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size of the informal sector.
In Sri Lanka credit applications are rejected mostly due to insufficient collateral. Only the largest and best connected businesses can obtain unsecured loans. The rest have to offer collateral. Many of the lending institutions such as banks in most parts of the world request for collateral when considering credit. There are three types of assets – ‘fixed’, ‘movable’ and ‘reputational’.
Fixed assets
In Sri Lanka access to secured bank lending is mainly possible by offering fixed assets such as Land and Buildings as collateral. Prior to disbursement of credit, the ownership of the asset taken as collateral is verified by the lending institution through the Land Registry where such information is available.
The asset is taken as collateral only when the lending institution is satisfied beyond doubt that it belongs to the prospective borrower and not to any other lender who may have lent against if by taking same as collateral. The availability of a facility such as the land registry gives comfort to the lender and therefore preference is always given for fixed assets when collateral is considered for credit facilities.
Movable assets
Most financial institutions are reluctant to accept movable property such as machinery, equipment, receivables, household objects etc as collateral. A sound legal and institutional infrastructure is critical to maximise the economic potential of movable assets, so that they can be used as collateral.
There is no register available to give the lender the same type of comfort as a Land Registry to ascertain the ownership of the asset. Therefore the risk is there of a movable asset being offered to two or more lending institutions by the same borrower as collateral. This is the principal reason behind lending institutions giving preference for fixed assets when collateral is considered.
Reputational collateral
This type of collateral is built on the borrower’s reputation for recognising and honouring his/her financial obligations and responsibilities in a timely manner. Payments on utilities such as water, electricity, telephone, insurance etc are considered. If the borrower has been paying his monthly bills on water, electricity, telephone and insurance promptly, he is regarded as a responsible person and therefore eligible for small advances. Reputational collateral provides access to small credit to all those who do not have any assets to offer as collateral for credit facilities.
Movable Assets Register or Secured Transactions Register (STR)
The primary problem faced by the SMEs is the non-availability of assets acceptable to lenders as collateral for credit. Access to secured bank lending is mainly possible by offering fixed assets. Sri Lanka, until August 2011 did not have a proper legal framework or mechanism to streamline the registration of security rights over movable assets which made it difficult for lenders to accept movable property as valued and viable collateral for advances.
A well functioning secured transaction system will assist businesses to use their movable assets as security to generate capital – such as a farmer pledging his cows as collateral for a tractor loan or the cash flow from customer sales as collateral for business expansion. The Secured Transactions Register was formed by Act 49 of 2009 to overcome such constraints. CRIB was empowered to maintain the register by registering notices of security interests of movable assets taken in as collateral by lending institutions similar to the Land Registry.
The registry as its first phase gives access only to the licensed lending institutions who are also members of CRIB. In the second phase access to the registry will be extended to all other financial institutions who lend against movable assets. Interestingly the Movable Assets Register (STR) benefits both the lenders and borrowers. Borrowers such as SMEs now have a better opportunity to improve their ventures through easy access to credit and lenders have easy access to transparent information on the collateral offered by Borrowers. The STR is therefore the ideal framework to increase access to finance and promote private sector growth in the country. The STR will help to widen the financial services market substantially by making credit available to a far wider range of borrowers. It will also promote various economic activities in the country especially in equipment, receivables, agricultural and consumer financing and reduce the dependency of lending institutions on immovable’s as security for credit facilities.
When a borrower applies for credit from a Lending Institution by offering a movable asset as collateral, the lender will register the security interest over this particular movable asset in the Secured Transactions Register. A security interest is the right of a lender to seize and dispose a property (collateral) belonging to the borrower in the event the borrower fails to perform its primary obligation.
A security interest can be created only when the borrower has an alienable right in the collateral. The most common right here is ownership of or title to the collateral, but it may alternatively be a leasehold right or a license or right to use the collateral. Lenders can now avoid the risk that they faced earlier if the same borrower approaches another lender with the same asset as collateral. The register will only provide notice of the existence of a relationship between a lender and a borrower over a particular movable collateral. It will also assist to determine the priority of claims made by lenders over the same collateral in the event of liquidation.
Effective secured transaction laws are a crucial component of a healthy financial market and business climate. They make it possible for lending institutions to provide the working capital to entrepreneurs so that they could in turn expand their business activities instead of relying on the slow accumulation of retained earnings. Economic analysts suggests that small and medium sized businesses in countries that have secured transaction laws and a register have greater access to credit, lower rates of non-performing loans and a lower cost of credit. The end result is higher productivity and higher growth. There are a number of success stories of countries that have achieved increased access to credit and increased growth by introducing secured transaction registers.
Awareness amongst the people who need to know about the STR Law and Registry extend beyond secured creditors. It is also important to businesses and consumers who may make use of the law to gain access to credit that was earlier not available to them. It is also important to buyers of movables that may be encumbered by a security interest of another lender. For example buyers of motor vehicles, equipment, receivables, farm products, livestock etc. The awareness program will include lawyers and creditors, judges and enforcement officers.
The STR Act No. 49 of 2009 is currently going through a reform process with the assistance of experts from the IFC, to address gaps in the current legal and regulatory framework that prevents optimal functioning of the Secured Transactions Registry in Sri Lanka.
