At this very moment, people around the world go about their daily business. A mother in Accra, Ghana comes home and turns on the lights. A child in Barrancabermeja, Colombia is on her way to school. A farmer in Nam My Commune, Vietnam washes his hands with clean water. They and a lot of others like them have access to public services like electricity, roads, water, and social programs due to prior investments into infrastructure made by subnational entities like municipalities, public-private partnerships (PPPs), or state-owned enterprises (SOEs).
When public entities need financing to undertake infrastructure projects by themselves or through special purpose vehicles (SPVs), a substantial tool they rely on is borrowing. However, the reality is, borrowing options can be limited or can be very expensive for subnational entities, SOEs, or SPVs unless the government provides some credit enhancement instruments such as a sovereign guarantee.
“Sovereign credit guarantees and government on-lending can catalyze private sector investment and fulfill specific policy objectives. However, contingent liabilities stemming from guarantees and assets stemming from on-lending expose governments to risk,” says Fritz Bachmair of the World Bank Treasury wrote in his working paper ‘Contingent Liabilities Risk Management.’ “Prudent risk management can help mitigate these risks. But developing a sound risk analysis and measurement framework requires significant investments in resources, capacity building, and time.”
Regardless of their developmental status or soundness of budget, every country faces the threat of indebtedness due to both explicit and implicit contingent liabilities. Among explicit liabilities are any obligations for which the government is legally bound to pay if the beneficiary entity fails to pay its lender. Guarantees for municipalities, SOEs or private investments, deposit insurance, crop insurance, flood insurance, and war-risk insurance are all explicit liabilities that can eventually become a direct liability on the government balance sheet. There are also implicit liabilities that the government is not legally obligated to cover, but which would cause major societal disruption if unpaid for, such as natural disaster relief or potential finance sector bailouts and defaults.
Most of the time, debt managers are closely involved in the analysis of explicit contingent liabilities due to their familiarity with debt characteristics, but also because they have the technical skills for risk analysis. However, in emerging countries, the institutional memory and knowhow of the debt management office may not be sufficient to build a sound risk analysis and management framework.
Such a framework requires well-defined objectives, analysis of risks, and the design and implementation of a risk management strategy that incorporates monitoring, reporting, and reassessment procedures.
Providing advisory and training services for managing contingent liabilities is an area of expertise of the World Bank Treasury Public Debt Management Advisory team. “We support each country within the program to develop their own unique solution to the contingent liability analysis and management issue,” said Cigdem Aslan, Lead Financial Officer of World Bank Treasury. “Countries like Colombia and South Africa, who already have a good contingent liability management framework in place, request our support in finetuning their methodologies. There are also countries we are assisting in building a robust methodology such as Indonesia, or where we are catalyzing South-to-South dialogue, such as Ghana”.
Through one-to-one missions, knowledge products, webinars, seminars and forums, and peer group dialogues, World Bank Treasury is building human capital among debt and risk management officers across the world. Recently, debt and risk managers from 18 countries participated in the World Bank Treasury’s first workshop on “Assessing and managing risks from contingent liabilities - A focus on government guarantees and lending”. The five-day, intensive workshop increased awareness about the risks governments are exposed to from contingent liabilities and to sensitize risk managers to frameworks and tools in identifying, measuring, and managing these risks with a focus on sovereign credit guarantees and on-lending. Participants had the opportunity to discuss various risk mitigation tools, including the structuring of guarantee agreements, limit setting, reporting and monitoring, as well as provisioning for financial losses. Among the faculty members was Mr. Mkhulu Maseko, Head of Credit Risk Team Asset and Liability Management Division of the South African Government, who shared the South Africa’s contingent liability monitoring system. “Legislative and policy frameworks are cornerstone to ensure efficient management of contingent liabilities,” he said. “It is important to have an institutional framework that ensures a thorough review of all transactions to advice principals accordingly, and the credit risk assessment methodology has to be robust, objective and consider sectoral peculiarities.”
Mr. Maseko is just one of the civil servants who are building sound risk management frameworks for contingent liabilities, so that infrastructure investments can be achieved sustainably with the goal of people having access to public services like electricity, roads, water, and social programs, even if their economy is hit by a shock.