Op-ed: Lending Reforms can Boost Pacific Growth
By Peter Dirou, PSDI Senior Financial Sector Expert, and Terry Reid, PSDI Business Law Reform Expert
Small and medium-sized enterprises in Pacific island states often find it difficult to get credit. Financial institutions in the region tend to view lending to smaller businesses as risky because, without land and buildings as collateral, the likelihood of repayment in case of default can appear low.
This situation is starting to change. Seven Pacific island countries have instituted a system to help lenders accept 'movable' property, such as vehicles, machinery or even accounts receivable, as loan collateral, and more are following in their wake.
Increasing access to finance will benefit business and promote growth. Finance enables entrepreneurs to start new businesses and expand existing ones. Businesses often need credit to buy equipment and for working capital to hold inventory and extend trade credit to their customers. Many farmers need credit to buy the seeds, fertilizer and feed needed to grow crops and raise livestock. This finance and credit may come from banks, finance companies or sellers of equipment, inventory, supplies and fuel. Without it, business opportunities can go to waste to the detriment of economic growth.
In January, Papua New Guinea became the seventh Pacific island economy to establish a framework for secured transactions. PNG's new web-based registry, within the context of the Personal Property Security Act passed in 2011, will allow lenders to safely and easily accept movable property as collateral and repossess and sell such assets if a borrower defaults. For lenders, this will reduce the risk of extending loans and increase the likelihood of being repaid.
For borrowers, the new arrangement will make it easier to access credit. For PNG, the framework will promote economic development by extending access to finance on commercial terms as has been the case in the Federated States of Micronesia, Marshall Islands, Palau, Solomon Islands, Tonga and Vanuatu.
Secured transaction reforms in each of these countries have been supported by the Asian Development Bank's Pacific Private Sector Development Initiative, a technical assistance facility supported by the Australian and New Zealand governments that addresses constraints to private-sector development. While lenders could already repossess movable assets offered as collateral and sell them to recover outstanding amounts before these reforms, this typically required the involvement of lawyers and the courts, making for costs and risks unacceptable to most Pacific lenders.
Under a secured transactions framework, lenders may seize pledged assets without a court order. Additionally, through online registries, lenders can quickly verify that the assets a borrower is offering as security have not already been pledged, adding another level of security. In the past, uncertainty on this point was often cited by banks as a major disincentive against lending because it was not uncommon for borrowers to pledge the same collateral to several parties.
PNG, along with Samoa, Fiji and East Timor, which are also in the process of instituting secured transaction frameworks, drew lessons from the seven Pacific island countries that have already enacted the reform. Lenders were approached early and advice provided to help them understand and apply the new framework.
So far, all the countries that have implemented the reform have benefited from increased lending, particularly to smaller businesses, the poor and women, who in the Pacific can be remarkably entrepreneurial.
As the new framework for lending allows borrowers to use movable assets as security for borrowing, it unlocks large amount of "dead capital" that was previously not usable as collateral for loans. Moreover, the reform promotes increased finance based on commercial lending that does not require government intervention or loan guarantees.
Another benefit of secured transactions, stemming from the convenience and accessibility of electronic registries, is that it encourages non-bank suppliers, such as equipment sellers, motor vehicle dealers, those who sell inventory to businesses and suppliers of agricultural inputs to extend credit to their customers secured against the output it is used to produce. For example, in Tonga, loans to rejuvenate and extend vanilla plantations are being secured against a pledge of future crops.
Establishing a secured transaction framework does not instantly expand access to credit. Lenders and suppliers need assistance to use the systems and encouragement to establish new loan products and credit services. Potential borrowers, especially SMEs, need to be made aware of how such frameworks can improve their access to credit. But in time, as much of the Pacific is discovering, these reforms expand and strengthen the business environment, spurring productivity, efficiency and poverty reduction.
This op-ed was first published in Nikkei Asian Review on 6 May 2016.