Secured Lending and its Poverty Reduction Effect

Abstract

Rapid, broad-based economic growth appears as the single most important factor of poverty reduction in recent economic studies. They show that the financing of micro, small and medium sized businesses makes an important contribution to poverty reduction. Further, microfinance and finance of small and medium-sized businesses complement each other. Such finance is dependent upon effective secured lending which requires both adequate debtor and creditor protection. And while the importance of debtor protection has been long recognized, not until recently has it been established that ineffective creditor protection decreases credit for poorer debtors. An important cause of the decrease is the fixed cost of monitoring debtor performance. Because monitoring costs are fixed and larger loans are more profitable, banks do not monitor smaller loans as carefully as they do larger ones. Inadequate monitoring encourages smaller borrowers to adopt riskier business and repayment practices. The same scenario occurs, mutatis mutandis, with secured lending: the more liquid the security, the greater the availability of commercial credit. This study focuses on the cultural and legal factors that make secured lending effective and especially on the manner in which third parties or strangers to underlying transactions are protected in different legal systems and cultures. Some of these cultures, particularly in developing nations, are prone to select the wrong third party and protective remedy thereby hindering the availability of commercial credit. The study discusses the principles that inspire the OAS Model Law of Secured Transactions as adopted by a growing number of Latin American nations and a comprehensive strategy for making commercial credit possible at reasonable rates of interest for smaller and medium sized businesses in developing nations.

Keywords: Poverty, Legal Culture, Secured Lending, Third Party Protection