Government mulls risk-based premia for sovereign guarantees

The finance ministry may consider charging risk-based
premium or establishing deductibles for cash payouts in the event of a guarantee invocation. This is among the measures the finmin may opt for while streamlining the process of assuming risk in the form of sovereign guarantee.

Risk-based premia would recognise that not all liabilities
assumed may be equally risky, according to a finmin policy paper on sovereign guarantee.

“So, every proposal for guarantee will be assessed independently and the guarantee fee would be fixed, based on the assessment of risk.”

And, the more risky projects would have a guarantee fee greater than the base level, as per the new thinking in the government.

At present, the rate of fee is fixed for government guarantee across various categories. For instance, the rate of fee per annum is 0.25% for borrowing under the market borrowing programme, 0.25% for borrowing under inter-corporate transfers, 1% for public sector borrowing, 2.5% for other domestic borrowings besides public sector and cooperative sector, and 1.2% for external borrowings.

However, the finance ministry has now proposed a change in the fee structure based on risk assessment of projects.

Another change that the finmin is contemplating is that the
government may reduce its exposure by paying for the last, rather than the first loss, “by setting deductibles that must be
satisfied before it makes payment”.

Under the ‘deductible’ arrangement, in case of default of
guarantee, government would pay 70-90% of the amount in default and the balance 10-30% would be paid by the borrowing institution, according to the policy paper that has been  sent to all ministries and government departments.

“The borrowing institution would first have to pay 10- 30% and then approach the government for settling the balance amount.” Therefore, the borrowing institution must identify resources from its own internl resources/assets to meet its obligation.

The paper further states that, before a guarantee proposal
is tendered, the sponsoring ministry/department must thoroughly analyse the project and demonstrate that it cannot be financed without government’s assistance and that cash flows will be
adequate to cover repayment of the debt as well as of interest.

Also, bankers and lenders may be asked to share the risk by bearing a minimum of 10-30% of the net loss associated with any
default.