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«Charles W. Calomiris, Mauricio Larrain, José Liberti, and Jason Sturgess February 2016 Abstract We demonstrate the central importance of ...»

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How Collateral Laws Shape Lending and Sectoral Activity1

Charles W. Calomiris, Mauricio Larrain, José Liberti, and Jason Sturgess

February 2016


We demonstrate the central importance of creditors’ ability to use “movable” assets as collateral (as

distinct from “immovable” real estate) when borrowing from banks. Using a unique cross-country micro-

level loan dataset containing loan-to-value ratios for different assets, we find that loan-to-values of loans

collateralized with movable assets are lower in countries with weak collateral laws, relative to immovable assets, and that lending is biased towards the use of immovable assets. Using sector-level data, we find that weak movable collateral laws create distortions in the allocation of resources that favor immovable- based production. An analysis of Slovakia’s collateral law reform confirms our findings.


Calomiris: Columbia University and NBER, email: cc374@columbia.edu; Larrain: Columbia University, email:

mlarrain@columbia.edu; Liberti: DePaul University, jliberti@depaul.edu; Sturgess: DePaul University, jsturge2@depaul.edu. We thank Emily Breza, Murillo Campello, Qianqian Du (discussant), Scott Frame (discussant), Todd Gormley, Li Jin (discussant), Martin Oehmke, Arito Ono (discussant), Tomasz Piskorski, Jacopo Ponticelli (discussant), Philip Strahan, Greg Udell, Paolo Volpin (discussant), Daniel Wolfenzon, Baozhong Yang (discussant), Zacharias Sautner (discussant), Stefan Zeume (discussant), and seminar participants at EBRD, Laboratoire d’Excellence ReFI, Columbia-NYU Junior Corporate Finance Meeting, Columbia Business School, NBER Law and Economics Meeting, CEPR Workshop on Corporate Financing (Oxford), Catolica Lisbon-Nova SBE (Lisbon), Junior Faculty Roundtable at UNC Chapel Hill, Symposium on Emerging Financial Markets (Columbia), Federal Reserve Board, ITAM Finance Conference (Mexico City), MoFiR Workshop on Banking (Kobe), University of New South Wales (Sydney), IMF, China International Conference in Finance (Shenzhen), Catholic University of Chile, University of Chile, University Adolfo Ibañez, University Los Andes, European Finance Association Meeting (Vienna), American Finance Association (San Francisco), University of Manchester, and Lancaster University for helpful comments. Jason Lee provided excellent research assistance. We are grateful for funding from the Jerome A. Chazen Institute of International Business at Columbia Business School.

1. Introduction The ability of creditors to enforce their contracts with debtors is fundamental to the market for credit. A debtor who cannot commit to repay her loan will find it difficult if not impossible to obtain one.

Over the past two decades, scores of academic articles have demonstrated the validity and importance of creditors’ rights for the supply of credit by showing how cross-country differences in the rights of creditors and reforms within countries that improve creditors’ rights are associated with dramatic differences in the supply of bank credit and economic growth.2 In this paper, we provide evidence on a new channel through which legal systems affect debt contracting, and in turn, credit supply and real economic activity. We demonstrate the central importance of creditors’ ability to use “movable” assets as collateral (as distinct from “immovable” real estate) when borrowing from banks.

“Movable” assets consist of all non-real estate assets (such as machinery, accounts receivable, and inventory). According to the World Bank, creditors in emerging markets are usually reluctant to accept movable assets as collateral (Fleisig et al., 2006). That is a major problem for firms that rely on bank credit because movable assets are central to the production processes of many firms in developed and emerging market countries, and in the absence of legal system shortcomings, movable assets are the most important class of collateral used in bank credit. For example, within the United States, 63% of collateralized loans made to small and medium-sized enterprises are collateralized by movable assets.3 In 2 King and Levine (1993), Levine and Zervos (1998), La Porta et al. (1997, 1998), Taylor (1998), and Beck et al.

(2000) employed innovative statistical techniques to identify cross-country patterns. A later group of scholars—most notably Rajan and Zingales (1998), Wurgler (2000), Cetorelli and Gamberra (2001), Fisman and Love (2004), and Beck et al. (2008)—focused on the development of sectors as well as countries, and they reached the same conclusion: finance leads growth. Research focusing on the growth of regions within countries by Jayaratne and Strahan (1996), Black and Strahan (2002), Guiso et al. (2004), Cetorelli and Strahan (2006), Dehejia and LlerasMuney (2007), and Correa (2008) produced broadly similar results. There are also various articles focusing on how creditors’ rights differences affect the structure of loans and the identity of lenders. See, for example, DemirgucKunt and Maksimovic (1998), Qian and Strahan (2007), Bae and Goyal (2009), and Liberti and Mian (2010).

3 Specifically, 46% of collateralized loans are collateralized by machinery, and 17% collateralized by inventory and accounts receivable. Data on collateralized lending for SMEs in the U.S. comes from the Federal Reserve Board’s Survey of Small Business Finance (SSBF). The SSBF combines accounts receivable and inventory. Accounts receivable and inventory are the two most fundamental forms of asset-based financing since they combine elements of secured lending and short-term business loans. A firm would use the value of their accounts receivable and inventory as collateral to secure financing to produce and sell their products and services. The financing is then repaid by converting the inventory to cash, either directly or through the collection of accounts receivables (see Udell, 2004). See Appendix Table A2 for details.

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markets reflects problems in legal regimes governing movables collateral use. Each country has a collateral law for immovable assets and another law for movable assets. Although collateral laws for real estate loans tend to be relatively well developed worldwide, creditors in many countries are reluctant to lend against movable assets because their legal systems limit the usefulness of such assets as collateral. In particular, legal systems for movables are weak in three dimensions: they limit the scope of movable assets that can be used as collateral, they lack centralized registration systems to monitor the security interests (to make sure no other lender has rights to the same collateral), and they allow enforcement in the event of default only through courts.4 We explore how the sophistication of a country’s collateral laws for movable assets affects loan supply, reflected in the loan-to-value (LTV) ratios for loans secured by movables assets compared to loans against immovable assets. We employ a novel cross-country micro-level dataset containing small and medium business secured loans issued by an anonymous global bank (which we label GlobalBank) in 12 emerging market countries. One advantage of the dataset is that it provides information regarding the liquidation value of the asset being pledged as collateral.5 This allows us to construct comparable LTVs, using meaningful measures of asset value, for loans collateralized by different types of assets – something that the previous literature has been unable to do, due to the lack of data on asset liquidation values.

Another novel contribution of our study is our analysis of how different countries’ treatment of movable assets as collateral shapes the allocation of resources across sectors. Because emerging market finance is typically bank debt, and is often collateralized, constraints on LTV and debt capacity should also constrain economic activity. 6 Specifically, we analyze how collateral laws affect the sectoral 4 Article 9 of the Uniform Commercial Code (U.C.C.) governs secured transactions for movable assets in the U.S.

According to the U.C.C., security interests over movables are well defined, easily registered, and can be seized easily if default occurs without the necessity of a judicial procedure (see Section 9-607).

5 As per GlobalBank credit manuals, the asset value is the fair market value that a willing and informed buyer would pay in less than 180 days under normal (non-fire sale) conditions.

6 According to the World Bank’s Enterprise Surveys, which are performed in over 100 countries, collateral is required for bank loans in 75% of loans worldwide. Moreover, the lack of collateral is one of the primary reasons for

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level output data covering the universe of manufacturing firms in our sample of countries.

We first investigate how the lending supply behavior of GlobalBank responds to differences in the quality of collateral protection for movable assets. We identify within-country differences in LTV across loans collateralized with movable and immovable assets for a single lender. Next, we examine how these within-country differences in loan supply and LTV are affected by different legal treatment of movable collateral. We measure cross-country differences in the quality of movable collateral laws using World Bank data from Doing Business to focus specifically on each country’s legal treatment of the three components of effectively secured transactions (creation, monitoring, and enforcement) over movable collateral. We start by showing that movables-backed loans are more frequent in countries with strong legal frameworks for movable collateral (which we label “strong-law countries”) than in weak-law countries. Next, we show that LTVs for loans collateralized by movable assets are higher in strong-law countries, but that LTVs for loans collateralized by immovable assets are similar across countries.

According to our difference-in-differences estimation, LTVs of loans collateralized with movable assets are on average 27.6 percentage points higher, relative to LTVs for loans collateralized by immovable assets, in strong-law countries relative to weak-law countries.

One concern in interpreting our cross-sectional regressions is the potential influence of omitted factors that could explain the observed relationship between collateral laws and debt contracting. We deal with this concern in two ways. First, we control for country characteristics that could affect the LTVs of movable and immovable assets differentially, such as the efficiency of contract enforcement, efficiency of bankruptcy procedures, rule of law, and property rights. Our results are robust to controlling for these variables. Second, we take advantage of the fact that one of the countries in our sample – Slovakia – improved all three components of movable collateral law during our sample period. To provide further the rejection of credit (Fleisig et al., 2006). Understanding the effects of movable collateral laws on production is particularly important given that on average 78% of developing countries’ capital is in movable assets, and only 22% is in immovable assets (Alvarez de la Campa, 2011).

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collateral law reform. Examining collateral in a within-borrower framework, we find that the LTVs for movable assets rose substantially after the policy reform, relative to immovable assets. The magnitude of this within-borrower change (20 percentage points) is similar to the magnitude of the cross-country difference between weak- and strong-law countries. To address the concern that the Slovakia results could be driven by other shocks or policies affecting movable and immovable assets differentially, we conduct a placebo test using the experience of the Czech Republic, a country that did not reform its collateral law.

Given the similarities between the two countries, it is plausible that both were exposed to similar shocks.

We falsely assume that the Czech Republic reformed at the same time as Slovakia, but we reject that assumption, finding no change over time in the LTVs for loans backed by movable assets in the Czech Republic.

To investigate the consequences of collateral laws for real economic activity, we study how collateral law differences affect the sectoral allocation of resources among manufacturing firms. Our measures of sectoral composition are from UNIDO data, which provide each country’s sector-specific output for 22 sectors. The sample of countries covered by UNIDO is more extensive than the GlobalBank sample of emerging market countries we employ in our analysis of lending. We measure exogenous immovable asset-intensity of each manufacturing sector using data for the U.S. sectoral composition of assets (ratio of value of land and buildings to total assets), which should be relatively free from distortions related to ineffective movable collateral laws. Examining the within-country allocation of resources across collateral law frameworks for the 12 GlobalBank countries, we find that weak-law countries allocate 15.4% more production to immovable-intensive sectors than strong-law countries. We also find that the investment rate in immovable-intensive sectors in weak-law countries is 3 percentage points higher than in strong-law countries. Results for a broader sample of 76 countries are similar but of smaller magnitude.

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of concerns about endogeneity bias due either to omitted variables or reverse causality. With respect to the possibility of reverse causality, it is conceivable that countries with a comparative advantage in realestate intensive sectors do not have as great a need for a strong movable law. We address that potential problem in two ways. First, we show that there is no correlation between the collateral law index and a measure of natural resource abundance, which shows that the most obvious source of reverse causality is implausible empirically. Second, we employ differences in legal origin as an instrument for differences in collateral laws, and find that, under the assumed exclusion restriction, the observed association between collateral law quality and sectoral allocation appears to be the result of exogenous variation in collateral laws.

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