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Protecting lenders to benefit borrowers

A new IDB study finds that enforcing creditor rights benefits not only lenders but also the small entrepreneurs that borrow from them. In their study entitled Bank Credit to Small and Medium-Sized Enterprises, researchers Arturo Galindo and Alejandro Micco report that smaller firms, in particular, have greater access to bank credit in countries where the creditor rights of banks are protected and enforced, in part because improving contract enforcement and bankruptcy procedures reduces the gap in credit access between small and large firms. The study presents evidence that reforms, to increase creditor protection, also can increase the size of financial markets and promote economic growth, while having a positive effect on credit allocation and income distribution. Creditor protection, suggest Galindo and Micco, could even ease negative shocks in the economy and credit market volatility, since credit reduction will depend on the regulations.

Laws in most Latin American countries do not protect creditor rights, or if they do, there is no proper enforcement, according to the study. “A critical aspect of creditor rights has to do with the right to repossess collateral in case of default,” Galindo and Micco explain. “If lenders feel that regulations do not protect them and that their chances of taking control of the assets pledged as collateral are uncertain, they are likely to prefer not to extend credit because the risk of bankruptcy will reduce their expected earnings.”

The study focus that better legal protection for creditors enhances their ability to operate in risky environments and increases the depth of capital markets. Thus, creditor protection has a greater impact on smaller firms because they are the ones most affected when stronger credit markets shrink. Lower protection reduces the possibility of seizing collateral at low cost and reduces the expected return to creditors in case of default.



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