A well developed financial sector, in which businesses can obtain working capital and long-term financing, improves productivity in the real economy and is crucial for helping the private sector drive economic growth.
In the developing world, the difficulty of accessing credit is among the top reasons private sector growth has been limited. According to World Bank data, more than half of private enterprises in emerging markets do not have access to credit. In the Middle East and North Africa, over 70 percent of private enterprises have no access to loans or a line of credit from the formal financial system.
Why are private enterprises unable to get credit? Among the reasons most cited is insufficient collateral.
Actually, often the problem is not the unavailability of collateral but rather the type of collateral and the inability to use valuable assets as collateral. In the developing world, 78 percent of the capital stock of a business is typically in movable assets like machinery, equipment or accounts receivable and only 22 percent is in immovable property like land and buildings. Financial institutions are reluctant to accept movable assets and heavily prefer land and real estate as collateral.
Reforming secured transactions laws and registries is one way to deal with this phenomenon and increase access to credit in the private sector, in particular the small and medium enterprise segment.
So, what does the term “secured transactions” mean and how do modern secured transactions frameworks contribute to private sector development? Secured transactions are credit transactions where a creditor grants a loan or a debt obligation to a debtor against an interest in a debtor’s movable property as collateral.
The interest in movable property is also referred to as security interest, pledge or charge.
Modern secured transactions frameworks strengthen financial systems in three ways. They provide banks with profitable lending opportunities. They diversify assets held by financial institutions as collateral, which spreads risk more efficiently. And they improve the liquidity of assets, especially short term assets such as accounts receivables.
A well-functioning secured transactions system also contributes to private sector development by significantly increasing access to credit for those firms who need it the most and decreasing the cost of credit through better terms and conditions.
While a dynamic private sector will be essential for Egypt to achieve robust and sustainable economic growth, an underdeveloped financial system still remains one of the key constraints to private sector development.
In the 2011 World Bank Doing Business rankings for getting credit, a measure of credit information sharing and legal rights of borrowers and lenders, Egypt ranked 72 out of 183 countries (a decrease from 2010). Specifically, Egypt scored only three out of 10 points on the strength of legal rights index, which measures the effectiveness of regulations on non-possessory security interests in movable property.
While domestic banks have not been significantly affected by the global financial crisis, the growth of credit in the private sector remains constrained by subdued economic activity.
The loan-to-deposit ratio of banks remains rather low, hovering around 50 percent. Currently, collateralized lending in Egypt is underdeveloped with immovable collateral primarily being used to secure lending.
However, businesses cannot utilize most of their movable assets, including equipment, inventory and accounts receivable, as collateral to obtain financing. This is primarily due to a weak legal framework relating to collateralized lending and the absence of a movable collateral registry that effectively supports proprietary rights of lenders.
Secured lending reform can greatly increase private sector access to credit in Egypt. The reform should include both the enactment of a law on secured transactions and development of a movable collateral registry to publicize lenders’ security interests in movable assets and to establish their priority in these assets.
These steps, taken together, can increase the availability of credit, reduce the cost of credit, improve financial system stability and expand the types of collateral that financial institutions will accept as security.
Such reforms will lead to increased availability of short- and medium-term credit to small- and medium-sized enterprises in Egypt and will contribute to private sector development and growth.
Cherine El Sayed is a project officer at the International Finance Corporation (IFC) and has over 15 years experience managing development projects in the Middle East and North Africa. This article was written exclusively for Daily News Egypt.
The findings, interpretations and conclusions expressed in this article are the authors’ own and do not necessarily reflect the views of IFC, a member of the World Bank Group.
