The logic is that banks are more likely to make loans to perceived “risky” small businesses when they know that the Government (or some government agency) will guarantee repayment even if the borrower defaults. Credit guarantee schemes have become the most popular of government support schemes worldwide since they combine a subsidy element with market-based characteristics.
The arrangements are also intended to make use of the banks’ infrastructure for loan administration. But guaranteed schemes are not perfect and lead to moral hazard since the banks’ funds are not at risk, and since the small businesses can default with little cost. Variations of the scheme have been devised to deal with these issues.