Getting Credit
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Getting credit Doing Business measures 2 types of institu- of collateral and the ability to enforce claims allowed? Do secured creditors have prior- tions and systems that can facilitate access in the event of default. ity rights to the collateral in a bankruptcy to finance and improve its allocation: credit procedure? The 2 types of institutions are measured by information registries or bureaus and the le- 2 sets of indicators. The first set of indicators The second set of indicators looks at the gal rights of borrowers and lenders in secured analyzes the legal framework for secured coverage, scope and quality of credit infor- transactions and bankruptcy laws (figure 1). transactions by looking at how well collateral mation available through public credit regis- These institutions and systems work best and bankruptcy laws facilitate lending. For tries and private credit bureaus. For example, together. Information sharing helps credi- example, does the law allow companies to do retailers or utility companies as well as tors assess the creditworthiness of clients use future crops as collateral? Does the col- financial institutions share credit information (though it is not the only risk assessment lateral need to be described in detail in the with public or private registries? Are data tool), while legal rights can facilitate the use loan agreement, or is a general description on both firms and individuals distributed in credit reports? FIGURE 1 Do lenders have credit information on entrepreneurs seeking credit? Is the law Rankings on the ease of getting credit are favorable to borrowers and lenders using movable assets as collateral? based on the sum of the strength of legal rights index and the depth of credit informa- Credit inform ation tion index (table 1). Potential Can movable assets be borrower used as collateral? LEGAL RIGHTS Movable Collateral Credit registries and In recent years access to finance has been Lender asset registry credit bureaus considered one of the main obstacles to What types can be Can lenders access business in Africa, particularly for small and used as collateral? credit information medium-size enterprises.1 The Organization on borrowers? for the Harmonization of Business Law in Africa (OHADA) is doing something about it. After 3 years of debate and consultation with TABLE 1 Where are legal rights and credit information systems strong—and where not? numerous agencies—including Juriscope, Strongest RANK Weakest RANK the World Bank Group, the Fondation Malaysiaa 1 Congo, Dem. Rep. 174 pour le Droit Continental and the United United Kingdoma 2 Iraq 175 Nations Commission on International Trade South Africaa 3 Syrian Arab Republic 176 Law—the organization’s council of ministers Hong Kong SAR, Chinab 4 Tajikistan 177 adopted amendments to the Uniform Act New Zealandb 5 Djibouti 178 on Secured Transactions in December 2010. United Statesb 6 Eritrea 179 Among the objectives are to make the legal Latviab 7 Madagascar 180 framework in the 16 member states more Australiac 8 São Tomé and Príncipe 181 conducive to lending activities.2 Bulgariac 9 Venezuela, RB 182 Singaporec 10 Palau 183 The amended act allows for the creation of Note: Rankings on the ease of getting credit are based on the sum of the strength of legal rights index and the depth of credit both possessory security interests (where information index. See the data notes for details. a. Malaysia, the United Kingdom and South Africa are tied in the rankings. the creditor has possession of the collateral) b. Hong Kong SAR, China; New Zealand; the United States; and Latvia are tied in the rankings and nonpossessory security interests (where c. Australia, Bulgaria, and Singapore are tied in the rankings. the debtor has possession) in all types of Source: Doing Business database. movable property (such as equipment, DOING BUSINESS 2012 GETTING CREDIT 2 machinery and receivables) while harmoniz- TABLE 2 Who has the strongest legal rights for borrowers and lenders—and who has the weakest? ing the legal framework in which they oper- Strength of legal rights index (0–10) ate. That means greater legal protection for Strongest Weakest lenders in case of nonpayment. It also means Hong Kong SAR, China 10 Cape Verde 2 that borrowers can use a broader range of Kenya 10 Eritrea 2 assets as collateral, allowing them to obtain Kyrgyz Republic 10 São Tomé and Príncipe 2 loans on better terms. With uniform imple- Latvia 10 Timor-Leste 2 mentation across all member states in the Malaysia 10 Bolivia 1 coming years, the changes could have a real Montenegro 10 Djibouti 1 impact on access to finance for businesses in New Zealand 10 Palau 1 those 16 African countries. Singapore 10 Syrian Arab Republic1 South Africa 10 Timor-Leste 1 WHY DO SECURED TRANSACTIONS United Kingdom 10 West Bank and Gaza 1 REGULATIONS MATTER? Note: The rankings reflected in the table on legal rights for borrowers and lenders consider solely the law. Problems may occur in the Movable assets, not land or buildings, often implementation of legal provisions and are not reflected in the scoring. See the data notes for details. Source: Doing Business database. account for most of the capital stock of pri- vate firms and an especially large share for Creditor rights and access Legal reform, enforcement and micro, small and medium-size enterprises. to finance economic growth In the developing world 78% of the capital stock of businesses is typically in movable Research has shown that both legal protec- Reforming the legal framework for secured assets, and only 22% in immovable prop- tion for creditors and institutions for sharing transactions can affect the behavior of lend- erty.3 In economies with a modern secured credit information are associated with higher ers. Studies show that banks tend to increase transactions system, these movable assets ratios of private credit to GDP. In developing their lending after amendments of collateral 10 could easily be used as collateral. But in most economies with poorly functioning legal laws. But for a legal reform to have a real developing economies movable property systems, credit markets might depend only impact, enforcement of the rights stipulated would probably be unacceptable to lenders on credit information sharing. But in devel- in laws needs to be possible in practice. The as collateral—either because the law does oped economies with effective systems of enforceability of contracts matters for the 11 not recognize nonpossessory interests in bankruptcy, creditor rights can play a greater structure and pricing of loans. Where en- 6 movable collateral or because it does not role. Strong creditor rights expand the avail- forcement of property rights is weak, lenders provide sufficient protection for lenders ac- ability of loans. One reason is that when tend to offer short-term credit as a way to cepting it. This constraint matters. Research lenders have better legal protection during protect themselves from debtor behavior 12 shows that in developed economies bor- bankruptcy and reorganization of the debtor, such as defaults. rowers with collateral get 9 times as much they become more confident about the Secured transactions reforms are strength- credit as those without it. They also benefit return of their investment in cases of default ening the legal rights of borrowers and from repayment periods 11 times as long and and therefore more willing to extend credit lenders in economies around the world interest rates up to 50% lower.4 on favorable terms. (figure 2). In Mexico secured lending picked Doing Business measures the legal rights of Legal and institutional differences may also up after reforms to its secured transactions borrowers and lenders in secured transac- shape the ownership and terms of bank system, as reflected in an increase in the tions (or collateral) laws and bankruptcy loans around the world. Research finds that lending activity recorded at the registry. laws—to describe how well these laws where creditor protection is stronger, loans The country introduced successive changes facilitate lending (table 2). A modern secured have more concentrated ownership, longer in the past 10 years to improve the system. 7 transactions system provides for the use maturities and lower interest rates. Similarly, The Law on Negotiable Instruments and of security interests in all types of movable where secured creditors have priority over Credit Operations was amended twice, in assets—whether tangible or intangible, unsecured ones, the recovery rate for loans 2000 and in 2003, to introduce modern whether present, after-acquired or future as- tends to be higher and the risks for secured types of security interests. And a nationwide 8 sets, and wherever located—including both creditors lower. And some studies find that registry for movable collateral was created in possessory and nonpossessory interests.5 A creditor rights can help prevent some effects October 2010. In the first 6 months of the modern legal framework for secured lending of an economic crisis, since weak creditor registry’s operation the number of filings also establishes clear priority rules to resolve protection and weak enforcement make almost tripled compared with the same 9 conflicting claims between secured creditors credit markets more volatile. period before the reform, and the registered when a debtor defaults, whether in a bank- loans amounted to a total of $70.9 billion in 13 ruptcy procedure or not. One effective way to financing for Mexican firms. By lowering establish priority rights is to record the secu- the fees associated with registering security rity interest in a centralized collateral registry. interests, the reform also led to savings for DOING BUSINESS 2012 GETTING CREDIT 3 borrowers, estimated at $1.41 billion over the FIGURE 2 East Asia & Pacific and Sub-Saharan Africa strengthened legal rights of borrowers and 6-month period.