Valuing and accounting for loan guarantees

To achieve certain policy objectives, governments frequently provide private borrowers with loan guarantees that cover some or all of the risk that the borrower will be unable to repay the loan. Such guarantees are extremely valuable, and their value increases with the riskiness of the underlying asset or credit, the size of the investment, and the duration of the loan. The flip side of a guarantee's value to a lender is its cost to the government. Such a cost is not explicit but is real nevertheless. When providing guarantees, governments therefore must establish accounting, valuation, and risk-sharing mechanisms. This article describes methods of valuing guarantees; reports estimates of the value of guarantees in different settings; and summarizes new methods of accounting designed to anticipate losses, create reserves, and channel funds through transparent accounts to ensure that the costs of guarantees are evident to government decisionmakers.