Commercial lenders require capital to bear risk. The capital enhancement guarantee (CEG) encourages lenders to make loans they would not otherwise make, such as microenterprise loans. The CEG is auctioned and awarded to bidders who promise the greatest amount of new lending for a given increment of permanent capital. Whether the incremental lending causes losses or gains for the lender, the incremental capital is free. The CEG subsidizes innovation in risk management. It places the analytical focus on risk and its cost, supports the key party to the lending decision, promotes skill in managing risk, is transparent, minimizes moral hazard, and has trivial transaction costs. The CEG should be attractive to donor agencies.
J. D. Von Pischke is president of Frontier Finance International, an American affiliate of IPC in Germany. Both firms specialize in the provision of management services for microfinance institutions and other small scale lenders. He was a financial analyst at the World Bank for twenty years, concerned with rural finance, industrial credit, and financial sector policy. He served for ten years on the board of directors of the Bank-Fund Staff Federal Credit Union in Washington, D.C.
Journal of Microfinance
Issue and Volume
BYU ScholarsArchive Citation
"Capital Enhancement Guarantees and Risk Management by Capital-constrained Lenders,"
Journal of Microfinance / ESR Review: Vol. 2
, Article 5.
Available at: http://scholarsarchive.byu.edu/esr/vol2/iss2/5