WORLD ECONOMIC FORUM

HONG KONG

March 2005

PROPOSAL TO IMPROVE BANKABLE PROPERTY RIGHTS

PROPOSAL CONCEPT:

In developing countries, and particularly in Latin American, the link between owning property and access to credit is broken. The economic affects of this are difficult to overstate. Lending risks are higher in countries that have weak legal and institutional frameworks for property rights. As a result, small and medium-sized companies do not have access to credit. The whole structure of interest rates is higher and therefore so is the country’s cost of capital. And investors, both domestic and international, are hesitant to invest in potentially productive projects in countries where interest rates are high and property rights are weak.

While there is a generalized understanding of the problem governments have been reluctant to make the necessary reforms. One reason for this reluctance is that politically sensitive issues related to the ownership and forfeiture of property lie at the heart of the reform process. Another is that there is little agreement on the characteristics of a good, functioning system. While the political sensitivities of property reform cannot be eliminated, they can be reduced if there is an agreement on what are the characteristics a well-functioning system. The proposal is to break the policy deadlock by developing a set of principles or standards that a country’s property rights framework should embody in order to ensure the judicial security of property ownership and to promote access to credit. Once principles are agreed, one important barrier to reform is removed and the debate moves from fractious differences of opinion on what is broken to a more collaborative effort focused on how to fix the problem.

Principles serve many purposes. They can be used to measure how each part of the chain is functioning, therefore informing officials and development agencies on the priorities for reform. The results of diagnostic studies made by applying the principles provide valuable information to potential investors. And the principles can easily be transformed into a numerical scoring system to measure one country against another, thereby creating a pressure in favor of reform.

THE BENEFITS:

  • Better access to credit. If homes and factories can be easily and effectively pledged to support the granting of credit, more homeowners and businesses will have access to credit.
  • Lower cost of capital. A loan backed by the security of a house, factory or building is a more secure loan. Since most loans require collateral, making the collateral system work can reduce the whole structure of interest rates in a country.
  • Safer, sounder banking systems. When banks can collect their loans, there are fewer bank failures.
  • Greater home ownership. Obviously.
  • Improved mobility of labor. If there is certainty of ownership, people are confident to buy a house from the seller. More housing transactions occur and the chain of being born, raised and dieing in the same house, prevalent in many under-developed countries, can be broken.
  • Lower transactions costs. Simplified, automated registry systems cost less to administer and generate higher revenues.
  • Increased property tax revenues. The same records that are required to demonstrate who owns what serve as an indication of where to send the property tax bill. Property taxes are arguably superior to sales-based taxes, which tend to be regressive, and to income taxes, which are difficult to collect.
  • Better urban and regional planning. If you know where the homes are and where the factories are, you know where to run the electricity wires and where to put the water and sewerage pipes.

OBSTACLES TO DATE:

  • Notaries and lawyers fear simplified procedures. It is more difficult to charge high fees for services that the public perceives as simple to perform.
  • Acceptance of the status quo. If you live with something long enough, you begin to regard it as normal. In many developing countries, property rights have never worked well, so there is not a lot of pressure for change.
  • Until recently the financial reform agenda was dominated by banking reform. When banking crisis threatened in the 1990s, most countries substantially reformed their banking legislation. These reforms crowded out secured transactions reform during the 1990s.
  • Procedural law and practices is hard to change. Legal procedures in many countries make it difficult to enforce mortgage guarantees. These procedures often permit the filing of repeated frivolous challenges to a legitimate foreclosure.
  • Lack of effective lobbying by stakeholders. Although both lenders and borrowers stand to gain substantially from secured transaction reform, they have not lobbied hard to get it.
  • Practices in developmental agencies. Large developmental agencies are driven by their loan activities. Technical assistance work usually must be tied to the development of specific loans or the assistance must be specifically requested by the countries. However, countries have been reluctant to call for the development of standards in the politically sensitive are of property rights reform.

RECOMMENDED NEXT STEPS

1.Create a principles- or standards-setting group. Creating the right group is crucial. The group must be knowledgeable and impartial. Also the points of view of different groups of countries need to be represented. The group also needs to be able to work expeditiously. (It took ten years for BIS to develop the first bank supervision principles and it is taking even longer to produce Basle II.)

Candidates for inclusion in the group include: Development banks, the IMF, commercial banks, finance ministries, central banks, think tanks like the Center for the Economic Analysis of Law, the Group of 30, the Institute for International Finance, the National Law Center, the Institute for Liberty and Democracy, registrar authorities, legal scholars, realtors’ associations, title insurance companies, and property developers.

2.Draft the principles and support material. The principles, numbering between ten and twenty, would each have a set of questions imbedded in them that would guide the analyst in the determination of whether a specific principle has been complied with or not. There would, for example, be a principle related to the transparency of information. Questions like “Is the property registry computerized or does it depend on physical documents and images?” and “Can an owner check the status of his/her property on-line without hiring a lawyer?” would help to reveal the degree to which the principle of transparency is met.

To maximize their utility of the principles as a tool, it is helpful to have, in additions to the questions imbedded in the principles, a manual that would guide the analyst in the administration of the diagnoses. The easier it is to administer the diagnostic tool, the more frequently it will be done and the easier it will be to replicate results and to follow the progress of the reform process.

3.Disseminate the results. To create a shared interest in the application of the principles of property reform, it will be necessary to put on a road show. Seminars can be held in selected countries explaining their importance and demonstration their application. Articles placed in journals and newspapers, etc.

4.Apply the principles to selected countries that show an early interest in reform. Any volunteers?