Governments often support private credit through guarantee schemes, which compen-sate private lenders in the event of borrower default. A key feature of such schemes isthat they rely on private banks to allocate guarantees among borrowers. Yet the role ofbanks in carrying out this allocation – and thus in shaping the effects of guarantees – isnot well understood. We study this role in an economy where entrepreneurial effort iscrucial for efficiency but it is not contractible, giving rise to a debt overhang problem. Insuch an environment, credit guarantees increase efficiency to the extent that they allowfirms to reduce their repayment obligations. We show that banks follow a pecking or-der when allocating guarantees, prioritizing risky, highly indebted firms, from whom theycan extract more surplus. The competitive equilibrium is constrained inefficient: all elseequal, a social planner would tilt the allocation of guarantees towards more productive,safer firms, and would fully pass through the benefits of guarantees to firms in the formof lower interest rates. We confirm the model’s main predictions on the universe of allcredit guarantees granted in Spain following the outbreak of COVID.