What is a Government Guarantee?
A government guarantee is an assurance to a lender by an agency of the government, or the main governing body itself, that a financial obligation will be honored, even if the borrower is unable to repay the debt. In many instances, a government guarantee allows the borrower to be approved for the loan. In other cases, without the government guarantee, the interest charged on the loan would be much greater. This is because many borrowers who receive government guarantees to support their loan applications are high risk borrowers — borrowers with limited financial resources, high debt loads or a poor repayment history. This is true for individual borrowers as well as corporations and even sovereign states that seek financial support.
When a borrower seeks funds, the lender conducts an assessment of the borrower's financial status that is similar to the underwriting process for a health insurance application. Financially healthy would-be borrowers, with high income streams, low levels of debt and a good record of honoring their debts often enjoy easy loan approvals and favorable interest rates. Less well-off borrowers, such as would-be homeowners with low incomes or poor credit scores, often find it difficult to obtain mortgages. Agencies such as the United States Federal Housing Administration (FHA) provide borrowers in the U.S. with financial government guarantees to provide for the repayment of their loans. The FHA also provides incentives for banks and other lenders that participate in their programs.
A government guarantee often is attached to the financing of infrastructure projects. For example, the U.S. Rural Electrification Administration, the predecessor of the Rural Utilities Service, provided financial support for the massive process of providing electric power to very poor, remote rural areas of the U.S. during the early 20th century. Government guarantees continue to be an important factor in providing financial support for infrastructure projects. In 2005, the U.S. Department of Energy began providing loan guarantees to projects in order to promote the development of clean energy sources.
Government guarantees are utilized worldwide. In 2009, South African power supplier Eskom initiated a bond issue of 150 billion rand (about $20 billion US Dollars) that was covered by a government guarantee to finance a capital infrastructure project. The South African treasury promised 176 billion rand (about $23 billion US Dollars) in guarantees for the bond issue over the following five years.
After the international monetary crisis began in 2007, many sovereign nations sought critical financial assistance and issued government guarantees to secure loans. A prominent example is the government of Iceland, which faced the collapse of its entire economy when its banking system failed in 2008. Iceland received huge monetary loans from Britain and the Netherlands to prevent the collapse of its banking system, with the Iceland government providing a guarantee that the funds would be repaid in order to secure the funding.
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