Securing Small Loans: The Transaction Costs of Taking Collateral

This report presents the findings of the recent research project carried out by four (Germany, the Netherlands, Switzerland and the ILO) members of the Donors' Working Group on Financial Sector Development (DWFSD), on "Transaction Costs in Collateralization."

Based on the three (Bolivia, India and Tanzania) countries surveyed, the paper:

• Analyzes lenders' transaction costs in collateralization, whether related to conventional or to alternative instruments;
• Shows how transaction costs can be compressed either through changes in the regulatory environment, changes in bank procedures and practices, improvements in property registry management and most importantly, adoption of collateral substitutes.

Findings reveal that:

• Only few banks have so far adopted collateral substitutes;
• Banks are not generally well informed about the costs and benefits of different forms of collateral;
• There is a need to promote awareness about collateral substitutes among banks as a strategy to improve the access of small producers to capital;
• Regardless of innovations in collateral-taking, there is also a need to increase the efficiency of the traditional collateralization process.

It offers recommendations for the institutions that are directly involved in securing loans or whose regulatory activities have a bearing on the collateralization process and concludes that:

• Their wider use will contribute to better access of small and micro-enterprises to credit and other financial services and, as a result, to a larger volume of profitable and secure transactions taking place at the 'smaller end' of the financial market;
• Traditional collateralization can be made more efficient by improving reforms in the regulatory framework and by increasing administrative efficiency of those state institutions involved in collateralization especially, with the registration and repossession processes.