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September 2014

Enlarging the Contracting Space: Collateral Menus, Access to Credit, and Economic Activity

Mauricio Larrain's picture

One of the main obstacles that firms in developing countries face is lack of access to credit. A key factor that restricts access is insufficient collateral. Interestingly, banks in less-developed countries usually lend only against real estate; they rarely lend against other assets such as machinery, equipment, or inventory. The problem is that assets such as machines and equipment often account for most of the capital stock of small and medium-size firms. In this context, these assets become “dead capital”: they lose their debt capacity and only serve as inputs in the firms’ production processes.

While it’s true that machines and equipment are less redeployable than real estate, banks in developed countries do lend against these types of assets. In a recent study with Murillo Campello, we argue that the root of the problem lies in weak collateral laws. The law makes a clear distinction between two types of assets: immovable assets (e.g., real estate) and movable assets (e.g., machinery and equipment). Developing countries have weak collateral laws regarding movable assets, which makes its very difficult to pledge these assets as collateral. This shrinks the contracting space, since the menu of collateral becomes smaller, which limits access to credit. Moreover, since movable assets lose debt capacity, firms under-invest in technologies intensive in movable assets.

Credit Information Sharing Reforms and Firm Financing

Maria Soledad Martinez Peria's picture

According to the most recent World Bank Enterprise Survey Data, firms in developing countries report that access to finance is the biggest obstacle for the growth of their operations. Across all regions, 17 percent of firms report that access to finance is the biggest obstacle. In some regions, access to finance is an even larger obstacle. For example, in Sub-Saharan Africa close to a quarter of the firms report access to finance to be the top obstacle.

An important impediment to firm financing is asymmetric information: a firm seeking to borrow from a lender in the credit market has better information about its financial state and its ability and willingness to repay the loan than the lender. Asymmetric information can lead borrowers less seriously intent on repaying loans to be more willing to seek out loans (adverse selection) and borrowers to use loaned funds in ways that are inconsistent with the interest of the lender (moral hazard). Seminal work by Stiglitz and Weiss (1981) shows that under asymmetric information the equilibrium interest rate is such that demand for credit exceeds supply - even borrowers willing to pay the market equilibrium interest rate are not able to get a loan (credit rationing).

Correlated Trading by Pension Fund Managers

Alvaro Enrique Pedraza Morales's picture

Despite the common perception that institutional investors herd, it is difficult to identify the reasons for correlated trading. For example, managers might buy into or out of the same securities over some period due to correlated information, perhaps from analyzing the same indicator. Alternatively, a manager might infer private information from the prior trades of better-informed managers and trade in the same direction. Also, managers might disregard their own information and trade with the crowd due to the reputational risk of acting differently from other managers. Finally, managers might simply have correlated preferences over certain types of securities.

In a recent paper, I study correlated trading by Colombian pension fund managers in the presence of a peer-based underperformance penalty known as the Minimum Return Guarantee (MRG). The MRG resembles a reputational risk, in that the manager might be penalized for having lower returns than her peers. With the MRG, the risk is explicit as the manager will be penalized financially if returns are below the maximum allowed shortfall relative to the peer benchmark. The rationale for the MRG, which is a common piece of the regulation in defined contribution pension systems, is to discourage excessive risk taking by pension fund managers.