FM302: Tutorial Questions Topic: Secured

Transactions in the Pacic Region (Week 11)

October 18, 2020

TO ANSWER THE QUESTIONS BELOW, REFER TO THE ARTICLES IN

THE KEY READINGS AND LECTURE NOTES ON MOODLE OF WEEK 10

1. Dene movable assets

Movable Assets: means any and all present and future movable assets,
including but not limited to, equipment machinery, installations, inventory
cars and other rolling stock to which each Pledger presently holds title of
ownership or may acquire title of ownership in the future. Examples of
these assets are machinery, tools, inventory, crops, accounts receivable,
future earnings, land rents, royalties, vehicles, vessels, and airplanes.

2. Discuss constraints on accessing credit?

(a) Problems using land as collateral. To date, lenders have gener-

ally required land or land leases as security for loans. However, this
has led to many problems arising from communal and traditional
forms of land holdings. Seizure after default is especially dicult
and can take years. As a result, the nonperforming loan ratio for
lending secured by land is in the double digits in many countries in
the region.

(b) Uncertainty of legal interests. In countries where it was possible

to pledge limited forms of movable property, the systems of registra-
tions were inadequate to assure lenders that borrowers' assets had not
been pledged as security for another loan and that, if they registered
a security interest in collateral, it had priority.

(c) High legal costs. The costs involved in obtaining pledges of assets
were high and required lawyers to draw up loan documents tailored
to a specic borrower with the assets being pledged as security. Since
each transaction was a one-o  event, legal fees and the associated
procedures eectively excluded all but the largest borrowers.

(d) Weak legal systems. Many laws governing nancial transactions

were outdated. The inadequacy or nonexistence of bankruptcy legis-
lation could negate lenders' rights to seize assets pledged as collateral
if a borrower declared bankruptcy.

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 (e) Poor enforcement mechanisms. Failure to repay required lenders
to obtain court authorization and use court ocials to seize the
pledged assets. Court systems are underfunded and enforcing judg-
ments was dicult and sometimes impossible. In some countries, it
could take months or years to execute a court award, during which
time the assets could deteriorate or disappear altogether. Expedited
procedures allowing rapid collection and disposal of secured assets
were absent before reform.

(f ) Weak nancial regulation and supervision. Banks are under-

capitalized in some Pacic island economies. Bank supervisory ca-
pacity is often not strong, although the Pacic region's foreign banks
are supervised from the countries in which they are based.

(g) Government-directed credit. Development banks often lend to

favored sectors of the economyor politically connected borrowers
at articially low interest rates. Development banks are unlikely to
lend to highly productive sectors. Governments are frequently the
biggest borrowers.

(h) Lack of credit information. There is very little credit information

on potential borrowers. In many countries, bank privacy laws pre-
vent information exchange. Credit bureaus can help the poor build
credit histories, turning favorable credit reports into a substitute for
collateral.

3. Explain the meaning of secured transactions?

A deal in which a buyer or borrower (called a debtor) guarantees payment
of an obligation by giving a security interest in property to the seller or
lender (called a secured party). The property in which a security interest
exists is called collateral. If the buyer or borrower breaches the agreement
to pay, the seller or lender may take possession of the collateral or anything
else specied by the security agreement. (https://www.law.cornell.edu/wex/secured_transaction
or https://www.law.cornell.edu/wex/secured_transactions).

Typically, the secured transactions imply the contracts, under which the
fulllment of the borrower's obligations is guaranteed with the movable
(assets); for example, the lender and the borrower may enter to the loan
agreement and that agreement may be secured by the pledge of equip-
ment. That deal is a simple example of secured transaction.

4. Discuss ways in which secured transaction reforms reduces con-

straints on access to credit.
Secured transaction framework has many advantages because it reduces
risks associated with securing loans with collateral. In particular, it pro-
vides more options for medium to smaller rms to obtain nancing, with
direct and positive ow-on eects for the economy. Because these reforms
reduce the risk of lending, they mobilize the assets of potential borrowers,

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 promote the development of new nancial products, and result in nancial
market development throughout the region.

Since a substantial portion of enterprises' assets consists of movable prop-

erty, a well-functioning secured transactions framework improves their
ability to borrow. Economic data suggests that countries that have mod-
ernized their secured transactions laws have experienced signicant in-
creases in credit access for the private sector, with a lower percentage of
nonperforming loans and lower credit cost. This results in greater invest-
ment and growth. Countries with reformed legal frameworks for secured
transactions support employment, productivity and economic growth. This
is because borrowers can use a greater proportion of their assets' value to
secure loans, in essence leveraging their ability to borrow.

Also, if businesses or persons pledge their assets as collateral, which can

be seized after a default, they have much more incentive to act prudently
and to not conceal adverse information from lenders.

5. Why is secured transaction reform necessary?

(a) Secured transactions reforms will improve nancial intermediation
and deepen nancial markets.

(b) Secured transactions reforms reduce the security aspect of risks to

lenders, increase the number of eligible borrowers, and increase the
range of borrowing instruments for accessing credit. These benets
can only be realized, however, if the legal framework enables the use
of movable assets as collateral.

(c) In countries where secured transactions reforms have taken place and
been eectively implemented, a far broader range of ways exists to
nance businesses.

i. Some examples of the types of nance that well-functioning law

permits: supply chain nancing; the nancing of seed and fertil-
izer secured by the proceeds of sale of future crops; cattle nanc-
ing; the nancing of inventories; nancing against future receipts
from a contract with the government or a large rm; and loans
against future land lease payments or royalty payments.

(d) This framework provides substantial benets to businesses, particu-

larly small and medium enterprises.

6. What is the "nancial paradox" in the context of secured trans-

actions and how does secured transaction reform solves this
paradox?
Financial paradox refers to the collateral gap, i.e. the borrower with the
movables which brings income to the borrower is unable to get the loan,
while the borrower with the real estate is able to get the loan, but that

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 real estate does not participate in the business income generation. There-
fore, once a secured transactions reform is successfully implemented, more
small businesses will have access to nance.

7. Why ecient enforcement procedures are vital (in secured trans-

action)?
Ecient enforcement procedures are vital. If any secured creditor faces
the delays and inecient sale of the movable, that creditor will no longer
view the movables as the reliable security. For example, if the creditor
took two tons of vegetables as a collateral, it can't wait long in order to
sell it in case of default. That said, it is really important the movables
of the defaulted borrowers (collateral providers) should be sold in a quick
and eective way; for such purposes, the creditors should have the oppor-
tunities to sell the movables or to take them into ownership in the manner,
as stated in the draft law.

The specic procedures should be applied if the movables are accounts

receivables or deposit sums. The secured creditors should be allowed to
sell the security themselves with the market price, if the movables are in
possession of the creditor. The objection of the borrower should not stop
the sale procedures, provided that the secured creditor should be ready to
cover the damage, caused to the debtor and/or collateral provider due to
the breaches in the sale procedures.

The secured transactions law must set out a workable system for enforcing
lenders' rights, including seizure and sale after default. The law's success
depends upon creditors' abilities to speedily enforce their rights. Upon
default, the creditor must have the right to take possession or control of
the collateral, and sell or otherwise eciently dispose of it. A sale may be
through public or private facilities.

8. SOME ADDITIONAL NOTES:

There are some common misconceptions regarding secured transactions

(a) Unrealistic expectations. It is a mistake to consider this reform

a panacea for immediately improving access to nance. The reforms
take time to be understood, and for lenders to gain condence in
the new framework. The reforms will not lead immediately to more
credit, or to an upsurge in growth. It took New Zealand nearly a
decade to fully implement secured transactions reform.

(b) The need to register security interests. Even some bankers do

not understand that under a reformed system, security interests must
be registered, including those that were secured under the previous
unreformed system. Failure to register the interest will leave the
holder only with an equitable interest, which will always rank behind
any registered or legal interest.

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(c) Borrowers register assets. A common misconception among those
who do not fully understand the framework is that borrowers must
register their assets to qualify for loans. However, it is lenders who
register a security interest in the assets of borrowers. There is no
mechanism for borrowers to register their assets. Borrowers can only
choose to declare movable assets that can be pledged as collateral.