Moving Secured Transaction Reform Ahead

September 2012

Steve Kay: I'm Steve Kay, senior economist and coordinator of the Atlanta Fed's Americas Center, and I'm talking to Ambassador Charles Shapiro of the Institute of the Americas and Professor Boris Kozolchyk, the Evo Deconcini Professor of Law at the University of Arizona and the Director of the National Law Center. We are going to discuss secured transaction reform.

Thanks for joining us today.

Charles Shapiro: It's a pleasure being here, Steve. Thanks for having us.

Boris Kozolchyk: Thank you very much.

Kay: My first question is, what is secured transaction reform, and why is it important?

Shapiro: Secured transaction reform is a change to law that makes it easier for small and medium-sized businesses to get loans from banks. It's important because now—particularly in Latin America and the Caribbean, but also in Africa and Asia—small businesses cannot get loans from banks and are going to loan sharks, where they pay exorbitantly high rates of interest. This allows small businesses to get loans from banks, not from loan sharks, at rates of interest that are never going to be as good as the large businesses but are going to be much lower than what they are paying now.

Kozolchyk: I think that, in addition to that, it is a way of doing business that is much healthier for the economy as a whole because, contrary to some form of lending that unfortunately became popularized in the last decade or so in the United States and other countries—subprime lending, in which the collateral itself was not a central piece of the loan—the collateral in secured lending is at the essence. It is the type of collateral that by itself could repay the loan. It is asset-based lending. These are business assets that have the capability of repaying the loan. Therefore, from an overall macroeconomic standpoint, it is a much healthier form of lending than one in which the collateral is hypothetical, or simulated, or whatever. That's why it has been so successful in the United States among other places.

Shapiro: Steve, I'm going to add one more point and that is—because most people don't understand this—and that is that every business in the world, large and small, black market or formal business borrows money to operate. It's a hardware store; it's Home Depot. They borrow money to operate.

Kay: What can governments do to encourage secured transaction reform? What kind of legal and institutional infrastructure is necessary?

Shapiro: I'm going to answer first, but Boris is the expert on this, because I'm going to give the simple version, and he can give a much more detailed version. You've got to change the law. It comes down to that—you've got to change the law. So that means that you've got to change laws that can be at one place … in another country might be at another place, but you've got to change laws so that people can use assets other than real estate as collateral for a loan, it has to be—and this starts getting complicated—it has to have a registry of those collaterals that have been used to secure loans. And there has to be a way so that courts operate fairly quickly, that if somebody defaults on the loan, the lender can take possession of the collateral.

Kozolchyk: I would add that everything as Charles just said is the case, but there is something to make governments aware of in terms of the change. It's not only the need to change certain key laws—like the laws of secured transactions, the law of bankruptcy—because unless you have a bankruptcy law that is enforceable, what you gain by having secured transactions on one side, you lose by people going de facto bankrupt all the time and not being able to collect on it so you need a law of secured transactions. You need some specialized law for collateral that might be very helpful to very many economies nowadays in which agricultural products are so much a part of their exports, etc., which might be a law of, say, warehouse receipts that we are talking about, whether it's paper-based or electronic. You need obviously to have electronic commerce laws that tell you that the same thing that you could do in writing, you could do by an electronic message—that has to be part of it as well. And in addition to these laws, which are official enactments, you need to be changing the business attitudes, the culture of how to do business. This is an institution that cannot exist without accounting standards, even though reduced to a level that small business people can actually understand and produce each day so that the bank can see that there is a source of repayment and an ability to repay. So you need to be looking at accounting standards.

You need to be looking at a culture of paying taxes and disclosure, because our principal problem, for example, when we started asking the people in the central market and Tegucigalpa, Honduras—you are paying 300 percent a year for these loans, the usurious loans—for heaven's sake, you are going to have access to 7.5 to 8 percent interest loans, let the people know that are going to lend you how much you earn every week and what is your cost and all that. Nobody wanted to do it. Why? Because nobody pays taxes. So there is a need for that kind of a change in culture. It brings about a number of very significant changes in the culture of doing business that could really help that country but at this time do not exist. So it's a change in the law, a change in the legal culture, and business culture.

Kay: So what countries in Latin America have instituted secured transaction reform? What's been their experience with it?

Shapiro: First of all, a number of countries are working on it. The country that has had the best experience is Honduras, because they have enacted it completely and with a good law that works well and a good registry that works well. There are other countries that have had less success because either the law has had some problems in it or they've tried to do this with a manual registry, where you have to go to the capital and record each one, one at a time, and so there are a number of issues. Honduras has completed it. Colombia will probably be the next. Guatemala, El Salvador, Peru, Jamaica are busy working on it and they are at various stages. Mexico has got a version that works OK that could work better. They've got a terrific registry; their law has got some problems in it.

Kozolchyk: It's now before Congress in Mexico, so Mexico is likely to enact a better law. Mexico is the first one that we started working with back in the early '90s, and to this day it has been off-and-on, but we are hopeful now that they will finally correct the law. The registry, as Charles said, is one of the best in the world, but you still have some problems with the law. The law is that which tells you what is a security interest, who is a secured creditor, who is a secured debtor, what is a perfection of a security interest, when can you enforce it, who has got priority. Without a registry that follows these rules—but the rules have to be there—then it cannot work. So Mexico has improved considerably where it is. It's a system and in some areas it is working well, but the law is still deficient.

Honduras is the model. Now, not only for this, but developing countries around the world, the World Bank uses it for, say, nonsocialist countries to do the registries and their law. So Honduras has been the model. Guatemala has a pretty good law but they have had a deficient registry. Peru has both a deficient law and a deficient registry, so they are in the process of fixing it now. El Salvador is likely to do that. They are sending their people here because they want to finish. It's in Congress now. Peru the same—it's in Congress.

Kay: What can the governments of the industrialized countries or multilateral financial institutions like the World Bank or the Inter-American Development Bank do to encourage secured transaction reform?

Shapiro: Your question answers your question, in some ways, and that is that they have to encourage it. Government leaders all over the developing world complain that small businesses can't get loans from banks. The answer ought to be, whether it's from a diplomat, from a developed world country, or it's from the Inter-American Development Bank [IDB] in the case of Latin America and the Caribbean, or it's the World Bank, which operates all over the world, ought to be...

Kozolchyk: ...or maybe CAF…

Shapiro: ...the Corporacion Andina de Fomento—should be to them, "You need you." See, that's the key point. It's not something that outsiders can do for a country; it's something that a country has to do itself. Obviously, only a country can change its own laws. Now, there are people who are experts from outside who can advise them how to do it. The World Bank has a unit that is dedicated to doing that. The IDB works at that quite hard. Dr. Kozolchyk, that's what he does, among other things, is help countries. He's the surgeon, the expert who can go in and knows how to take model laws, work with local lawyers, legal experts, [on] what changes need to be made to graft that model law to the legal system of a particular country.

Kozolchyk: And governments, once they realize that this is not a change in—let us call it "official law" or the "law of the books," but a change in the way of doing business in a way in which it is very good for the government to have—take the case of tax payments etc.—but more than that transparency. See, if you are trying to inculcate transparency of rights in a society, how could you do it in this area if you are going to say Mexico started doing it first? There are all sorts of rights that can be enforced without having to be recorded. Transparency, which is so crucial in banking transactions, generally gets a huge boost by having a law that says, "Everybody who wants to have a right enforced in this area has to have that right recorded." I remember when I was trying to tease out of the Guatemalan so-called trial experts, how would they stop a procedure of recovering these things? And the guy kept on telling me, the professor of civil procedure at the University of Guatemala, kept on saying, "I can stop at any time because I know a procedure whereby I get a court to issue an order to sequester the very same thing and then I could do it in two days." So what that told me was that if we get a law that says any court before it could take anything, has to record its attachment procedure with everybody else, then everybody knows about it, then that negates this special access that this attorney has to the court, etc. So that's transparency. So it inculcates transparency. And it also inculcates a much better way of doing business because of this idea of using the collateral to liquidate. It imposes upon the merchant the responsibility of monitoring better the collateral. The creditor has to be there and sample and see what is going on with the accounts, or the collateral, etc. So it is a fundamental change in terms of governance as well, particularly commercial and financial governance. It places an emphasis on sound and, sometimes, best practices.

Shapiro: I want to thank the Atlanta Federal Reserve, which is hosting this conference, which starts tonight here at the Atlanta Federal Reserve Bank—the Americas Center is doing that. We've brought together—you asked earlier, what can developmental banks do?—we've brought together the development banks, the representatives of a dozen countries, commercial banks, legal experts, and academics so that we all can work on this together, share ideas from country to country, and hopefully get the sort of synergy where country "X" can learn from what went well for country "Y," and also what were some of the problems that country "Y" encountered. How do you convince people who oppose [this change] to support [it]? How do you convince people this is a good idea, that changing what they learned in law school 20 years ago is a good idea? And that is what all of this is about.

Kay: You mentioned that Honduras was one of the first countries to adopt secured transaction reform. What have you learned from Honduras?

Kozolchyk: Something very important, and that is that this credit is not only good to allow small businesses and medium-sized businesses access to a much cheaper type of credit than they would otherwise get through the usurers, but it is also proving in Honduras to be very helpful to microbusinesses, microborrowers, graduating them to the level of a small business. This idea that the only way in which microbusinesses can borrow is by the Grameen model, or the family-type of a loan, is totally baseless once you allow them to have access. See, when we—Charles was asking me for the statistics on how that registry worked, first we got a very bad set of statistics because...—so when we started getting the real statistics out of that registry, one thing that really caught my eye was the number of microborrowers that were taking in things that were usually not used as collateral. The photographer who needs to buy a Xerox machine for this or that or the other thing, the lawyer who suddenly has a few accounts—that is to say, invoices—that he is sending out to the clients that haven't paid him that is given suddenly a loan because an account receivable is like kind of a collateral. And it could be anybody, distributing newspapers, whatever, as long as he has got an account and a reliable account, then it could be collateral, and Honduras is showing that. The figures of recordings are just out of the roof. I never thought that... This is not how a commercial country...I don't know if... but my God, Tegucigalpa, and the number of... I thought maybe San Pedro Sula would have all that... Tegucigalpa...Well, Charles, subbed the figures. I sent him the figures of a provincial registry and said, "That's nothing." I said, "Well, look at the ones in Tegucigalpa"—thousands of thousands. So it helps that the recording fee is 15 dollars. See, in Guatemala the recording is much higher. The fee, because they see it as a cash cow and, therefore, there is not that much recording—sometimes thousands of dollars to record, but in Honduras anything is 15 dollars.

And another thing that Honduras did very good is that instead of requiring all sorts of formalities to become a debtor and be recorded—your identity card, that's the only thing you need. With your identity card, the registry can register you as a secured debtor. Forget about all this creating a company and the notary and this and that. You can just go with your identity card. So I think that's what's been part of that good example that Honduras has provided.

Shapiro: We in the United States think in terms of giving assistance to another country. What's key about this is a country changing its own laws with technical assistance from development banks, but changing its own laws to assist itself. This makes it easier for microbusinesses to become small businesses and small businesses to grow into medium-sized businesses, and as they do so, they are going to create employment, they are going to help the economy in their countries grow. And so this is really, really key. It's a way for people to help themselves.

Kay: Thank you both for joining me today.

Kozolchyk: Our pleasure. Thank you so much.

Shapiro: It's a pleasure, Steve. Thank you.

Kay: Again, we've been speaking today with Ambassador Charles Shapiro and Professor Boris Kozolchyk. This concludes our EconSouth Now podcast on secured transaction reform.

For more information, please see the third-quarter 2012 edition of EconSouth magazine, where you'll find our article on secured transaction reform. On our website,, you can read the full article about this topic or subscribe to EconSouth in print.

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