Contingent Liabilities: Issues and Practice; Aliona Cebotari; imf working Paper 08/245; October 1, 2008

Figure 1. Typical Infrastructure PPP Project Risks and Hypothetical Allocatio
n
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Source: OECD, 2008. 
 
C. Strategies to Transfer Risk or Costs Related to Contingent Liabilities 
Risk sharing with the private sector 
Once the government decides to take on risk by issuing contingent debt, it should 
structure these debts in ways that minimize moral hazard behavior of the beneficiary 
and hence the government’s exposure. Banks whose lending is fully insured by the 
government would have few incentives to do due diligence with regard to borrowers’ 
creditworthiness and to reduce credit risk, which would increase costs for the government. 
Similarly, depositors whose deposits are fully insured, will also have little incentive to do due 
diligence with regard to bank performance. 
One of the key instruments for minimizing moral hazard is to leave some risk to be 
borne by the guaranteed party. This is generally achieved by limiting the government 
guarantee to a share of the potential losses or by setting maximum limits on financial claims 
that can be made under the contingent liability instrument. In the case of loan guarantees, for 
example, most guarantee schemes limit the share of the loan guaranteed by the government 
to 70–85 percent (Honohan, 2008). For instance, EU state aid rules prohibit the government 
from guaranteeing more than 80 percent of any loan, in Canada the government limits its 
guarantees to at most 85 percent, while the United States’ Small Business Administration 
also guarantees up to 85 percent of the loans to SMEs. In Chile, where credit guarantees to 
SMEs are provided by auctioning guarantee rights to commercial banks, the auctions have in 
fact resulted in government guaranteeing on average 70–80 percent of the loans (Bennett et 
al., 2005). In the case of deposit insurance, depositors are usually required to bear some risk 
on their deposits, with only very few countries offering full coverage at some point in time 
(Garcia, 2000). In the case of pension insurance, the Pension Benefit Guaranty Corporation 

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in the U.S., which ensures employee pensions in case of default of the private pension fund, 
also stipulates a maximum level of the insured pension.