Executive Summary

In Nicaragua, several problems in the framework for secured transactions limit access to credit in agriculture. These problems involve creating, perfecting, and enforcing security interests in movable property –- such as inventory, equipment, cattle, and accounts receivables. Creating a security interest in movable collateral --typically the pledge-- is costly. At the same time, many types of property are not envisioned as possible objects of collateral under the pledge laws. Perfection rules do not call for registries that provide for a public and inexpensive means of finding out whether prior encumbrances in collateral exist. The rules for the priority of secured lenders do not clearly rank interests in collateral. Finally, the rules for enforcing security interests establish a costly process (with substantial court procedures) -- a process so lengthy that most movable collateral depreciates in value before it can be repossessed and sold to pay a defaulted loan.

These problems in Nicaragua’s framework for secured transactions limit access to credit in agriculture. First, because farmers and agricultural intermediaries in the rural chain of credit have no means to safely secure loans with the physical capital that they actually have – capital in movable property. Second, because sellers of this capital cannot safely sell on credit using as collateral the movable property being sold. Third, because this defective framework for secured transactions makes it difficult for formal sector lenders to provide refinancing for the natural conduits of rural credit, especially to buyers of farm products and to dealers and suppliers of farm inputs. This limited access to credit is a key constraint on rural development.

Nicaragua: Access to Credit and the Framework for Secured Transactions

Improving access to credit in agriculture is often seen as a key element in rural development strategy -- because projects exist that could increase the incomes of farmers and other rural businesses if they only had access to that credit. Nicaraguans interviewed in the course of this study offered many examples of such investments. Equipment dealers, for example, believed that increases in sales of 200% to 300% were possible at current interest rates if they were able to sell with four year loans instead of one or two year loans. A broad range of producers -- coffee, fruit, cotton, vegetables, and timber -- believed that loans for seed, fertilizer, pesticides, and fungicides could easily double output.

Similarly, access to credit is often seen as an important tool in attacking rural poverty. Profitable projects do exist that could raise income. Also increasing access to credit would achieve other social objectives, such as improving the independence and self-reliance of the target groups, increasing agricultural self-sufficiency, or permitting the able rural poor to swiftly raise their earning prospects. Again this was broadly confirmed in the interviews conducted in the course of this research. However, the smallest producers had limited access to credit, and then only if tied into an established monopoly exporting chain. That market power gave lenders security in their loans. Otherwise, small borrowers had no access to credit at all. At the same time, access to credit in Nicaragua was limited even for the largest and most prosperous companies. By contrast, similar companies in the United States and Canada would have ample access to credit at interest rates close to the government borrowing-rate. In this way, the problem in the framework for secured transactions imposes a large competitive disadvantage on Nicaragua agro-processors that will grow worse as economic integration improves with North America.

There has long been concern in Nicaragua that banks and other private formal sector institutions do not deliver sufficient credit to farmers and other rural businesses. Of particular concern has been the absence of credit to small farmers. Consequently, the government, and bilateral and multilateral donors have focused on different institutional innovation that could improve the delivery of such credit.

At first, the government attempted to disburse these credit lines through state banks, and state guarantee funds. These attempts were a costly failure. Private lenders would not make these loans because they are too risky to set up and collect against movable collateral since the legal and institutional framework for loans secured with movable property collateral does not provide for the key features of a safe system. When public lenders made them, they too found them indeed uncollectible. Moreover, public lenders faced political pressures to charge uneconomically low interest rates, to lend to politically favored groups who were not always able to pay, and were less enthusiastic in debt recovery than would have been private sector institutions. Poor performance combined with visible failure to reach target groups. This led to plans to refinance agricultural loans and dissolve public lending institutions and guarantee funds.

In its place, the government and donors set up a system that would disburse through private for-profit institutions. This improved the efficiency of these onlending operations. Private lenders, in the framework of a substantially strengthened system of supervision and regulation, took great care to disburse only where loans could be collected. However, in most cases this improvement in efficiency took place at the expense of reaching the target groups -- the price of improved efficiency was that target groups had even less access to credit.

In Nicaragua, problems in the legal framework for secured transactions continue to block access to credit. They restrict formal sector institutions in their direct delivery of credit to farmers and small and medium size agricultural enterprises. They limit formal sector financial institutions in their refinancing of credit extended by rural equipment dealers and suppliers. They hamper innovative new institutions that aim at delivering such credit:

In the secondary market for agricultural credit, two important problems surfaced. First, problems in the framework for secured transactions made the loan portfolios of rural lenders that are secured with movable collateral are often “non-legal” or “risky” to collect. Bundled together, they still represented risky collateral for a larger loan with larger lenders or for backing up securities. Second, Nicaragua’s framework for secured transactions does not provide for security interests in portfolios of unsecured and secured loans (accounts receivables and chattel paper financing). Thus, it is costly and risky (if not, “non-legal”), to use portfolios of secured or unsecured loans as collateral for a loan with banks or finance companies.

This paper reflects interviews of producers of coffee, fruits, peanuts, shrimp; manufacturers; distributors of construction, and farm machinery; traders in farm products; sellers of fertilizers and pesticides; the regulatory team of the Superintendency of Banks; bank lawyers; registry officials; and managers medium and large banking institutions, financial companies, warehouse operators, and retail businesses.

Most businesses interviewed operated simultaneously as lenders, credit-sellers, borrowers, and credit-buyers in the Nicaraguan credit chain. In each case, however, access to credit was typically limited to the value of real estate they could offer as collateral, using a mortgage and borrowing from only one lender. For a few commodities, additional credit was available through warrants on merchandise immobilized in warehouses; for a few lenders, the pledge on equipment was useful.

However, the current provision of credit does not adequately serve the needs of Nicaraguan producers. For example, in the practice of the trade in coffee production, a rural coffee purchaser will buy from the final producer, who typically is a smallholder operating on a small plot. The purchaser will establish a working relationship over years with their producers and extend credit for fertilizer, fungicide, and pesticides. The amount of credit they offer will depend on their confidence in the ability of the final borrower to repay. There is no security. This unsecured lending system depends on the purchaser’s personal knowledge of the small producer. Such a system underlies trillions of dollars of loans in North America. However, unlike North American lenders, the purchaser has a limited ability to offer unsecured credit: the amount that the coffee purchaser can lend is limited by his own access to capital. Where the North American lender could use the portfolio of these well-performing loans to secure loans from a larger formal sector lender, such as a bank, the Nicaraguan purchaser cannot. Rather, the coffee purchaser’s access to capital is limited because of the collateral restrictions placed by the legal and institutional framework for secured transactions. The purchaser could, of course, get a mortgage on real estate. However, the business of the purchaser does not involve many assets tied up in real estate. Rather, the purchaser has movable property as assets: tangible movable property -- trucks, rotating inventories of coffee, or fruit -- and intangible movable property -- accounts receivable from the small producers, accounts receivable from the coffee exporters in the cities. In Nicaragua, all of this movable property must be financed from the purchaser’s own capital; none of this movable property serves as collateral for a loan that would permit the purchaser to expand his operation by offering more credit to his producers.

Some borrowers give the appearance of using their machinery, inventories, and receivables as collateral. Typically, though, that financing was illusory. Rather, banks would give firms a credit line based on the firms' real estate holdings -- bienes inmuebles. Subsequent financing secured by movable property would usually be deducted from this credit line. No additional credit was granted to companies that increased their accounts receivable with more sales or that had double their movable property inventory through a more efficient production of agricultural produces. Their available credit reached a ceiling determined by their ownership of real estate, and no credit was granted secured solely on their assets in movable property. Few types of property, besides real estate, seemed to "really" serve as collateral in the sense that additional offerings of such collateral persuaded lenders to offer additional credit. Such a limitation represents a near-fatal constraint. It means that as rural demand for credit for movable property rises – such as equipment, inventories, pesticides, herbicides, or seed – that credit cannot rise to accommodate it. In each case, legal and institutional limits in using movable property as collateral for loans limited access to credit to profitable transactions and growing businesses in agriculture.

These limits in using movable property as collateral for loans do not arise from macroeconomic problems or from high intermediation spread, but from problems in the Nicaraguan secured transactions framework that makes movable property a very risky collateral.

These problems in the Nicaraguan secured transactions framework have been observed in other countries such as Argentina, Mexico, Uruguay, Bolivia, Honduras, and El Salvador, that share Nicaragua's Civil Code tradition. But it is not confined to these countries. Bangladesh, India, and Pakistan are Common Law countries with similar problems that arise from an inadequate framework for security interests in movable property.

Next steps

The next steps warranted by the findings in this report include:

· Prepare a draft law addressing the problems set out here.

· Prepare a report assessing the options for reform of the registration system of security interests in movable property, being especially careful to delineate private and public responsibilities

· Prepare project for the reform of the such registration system