Loan Guarantees Schemes in Risk Management

Abstract

Banks and other lending institutions have to find ways of pricing risk if they are to ensure survival and to maximise profits. It is now known, however, that small businesses are more risky than large — such risk being measured by income and capital variability (Cressy and Olofsson, 1997). The differential risk of small and large enterprises, however, presents difficulties for loan pricing by way of the well established credit market phenomena of adverse selection and moral hazard. Both these phenomena occur in the context of what economists call asymmetric information,essentially a market situation where one signatory to the contract knows more about the parameters relevant to the credit decision than the other.