C § E § A § L

Center for the Economic Analysis of Law










Creating a Legal and Institutional Framework to Promote Access to Credit by the Poor


Heywood W. Fleisig

Nuria de la Peña


March 1999






© Copyright 1999, Center for the Economic Analysis of Law.  All Rights Reserved.


*Heywood W. Fleisig is Director of Research at the Center for the Economic Analysis of Law (CEAL), Nuria de la Peña is Research Associate and Director of Legal Operations at CEAL. 

This work was undertaken under the supervision of Rodrigo Chaves; the authors thank him for his substantial intellectual and administrative contributions.

The authors thank for their valuable help attorneys Ion Mazalu, and John Spanogle. Also the authors thank many Romanians who have generously given their time to explain their perspectives on these problems. The views and opinions expressed in this paper and commentaries, however, are those of the authors and any errors remain entirely their responsibility. 


Executive Summary

            Improving access to credit by the poor  -- lowering interest rates, increasing the size of loans, and lengthening the terms of repayment -- would permit poor farmers and other low-income business operators to take better advantage of investment projects that would permit them to raise their incomes.  Even for those poor without investment opportunities, a more favorable environment for financing will increase investment, the capital stock and, thereby, the demand for labor and the wages of poor workers.  For all the poor, improving access to credit will permit them to rearrange consumption, reducing the unpleasantness associated with poverty. Moreover, improving access to credit in the ways set in this report would not prevent following other anti-poverty policies.  The options discussed here are not logically inconsistent with other polices and, because they are inexpensive, would not represent any substantial diversion of resources from other programs.  The recommendations set out here deserve a prominent role in any policy aimed at expanding access to credit and alleviating poverty.

            The policies described here rely mainly on changing the law and legal institutions to permit better access to credit by the poor.  The changes set out here would permit the existing state-run and NGO supported lenders to better collect small debts and credit.  They would also facilitate the refinancing of such loans, permitting these lenders to expand their efforts.  These two features taken together – better collection and better refinancing – will also have an enormous impact in increasing the private provision of credit to the poor.  The likely longer-term consequence of these policies, therefore, is expanded credit with greater private sector participation.

            Five broad areas underpin a strategy to change the legal and regulatory framework in ways that will improve access to credit by the poor

Reform the Framework for Secured Transactions

            During the preparation of this report, the Government, supported by the World Bank, took a major step forward:  it passed a Law of Secured Transactions that will permit movable property, both tangible and intangible, to serve as collateral for a loan.  The reform is not entirely complete, as it remains to set up the filing archive to permit the law to operate.  Once this is done, however, this legal reform will have two major impacts on access to credit by the poor:

·        Better collection means better access: Permit poor borrowers to use as collateral their movable property, the property they are most likely to own; to purchase such property on credit, to improve their income prospects, while permitting the movable property itself to serve as collateral for a loan

·        Securitization permits expanding operations: Permit those lending to poor borrowers, who offer no collateral, to use as collateral their portfolios of such small loans or accounts receivable as collateral.  Using such portfolios as collateral will permit lenders and credit sellers who deal regularly with poor clients to refinance their operations even where thy have no deposit funding.  This will increase competition among potential providers and improve access to credit by the poor.

·        Expanded operations by non-bank lenders and credit sellers: The law eliminates supervision, by banking authorities, of the lending and credit-selling activities limitations on non-deposit taking lenders and credit sellers.

Restructure Homestead And Exempt Property Provisions

All civilized countries restrict the type and amount of property that lenders may take from debtors in debt collection proceedings.  Those provisions in Romania, however, are drafted with insufficient attention to the need of lenders to be able to recover property used to secured loans.  That makes most lenders and credit sellers unwilling to make the loans.  For those that do make them, they will have trouble refinancing their portfolios as formal sector lenders will not typically accept loans that cannot be collected under law.

The section sets out options for redrafting these provisions in ways that will preserve the basic public policy protections for debtors without limiting their access to credit.

Permit Using Leases Of Real Estate As Collateral For Loans

Many advanced countries use leases of real estate to form the basis of the real estate market.  So, for example, much of the land under Wall Street in New York, the financial district of London, and much of the state of Hawaii has land owned by entities that either cannot or will not alienate property.  Instead, long term leases are used to transfer property rights to land.  These leases have value and can be used as collateral for loans to finance the construction of buildings or factories on the land itself.

In Romania, such an institution could play a key role, in view of the poor condition of the real estate registries, the costliness of the mortgage process, and the unclear title for much of the land.  However, Romanian law prevents the use of leases of real estate as collateral for a loan. The Law limits agriculture land lease rights, does allow foreign investors a lease for less than 5 years, imposes rental ceilings, and prohibits subleases. The paper discusses why this is and what steps must be taken to change this.

Reduce Barriers To Using Small Properties As Collateral For Loans

Land is the traditionally favored collateral for formal sector lenders. Romania, however, faces fundamental problems in using real estate as collateral for loans.  These problems arise from the poor system of registration and a law that specifies an expensive, cumbersome, and risky system for repossessing and selling real property taken as collateral. Discretionary land titling rules and problems in the creation, registration and enforcement of mortgages often increase the difficulty of using real estate as collateral for loans.  The present reform, which appears to emphasize mapping and titling, will address none of these problems.  The ensuing costs of this system are partially or entirely fixed. As a consequence, they bear heavily on small parcels of land.

The discussion sets out a list of the legal reforms needed and proposes that the real estate registration system be privatized in a manner similar to that underway for the filing of security interests in movable property.

Simplify Complex And Expensive Procedures For The Legalization Of Small Business

Operation of business in a modern society requires a complex regulatory framework.  However, the system in Romania offers many out-of-date requirements and no systematic linking of the key administrative procedures required to set up a business.  This sets out an addition barrier to micro, small and medium scale enterprises that might get better access to credit were they to formalize.

The section sets out options for simplifying this system, including a careful evaluation of the public policy issues in each regulation, the streamlining of the procedures called for under the commercial code, and the setting up of a “one-stop shop” that might augment the licensing procedure of the Chamber of Commerce.

Homestead and exempt property provisions prevent the rural smallholder, preeminently the poor, from using their small holdings or their equipment, crop, or animals as collateral.