporate finance question Liability structure is a corporate finance question Because of moral hazard and adverse selection corporations have specific debt-equity structures, short, long-term, banks versus bonds, covenants, etc Because of moral hazard and adverse selection corporations have specific debt-equity structures, short, long-term, banks versus bonds, covenants, etc Also similar to optimal insurance contract design: deductibility, risk-sharing, premiums Also similar to optimal insurance contract design: deductibility, risk-sharing, premiums Also means partial guarantees is one of many tools Also means partial guarantees is one of many tools Optimal financial structure for any firm can include partial guarantees, but also co-financing/-funding, Or for insurance: Optimal financial structure for any firm can include partial guarantees, but also co-financing/-funding, Or for insurance: Parallels suggest rich toolkit from which to draw optimal contracts for (partial) guarantees: extend work if possible Parallels suggest rich toolkit from which to draw optimal contracts for (partial) guarantees: extend work if possible

Arpin, Loranth and Morrison paper: Broaden set of tools Can one fit partial guarantee in overall financing Can one fit partial guarantee in overall financing Does this means a pecking order of tools? Are there tradeoffs? Does this means a pecking order of tools? Are there tradeoffs? Is there an optimal, joint combination? Probably, since that is what we observe in most real corporate finance settings Is there an optimal, joint combination? Probably, since that is what we observe in most real corporate finance settings Somewhat addressed, but can one model/quantify more general? Somewhat addressed, but can one model/quantify more general? Adjust financial structures/guarantees to the issues Adjust financial structures/guarantees to the issues Nature of second-best should affect financial structure Nature of second-best should affect financial structure E.g., sector, size, information, specific risks, inputs E.g., sector, size, information, specific risks, inputs Bring in government versus private sector Bring in government versus private sector Is this a “standard” corporate finance? If not why does the presence of government make it special? Is this a “standard” corporate finance? If not why does the presence of government make it special?

Benavides and Huidobro: Framework Framework not so clear Framework not so clear Why are banks risk-averse? Can one model the source: capital adequacy requirements, managerial, are diversification markets incomplete? Why are banks risk-averse? Can one model the source: capital adequacy requirements, managerial, are diversification markets incomplete? Is this (just) a matter of supply curve moving? If so, are there other ways, e.g., subordinated loan to the bank to lower risk? Is this (just) a matter of supply curve moving? If so, are there other ways, e.g., subordinated loan to the bank to lower risk? Does framework tell about efficacy of guarantee? Does framework tell about efficacy of guarantee? Is this just a subsidy, but no leverage, or more? Is this just a subsidy, but no leverage, or more? Is the subsidy best given to the bank or to the borrower? Is the subsidy best given to the bank or to the borrower? Minor: is break-even per unit or per program? Minor: is break-even per unit or per program?

Benavides and Huidobro: Data and Empirics Many programs in Mexico Many programs in Mexico Why are only government banks in this business? Why are only government banks in this business? Are the programs coordinated in some way? Seems not Are the programs coordinated in some way? Seems not Data good, but with problems, not to be ignored Data good, but with problems, not to be ignored Aggregate analysis is mostly suggestive Aggregate analysis is mostly suggestive Very hard to estimate credit demand functions, especially with aggregate data. Few degrees of freedom, 67 observations. Many other reforms and changes over period Very hard to estimate credit demand functions, especially with aggregate data. Few degrees of freedom, 67 observations. Many other reforms and changes over period There are other, better tests of presence of credit constraints There are other, better tests of presence of credit constraints In any case, bank or firm level analysis better In any case, bank or firm level analysis better Would help provide answers to: targeting, additionality, etc. Would help provide answers to: targeting, additionality, etc. If can not, could still consider overall crowding out of fiscal If can not, could still consider overall crowding out of fiscal

How to model the best approach in general for these problems? Define objective Define objective Economic, social or political (economy)? Economic, social or political (economy)? Static or dynamic? Static or dynamic? Is government unique relative to private sector? Is government unique relative to private sector? If truly public goods in light of market failures (which?) If truly public goods in light of market failures (which?) If better at enforcement, information (?) If better at enforcement, information (?) If better at building institutional environment, dynamically aided through guarantees If better at building institutional environment, dynamically aided through guarantees If not unique, or facing institutional and political economy constraints If not unique, or facing institutional and political economy constraints How can guarantees best be done by private sector/contract? How can guarantees best be done by private sector/contract? Is it (just) a question of how to optimally use a given amount of public funds for a certain objective? Is it (just) a question of how to optimally use a given amount of public funds for a certain objective?

Can one model the best designs? What is then the best design given objectives, government and private sector constraints? What is then the best design given objectives, government and private sector constraints? Auction of guarantees Auction of guarantees Support for financial intermediaries Support for financial intermediaries Subsidy to borrower Subsidy to borrower Co-financing or co-funding Co-financing or co-funding Insurance type products Insurance type products Risk-sharing Risk-sharing Guarantees, partial, full Guarantees, partial, full Etc. etc. Etc. etc.