Collateralized Transactions : Key Considerations for Public Lenders and Borrowers published by IMF and World Bank (2/2020).
“In a response to a request from the G20 IFA Working Group, this note provides a framework for public lenders and borrowers to assess collateralized financing practices from a development perspective. It describes the main dimensions of collateralized debt instruments. Starting from the observation that collateralization may permit market access and transactions that otherwise would not occur, it then discusses the broader pros and cons of such arrangements, as well as technical and macroeconomic considerations that arise in their design. It concludes by describing a decision process for public lenders and borrowers (general government entities, state enterprises, and agencies that act on their behalf) to ensure that collateralized transactions are consistent with the G20’s Operational Guidelines for Sustainable Financing.1
The work of the IMF and World Bank suggests that the availability of collateralized financing can be beneficial to a developing country borrower under a range of circumstances, but also points to pitfalls. Whether or not the benefits of collateralized financing outweigh its drawbacks requires a case-by-case assessment. Inter alia, this will depend on the institutions and legal processes of the borrowing country. In general, from a development perspective:
- Collateralized finance is more likely to lead to beneficial outcomes if: (i) the transaction produces assets or revenue streams that can be used for repayment (as opposed to financing consumption or the general fiscal deficit); (ii) the reduced risk resulting from collateralization is reflected in improved financial terms; (iii) a rigorous debt sustainability assessment is passed; (iv) there is full, public transparency on all contractual terms; and (v) collateralization respects and complies with any applicable Negative Pledge Clauses (NPCs). Transparent non-recourse project finance can generally meet these tests.
- Collateralized financing could be harmful in two key circumstances. Foremost, when a transaction does not produce an asset or revenue stream that can be used for repayment, and the volume of the transaction raises broader financing or debt distress concerns. Second, when the transaction does not involve adequate transparency and disclosure (and would thus impede the ability of future creditors to correctly assess risks and lend sustainably, contributing to future problems).
This note represents a contribution to the IMF and World Bank’s Multi-Pronged Approach (MPA) to address debt vulnerabilities. The MPA includes pillars on transparency, capacity building, analytical tools, and IFI policies for sustainable lending. The discussion of collateralized transactions is meant to encourage greater transparency and provide guidance to both creditors and borrowers (building their capacity to analyze such transactions). It will also inform the policy pillar of the MPA, in particular the reviews of the the IMF’s Debt Limits Policy (DLP) and World Bank’s Sustainable Development Financing Policy (SDFP), and guidance on how to assess and handle collateralized loans and existing lending exposures…”
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