C § E § A § L

Center for the Economic Analysis of Law







The Legal Framework for Microcredit Lending



Heywood W. Fleisig

Nuria de la Peņa

March 1998



            * The views and interpretations expressed in this paper are those of the authors and do not necessarily represent the views and policies of the Government of Jamaica, Paul Chen Young Associates, or the Center for the Economic Analysis of Law (CEAL).

            Heywood Fleisig is the Director of Research at CEAL; Nuria de la Peņa is an attorney and Research Associate at CEAL.  The authors thank James Hanna, Maureen Webber, Lenworth A. Burke, Bruce Harrison, Trevor Reynolds, and Bruce Tucker for thoughtful guidance.  They also thank Ronald CC Cuming and John A. Spanogle for their excellent advice about legal problems in the framework for secured transactions. Many Jamaicans have generously given their time to explain their perspectives on these problems.  The authors thank them for their help.  Any errors, however, entirely remain the responsibility of the authors.



I.                        Executive Summary

            Microcredit lending depends on a combination of secured (with collateral) and unsecured (without collateral) lending.  However, the legal, regulatory, and institutional framework in Jamaica for this lending has several problems that limit both the lending and borrowing operations of microcredit lenders:

A.                 Problems in taking movable property as collateral for loans:

·        the usefulness of hire-purchase is limited by the inability to effectively use legal registries to determine the priority of the lender against the collateral

·        hire-purchase itself can be used only to finance readily identifiable goods.  It is not suitable for taking as collateral the inventories of inputs and finished goods that small farmers and businesses own and need to pledge or would like to buy on credit

B.                 Problems in using portfolios of unsecured loans as collateral:

·        the portfolios of microcredit lenders, potentially valuable as collateral for loans, have reduced value because of needlessly cumbersome and expensive procedures to use them for this purpose

·        these portfolios are needlessly risky as collateral, because no working procedure exists for lenders to file security interests against these portfolios

C.                 Consequences

The exiting framework for secured transactions in Jamaica

·        Raises the cost of unsecured credit by making it too expensive to refinancing portfolios of unsecured loans.  Where such frameworks are well-developed, as in the United States and Canada, strictly unsecured loans -- loans to those who offer no collateral and do not own real estate -- are readily available.  Moreover, they are available at in interest rates ranging between of 6 to 12 percentagepercentages points above the government borrowing rate.  Such loans in Jamaica ranged between 30 and 40 percentage points above the government borrowing-rate.

·        Raises the cost of credit secured by movable property.  Where frameworks are well-developed, the cost of credit secured by equipment and inventories, ranges 3 to 4 percentage points above the short term government borrowing rate.

·        Limits the amount of credit..   W Where systems of secured truncations are well developed, as in Canada and the United States, many non-bank financial intermediaries exist to finance and refinance loans that are unsecured or secured by collateral other than real estates.  The ratio of credit to GNP in those countries is about 200%.  By contrast, in Jamaica, the ratio is considerably lower. 

·        Reduces the repayment terms of credit.:  wWhere systems are well developed, unsecured loans typically have a repayment period of 1 to 4 years and equipment loans have a repayment period of three to seven years.

D.                Options for reform:

1.                  Rewrite the laws governing secured transactions

 Permit a broader range of goods and the portfolios of microcredit lenders to better serve as collateral. This inexpensive reform will produce benefits many times exceeding its cost.  Moreover, these benefits will be broadly distributed, ensuring that the reform will be well supported and uncontroversial.

2.                  Rewrite the laws of the registries and modernize the registries

Appropriately divide the responsibilities for registration between private and public providers; modernize the public registry sufficiently to give confidence to lenders about their priority.  As with the legal reform, this reform will have large and broadly distributed benefits with few costs.