Secured Transaction Reform and Access to
Credit
Frederique Dahan & John Simpson, eds.
(Cheltenham, UK: Edward Elgar Publishing Ltd., 2009)
283 pp.
CND$130
William P. Armstrong*
Secured transactions are a part of financial plumbing that exists behind the
walls of most financial systems — key to their operation but invisible to all but the
plumbers themselves. In the U.S. and Canada, and in some other developed countries, the links between property rights and credit are well established through laws
and institutions that enable secured transactions to be created, perfected and enforced. Depending on the country (or province, or state) the links in the chain consist of laws, courts, notaries, bailiffs, sheriffs, lawyers, auction houses, appraisers
and others. If this framework of laws and institutions works well, it is relatively
easy for a person or a business to give a security interest in its assets in order to
gain access to credit under terms and conditions significantly better than if the person or business borrowed on an unsecured basis. In the U.S. and Canada, this
framework is a solid one and as a result, credit is easily obtained (too easily, we are
now learning!).
Things are decidedly different in most developing countries. There, many devils in many details frustrate the pledging and enforcement of property rights and
this impedes access to credit. It would take too long to list all the problems, and
they differ from country to country, but dysfunction is the norm, not the exception.
In some countries, the overall level of lawlessness makes banks unwilling to lend
against anything other than fixed property, in others the registration process for the
pledge is so long and costly that it makes transactions uneconomical.
The European Bank for Reconstruction and Development (EBRD) is a relatively young development bank whose remit is to rebuild the countries of Eastern
Europe. With the collapse of the Soviet Union, they had from the beginning a new
playing field in which to wield their developmental wand, one that had not yet
succumbed to the economic arteriosclerosis that plagues many older countries as
the build-up of bad policies and vested interests over time clogs the economy’s
arteries. Also, they had a largely cooperative clientele eager to separate themselves
from their Soviet-dominated past and anxious to join the EU. The EBRD had fertile
*
William P. Armstrong, formerly an investment banker and a development banker, is
now a financial consultant working on banking issues in developing countries. He has
often tilted at the windmill of secured transaction reform in Latin America.
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fields to plow and some of their best plowing was, and is, being done in the field of
secured transactions reform.
Leading the charge at the EBRD are Frederique Duhan, Senior Counsel, and
John Simpson, Secured Transactions Project Leader. Working with other developmental organizations like the World Bank, they brought together experts in the field
who broke new ground in the economics and law of property rights and developed
a very useful body of knowledge about what does and does not work, and about
how to pull off successful reforms in the area.
Duhan and Simpson have co-edited Secured Transaction Reform and Access
to Credit, a book that is a collection of articles presented at an international workshop on the theme held in London in 2006. These articles reflect the thinking of
many of the leading experts in the field. In most cases, these experts were the same
people who designed and helped to implement the innovative reforms that have
been successful in some of the counties of Eastern Europe, so they bring a practical
as well as theoretical knowledge. While the focus is on the Eastern European experience, their book includes useful information about the efforts of other countries,
notably Latin American countries, that have shown an inexplicable and almost uniform hostility to the reforms that have proven to be so useful elsewhere.
Some of the articles in the book are on the economic aspects of secured transactions, and others deal with legal aspects. The economic articles, by and large,
develop the connection between the quality of the legal and institutional arrangements for property rights and economic growth. While it may sound somewhat obvious that a causal relationship should exist between how well property rights are
defined and how easily secured transactions work, on the one hand, and economic
development on the other, it had been difficult to prove until Florencio Lopez-deSilanes, a professor at the National Bureau of Economic Research and the author of
the book’s first article, and others developed clever methods to deconstruct and test
some of the elements of secured transactions law and institutions and observe their
effects on economic growth. The results of their efforts proved the link between
good frameworks for secured transactions and economic growth and provided a
substantial boost to the efforts of reformists. Before, reforms like the ones that the
EBRD has spearheaded could not get to first base. No minister would spend his or
her political capital on launching esoteric changes to the heart of the country’s legal
system without being able to convince themselves and their counterparts in other
ministries that an economic payoff was likely to result.
Heywood Fleisig, Director of Research at the Center for the Economic Analysis of Law (CEAL) another noted economist in the field, has contributed an article
that illuminates a number of important points, starting with showing that a loan that
is secured by a movable or immovable asset is far less expensive for the borrower,
and that the borrower can raise a much larger loan for a longer term if he/she is able
to pledge an asset. Fixed assets work better than movable assets in improving lending terms, since they cannot disappear or spoil. However, many kinds of movable
assets can and are used to gain access to credit, such as accounts receivable, negotiable securities, inventory, cattle in the field and royalties. Mr. Fleisig goes on to
describe important aspects of the process of building reforms in the area and notes
with frustration that in spite of the fact that these reforms are largely a win/win
situation for almost all the constituencies involved, they are seldom made.
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Martin Holtmann of the International Finance Corporation shares some useful
information about the use of secured transactions to promote microcredit. In general, it is difficult and expensive to seize low value assets from poor people and, as
a result, the microfinance industry is largely based on credit management technologies that do not involve collateral. However, exceptions to this general rule exist
and some microlenders have improved the performance of their loans by taking
collateral in innovative ways.
Several articles in the book are very good at describing the elements of a good
reform program and how to pull off a successful reform. In fact, the EBRD has
developed a set of core principles that the legal and institutional framework should
exhibit in order for secured lending to work well. These principles are set out in the
article by Dahan and Simpson.
Katerina Mathernova, Deputy Director of the European Commission, provides
an article on the Slovakian reform program that serves as an excellent checklist for
reform. Her article emphasizes the importance of having a willing patient and developing a consensus among the constituencies concerning what needs to be done.
The article leaves one with the impression that such reforms are only possible when
a unifying force (like the desire to modernize an economy in order to join the EU)
exists. Slovakia was a very good patient indeed and it won the World Bank’s Doing
Business award for the most reformed country in 2005.
Diana Lupulescu, the Director of the Chamber of Commerce of Romania, contributed an article on the Romanian electronic archive for pledges on movable assets that contains a very good description of how these important institutions are
intended to function. She is in a position to know. She was a champion of the
secured transactions reform in her country. Romania has more secured transactions
filings (measured in proportion to population or GDP) than any other country, and
the access to credit that these measures have supported have, in turn, supported
strong economic growth.
Near the end of the book is a very good but decidedly disheartening article by
Nuria de la Pena, Director of Legal Operations for CEAL. She writes on the many
efforts that have been made and continue to be made to reform the regimes for
secured transactions in Latin American countries. In spite of these efforts, it is almost impossible to think of a success story in Latin America. Ms. de la Pena’s
frustration is evident as she tells us where the bodies are buried, how legal conservatives in Nicaragua refused to acknowledge that creating security interests on future
flows could be made consistent with a Civil-Code-based legal system; or how notaries of Bolivia stifled reform, since it would relax the monopoly they enjoyed in the
business of preparing simple mortgage documents. Her article is also an excellent
checklist of the problems that can frustrate secured transaction reform. After the
book was published Guatemala finally undertook a reform of secured transactions
that CEAL and this reviewer had worked on over the years. Regrettably, the reform
elements that were contained in draft legislation calling for an automated filing
system and for expedited enforcement in the event of default were watered down
significantly. Time will tell if Guatemala can overcome these deficiencies and
make their system work, but it has gotten off to an inauspicious start.
The book is unique and quite useful. It brings together articles on the economics and the law of property rights, and combines these with case studies, observations of what works and what does not, and a checklist of things to watch for.
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Nonetheless, it falls a bit short — it could have been a contender with a little more
attention to detail.
Mr. Lopez-de-Silanes’ article is overly long, written in high econospeak, and
several key charts have missing column headings, which render them inscrutable.
Some articles seem to be filler — one article is not even about secured transactions.
And the book is littered with distracting and unnecessary footnotes, often of the
author conveniently citing other articles he has written. Also, the book could have
usefully included some explanation about key problem areas of secured transactions reform that confound many practitioners, such as why registering property
ownership is fundamentally different that registering a security interest and the
problems that Civil-Code-based legal systems present for reform. With the addition
of some explanation of the main problem areas, the book could nearly have become
a textbook for reform. As it is, such a textbook is still to be written.
Finally, this reviewer wishes to register his strong objection to invoking asymmetrical information as the reason lenders require collateral. This notion has been
handed down over the years from footnote to footnote and is now a defect firmly
coded in the DNA of the field. It is difficult to find an article about collateral that
does not refer to this.
When two parties enter into a contract, in our case a loan contract, the borrower knows more about whether he is actually going to pay or not than the lender
does, or so the theory goes. To compensate for this asymmetry of knowledge, the
bank requires the borrower to post collateral to guaranty that he/she is not hiding
some material facts or lying about their intention to repay. Alas, it is just plain
wrong as a general theory, (though it may be present in very specific and not very
important circumstances). With the experience of thousands of borrowers to compare and analyze, banks are not exactly innocents in this game and actually have a
better idea of whether the borrower will be able to repay than the borrower herself.
Thus, there is no such asymmetry, at least none of the kind that the literature is
imagining. Furthermore, even if both borrower and lender had exactly the same
information, banks would still require collateral, since the purpose of collateral is to
protect against the natural rhythms of business, where some businesses succeed and
others fail, and not, as the theory of asymmetrical information would tell us, to
protect against information that the borrower has not shared with the lender. Collateral is required in order to provide the lender with some insurance against the basic
uncertainty of the future, not against being taken advantage of by an unscrupulous
borrower. The academic record on this point should be corrected.
Apart from these distractions, it is fair to say that this is a very useful book
that should appeal to reformers working in the field, whether they are governmental
officials trying to modernize their economies, or economists and lawyers working
in developmental agencies. It covers the issues in secured transactions fairly well
and there are few other books or publications that bring together the views of experts working in this important, albeit somewhat neglected, area of financial sector
plumbing.