GVEP Loan Guarantees: Lessons learned from Uganda and Best Practices for the future

Transcription

1 GVEP Loan Guarantees: Lessons learned from Uganda and Best Practices for the future April 2013 By Micah Melnyk and Juliet Gibbs GVEP Uganda

2 This is an expanded version of a paper originally presented at the 2 nd Annual Microfinance Workshop, Makerere University Business School, Kampala, Uganda on March 13/14, Introduction Access to finance has been identified as a critical issue for the uptake of improved and renewable energy sources in Uganda and other developing countries. GVEP has been working on implementing loan guarantees to promote access to micro-finance to energy products across East Africa, and has implemented nine loan guarantee agreements with five financial institutions in Uganda across the spectrum of financial institution type. This report explains the approach that GVEP has used to implement these loan guarantees, and highlights the challenges that GVEP has experienced, on both the client (end-users and entrepreneurs seeking loans) and the financial institution sides. This report also outlines some strategies that GVEP has employed to overcome these challenges, allowing the micro-finance sector in Uganda to gain from lessons learned and best practices of lending at a microscale, specifically in relation to energy. 2 Background to GVEP loan guarantees 2.1 Context for GVEP Energy is critical to development, as it plays a key role in meeting basic needs such as food, running water, heat, light and transport. Without energy, important services such as healthcare, education and communication flounder. Unless substantial progress on energy access is made, the UN Millennium Development Goal of eradicating extreme poverty by 2015 will be missed. In this context, GVEP has been working in Africa and the Caribbean to increase access to modern energy and to improve the quality of lives for millions of people. GVEP s approach to increasing access to modern energy has been to facilitate the development of markets and entrepreneurs for energy products, including more energy efficiency cook stoves, solar products, and charcoal briquettes. For the past five years, GVEP has done this through the Developing Energy Enterprises Project (DEEP), a program jointly funded by the European Union (EU) and the Dutch Ministry of Foreign Affairs (DGIS) under the African Caribbean and Pacific (ACP-EU) Energy Facility. DEEP ran from March 2008 to February 2013, and was set up to deliver access to energy for 1.8 million people. At the end of the program, DEEP had supported over 900 micro and small energy enterprises (MSEEs), reaching over four million beneficiaries and creating approximately 3,000 jobs in the region. 1

3 These businesses were involved in the manufacture and/or supply of clean cookstoves, solar PV products and services, clean fuel briquettes and biogas systems. GVEP provided them a package of services that included mentoring, training and support services covering product quality and technical issues, business and sales skills, access to business networks, and access to finance. These entrepreneurs work at the bottom of the pyramid (BoP) in rural and periurban areas, and the products and services they offer have contributed to provide an improved access to clean energy solutions for low-income customers in these communities. 2.2 Development of the loan guarantee DEEP s initial strategy was to link both technology and business mentors to energy entrepreneurs. Mentors provided the support that the entrepreneurs needed to grow their businesses, specifically in terms of business skills and technical knowledge and advice. Early in the project, field reports indicated that a major obstacle to business growth was limited access to financial services; particularly credit for purchase of equipment or working capital, and the entrepreneurs that GVEP worked with faced a number of challenges in accessing credit. Almost half of energy entrepreneurs cited lack of access to capital as a barrier to business growth. First, a majority of the entrepreneurs lacked the confidence to walk into a financial institution and to acquire the information they needed on financial services available. Second, for those that investigated loans, the financial costs of borrowing were high and entrepreneurs feared that a loan potentially threatened the health of their enterprises, a fear worsened by the experiences that defaulters encounter when loan officers try to recover loans in arrears. Third, many entrepreneurs lack a credit history upon which a financial institution can base a loan assessment. Finally, financial institutions always demand collateral to secure the loan which in most cases must be in the form of immovable assets. These kinds of requirements result in many interested borrowers being excluded from borrowing. Since GVEP does not offer financial services or run microcredit programs, the organisation sought instead to develop partnerships to allow for linkage of entrepreneurs to financial service providers. It was in this context that GVEP developed the Loan Guarantee Fund, to provide a guarantee to financial institutions for loans they make for the energy products and to businesses that GVEP is supporting. 2.3 GVEP approach and experience with loan guarantees The approach GVEP adopted to overcome the financial barrier to uptake of renewable and clean energy was the use of loan guarantees for both entrepreneurs and end-users. The GVEP approach is currently a partial guarantee program, where the financial institution and GVEP share the loss in the case of a default; normally this is in the ratio of 50:50. However, one early loan guarantee was a complete guarantee, where 100% of the loss for default was borne by GVEP. Energy lending at the time was very new and the expectation of GVEP was that the level of guarantee would decline as the lender gained confidence. This did not happen. GVEP no longer offers 100% guarantees, as it is preferable that the financial institution bears some risk. This is so the financial institution ensures that a proper credit 2

4 analysis is conducted and that all recovery procedures are enforced in case of default. This is explored further in this report. To implement the guarantee, GVEP has historically placed an agreed amount of money on fixed deposit at a financial institution, which acts as a guarantee against defaults. The interest rate GVEP earns on the fixed deposit has ranged from 0-6% depending on the institution, less than what GVEP would otherwise earn on the deposit. This was done as part of a negotiation to enable the financial institution to reduce the interest rate that is charged on the credit to clients included in the loan guarantee program. The financial institution was able to make loans that are part of the loan guarantee program up to an amount where the projected defaults equaled the amount placed on fixed deposit with that institution, however, all the institutions that GVEP worked with limited total loans to less than the fixed deposit amount. The deposit is restricted and cannot be drawn down by the financial institution until GVEP is satisfied that all efforts have been made to collect the loan from the borrower. Collections are the responsibility of the financial institution; however GVEP may intervene during or at the end of the collection procedures. GVEP clients were then linked to the financial institution through GVEP business mentors and financial linkage staff. Clients are informed of the benefit of maintaining a good repayment record that earns them a good credit history and allows them to have further and larger loans. GVEP also only provides a guarantee for an entrepreneur for two loans, after which the client is expected to be able to demonstrate their repayment history to the financial industry, and the financial institutions can lend to this client through normal means without a guarantee. The target client for the GVEP loan guarantee was initially entrepreneurs that sell energy products and who were supported by GVEP through DEEP, however the loan guarantees have expanded over time and now cover both the supply side (including entrepreneurs, wholesalers and dealers) and demand side (end-users, including institutions) of the energy market. Of the total amount of fixed deposits placed with Ugandan financial institutions for the loan guarantee program, only approximately onethird has been for DEEP entrepreneurs. GVEP has now completed nine separate loan guarantee agreements with five financial institutions in Uganda. Of these specific agreements, five are with the same institution, while the other four institutions have one agreement each. In terms of types of institutions, GVEP has completed loan guarantee agreements with three SACCOS, one Ugandan tier 2 bank, and one micro-finance institution. GVEP has placed a total of approximately two hundred and forty million (240,000,000) Ugandan Shillings (USD 92,440.80) on deposit with the various financial institutions in Uganda to back up the guarantee. So far, only approximately one million and five hundred thousand (1.5 million) shillings (USD ) has been claimed by financial institutions from those deposits due to losses incurred via defaults. 3

5 2.4 Impact of the loan guarantees in Uganda As a result of the loan guarantee, financial institutions have been able to lend to energy entrepreneurs and end-users, helping to transform the market for renewable and improved energy in Uganda. Since the inception of the loan guarantee, over 150 million Ugandan Shillings (USD 57,755.10) has been lent to over 60 individual clients, approximately one-quarter of which received more than one loan, helping to expand businesses, purchase energy products, and bring better and more sustainable energy to people in Uganda. The impact of access to finance and the other GVEP interventions on individual businesses has been significant. For example, entrepreneur Margret Kisakye runs a briquette making business called Sano Briquette Manufacturers from Kimaanya, Uganda. Through GVEP s loan guarantee, she was able to obtain a loan worth 2,500,000 USH (USD 963) which she used to buy a mechanized briquette machine, enabling her to double her production capacity. She opened up two branches in Kyotera and Kibimba and hired the services of two permanent workers to handle sales and marketing. In January 2012, Margret was invited to be part of a widely popular radio talk show Kiliza oba Gaana (Agree or Disagree) on one of Uganda s most prominent vernacular stations, Central Broadcasting Station. Since the broadcast, Margret gained new clients including three schools and has trained 60 people in briquettemaking for a fee of 50,000 USH (USD 19.00) per person. After the show, her challenge was keeping up with demand from the public. In another example, Kennedy Matovu is the co-founder of SunLimit, a solar installation and products business that now has branches in Kachanga, Mbarara and Entebbe, Uganda. Obtaining finance was the toughest obstacle to business growth, and applications for loans in the past were unsuccessful because he did not have suitable surety, such as a land title, as required by banks. Through GVEP s loan guarantee, Kennedy obtained a 10 million USH loan (USD 3,852.00) to expand the business, which he has now fully repaid. These examples are just two of the over 60 individual clients that obtained access to finance through GVEP s loan guarantee in Uganda. Other entrepreneurs were able to access loans, facilitated by GVEP s loan guarantee, in order to purchase machinery, stock, open new locations and otherwise expand their business. 3 Implementation challenges and strategies used Lending in the energy market is new, and is a difficult sector for many financial institutions. The clients are challenging to lend to the products are not well understood by financial institutions and easily movable. GVEP developed loan guarantees in the energy market as a way of facilitating learning and enabling market transformation; indeed, many lessons have been learned. In the implementation of the loan guarantees, GVEP has faced a number of challenges and has had to modify the loan guarantee offering and devise strategies to overcome these challenges. Broadly, these challenges can be divided into challenges on the client side (both suppliers of products and end-users) and the financial institutions side. 4

6 3.1 Challenges on client side: suppliers Challenges with suppliers of the energy products, specifically energy entrepreneurs that may retail several types of products and dealers of a particular product, have consisted largely with the lack of collateral and the risk of repossession, high interest rates, and a mis-perception of the loan guarantee as a subsidy or a grant Supplier Client Challenge #1: Lack of collateral Challenge: A majority of energy entrepreneurs lack the collateral that is required by financial institutions for a loan to be processed. The financial institutions that GVEP worked with are used to having collateral in the form of immovable assets or consumer goods: assets that are easy to value and relatively easy to repossess and sell to recover the loan amount. However, a majority of energy entrepreneurs either do not own or own limited quantities of such assets, and many lack a permanent residence which complicates the loan appraisal process in an urban setting. For those that do have some collateral, entrepreneurs are often risk-adverse about taking on a loan. In particular, entrepreneurs feared that a loan could potentially threatened the health of their entire enterprises, particularly as the recovery of a loan in arrears could leave the entrepreneur with less assets than before they took the loan. Thus a loan to expand an enterprise could leave a smaller business if the expansion efforts were unsuccessful and unable to repay the loan. Strategy adopted: Although the GVEP partnership and loan guarantees with financial institutions has enabled more flexible terms to the entrepreneurs, the requirement for collateral is an important part of the financial institution conducting proper due diligence and ensuring security for the loan. As such, GVEP did not seek to eliminate the collateral requirements. However, some financial institutions were willing to make their approaches flexible through the partnership to tailor products to suit the abilities and circumstances of the entrepreneurs. For instance one financial institution was able to consider some of the clients to fit the group lending model. In this case, group members were not required to put up individual collateral, and instead group members are required to guarantee each other; in effect, social collateral replaced physical collateral. This was done with entrepreneurs that operate in related energy businesses and within the same location. For this to be possible however, the financial institution needed to revise their group lending policies, for example, lowering the minimum group size number. The groups had to also allow for other clients with in the community to join but with separate tracking, so that the other clients are not guaranteed by the GVEP loan guarantee fund and do not necessarily need to be energy entrepreneurs, but are still eligible to participate in the group lending model. Finally, GVEP also mentored entrepreneurs to take on loans for manageable amounts, where they would have greater confidence of repaying. Not only did 5

7 this lower the risk of default for the entrepreneur that took out the loan, but also helped to avoid a case where a default causes a severe impact, serving as a 'cautionary tale' and thus heightening risk-aversion for other entrepreneurs. Recommendations: As GVEP carries partial risk for the default of the loan and also prefers to be repaid, and as the collateral requirement is an important part of the financial institution due diligence and loan security procedure, it is recommended that this collateral requirement not be waived, but instead be made more flexible. GVEP has found success with the group lending model for enterprises of a similar type and size. In the future, it is recommended that financial institutions be willing to take the energy products themselves as collateral. For example, a loan to build a stock of solar lanterns could be secured, at least in part, by the stock of lanterns themselves, rather than other assets. This could be possible as financial institutions begin to increase their understanding of energy products, particularly their value and ability to be sold into an increasingly active market Supplier Client Challenge #2: High interest rates Challenge: One of the major challenges entrepreneurs and dealers faced was with the high interest rates that loans were available at in Uganda. Financial institutions determine their financial charges on the loans based on their costs, including the costs of obtaining finance themselves. In Uganda, the inflation levels through 2011 and 2012 had a significant impact on rates set by the Bank of Uganda and consequently lending institutions. Ranging from 27 31%, entrepreneurs found the cost of borrowing to constrain the growth of their businesses. The cost of lending in many cases could consume the entire profits made by the client. As a result, energy entrepreneurs, just like other business people, were not able to borrow for business growth, constraining the uptake of loans. Strategy adopted: Recognizing the constraint that the interest rate placed on entrepreneurs taking loans, GVEP sought to bargain for a reduced interest rate for clients that were part of the loan guarantee. GVEP did so by negotiating with the FIs to reduce or completely trade off the interest that GVEP would otherwise have earned on the fixed deposit placed with the bank for the loan guarantee in favour of lower interest rates on loans of the entrepreneurs. Recommendations: GVEP has found success with reducing the interest rate on the loans to clients, as it allows for a higher uptake by clients given the more favorable interest rate. The lower interest rate is also a benefit that GVEP can point to for why a client would go through GVEP to obtain a loan, rather than highlighting the benefit of the guarantee (see further discussion in next challenge). Where a significant barrier to taking a loan is the cost of finance, then lowering the interest rate using a similar approach would be recommended, however, as interest rates decline and other factors become more critical barriers, then concentration would be appropriately applied to those barriers. 6

8 3.1.3 Supplier Client Challenge #3: Misperception of guarantee for grants / subsidy Challenge: The concept of loan guarantees was a new concept in Ugandan microfinance and in particular for entrepreneurs. Entrepreneurs interpreted the role GVEP was playing in linking them to micro financing as one of a subsidy or a grant. This was compounded by mistaken communication by the volunteer business mentors that GVEP had engaged to support businesses at the grass roots; these mentors mis-communicated the guarantee as a grant or a subsidy and as a result some clients chose to not complete repayment on credit deliberately. Others even failed to cooperate with financial institutions regarding pledging collateral as required on assumption that the guarantee is their free money only channeled through financial institutions. Strategy adopted: GVEP took the strategy to sensitize clients on the need to repay the loan and then conceal the GVEP guarantor role. This misperception was addressed through combined visits of GVEP and financial institution staff to clarify the partnership and communicate that repayment was required. Emphasis was made on the benefits of the partnership that the clients should take advantage of, including the lower interest rates compared to the market rate. Clients were also sensitized to the importance of building a clean credit history with the financial institution as beneficial to them even after closure of the project. Further, GVEP and the financial institutions agreed that the loan guarantee should not be revealed to the beneficiaries. Clients were led into appreciating the advantage of being linked to financial services through introduction to financial institutions that they would otherwise never visit and the ability to receive a lower interest rate. Recommendations: Communicating a loan guarantee to potential clients remains a difficult task, and that even if the communication is successful there would remain the perception that the financial institution could get a portion of the loan back 'for free'. As such, it is recommended that the loan guarantee be a private arrangement between the provider of the guarantee and the financial institution, and that the guarantee portion of the partnership not be revealed to clients Supplier Client Challenge #4: Diversion of the loan Challenge: Some clients would sometimes apply for a loan in order to purchase stock or otherwise expand their business, but would instead use a portion of that loan for the purchase of other goods that were neither for their energy enterprises nor identified in the loan application. In this way, the suppliers would divert the resources away from an activity that could enable them to repay the loan (expanded energy business and stock that they would sell), and instead to a consumptive or non-energy activity. Strategy adopted: To avoid diversion, the payment process was modified. Instead of the financial institution giving the loan amount to the client and then the client giving the loan amount to the 7

9 wholesale vendor of the product, the financial institution would give the money to the wholesale vendor of the product directly, who would then release the product to the client. The client would then repay the financial institution. In this way, the same exchange occurs (client borrows money to purchase stock of a product) but the money does not flow through the hands of the client. This was adopted for one specific loan guarantee program that GVEP engaged in to guarantee loans to dealers of a particular solar product to purchase stock. An agreement was signed between GVEP, the financial institution, and the wholesaler of the stock. As the wholesaler of the stock was the same for all potential clients, it was easier to implement otherwise, multiple agreements would need to be made with multiple wholesalers. However, uptake by the clients (the dealers of the solar products) was low as dealers preferred to receive the cash and were reticent to take a loan where they received product instead and, in addition, dealers felt it was difficult to sell the solar products as end-users lacked finance as well. As a result, GVEP modified this loan guarantee agreement to include the potential for end-users as well; the uptake of end-user loans and the impact that end-user loans have on the uptake on dealer loans is yet to be seen. Recommendations: A procedure where the client (who is taking on the loan) does not receive cash and instead received the intended product will help avoid diversion of the resources. However, this is advisable only where the risk of diversion is high and where there will be a large number of products from a single wholesale supplier due to the administrative hurdle of agreeing to a specific loan guarantee agreement for such an arrangement. However, it is clear that there is a desire from potential clients to borrow money to purchase other goods, beyond expanded stock for a business, including energy products for their own use. While a financial institution may believe they are lending for specific purposes, they are in many cases lending for something else. Instead of having clients divert the resources the financial institutions should examine the possibility of allowing lending for these other purposes for which clients have a desire, so that clients do not need to deceive on the purpose of part of their loan. 3.2 Challenges on client side: end-users GVEP has used the loan guarantee fund to enable the purchase of energy products by two types of endusers: institutions and domestic consumers. On the institutional side, GVEP engaged in a partnership with a solar distributor company to structure a loan guarantee to enable schools to get financing for solar installations. On the consumer side, GVEP engaged with financial institutions to give loans for small solar products as a top up to a loan that is primarily for another purpose. Challenges with end-users of the energy products have consisted largely of administration difficulties, either with the decision making of the institutional end-users or with managing small loans by the financial institutions. 8

10 3.2.1 End-user Client Challenge #1: Bureaucracy in institutional (school) decision making Challenge: While the guarantee for purchasing solar installations was well-received by the schools, the major challenge lay with the bureaucracy in decision making for schools. The schools needed to make adecision on the solar system and on financial matters such as agreeing to a loan and possibly opening a new bank account, as very often the financial institution where the school operates an account was different from the financial institutions working in partnership with GVEP. Such decisions cannot be made until the school board has sat and agreed, which may only occur once a term. As a result, decision making for institution may be delayed or be caught up with internal issues. Strategy adopted: GVEP has taken the strategy to target privately owned schools, as they are often sole proprietors who do not rely on a board to make decisions and decision making is quicker. The financial institution that GVEP is working with for solar installations on schools has also indicated that one of the criteria for selection of schools for loans is that the school must be private. GVEP also adopted a strategy to identify the financial institutions that most schools bank with, so that partnerships could be sought with these banks in advance to remove one barrier to uptake. Recommendations: GVEP has discovered that many schools bank with a particular subset of financial institutions in Uganda, namely Centenary bank, Stanbic bank and to some extent Equity bank. As such, if a loan guarantee is to target lending to the school sector, it would recommended to seek partnerships with these financial institutions; indeed, for any sector it will reduce administrative overhead and bureaucracy if partnerships can be set up with the institution that sector predominately banks with, as the added bureaucracy of opening an additional bank account can cause an added barrier to uptake. Further, a greater understanding of the decision-making schedule or cycles of the institutions is needed, so that an approach about installing equipment in this case solar installations on schools can be timed properly. A proposal just after a board meeting, for example, will have to wait some time before the next meeting, and the information may not be top of mind in advance of the next meeting where such an installation can be approved End-user Client Challenge #2: Required consumer finance for some energy products is small Challenge: Some end-users require finance to purchase an improved energy product, even if the product is low-priced (e.g. 50,000 Uganda Shillings/ USD ). However, for a financial institution to make a specific loan at this amount would be administratively costly and burdensome. As a result, these energy products are too small to be eligible for finance, but finance remains a barrier to their uptake. Strategy adopted: GVEP worked with one financial institution to develop an end user financing model. The arrangement is to extend credit in the form of a top-up loan to the financial institutions existing 9

11 borrowers through their group lending methodology. This arrangement is just beginning, but should be practical for the clients to take on small loans for the solar products and repay alongside their other business loans, and should be practical for the financial institution as this approach allowed for easy loan appraisal, monitoring and collections as it is alongside a larger loan. As well, the financial institution will be able to facilitate product promotion as they can increase the loan amounts, and this should aid entrepreneurs who continue to hold stock as potential buyers have been unable to purchase the products. Recommendations: As end-user finance remains a barrier to uptake of improved energy products but is difficult to implement, it is crucial that financial institutions develop such products that target end-user financing. It is recommended that customers that are able to take on larger loans for another purpose, for example a business, be able to explicitly include a loan for a consumer product such as an energy product in or alongside their loan. This would have the benefit of the client not needing to increase their loan amount request with the intention of diverting some of the resources of their loan to these purposes anyway, and enable the financial institution the ability to promote the product to those that may not be aware of it or its benefits. 3.3 Challenges on Financial Institutions side GVEP worked in partnership with three SACCOs, one MFI and one Ugandan tier 2 banks to implement the loan guarantees. In doing so, GVEP encountered several challenges, some as a result of low understanding of loan guarantees and some as a result of actions by the financial institutions Financial Institution Challenge #1: Mis-understanding of the loan guarantee Challenge: The concept of loan guarantees remains new to a majority of the staff at financial institutions in Uganda. In all of the institutions that GVEP engaged with the loan guarantee arrangements were better understood by the senior management than the branch staff. For some unregulated institutions such as SACCOs, the challenge was even greater as the skill level of many of the staff was less than in the MFI or bank. Despite the low capacity, GVEP felt that SACCOs would be good partners given their reach among the rural entrepreneurs that GVEP was working with, and the objective of the loan guarantee fund of facilitating financial institutions to learn to lend to this sector. As a result of low or mis-understanding, some of the staff had mis-perceptions of the loan guarantee and how it works. There were some cases of mistaking the loan guarantees for a loan subsidy or as loan capital. In this way the financial institution felt it could disburse loans only equivalent to the guarantee and then stop further appraisals claiming the fund is used up, while instead the fund was intended to match up with the defaults rather than total loan amount. Further still, in case of default, financial institution staff assumed that the default was to the GVEP fund rather than their own institutions capital as well, resulting in lax recovery operations. 10

12 Strategy adopted: GVEP engaged in educating the financial institution staff to enable them to gain a clear understanding on the working of loan guarantees. This was done on a case-by-case basis with specific financial institution staffs that were involved in implementing the GVEP loan guarantee, as part of increasing the capacity of the financial institutions. GVEP is also expanding relationships with regulated financial institutions that have a focus and reach to the small, rural entrepreneurs that GVEP supports, and reducing relationships with unregulated SACCOs. Recommendations: First, care should be taken to ensure to select the right partner financial institutions. This will require balancing between the capacity of the financial institution (including the capacity of the staff), and the reach of the financial institution with the type of clients that are targeted. A commercial bank would have high capacity staff but be a poor partner to reach small entrepreneurs. Second, it cannot be expected that financial institutions and their staff will be able to understand the loan guarantee immediately, and thus an element of any loan guarantee program should be enhancing capacity of the financial institution. It would be recommended that for any future or similar partnerships, trainings should include a session on the concept of loan guarantees Financial Institution Challenge #2: Low-use of the amount placed on fixed-deposit for the guarantee Challenge: Some of the financial institutions viewed the fixed deposit as free money, and were more interested in the guarantee being placed on their balance sheet as low or no-cost capital and benefiting from it in other various ways than making loans. Those that did make loans only made loans up to a value equal to or less than the amount of the fixed deposit, while the intention of the loan guarantee was that the fixed deposit was to match projected defaults; the outstanding loan amounts could and should have been larger than the fixed deposit amount. This was in part due to a mis-conception of loan guarantees. This can be seen clearly in the end result: approximately 240 million Ugandan Shillings (USD 92,440.80) were placed on deposit, but only approximately 1.5 million Ugandan Shillings (USD ) have been claimed by financial institutions for defaults. Clearly either the loan amounts could be more, or the deposit amount needed could have been much less. Further, some financial institutions also failed to agree on the targets for financing the GVEP entrepreneurs, making it challenging to appraise the financial institution s progress in implementing the loan guarantee agreement. In addition, in several financial institutions there was a lack of incentive to motivate loan officers into the new sector, a major limiting factor to loan promotion and approval, in part possible due to a lack of desire to see loans made against a loan guarantee that was viewed as free money. This was compounded by a lack of highly credit-worthy clients for the financial institutions to lend to. GVEP was to recommend potential clients to the lender, but since the focus of GVEP staff was with business development, and the target population micro-businesses, some of the clients presented by GVEP were weak candidates for a loan in the eyes of the lender. In addition, one financial institution expressed concerns about GVEP staff having a vested interest in some of the loans being issued. This was investigated and dealt with but undermined the relationship with the financial institution. 11

13 Strategy adopted: To address the low-usage and the mis-perception of the purpose of the fixed deposit, GVEP changed its negotiations with financial institutions. In discussions with the last institution that GVEP agreed to a loan guarantee with, the fixed deposit was explicitly explained to only be an amount equal to expected defaults, so the institution could make loans that had total value greater than the fixed deposit amount. To address the incentive of staff to make loans, GVEP actively engaged one of the financial institutions in discussions to include an incentive structure for all financial institution staff engaged in the recruitment and/or processing of loans for energy products. GVEP has also enhanced internal controls over the recommendations of potential clients to the financial institutions. Where initially a business development staff would recommend the clients to the financial institutions directly, GVEP has added steps to the loan recommendation process: a loan guaranteespecific staff person that has a background in micro-finance reviews the applications, and key performance data that is used to assess the financial capacity of the client to repay is checked with GVEP monitoring and evaluation. Recommendations: In order to avoid the low use of the loan guarantee in comparison to the amount deposited to ensure the guarantee, the communication of the purpose of the fixed deposit must be made clear. Any fixed deposit amount should be considerably less than the expected total loan amounts outstanding, and should instead be equal to the projected defaults. To overcome the possibility of a large amount being deposited but not lent against, the fixed deposit could be issued in tranches as the total loan amounts outstanding increases. An alternative solution would be to have no fixed deposit, and instead the guarantee would be the promise of the guarantor to the financial institution to pay for their portion of losses when they occur. To ensure that there is motivation for the staff of an institution, it is recommended that there be an explicit incentive structure for staff that are assigned with facilitating lending in this sector. However, incentives will not work if there are no clients to lend to. Thus, the guarantor must also ensure that the needs of the credit provider are well understood and that there is a pipeline of opportunities to lend to quality clients that will provide a sufficient quantity of business. Finally, it is important to have proper internal controls on the guarantor. It is recommended that there be a separation of the functions of business development staff working with a client (e.g. an entrepreneur) to make a proposal for a loan, and the function of approving the loan application to be forwarded to a financial institution as part of the guarantee. This approach allows for proper checks and ensures that the recommendation for a loan does not rest with one person. 12

14 3.3.3 Financial Institution Challenge #3: Lack of proper due-diligence and recovery knowledge. Challenge: Four out of the five financial institutions did not make proper, independent loan appraisals on the clients prior to loan disbursement, and instead used GVEP s recommendation that a client be considered for a loan as a recommendation for approval. While GVEP staff review loan applications for suitability and ability to pay, this is to serve only as an initial check as GVEP staff expertise lies more with business development, rather than micro-credit. The financial institutions were to go through their own due-diligence assessment of the client, which should be more thorough and in-depth than GVEP s initial review, but these financial institutions did not complete this required assessment. As a result, loan requests did not receive full due-diligence checks, and in addition, the financial institutions made poor recovery efforts. This was particularly an issue with the SACCOs that GVEP partnered with for the loan guarantee. SACCOs are not regulated institutions in Uganda and possess limited knowledge on portfolio quality and the repercussions of default, despite that many SACCOs suffer challenges with their capitalization and most of the loan capital is member savings. Lack of proper loan appraisals was also an issue where GVEP had granted a 100% guarantee, however, with this institution the reluctance to engage in recovery likely hadmore to dowith the assurance of recovery from the guarantee. Strategy adopted: GVEP communicated to these financial institutions to place emphasis on the required role of the financial institutions. GVEP would also insist on receiving evidence of proper due diligence and recovery efforts prior to the authorization to draw on the guarantee to cover a specific default. GVEP also adopted a strategy of sharing risk with the financial institutions, instead of taking on the complete risk; therefore, GVEP no longer accepts 100% guarantees and instead does partial guarantees. Recommendations: It is recommended that a guarantor only give a partial guarantee to the financial institution, to ensure that the financial institution shares the risk and motivation for proper duediligence and recovery. However, even if the financial institution shares risk, it does not ensure that either appraisal or recovery will be done properly. As a result, it is recommended that a guarantor work with more sophisticated financial institutions that have internal controls for due-diligence, or if working with less sophisticated institutions that the respective roles of the guarantor and the financial institution are explicit and clear. In all cases, what evidence will need to be presented loan appraisals upfront, recovery efforts done before pay out on the guarantee needs to be explicit Financial Institutions Challenge #4: Loans to ghosts Challenge: One financial institution (a SACCO) falsified the portfolio reporting to GVEP, indicating that they had given loans to particular individuals that had not actually received them. GVEP had recommended a set of entrepreneurs to the SACCO to receive loans. While the SACCO reported to GVEP that they had given loans under the guarantee program, a majority of the GVEP entrepreneurs did not actually receive the loans. On the reporting to GVEP, the SACCO slightly modified the names of the 13

15 entrepreneurs, so that the loans were either to ghosts or other members of the SACCO that GVEP had no contact with. Strategy adopted: GVEP investigated the reporting and verified that several of the entrepreneurs that had been reported as receiving loans had not actually done so. The SACCO was instructed to clean up the list to represent loans actually issued, to which the SACCO excluded some loans to non-gvep clients but also included some loans to GVEP entrepreneurs that had not been issued. Through field visits and meetings with the SACCO to determine those actually issued and that could be included in the guarantee, GVEP actively reduced the list of loans from 24 loans with a total value of approximately 41 million Ugandan Shillings (USD 15, ) to 9 loans with a total value of 13.5 million Ugandan Shillings (5,007.20). Whether the other loans were actually issued to other members of the SACCO or to ghosts cannot be determined. Recommendations: First, it is recommended that guarantors undertake a thorough due diligence on potential financial institution partners, to ensure that the institution has proper internal financial controls and reporting structures. However, due diligence is a snap shot in time and continued monitoring of the reporting and financial controls of the institutions should be able to capture any changes or issues not identified in the due diligence. Second, the financial institution could be required to provide contact information for the borrowers. This would enable close monitoring of the loans that have been issued and are to be included in the loan guarantee, so that the guarantor can engage in spot checks or verifications based on their view of risk of accuracy in the portfolio reporting Financial Institution Challenge #5: Low flexibility Challenge: Some financial institutions were inflexible in implementing the loan guarantees. First, they were inflexible on the collateral requirements. As discussed in the client challenges section, energy entrepreneurs still suffer with the inability to pledge required collateral to enable them to borrow money. Microfinance employs methodologies such as the group lending model where group members guarantee one another to address such limitations. It was however difficult for some financial providers to open up such an opportunity to the GVEP guaranteed clients despite that the institution had such a model in place. Second, some financial institutions were not flexible to allow sharing in part of the risk there by demanding that GVEP guarantee covers all the 100% default risk. GVEP agreed to this requirement in one loan guarantee agreement in the expectation that the level of guarantee would decline over time as the lender became more confident. For various reasons this did not happen. Strategy adopted: GVEP adopted the strategy working with a financial institution that was able to meet the flexible requirements that energy entrepreneurs required. As a result, GVEP was able to develop a new partnership with a financial institution that was ready to embrace the partnership and was more flexible; this partnership has resulted in multiple loan guarantee agreements of different forms for different target clients. GVEP has stopped engaging in partnerships where the financial institution 14

16 required a 100% risk guarantee, and insisted on risk sharing; all other agreements that GVEP signed have included partial guarantees and risk sharing. Recommendations: It is recommended that guarantors forge partnerships with more flexible financial institutions, as these institutions are more willing to tailor programs to the benefit of the guaranteed clients. However, care must be taken to ensure that flexibility does not compromise the minimum requirements for appraising a loan and other relevant guidelines. It is also recommended that loan guarantees engage in a level of risk sharing, which in part demonstrates the commitment of the financial institution to ensuring success in the partnership. 4 Conclusions and summary of recommendations While GVEP has encountered a number of challenges in implementing loan guarantees, the loan guarantee fund has been effective at mobilizing lending to the energy sector in Uganda. The cost of providing the guarantees to the various financial institutions has been two-fold: a relatively small cost of approximately 1.5 million Ugandan Shillings (USD ) to cover defaults, and the considerably larger cost of the staff time, travel, training and other resources required to implement the agreements and overcome the challenges. However, there are lessons learned. This report outlined the strategies that GVEP undertook to overcome the specific challenges identified, as well as recommendations for future implementation. If an organization was considering implementing a loan guarantee program, based on the experience of GVEP in Uganda, the following would be recommended: 4.1 Recommendations for guarantors Engage in risk sharing: implement partial loan guarantees, so that the financial institution has an incentive to ensure due-diligence and recovery. Give deposit in tranches, or not at all: if there is a fixed deposit against defaults, it should be issued in tranches to the financial institution as the total loan amounts outstanding increases, or, alternately have no fixed deposit and instead just pay for defaults when they occur. Seek flexible partners, but responsible partners: financial institutions can be flexible in their implementation of policies, but must be firm in their loan approval and appraisal procedures and have proper internal and external controls. Complete due-diligence on the financial institution before partnering, and as a check the financial institution could be required to provide contact information for the borrowers. 15

17 Keep the loan guarantee confidential: the loan guarantee should have well laid out disclosure clauses that enable the guarantee to be confidential between the guarantor and the financial institution, and not communicated to the clients. Partner with relevant institutions: seek out those financial institutions that are most relevant or used by the client sector, as the added bureaucracy of opening an additional bank account can cause an added barrier to uptake. Clear communication and reporting: communication should be clear on the roles of the guarantor and the financial institution for loan appraisal and recovery, and reporting of loan portfolios, delinquencies, defaults and other important information should be proper and timely. Clear training: Ensure that everyone that is involved is trained and knowledgeable about what the loan guarantee is, and what it isn t. For energy, train on the types of businesses and opportunities that financial institutions can lend to. Internal controls: Ensure that there are proper internal controls for recommending potential clients to financial institutions, including separating functions for application preparation and approval of forwarding the application to the financial institution. Develop a pipeline of lending opportunities: The financial institution must have sufficient opportunities to lend in order to view this sector as a good business opportunity and to adequately use the loan guarantee. Creating a loan guarantee is not enough: the guarantor must also work to develop a pipeline of credit-worthy potential clients. 4.2 Recommendations for financial institutions Be flexible: micro energy entrepreneurs may require a flexible approach that still complies with the principles of good lending. Specifically, lenders should consider alternate collateral requirements such as accepting the energy products themselves as collateral. Enable loans for consumers: enabling explicit top up of loans for other purposes, including purchasing energy products for domestic use, would help avoid diversion of the loan resources to these other purposes and enable promotion of energy products, potentially increasing total loan amounts. Motivate staff: there should be an explicit incentive structure for staff that are assigned with facilitating lending in the energy sector. 16