How legal restrictions on collateral limit access to credit in Bolivia

Report No. 13873-BO How Legal Restrictions on Collateral Limit Access to Credit in Bolivia December1 994 Office of the Chief Economist Latin America and the Caribbean Region Document of the World Bank   HOW LEGAL RESTRICTIONS ON COLLATERAL LIMIT ACCESS TO CREDIT IN BOLIVIA December 1994 *This report is based on the findings of two missions to Bolivia in March 1991 and March 1992. The team was led by Heywood W. Fleisig of the Bank and included Juan Carlos Aguilar, economist at the La Paz Resident Mission, and Nuria de la Pefia, laywer and consultant to the Bank. The authors are obliged to Robert Effros of the International Monetary Fund for his early guidance about the economic importance of these legal provisions, and to Alejandro Garro and Andrew Spanogle for extensive advice on the legal issues. Marcelo Selowsky advised throughout on the economic analysis and its bearing on the Bank's credit line operations. William Shaw worked closely with us and advised us from the inception of the project. Roberto Cucullu, Mark Dorfman, Graciela Rodriguez Ferrand, Lance Girton, Thomas Glaessner, Roberto Laver, and Hal Scott made many helpful comments. Many Bolivians have generously given their time to explain their perspectives on these problems. Any errors are entirely the responsibility of the authors.   CONTENTS Executive Summary ............. - I. Introduction.. 1 - II. How the Laws Governing Financial Instruments Affect Credit and Economic Growth .- 3- How Do Borrowers Back Their Loans? .- 3- Collateral Problems Reduce Investment and Growth .- 4 - Collateral Problems Distort Credit Allocation. -6- CoHateral Problems Narrow the Distribution of Credit. -6- Conclusion.. 8- III. Extralegal Repossession and Sale of Collateral .- 10 - IV. Financial Instruments and Collateral: Overview of Legal Issues .- 14 - Definition of Property .- 14 - Structuring Claims Against Property .- 15 - Establishing the Existence of a Claim Against Collateral in Bolivia .- 17 - Obtaining and Enforcing Judgment.. 17 - V. Creation and Perfection of Security Interests .- 18 - Creation and Perfection with Physical Possession .- 19 - Creation and Perfection without Physical Possession and without Written Registration .- 22 - Creation and Perfection without Physical Possession and with Written Registration .- 23 - The Registries .- 24 - Problems and Options for Solutions .- 26 - Pass a Comprehensive Law of Secured Transactions .- 27 - Improve the Operation of Legal Registries .- 29 - VI. Obtainine Judgment in Bolivia .- 31- Judicial Procedures .- 31 - Problems and Options for Solution .- 35 - Permitting Private NonJudicial Enforcement of Loan Contracts .- 36 - Improve the Administration of Justice.- 37 -  VII. Enforcin2 Judoment .......................... - 41 - Determining the Amount Owed . .......................... - 42 - Attachment and Seizure . ..........................- 43 - Public Auction ...........................- 44 - Problems and Options for Solution .......................... - 45 - Appendix I: Economic Cost of Deficiencies in Bolivia's Collateral Law ....- 49 - Appendix II: Results of an Analysis of Bolivian Debt Collection Cases ... - 61 - Appendix III: le2islacion Sobre Garantias Reales Mobiliarias: Terininos de Referencia . - 71 - Appendix IV: Legislacion Sobre Acceso Publico a los Registros. Bienes Inembargables v Contratos Modelos para el Credito Mobiliario: Terminos de Referencia - 107 - Glossaries: English/Spanish .. . - 119 - Spanish/English .. . - 127 - MAP (IBRD 16591)  Executive Summaary i. In Bolivia, banks supply most of the loans to the private sector. Bolivian banks usually accept only real estate as collateral for these loans, or the personal guarantee of someone who owns real estate. They usually will not accept inventory, accounts receivable, livestock or industrial equipment as collateral without demanding a supplemental guarantee based directly or indirectly on the ownership of real estate. ii. These policies: * Make it difficult for anyone without real estate to finance the purchase of equipment, inventory, or livestock. Limit access to credit by business enterprises in rented quarters, by farmers who work rented land or have unclear title, and by all who don't own real estate. * Limit profitable and socially useful lending by banks, as well as credit sales by industrialists, importers, and merchants. Make non-bank credit expensive, because lenders find collateral other than real estate very risky. Deprive lenders and borrowers of due process of law, by misusing the punitive sanctions of the criminal law to substitute for inadequate civil enforcement of contracts. Broadly, these lending policies lead to high interest rates, low volumes of lending, investment rates that fall short of socially profitable needs, and lower output and incomes. Problems in Securing Loans Against Movable Property iii. Why is credit so tightly linked to urban real estate and large rural land holdings in Bolivia? Not because of low income, low growth rates, or the relatively small size of the country. Nor is there evidence of excessive conservatism by commercial banks, disinterest in the needs of commerce, or excessive restriction by the Superintendency of Banks. Rather, this link arises from Bolivian law and legal procedures. iv. Lenders regard loans secured only by movable property and equipment as more risky than loans secured by real estate; this is correct:  - ii - * Inadequate legal definition of collateral and guarantees makes it impossible to cover some important economic transactions with legally-recognized agreements. * The law permits only complex and time-consuming measures for repossessing collateral, procedures that take longer than the economic life of many movable property. * Inadequate registries make it hard for lenders to trace claims, pledges and mortgages and to identify their collateral in the eyes of the court. v. Movable property typically depreciates rapidly with time and use. If collection procedures take too long, such property has little value as collateral. In an examnination of over 500 debt collection cases, the average collection time was over two years. Lenders, understandably, require other forms of collateral. Ad Hoc Solutions to the Collateral Problem Have Failed in Bolivia vi. Lenders and borrowers, struggling to make profitable and socially beneficial deals despite the inadequacies of laws and legal institutions, go beyond the law. They use postdated checks to guarantee payment and send the borrower to jail in the event of default. They use bailee agreements that subject the bailee, typically a family member of the borrower, to jail if the collateral is not delivered. Nearly a third of the people in jail in La Paz -- and 60 percent of the women -- are there because debt collection has been criminalized. Debt-related "crimes" account for more prisoners than murder, theft, drugs, or rape. vii. Because these ad hoc solutions convert ordinary commercial risk into criminal risk, these are not good remedies. Where ordinary businessmen outside Bolivia face the prospect of loss if they default on a loan, Bolivian businessmen face the prospect of jail. Understandably, potential sellers hesitate to sell on credit, and potential buyers hesitate to buy on credit. Lenders with important reputations to protect, like banks, will not use these illegal methods to protect claims on movable property; for banks, illegal solutions are not solutions at all. The High Economic Cost of the Collateral Problem viii. Breaking this tight link between access to credit and ownership of real estate requires changing the law so that more lenders would find it profitable to make loans secured by movable property. This change could provide large and broadly distributed economic benefits. Banks would gain from undertaking profitable loans presently closed to them because of excessive collateral risk.  - ill - * Manufacturers and dealers in equipment, fertilizer, seeds, and grains could extend their own credit to buyers. * Banks could accept the loans arising from such credit sales as collateral for other loans that would let these manufacturers and dealers sell more on credit. * Other financial intermediaries such as leasing companies could borrow to finance sales, accounts receivables, and machinery. * Potential buyers who now lack access to credit because they cannot offer real estate collateral could borrow in the private sector for productive loans using the movable property itself as collateral. ix. The overall benefit to the Bolivian economy would arise from the wider use of equipment and working capital in projects where it is profitable but, at present, difficult to finance. A rough estimate of this benefit indicates that -- with the drop in interest rates that might be expected from improved collateral -- the demand for equipment could rise by about $1 billion. That expanded use of equipment could increase output by an estimated $230 million to $330 million, about 3 percent - 4 percent of Bolivian GDP. Options for Solutions x. Addressing this problem requires revising Bolivia's Laws, improving legal registry systems for those commercial and civil contracts that create security interests, and speeding up the process for settling claims. The government of Bolivia has several options. Change the Law to Permit a Broader Range of Security Interests to Cover all Economically Important Transactions: xi. Enact a new law on secured transactions for business and consumer borrowers that includes substantive and procedural rules that: * Expand the range of assets that can serve as collateral. * Regulate floating security interests for all secured transactions and agreements, using commercial inventory as collateral. * Regulate accounts receivable as collateral, avoiding the transfer of accounts requirement. * Give a clear perfection of security interest in the goods sold on credit.  - iv - * Establish clear regulations for disclosure of fees, interest rates, and other termns of lending. Accelerate the repossession and sale of collateral: In the short-tern: * Apply rapid resale to all movable collateral. Regulate or amend Article 171 of the Civil Code to clarify that its application is not limited to fruits and vegetables, but applies to all movable property that decline in value (si hubiere peligro de perdida o desvalorizaci6n) in an amount sufficient to endanger the collateral because of the long time required to litigate repossession and sale. Regulate or amend the law to clarify that the judicial power to order sale in the most convenient way (podra ordenar la venta en la forma mas conveniente) should include sale controlled by the creditor. * Clarify rapid repossession procedures. Regulate or amend Article 162 of the Civil Code, which gives the court the power to act rapidly, to set specific procedures for the rapid repossession of movable property. (Clarify which contracts pernit rapid repossession and sale. Regulate or amend the law to provide that rapid repossession and sale procedures can apply to several important secured transactions contracts such as right of retention (Commercial Code, Article 812); the right of adjudication related to the pledge without transfer of possession (Civil Code, Article 1427); and to the conditional sale or sale with retention of title (Commercial Code, Article 839). Draft sample contracts. Include model standard contract forms for seller credit, specifically a standard contract for business borrowers, negotiated under freedom of contract (Commercial Code, Article 786 and Civil Code, Article 454), providing that the seller can retain title to the goods. For bank credit: use pledge-without-transfer and chattel mortgage agreements when lending against movable property. In the long-term: * Change the law. Let private parties bypass the court procedure for execution of judgment by allowing them to write contracts permitting harmless repossession so that the creditor may repossess collateral, to sell it through private sale controlled by the aggrieved lender or through judicial sale without appraisal. This procedure will also let private parties bypass existing auction procedures.  Improve Legal Registries: xii. After the law has been changed to make it economically useful to register security interest against movable property, reform the registries: * Index and computerize the registries in which secured claims are registered. * Computerize and modernize the Commercial Registry. * Expand the use of equipment registration at the Real Estate Registry. * Strictly enforce the public access requirements to government registries. * Set targets for improved performance and maintain public records of the amount of time required for each step in the registration process.   How Legal Restrictions on Collateral Linit Access to Credit in Bolivia I. Introduction 1. In Bolivia, most lenders require real estate as collateral. This practice makes it very difficult for merchants, mine owners, industrialists, professionals, and farmers to borrow against equipment, inventory, crops, or anything else they might use in the course of their trade or business. 2. This paper asks why such a limited range of property should serve as collateral for loans. It finds the answer in the Bolivian legal, judicial, and regulatory systems: the court system operates very slowly and the system of laws makes it difficult for parties to make loan contracts that can bypass the courts for their full enforcement. 3. This paper aims at both economists and lawyers. The economic problem is relatively simple: collecting any debt in Bolivia is expensive and takes a long time. Only the most durable and valuable collateral is worth anything in such a system; therefore, most loans are ultimately secured by urban real estate, which will last beyond the time expected for a court decision and has great enough value to cover at least the minimum cost of collection. The typical piece of industrial or agricultural equipment is worth less than the typical real estate holding and, unlike real estate, typically falls in value with age. For lenders facing high fixed legal costs of repossession and sale, equipment is much less attractive as collateral than land. 4. This problem has complex legal and judicial roots. Consequently, this paper covers these issues at a level of detail that may seem tedious to some legal readers; this is regrettable but unavoidable. It is important to distinguish technical legal terms from common usage. To indicate technical legal terms for the non-legal reader, italics are used for English legal terms, with Spanish terms in parentheses. This also identifies legal terms for lawyers trained in only one of the legal systems, civil or common law, relevant to discussions in this paper. In most cases, these terms appear in the appended glossary. In some cases, differences between the civil and common law usage means that no equivalent term exists in the other language. In that case, the glossary sets out the sense in which the term is used in this paper.  - 2 - 5. Chapter II discusses how Bolivian lenders actually secure their loans in the face of these severe problems that restrict the use of collateral. Chapter III discusses how the legal treatment of collateral affects credit and, in turn, the financing of investment and economic growth. Chapter IV introduces the legal issues: it defines property, explains how claims are secured by collateral, and discusses how the legal and judiciary system in Bolivia enforces those claims. Chapter V presents the general issue of the creation and perfection of security interests and how they are handled in Bolivia. Chapter VI describes how a Bolivian creditor would obtain judgment from the court in the event of a breach of a financial contract; it explains why the process takes a long time and sets out some options for shortening the process. Chapter VI discusses how a Bolivian creditor would enforce such a judgment; it also explains why that process is so protracted and discusses options for reform. 6. Appendix I sets out a back-of-the envelope estimate of the economic cost of the collateral problem in Bolivia. Appendix II presents the analysis of debt collection cases in Bolivian courts. Appendix III contains the terms of reference for a general law of secured transactions for Bolivia, prepared by Professor Alejandro Garro. Appendix IV has the terms of reference for a series of short-term solutions that address aspects of the collateral problem.  II. How the Laws Governiig Financial Instruments Affect Credit and Economic Growth 7. Bolivian law envisions two broad classes of private borrowers: commercial banks and everyone else. As a practical matter, the debt of non-bank private borrowers is backed by real estate: property other than real estate cannot readily serve as collateral. This system limits the volume of credit available for productive transactions. It allocates credit away from farmers who rent, from farmers with unclear title to land, and from manufacturers who need large amounts of machinery relative to their real estate holdings. It allocates credit toward real estate development, and keeps credit out of the hands of those without land. This credit system reduces economic growth and directs the benefits of growth away from the poor. How Do Borrowers Back Their Loasm? 8. Private lenders care deeply about how their debts will be repaid. Therefore, they care about what backing the borrower offers. Commercial banks borrow by taking deposits, by selling certificates of deposit, or by issuing bonds. They back their debts with their real property, their investment assets, and their expected profits. At one level, these anticipated profits depend on the bank's expected interest costs, interest receipts, and loan performance. At a deeper level, however, the quality of the backing that the bank offers depends indirectly on the quality of claims against the government. First, because the de facto and de jure policy of the Bolivian government on insuring depositors effectively provides a state guarantee to some of the debt of commercial banks. The state does not offer comparable guarantees for non-bank private borrowers. Second, because how well a commercial bank services its own debt will depend on government policies -- how freely the Central Bank rediscounts the private loans presented to it by the commercial banks, and how aggressively the bank regulators force banks to recognize losses. 9. What backs the promises to repay by other borrowers -- consumers, industrialists, merchants, and farmers? For some loans to individuals, collateral is not necessary. To some degree, individuals, like nations, will service debts because the gain from future, larger loans exceeds the burden of servicing past, smaller loans. Accordingly, revolving funds that lend for recurring needs, like seeds for farmers, often show high servicing rates. In other cases, community pressure ensures repayment. Often community or church cooperative lenders show high servicing rates, and, no doubt, some individuals can be counted on to repay loans because they have strong moral views that loans should be repaid. These loans are unsecured but they have good backing. 10. But, even while some lenders will make unsecured loans, if they have intimate knowledge of the borrower, few lenders will make substantial loans under such conditions. For lenders in most countries, good collateral and good collection make good loans. In most cases in Bolivia,  - 4 - such borrowers secure their promises to pay by either mortgaging real estate to secure their loans' or by giving evidence of the ownership of real estate that could be attached to pay loans. Such borrowers give personal guarantees,2 which involve a generalized pledge of their wealth, or use a surety of the wealth of another. Few Bolivian borrowers secure their loans by pledging durable equipment or personal belongings. This situation has roots in problems of Bolivian law and legal procedures. Collateral Problems Reduce Investment and Growth 11. How important are these legal obstacles compared to other factors in explaining high interest rates or reduced investment? Do legal problems in creating collateral explain the high interest rates facing borrowers who secure loans with real estate? Most likely, they do. Consider some frequently offered alternative explanations: 12. Macroeconomic instability and high bank intermediation margins. Only a small amount of the high interest rates facing Bolivian borrowers arises from macroeconomic factors or high bank intermediation spreads. Loans to individuals without real estate in Bolivia run between 36 percent and 72 percent per year, versus a range of 9 percent to 14 percent in the United States -- a difference of 22 - 63 percentage points (Table 1). 13. Of that difference, about 8.5 percentage points arises from the risk of macroeconomic instability in Bolivia and another 5.5 percentage points arise from higher bank intermediation spreads. The additional interest rate differential -- 14 to 50 percentage points -- arises from problems with movable property as collateral. 14. Put a different way, half to three-quarters of the higher interest rates observed in Bolivia arise from the collateral problem. For lawyers, "real property" refers to real estate as distinct from other physical or 'personal property.' For economists, "real property" connotes both real estate and 'personal property,' as distinct from "nominal" assets like paper securities. Broadly speaking, under Bolivian lav, borrowers can give lenders one of two guarantees: a real guarantee or a personal guarantee. Under a real guarantee, the creditor has a security interest in a specific asset of the debtor, such as a mortgage on the debtor's house or a pledge on the debtor's equipment. The lender is then a secured creditor who holds a position in the line of priority to recover the amount that he is owed from the proceeds of the eventual sale of that specific piece of property. tJnder a personal guarantee, the lender is an unsecured creditor because the borrower will [respond] with any and all of his property, giving the creditor no specific interest, priority, or security interest against any specific property (C(6digo Civil, Art. 1335). In such a situatiol, the lender-creditor will be unsecured until a court orders an attachment or a judgment lien recorded in the appropriate registry. Whetn the creditor records such a court order, the creditor creates a specific lien on a specific asset of the debtor; the lender then becomes a lien creditor with respect to that specific asset, and will remain an unsecured creditor for any deficiency judgment (the creditor will have a personal guarantee on any of debtor's assets until the total balance due is paid). Under Bolivian law, the parties need not stipulate in their contracts the debtor's personal guarantee: a personal guarantee of the debtor always exists under the law. without the need to provide for it specifically.  Table 1: Explaining High Interest Rates for Loans in Bolivia United States Bolivia Difference I. Greater Macroeconomic Risk in Bolivia: [7There is no risk that the U.S. government will be unable to pay its bonds in dollars, because it has the legal monopoly on printing dollars. The government of Bolivia must get its dollars by raising taxes or cutting spending. These are politically difficult actions and lead to perceptions of macroeconomic risk. The differnce between the U.S. interest rate on dollar bonds and the Bolivian interest rate on dollar bonds is entirely macroeconomic risk. Government borrowing rate in dollars | 3.5% 12.0% 8.5% 2. Higher commercial bank intermediation spreads in Bolivia: [Commercial banks in Bolivia have less competition than do U.S. banks so they charge more to intermediate funds. Reserve requirements are similar and do not explain differences in intermediation spreads] Prime business rate 6.0% 20.0% l --Spread over govemment borrowing rate 2.5% 8.0% 5.5% 3. Movable property is less adequate collateral for loans in Bolivia: [Differences in macroeconomic risk and intermediation cost apply equally to loans secured by real estate and loans secured by movable property. In the United States, loans secured by movable property have interest rates close to the interest rates on mortgages; in Bolivia, banks do not make loans secured only by movable property and informal lenders charge rates of 36 percent to 72 percent] Mortgage Interest Rate 8.25% (25 year) 18% (5-10 years) Equipment/Automobile Loan 9.30% (4 yr) - 12.7% (10 yr) 36% - 72% FSpread 1.05% - 4,45% | 18.00% - 54.00% 13.55% - 50.00% Source: U.S. data taken from Federal Reserve Bulletin, July 1993, tables 1.35, 1.53, 1.56; Bolivian data from the Bulletin of the Central Bank. Rates for loans secured by movable collateral based on evidence given during interviews. 15. High transactions costs relative to loan size. One explanation offered for the reluctance to lend for equipment rests on the supposed small size of such loans. This doesn't hold up well under examination. In fact, about three-fourths of the loans made by Bolivian commercial banks are for US$10,000 or less. Loans of that size for movable equipment are common in the United States, where the labor costs of loan processing are higher. High transactions costs can't explain the reluctance of the Bolivian banks to make these loans. Their reluctance, rather, arises, as the bankers themselves repeatedly and consistently stress, from their belief that the movable property do not offer much value as guarantees for loans. 16. Structure of banking. Some explanations of high interest rates rest on allegations of conservative bank lending policies. But banks cannot substantially liberalize their policies regarding collateral unless the underlying quality of collateral policy is changed. Without reform, loans secured only by movable property do present substantial additional risks. Where high bank intermediation spreads arise from too little competition, the collateral problem limits development of non-bank lenders that could compete with banks and lend for movable equipment.  - 6 - Collateral Problems Distort Credit Allocation 17. Restrictions on collateral distort Bolivian economic activity. Economic sectors in Bolivia, as elsewhere, differ substantially in their most profitable combinations of real estate, equipment, and human capital. Since real estate security is better in Bolivia, the legal and regulatory environment for lending operates to lower the risk of lending for real estate; this permits lower interest rates for such loans and leads the market to allocate more capital toward operations intensive in real estate. Hotels and commercial buildings will be relatively easy to finance. By contrast, though, a factory operating in rented space will find it difficult to finance machinery because it cannot mortgage the real estate. A service company -- such as a bus, taxi, or road transport company -- that requires large inputs of durable equipment and relatively little real estate will also find financing difficult. A landless farmer, or one whose land is covered by murky homestead provisions, will have trouble financing equipment. 18. How much is it worth to address this problem? Appendix I sets out a rough estimate. In Bolivia, about 10 percent of commercial bank loans are granted using movable equipment as collateral; in the United States, about 40 percent. If fixing the problem of collateral led to a similar expansion in lending and drop in interest rates, total lending for equipment could rise by as much as $675 million. That increase in equipment use could increase Bolivian GDP by as much as $200 million a year, an increase of about 2 percent. Collateral Problems Narrow the Distribution of Credit 19. While both wealth and income are distributed quite unevenly in Bolivia, real estate is distributed even more unequally. Indeed, Bolivia has one of the most concentrated patterns of land ownership in Latin America, with about 5 percent of the people owning about 95 percent of the land (Table 2). Problems with using movable property as collateral, therefore, lead the present system to distribute credit even more narrowly than the distribution of wealth. In countries with different credit-granting systems, an employed person without wealth can borrow using movable property as security: a businessman in rented quarters might borrow to buy equipment or inventory, using these goods as security for the loan; a farmer on rented or inalienable land might pledge his equipment or his crop as collateral. Present Bolivian laws and legal procedures make such transactions nearly impossible. Not surprisingly, small farmers, small businessmen, and the poor cannot borrow in the formal banking sector. Nor can they get much credit from merchants or machinery dealers because those businesses, in turn, cannot get credit to finance their movable property: inventories and accounts receivables. Instead, they must borrow in the informal or illegal sector, where rates are higher than they would be if the legal framework permitted competition, and where borrowers are often subject to extralegal collection techniques.  Table 2: Size Distribution of Loans, Deposits, Borrowers and Lenders Amount of Deposits Number of Depositors Million Comulative Comulative DEPOSITS US$ Percent Percent Number Percent Percent $200,000+ 301.4 25.8 25.8 599 0.2 0.2 $100,000 - $200,00() 131.2 11.2 37.0 947 0.3 0.5 $50,000 - $100,000 170.5 14.6 51.6 2,439 (.8 1.2 $40,000- $50,(0() 63.9 5.5 57.1 1,463 0.5 1.7 $30,000- $40,000 65.4 5.6 62.7 1,933 0.6 2.3 $20,001)- $30,000 92.0 7.9 70.6 3,855 1.2 3.5 $10,00(0- $20,000 128.1 11.( 81.5 9,220 2.9 6.3 $5,00) - $10,000 93.6 8.( 89.6 12,899 4.0 1(0.4 $1,000 - $5,000 92.7 7.9 97.5 37,93() 11.8 22.1 $500- $1,00(0 12.6 1.1 98.6 17,351 5.4 27.5 < $500 16.6 1.4 1((.( 233,529 72.5 10().( Total 1,167.8 1(XI.0 322,165 1()(1.() Amount of Loans 1/ Number of Borrowers Thousand Cumulative Cunmulative DEPOSITS US$ Percent Percent Number Percent Percent $1,500,0(0)(+ 314,366 18.0 18.0 108 (1.1 (.1 $1,0(0,(X)( - $1,500,000 84,551 4.8 22.8 78 ().1 0.2 $750,000 - $1,0)0).0()(( 94,519 5.4 28.2 134 (0.2 (1.4 $500,00) - $750,000 128,572 7.4 35.6 30)0) 1).4 ().8 $250,0(X) - $5(0,((( 229,151 13.1 48.7 752 1.() 1 7 $1(0),00) - $250,000 260,431 14.9 63.6 1,71)8 2.2 3 9 $75,0(0) - $10(1),1000 78,548 4.5 68 1 979 1.2 5.1 $50,)0 - $75,0(00 88,718 5.1 73.2 1,559 2.( 7.1 $25,000 - $50,000 141,132 8.1 81.3 4,15(0 5.3 12.4 $1(0010 - $25,(0(N) 157.466 9.() 90.3 1(),168 12 9 25.2 < $1(,0(1() 109,335 9.7 1()().() 59.056 74.8 10.() Total 1,746,791 1()().() 78,992 1()().() Source: Superiltelldenley of Banks of Bolivia, Monthlv Bulletih. I/ Including contingents.  -8 - Conclusion 20. These effects of law on the allocation and distribution of credit reflect the rational responses of borrowers and lenders to the legal structure of the country. These allocative and distributive effects would not, however, follow in an environment where the legal structure made personal property better collateral, as it does, for example, in Trinidad, Jamaica, the United States, and Germany. A different legal structure would yield lower interest rates without lowering risk to lenders. That would permit more investment in equipment at the same level of profit and, consequently, produce a higher rate of economic growth. 21. The policy question facing Bolivia revolves around devising an alternative legal structure that could meet these economic needs and yet remain at least as politically acceptable as the current structure. Setting up public institutions that lend for the purchase of movable property despite these legal problems will not solve the problem -- such institutions would simply find themselves with non-collectable loans. They would fail for precisely the same reasons that private lenders originally refused to make such loans.  - 9 - Table 3: Gini index values for concentraion of land ownership in 54 couz,ties a! Number of countries in range Range of index values Latin American countries Other non-industrial countries b/ Industrial counries cl .80 and over 12 3 3 .70to .79 5 4 4 .60to.69 0 7 4 .50 to .59 0 4 3 .40 to .50 0 3 3 Total 17 21 17 Gini values for selected Latin American countries Bolivia .94 Brazil .84 Venezuela .89 El Salvador .83 Peru .88 Uruguay .82 Guatemala .86 Dominican Republic .79 Ecuador .86 Honduras .76 Colombia .86 Nicaragua .76 Argentina .86 Panama .74 Mexico .69 a Most available data are frouitn e 1960s For three countries, irtdex values before and after land reform were available. Pre- and post-refoim valucs are, respecsely: Mexico, 0 96-0 69, Egypt, 0 81-0 67; Taiwan, 0.65.0.46 b/ Countries in Asia, North Africa, Southern Europe, plus Jamaica. c/ Less than 30 percent of labor force employed in agriculture. Source Samuel P Huntington, Political Order in Changing Societies (New Haven, Conn Yale University Press, 1968); Table 6.2, p. 382, cited an Malcolm Bale, LA Tenare in Venezuela, IBRD 1992  - 10 - III. Extralegal Repossession and Sale of Collateral 22. If Bolivia could use property other than real estate as collateral, it would open up a large number of profitable transactions between lenders and borrowers. These transactions would increase Bolivian economic efficiency, production, and incomes. Not surprisingly, Bolivians have devised ways to bolster the value of personal property as collateral, but these solutions are not legal: the postdated check (cheque postdativo), theft of collateral, police harassment, misuse of the bailment (depositario) agreement, misuse of sale with an option to repurchase (venta con pacto de retroventa), and illegal pawnshops. This chapter explains how these Bolivian laws and legal procedures criminalize these business transactions. 23. The postdated check. The borrower writes a check to the lender for the amount of the loan but does not date the check. If the borrower does not pay the lender, the lender can threaten to deposit the check. If the borrower has insufficient funds, the check bounces; the borrower who wrote the check has committed a criminal offense.3 The lender can present the returned check to the police station and have the borrower arrested. While using postdated checks to guarantee loans is a criminal offense for both borrower and lender, respondents could cite no case of a person jailed for accepting a postdated check. 24. The postdated check, Dickensian though it is in its workings, is a major form of guarantee in Bolivian lending. Half the inmates in La Paz jails are imprisoned for non-drug offenses; of these, half are imprisoned for the crime of writing checks without funds. The mission interviewed approximately 15 of these inmates. In each case, the "check without funds" had been written as the guarantee of a business transaction and in each case the prisoner was a small business operator. Those imprisoned typically lacked the family connections necessary to raise the funds necessary to cover the check. They remain in prison until the check is covered, even if that means staying imprisoned beyond the four-year maximum penalty for crimes related to the use of the check. For imprisoned women this can take on a particularly disturbing dimension, as they bring their children to the jail. 25. Abuse of the bailment (dep6sito). Under a bailment agreement, a third person is named bailee (depositario). The lender drafts the agreement requiring the borrower to name a close relative as the bailee, such as the wife, mother or child. That person is responsible for turning over the collateral in the event of nonpayment. Failure to turn over the collateral is a criminal offense and the bailee can be jailed. 26. Misuse of the sale with reservation of title (venta con reserva de propiedad). The lender has the borrower execute a sale document granting the lender ownership until the total purchase price is paid.4 If the borrower fails to repay, the lender gets a summary judgment and the property is passed Codigo de Comercio, Art. 602, 640; C6digo Penal, Art. 204-205. See also D.S. 1943, March 6, 1950 which defines checks drawn without funds as a swindle (estafa) punishable under the C6digo Penal, Art. 637. 4 The sales agreement under reservation of title does not constitute a security interest, but merely an agreement specifying the time at which ownership passes to the buyer. See Alejandro M. Garro, 1990. "The Reform and Harmonization of Personal Property Security Law in Latin America," Revista Juridica de la U.P.R., V59:1:90.  - 11 - to the lender. Sometimes the amount of the loan is a small fraction of the value of the collateral, so the debtor loses far more equity than would be the case with legal foreclosure procedures. The abuse arises from the frequent occurrence of unconscionable contracts where the loan is for only a small fraction of the value of the property. Under conventional foreclosure procedures, the borrower receives the difference between the selling price of the collateral and the loan due; in this case, the borrower does not. Such contracts are typically unenforceable because they are unconscionable, but a borrower with insufficient funds to exercise the option to repurchase may also lack the funds for a lawyer to press the case and will lose the property anyway. 27. Police harassment. Some lenders avoid judicial proceedings by requesting police investigation of a person whose payments are in arrears. Such investigations can lead to the debtor being jailed for minor infractions, apparently unrelated to the debt. Such harassment continues until the debt is serviced or the collateral returned. Legally, the police have no such function; in practice, creditors prepared to pay the police can sometimes obtain their cooperation in such efforts. 28. Forcible repossession of collateral. Some industrial countries permit harmless repossession: a creditor may seize collateral for a loan so long as there is no breach of the peace, and a debtor wronged in the process can sue for redress. In Bolivia such peaceful seizure would, strictly speaking, be theft. Nonetheless, creditors on occasion simply seize the collateral. In some cases, repossession is done harmlessly; in other cases, bands of armed men are sent to collect equipment. It is then up to the debtor to use the painfully slow legal system to recover the property if it was wrongfully seized. 29. Illegal pawnshops. Informal lenders apparently grant loans with personal property as collateral. They charge interest rates above the usury ceiling and illegally privately sell collateral. It is difficult to pass and enforce consumer protection legislation stipulating publicly quoted rates and clear procedures for privately selling collateral. The current practice ensures that the poor pay higher interest rates than they would if legal lenders competed under clear disclosure rules. 30. Extralegal solutions are socially undesirable; lenders averse to taking risks will avoid them, making interest rates and transactions costs higher than they would be otherwise. Borrowers averse to taking risks will also avoid them, because sanctions in the extralegal market expose them to far greater risks to person and property than would sanctions in a country whose laws facilitated these transactions. The fundamental issue is that private parties can contract around many defects in government performance, but they will have great difficulty contracting around defects in the government's provision of a legal framework in which to exercise the right to contract. 31. Arrest and imprisonment of debtors. A credible criminalized debt collection mechanism must actually imprison debtors who fail to pay. In Bolivia, those who used the foregoing security devices are typically jailed for check without funds, fraud, or abuse of confidence. 32. Who gets arrested? Offenders can be arrested and detained or they can be arrested and subsequently freed. Over the period 1990-1993, about 20 percent of those arrested and detained and about 40 percent of those arrested and freed were arrested in connection with an offense broadly  - 12 - associated with substituting criminal sanctions for collateral -- about 1/3 of those arrested in La Paz between 1990 and 1993 (Table 4). Table 4: Arrests, annually, with and without detention Total and arrests related to the use of checks as collateral Year 1990: 1991: 1992: 1993 (Jan-Mar): Total 19993) Year arrested arrested, arrested arrested, arrested arrested, arrested arrested, and not and not and not and not detained detained detained detained detained detained detained detained bad check 75 1215 98 942 81 1227 12 495 4145 fraud 61 295 43 248 54 170 25 72 968 abuse of confidence 11 112 16 85 10 39 8 12 293 total, collateral- 147 522 157 1275 145 1436 45 579 4306 related (est) total arrested or 541 2869 661 2654 834 2832 314 971 11676 detained for all crimes | Collateral-related 27.2% 18.2% 23.8% 48.0% 17.4% 50.7% 14.3% 59.6% 36.9% (es() as a percentage|lllllllll of total crimes l l l l l l l l l Source: Corte Superior del Distrito, Presidencia, La Paz, Bolivia. Statistics supplied to the mission, April 19, 1993 33. Who is in jail? Because different groups of offenders get jail sentences of different lengths, the number of people in jail for different crimes may differ from the number of people arrested for different crimes. Counting as collateral-related crimes only check offenses and "fraud," typically both used in post-dated check guarantees, would place the number of inmates imprisoned for collateral-related crimes at just under 20 percent of the jail population (Table 5). This represents a heavy concentration of women inmates -- over 40 percent of the women in jail are there for check and fraud offenses. 34. A larger category of "economic" crimes would embrace other collateral-related offenses -- for example, misuse of bailee and trustee agreements. About 40 percent of the La Paz jail population is imprisoned for "economic crimes" -- about 2/3 of the women and about 1/3 of the men. 35. Economic crimes represent the largest single cause of incarceration in La Paz -- more than murder, theft, narcotics, or rape. Indeed, even narrowly defined collateral-related crimes like check and fraud offenses are a more important cause of imprisonment than theft, drugs, or rape and a close tie for  - 13 - murder and assault. Between 40 percent and 60 percent of women inmates are imprisoned for collateral- related crimes. In many cases, their children live in jail with them. 36. The mission spent a day in the La Paz jails interviewing inmates of the men's and women's prison charged with economic crimes. In every case, these were business people who used post-dated checks or bailee's agreements to secure a business deal -- a truck, a liquor shipment, a tv shipment. As interpreted by Bolivian courts, those jailed for check-related crimes are not freed until they have paid the civil penalties; the civil penalty is typically equal to the amount of the check. The mission interviewed inmates who had been in jail for 5 to 7 years and who had no prospect of release. 37. In considering changes in the law that speed up repossession and sale of property used as collateral, it is important to consider not just the abstract concepts of the rights of the debtor and creditor; important as well is the reality that confronts the actual borrowers in the system. Table 5: Inmates of La Paz Prisons by Gender and by Nature of Crime, 1993 Men Women Total Crime: Number Percent Number Percent Number Percent of total of total of total Minimum Estimate of 14.0% 41.9% 18.3% Collateral-related Crimes --Check offenses 120 8.8% 79 31.2 % 199 12.3 % --Fraud 71 5.2% 27 10.7% 98 6.0% Maximum Estimate of 33.6% 60.9% 37.9% Collateral-related Crimes --Economic Crimes 460 33.6% 154 60.9% 614 37.9% Non-Economic Crimes: --Crimes against people 325 23.8% 33 13.4% 358 22.9% --Crimes against property 214 15.6% 11 4.4% 225 13.9% --Narcotics trafficking 134 9.8% 62 24.5% 196 12.9% --Sex crimes 167 12.2% 167 10.3% --Other 38 2 8% 3 1.2% 41 2.5% Total: 1368 253 1621 . Sotircc Coret Superior del Disirito, Presideiscia, La Paz, Bolivia. Statistics supplied to die missioin. April 19, 1993.  - 14 - IV. Financial Instruments and Collateral: Overview of Leal Issues 38. Assets may have great economic value but be useless in credit transactions if the law does not permit transfer of property rights in those assets. For example, mining machinery could represent excellent collateral for a loan in a legal system that permits the pledge of mining equipment, but not in a legal system that forbids it.5 Agricultural land may produce a good yield but be useless as collateral if the terms of occupancy forbid transfer of land rights or the seizure of the crop. For assets technically acceptable as collateral, such as a car or a lettuce crop, collection procedures may be so slow that the collateral loses its economic value during the collection process. 39. Such restrictive legal institutions can have major effects on credit markets. Land reform that makes land inalienable makes farmers better off by ensuring they will always own land. It makes them worse off by preventing them from borrowing against the land. Under such a land policy, other compensating measures are necessary to make it possible to seize collateral like cash crops or farn equipment, if the farmer is to receive secured credit at all. Similarly, when lengthier and more extensive legal procedures are introduced to protect the rights of debtors, compensatory policies to maintain the speed of these legal processes are necessary if those protected are to have access to credit. 40. These legal issues raise several general questions: What does the law view as property? How can individuals establish claim to property when they secure a transaction with an interest in that property? If the borrower does not perform under the contract, how does the creditor obtain compensation? If compensation is necessary, how does the creditor arrange for it, including seizure and sale of the collateral? When a court judgement is required for compensation, how does the creditor execute that judgment? Definition of Property 41. The law defines property. This paper follows the following definitions, typical in common and civil law: * Real Property -- real estate. * Fixtures -- property physically attached to but not incorporated into real estate, like carpets or most production machinery in a factory. Bolivian law exempts mining equipment from the reach of all creditors. Bolivian lenders cannot legally accept movable personal property used in mining activities as collateral. Articles I to 10, 27 and 28 of the C6digo de Mineria states that they are 'goods of public utility" (bienes de utilidad publica). Article 179 (Clauses9 and 10) of the Code of Civil Procedure, in conjunctionwith Article 449 and 456 of the Commercial Code, states that property indispensable for the operation of the mine (or any business) cannot be attached to satisfy creditors' claims. So "protected," these citizens cannot buy such equipment on credit without offering other property as a guarantee.  - 15 - * Tangible Personal Property -- inventory, equipment, farm products, or consumer goods. * Intangible Personal Property -- assignments of rights for payment of money, such as the accounts receivable, promissory notes or documents of title (a warehouse receipt, a promissory note, or a bill of lading); intangible assets of a business may include its value as an on-going concern, good will, or the right to use a trademark, copyright, or patent.6 Structuring Claims Against Property 42. Claimants against property fall into two classes: * General creditors having a general claim against a debtor's property. * Secured creditors having a security interest in a specifically designated property of the debtor. 43. A security interest7 is "a right of satisfaction" from the property -- the collateral -- to which the security interest is attached. When the collateral is sold or exchanged, the claim of the secured creditor will be paid or "satisfied" in the order of its priority among all claims against the collateral.8 A secured creditor has a security interest in the designated property of the debtor. This secured claim must be satisfied before any claim of the general creditor.9 The general creditor has a general claim against all past, present or future properties of the debtor, but has no security interest in any specific property of the debtor."' A security interest in a designated property has priority over the general claim of a general creditor. " 44. Using security interests, firms can borrow from suppliers, merchants, or banks, and can offer their inventory as security; they can borrow to buy equipment and secure their promises to pay with that 'This paper uses the term "movable property" to include tangible, intangible, and fixtures property. 7 The term security interest should be distinguished from securities. Securities are instruments that represent a general claim against all the nonexempt assets and income of the issuing agent or corporation, such as stocks, bonds, commercial paper, certificates of deposit, or bank deposits. Under U.S. concepts, a security interest is also an ownership interest in the property itself but less than full ownership. For example, a mortgagee or pledgee is a secured creditor (Bolivian Civil Code, Articles 1360, 1397, 1398, 1405, 1406, 1427, and 1428). '