BOX 2.4 BOLIVIA: THE ECONOMIC VALUE OF COLLATERAL
In Bolivia commercial bank lending is mainly collateralized by
land or the personal guarantee of wealthy individuals. Because of inadequate
property laws and legal procedures, assets such as inventory, industrial
equipment, and accounts receivable are not considered acceptable collateral. And
because the registries for recording security interest in property function
poorly, it is hard for lenders to trace claims and identify their collateral in
the eyes of the court. Repossessing collateral is made complex and
time-consuming by gaps in laws that govern financial transactions. The judicial
process for enforcing these laws, for instance, takes considerably longer than
the times specified under law. As a consequence of these legal and
administrative deficiencies, persons without real estate cannot finance
equipment purchases. Only those with unencumbered fixed assets can get credit
for working capital. Credit sales are discouraged. Non-bank credit is very
expensive. And lenders must rely on criminal rather than civil law to enforce
contracts. If deficiencies in laws governing collateral were rectified and
financing were easier, demand for equipment in Bolivia could rise by more than
$500 million. That in turn would increase the country's output by an estimated
$150-$200 million, roughly 2 percent of GDP.
Basic business laws. Many countries have not adapted the
business laws introduced by colonial powers to today's economic circumstances.
Madagascar's commercial code is virtually unchanged from the French code adopted
in 1867. In Sierra Leone, company law dates from 1929 and has undergone few
modifications. Business laws need to provide for fuller disclosure that allows
outsiders to evaluate the financial position of firms and firms to effectively
leverage their assets. One of the biggest problems is inconsistency in laws
relating to foreign exchange transactions, income taxes, and customsa
consequence of the failure to repeal obsolete laws and regulations and formulate
new laws to reflect changes in policies. For example, despite government policy
to provide duty-drawback relief to Nigerian exporters, rules for operation of
the scheme have yet to be formulated and incorporated in customs regulations. In
most countries, consumer protection laws also are poorly developed, and most
countries still lack laws on standards allowing the public or smaller firms to
challenge monopolistic behavior.
Laws governing financial transactions. Laws often do not permit
full play of financial relationships and instruments. In many African countries,
laws and regulations governing capital market transactions are inadequate and an
underdeveloped legal framework for leasing prevents small firms from increasing
their equipment investments and denies lenders a more secure method of lending
to small enterprises. In Ghana, small firms improved their access to credit
following introduction of leasing laws.
Most countries have neglected the legal issues of debt recovery.
Inefficient adjudication has often rendered court-based remedies ineffective and
encouraged willful default. In Bangladesh and India, judicial procedures
relating to debt recovery can take years. Extra-judicial foreclosure
arrangementsallowing lenders to exercise control rights over the security
or operations of firms are normally not available in most lowincome
countries. As a result, financial intermediaries prefer to lend only to
established firms. Newer and smaller firms without a track record or
unencumbered real property find it difficult to get finance.
Sustained growth will require large infusions of capital, much
more than entrepreneurs can get from their own resources or from friends and
relatives. And expanding access to outside financefrom banks and
institutional investorswill require comprehensive revision of laws
relating to the creation, trading, and enforcement of security interests.
Laws for arbitration and other dispute resolution mechanisms. In
many countries, such laws and mechanisms are not responsive to changing
commercial needs. In the absence of quicker alternative dispute resolution
mechanisms, firms must rely on tedious court procedures, increasing the costs
and risks of market transactions and squelching the opportunities to expand
Specialized institutions, such as law reform commissions, can
improve the relevance of laws and provide a mechanism for gradually revising
laws on a consensual basis in harmony with existing social and legal traditions.
In many low-income countries, these institutions either do not exist or have
become moribund, as in Sierra Leone. Strengthening institutional mechanisms for
law reform is particularly important for privatization programs, for the private
provision of infrastructure services, for attracting foreign investment, and for
protecting the interests of small and new enterprises.
Equally important is strengthening public awareness of laws and
legal decisions. When the substance and applicability of laws are known only to
a few, uncertainty rises for all business decisions. Poor law reporting
arrangements, outdated legal indexes, and delayed gazette notifications are the
main culprits. In Ghana, there is a considerable backlog of law
reportingand until recently, even summaries of court decisions were
unavailable. In Sierra Leone, the last available law reports date back to 1984.
The efficacy of laws depends on disposing of court cases
expeditiously. In most low-income countries, adjudication is cumbersome and
unreliable. Serving summons, filing suits, obtaining judgments, and executing
decrees are all time-consuming. Efficiency is impeded by limited knowledge of
economic laws and severe shortages of trained court clerks, process servers,
transcribers, and bailiffs. Further handicapping the functioning of the legal
and judicial system is the poor state of the physical, logistical, and
informational infrastructure. In many low-income countriessuch as
Bangladesh, Ghana, Sierra Leone, and Tanzaniathe facilities for recording
court proceedings are rudimentary. Judges often have to record the proceedings
manually, so delays in completing cases are common.
In many Sub-Saharan African countries and formerly socialist
economies, government agencies are ill-equipped to convert legislative proposals
and government intent into coherent legislation. Legislation, rules,
regulations, and public notices fail to keep pace with government policy
announcements and decisions, particularly in matters relating to investments,
foreign exchange, customs, taxes, and finance. That naturally hurts the
credibility and timeliness of reforms. The result is confusing and inconsistent
legislation that allows civil servants wide latitude in interpretationthus
denying predictability, flexibility, and security for property transactions.
Efforts to improve the quality of legal drafting and analysis
can pay large dividends in private investment. Witness the mining sectors in
many African countries, where the private sector responded positively to clear,
revised mining codes. The Bank Group has been helping low-income countries to
address specific deficiencies in laws through technical assistance directed at
improving institutional and infrastructure capacity (box 2.5). These efforts are
collaborative undertakings by governments, the judiciary, and the private
sector, with IDA's support. They are creating a broad consensus about reform and
the most effective way of implementing itto strengthen the legal and
regulatory system in low-income countries.
The objective of this effort is to establish, visibly, a
rule-based economic system in which the rules governing economic activity are
generally available and understood by the population. Those rules are to be
enforced uniformly and universally, with a stable, predictable pattern over
time. And they are to be changed through transparent means. Such open processes
have special merit for countries that have experienced gradual breakdowns in
their judicial systemand where the expropriation of private property in
the 1 960s and 1 970s left many private companies, particularly foreign ones,
doubtful about the wisdom of continuing to invest.