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Reforming collateral system to unleash credit |
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Even though eastern Europe’s transition to the market economy began 15 years ago, “access to credit is still very much a problem that the private sector must overcome every day,” according to the EBRD General Counsel, Emmanuel Maurice. At a recent international conference on collateral reform and access to credit in the region, Mr Maurice, head of the EBRD’s legal team noted that since its inception in 1991 the EBRD has been involved in resolving problems in these areas. “At the beginning our work in collateral reform was not part of an overall programme of law reform, but part of the solution to a very specific problem: the shortage of available credit.” Representatives of about 40 organisations in 25 different countries gathered at EBRD headquarters in London in early June to discuss collateral law reform and how it is one of the key factors influencing the availability of credit for business growth in a country. The conference was hosted by the EBRD and the World Bank with support from the Canadian International Development Agency and the UK Department for International Development. Access to credit When credit is not available, businesses cannot invest in new opportunities and grow; often credit is also needed as cash flow to cover day-to-day needs until sales yield income for the business. “When considering extending credit, the main question facing any private lender is, ‘How do I get my money back?’ ” commented Heywood Fleisig, Director of Research at the Center for the Economic Analysis of Law based in Washington, DC. “Under what circumstances would a lender believe a borrower will pay? One way for the borrower to prove sincerity is to offer collateral: to place property at risk of being seized if the borrower fails to pay.” By offering collateral, the borrower would give the lender the means by which, should the borrower default, the money can be paid back through the sale of the collateral. “Collateral can increase access to finance, especially for small firms and lead to better terms for loans,” added Mr Fleisig. In emerging markets, when firms apply for loans, “the most common reason that their application is rejected is insufficient collateral.” And yet lack of sufficient collateral is not the reason why many businesses in emerging markets cannot access finance. “Firms do have assets that could, in industrial countries, easily be used as collateral for loans – moveable assets such as the goods they produce or the machinery they use. The problem lies in a mismatch: the property that lenders in emerging markets can accept under their law as collateral is not the same kind of property that borrowers have,” said Mr Fleising. Mehnaz Safavian, World Bank’s economist, described the findings of a 2005 survey by the World Bank, conducted in more than 60 low and middle-income countries, illustrates this mismatch. Companies reported that, of their corporate assets, 44 per cent were in machinery, while just 22 per cent was in land and buildings. Banks, on the other hand, reported that of the assets pledged to them, 73 per cent was in the form of land and buildings. In emerging markets, the legal systems governing the use of collateral are often unreformed and often there are legal prohibitions to the use of moveable assets to secure loans. Moveable assets are simply ‘dead capital’ in these countries. Collateral reform matters “We all agree that collateral is important. What we need to better understand is what is preventing collateral reform from taking place,” commented Erik Berglof, the EBRD Chief Economist. The conference provided some answers to the collateral problems, ranging from the use of collateral by banks to lower the risk of a loan, to the difficulties in reforming the legal system, via the responsibility of international financial institutions and donors to put forward a united and consistent message for reform. Economists and lawyers agree that poorly drafted laws plus badly-designed and ill-managed legal institutions and weak law enforcement are blocking private sector access to finance. Good reforms require the experience of both lawyers and economists. “In order to bridge the gap between economic analysis and legal practice and make collateral reform work,” added Mr John Simpson, EBRD’s Secured Transactions Project Leader, “economists and lawyers must influence each other from the moment the decision to reform the collateral law is taken, to the final step when the law enters into force.” Experience in Slovakia shows how reforming the collateral system had favourable impact on the financial sector. Thanks to pressure from the private sector and international organisations, a new law governing collateral was adopted on January 1, 2003. Then a pledge registry was set up. This is a publicly-available database in which borrowers register the collateral they are pledging against loans; it inhibits debtors from pledging the same asset to different borrowers without the borrowers’ knowledge. “The Slovak registry system is in high demand with entries increasing from about 6,000 in 2003 to 24,000 in 2006. The reform was led by the Slovak Government with guidance from the EBRD and the World Bank,” said Katarina Mathernova, formerly an adviser to the Slovak Deputy Prime Minister, now a Director at the European Commission. Diana Lupulescu, Director of the Romanian Chamber of Commerce and Industry reported on the extremely successful Romanian secured transactions reform, supported by the EBRD and the World Bank. It started operating in 2000. “The EBRD takes seriously collateral reform in its countries of operation,” said Frederique Dahan, Senior Counsel in the EBRD’s Legal Transition Team. “We helped to draft the collateral law in Georgia. It was adopted in June 2005. Now we are working with the Georgian Ministry of Justice to set up the pledge registry and with the Mongolian Ministry of Justice and Home Affairs to draft a concept paper on collateral reform. And hopefully, one day, lack of access to credit will be a story of the past,” said Ms Dahan.
By Marjola Xhunga, EBRD Communications Adviser.
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