Edited by Frederique Dahan and John Simpson
Chapter 3: The Economics of Collateral and of Collateral Reform
Heywood Fleisig Developing countries face daunting problems in funding the investment they need for growth. Private funding, domestic and foreign, will play the most important roles. Donor funding will supply a small fraction of these needs. These savings alone, though, cannot guarantee that domestic investment opportunities will be funded. Rather, funding investment successfully also requires a ﬁnancial sector – bank and non-bank – that mobilizes these savings and delivers them to the highest return domestic investment opportunities. If industrial country experience is a guide, the most important funding instrument will be lending, not capital market equity. In mobilizing loans and directing them to their most eﬃcient use, secured transactions play an important part. The importance of collateral arises from how well it addresses key features and risks in ﬁnancial markets. Financing movable property is essential to growth, as it amounts to more than half of the enterprise capital stock (see Figure 3.5 below). Obsolete laws and legal institutions, however, sharply restrict the use of movable property as collateral for loans. The remedy lies in reforming the laws and institutions that govern using property as collateral for loans. This reform costs little and delivers large beneﬁts. Therefore, a simple economic model of social change that imagines governments and donors gravitating toward reforms with large net beneﬁts would predict its wide acceptance. This has not happened. While the reform has progressed slowly over the past 15 years, many factors continue to impede its adoption. The outlook is for continued slow progress,...
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