Credit Markets in Brazil: Institutional Reforms and Growth

Transcription

1 Credit Markets in Brazil: Institutional Reforms and Growth Aloisio Araujo (IMPA and EPGE/FGV) Bruno Funchal (FUCAPE Business School) Abstract The main goal of this paper is to study the impact of institutional reforms on credit market development. To do this we analyze the recent Brazilian Credit Legislation Reform: the personal credit, home loans and mainly the Brazilian Corporate Bankruptcy Law. After describing changes of legislation, we do an empirical analyzes of the consequences. Using data from firms balance-sheet, we found that the reform brought a reduction of the cost of debt and an increase in the amount of credit. This result is explained by the increase in the level of creditors protection, thus reducing the cost of debt and motivating firms to take more loans. 1 Introduction The present paper aims at analyzing how institutional changes linked to the credit market impacts the economic enviroment, and more especificaly the individuals and firms life. To reach our goal we first motivate the theme describing three major institutional changes occured in Brazil in from 2004 to Them, taking advantage of the recent Reform made at the Brazilian Bankruptcy Law that provides a significant increase in the protection to creditors we estimate the impact of such change at the firms debt financing. Historically, the Brazilian ratio of private credit to GDP has been very low if compared not only to the OECD countries, but also to Latin America and the Caribbean countries. This situation is worse than it aloisioa@fgv.br bfunchal@fucape.br 1

2 seems, however, since a significant share of credit came from the government loans, highly directed to wide sector of agriculture, industries and housing at a subsidized interest rate (see graphic 1). The data for the interest rate spread confirms this situation: the Brazilian spread was more than four times larger than the average spread in Latin American countries and more than twelve times larger than the average for OECD countries. Table 1: Credit Indicators Private Credit/GDP ( ) Interest Rate Spread ( ) Brazil 35.00% 49.00% Latin American Countries 44.23% 11.00% OECD % 3.87% Source: World Development Indicators An important reason for that situation of the Brazilian credit market was the institutional environment. Recently, creditors had a very low level of protection in Brazil. This characteristic reduces creditors expected returns in default states, which raises the interest rate spread and inhibits the supply of credit. To reduce this problem several changes was madebythebraziliangovernment intherecentpast. Thefirst one, relative to personal credit, refers to a new law that regulates payroll loans. The payroll loan is a type of personal credit with repayments directly deducted from the borrowers payroll check, which, in practice, makes a collateral out of future income. The new law provides to creditors the capacity to receive their loans repayment immediately, whenever the debtors have enough income to do it. Thus, such type of loan eliminates asignificant part of the strategic default, diminishing informational failure, such as moral hazard. The second set of changes refers to home loans, including: alienação fiduciária para bens e imóveis, patrimônio de afetação e lei do incontroverso. Thealienação fiduciária allow the house to remain in the possession of the creditor, thereby circumventing the difficulty of the judiciary not to transfer property from the debtor to the creditor in case of default due to an ideological bias, very usual in Brazil. The parte of the law called patrimonio de afetação separates the assets of the construction firms from the assets of the future home owners. The third part, lei do incontroverso, saysthatincase of a dispute between the mortgage owner and the bank only the part interest and principal directed related to the litigation can be stoped. To complement the reform, at the end of 2006 the government implemented new policies which includes the extension of the payroll loans to home loans. Finally, the third one was the New Brazilian Corporate 2

3 Bankruptcy Law where the most significant change concerns the secured creditors, not only increasing their priority order to receive the proceedings under liquidation but also making them to participate actively of the bankruptcy procedure. The old procedure was very inefficient (long -tenyearsinaverage-andcostly);itrarelyachievedanefficient outcome; it reduces the return in bankruptcy states; and it raises the cost of capital. Creditors recovery rate inthecaseofbankruptcywasamere U.S.$0.002 on the dollar in Brazil, while the average of Latin American and OECD countries is U.S.$0.26 and U.S.$0.72, respectively. 1 Notice that all institutional reforms comes to increase the level of creditors protection. Recent research in development of credit markets points to an important role of the legal protection to creditors in supporting these markets (e.g., La Porta et al. 1997, Araujo and Funchal 2005 and Djankov et al. 2006). The current literature stresses that creditor protection through the legal system is associated with a broader credit market in a monotone way, or simply the higher the protection to creditors the better is to the credit market. Araujo and Funchal (2006) show how this result changes if the degree of punishment to debtors is the unique determinant of creditors protection. They found that extreamely higher levels of of creditors protection will not provide a broader credit market, in fact, there is an intermediate level of protection that is optimal for the development of such market. In the present paper we show, using the Brazilian Bankruptcy Reform Reform, that the positive relationship between creditors protection and credit market conditions holdsforcountrieswhichtheprevioussituationwasextremelybadin protecting creditors interests. However, this relationship is just a direct consequence of the an institutional reform. Others important impacts of an improvement of the reform are indirect, that is, the consequences generated by financial development. They are two-fold: one is the impact of financial development on growth and the other is the impact on income distribution and poverty. King and Levine (1993) and Levine, Loayza and Beck (2000) indicate a very strong connection between financial development and economic growth. With regard to the relationship between financial development and both income distribution and poverty alleviation, the theory provides conflicting predictions. Some theorists claim that a financial-intermediary development makes financial services available to a lager portion of the population, rather than restricting capital to selective groups. Thus, by ameliorating credit constraint, financial development may foster entrepreneurship, formation of new firms and economic growth. Ontheotherhand,somearguethatitisprimarilytherichand 1 See Doing Business World Bank. 3

4 politically connected who benefit from improvements to the financial system. Especially at early stages of economic development, access to financial services, especially credit, is limited to wealthy and connected persons. Thus,itisanopenquestionwhetherfinancial development will narrow or widen income disparities even if it boosts economic growth. Other theorists analyze the relationship between financial development and income distribution as a non-linear form. Greenwood and Jovanovic (1990) show that the interaction of financial-intermediaries development and income inequalities can give rise to an inverted U-shape curve. At early stages of financial development, only a few relatively wealthy individuals have access to the financial market and hence higher return projects. With the aggregate economic growth generated, more people can afford to join the financial system with more positive consequences on economic growth. The distributed effect of financial deepening is thus adverse to the poor at early stages, but positive after the turning point. Using cross-country regressions, a very recent research by Beck, Demirguc-Kunt, and Levine (2004) examines whether the level of financial-intermediaries development influences the growth rate of Gini coefficients of income inequality, the growth rate of the income of the poorest quintile of society, and the fraction of the population living in poverty. Theresultsindicatethatfinance exerts a disproportionately large and positive impact on the poor and hence reduces income inequality. Most causes of future economic development has been discarded like human capital, trade, infraestructure etc. Institutional reforms, however, remains as a possible explanation for development. Rodrik and Iygun (2004) analyze the effect of institution reforms on different environments of enterpreneurial activities. They show that institutional reforms work best in settings where entrepreneurial activity is weak, while it is likely to produce disappointing outcomes where the cost discovery process is vibrant. Also pointing the relevance of institutions, Acemoglu, Johnson and Robinson (2004) developed the empirical and theoretical case that differences in economic institutions are the fundamental cause of differences in economic development. To reach our goal we estimate an econometric model (panel with fixed effects) of the effect of the changes of the Brazilian Corporate Bankruptcy Law that is a dummy variable with zero for the prereform period and one for the post-reform period on firm-level cost of debt and loans. The remainder of the article is organized as follows: section 2 discusses two institutional reformas concernig the credit market; section 3 presents the Brazilian Corporate Bankruptcy Reform; section 4 presents 4

5 the empirical results; and section 5 concludes. 2 Institutional Reforms: personal and home loans At the end of 2003 the Brazilian Congress approved a new law that regulates payroll loans. The payroll loan is a type of personal credit with repayments directly deducted from the borrowers payroll check, which, in practice, makes a collateral out of future income. Before the implementation of the new law, only workers, pensioners and retired workers from the public sector had access to this type of credit. The new law comes to provide such credit to private workers associated to trade unions, pensioners and retired workers from the National Institution of Social Security (INSS) 2.Onlysomefinancial institutions (those authorized by the government) are able to provide this loan for the INSS beneficiaries. The new law provides to creditors the capacity to receive their loans repayment immediately, whenever the debtors have enough income to do it. Thus, such type of loan eliminates a significant part of the strategic default, diminishing the informational failure costs, as moral hazard. The reduction of the default probability increases the expected repayment for the lenders, making them more willing to offer credit at better terms. Figure 1 presents the evolution of the consumer credit before and after the new law of payroll loans take in force. Notice that the amount of personal credit boost after the new law, increasing from R$ 5 billions at March 2004 to almost R$ 35 billions at October The Brazilian pension system, a pay-as-you-go scheme, is publicly managed by this governmental agency, INSS. 5

6 Figure 1: Amount of consumer credit (R$ millions) R$ (billions) New law of payroll loans jun/00 dez/00 jun/01 dez/01 jun/02 dez/02 jun/03 dez/03 jun/04 dez/04 jun/05 dez/05 jun/06 dez/06 jun/07 Source: Brazilian Central Bank Taking advantage of this experiment Coelho and Funchal (2006) measured the average treatment effect of the new law of payroll loans over the amount of new loans and interest rates of personal credit. The empirical methodology applied to identify the average effect of the new law on personal credit accounting for general equilibrium effects was the difference-in-difference procedure. The results pointed to an increase in the new loans and to a reduction in the interest rate. In quantitative terms, their estimation indicates an increase of approximately 42% in the new loans and a decrease of 10.3% in the interest rate. Therefore, the main result of their paper shows that the information failures produce a significant economic cost in the personal credit market, pointing to the relevance of institutional reforms that look to mitigate such costs as a way to improve the financial market conditions. Since the depth of the credit market boosts the economic growth, such an institutional reform provides an important instrument for the development of the economy. 3 The second set of reform conerns home loans. From 2004 to 2006 several actions was taken by the Brazilian government to give incentives to the development of the Home Credit Market, including: alienação fiduciária para bens e imóveis, patrimônio de afetação e lei do incontroverso. The alienação fiduciária allow the house to remain in the posses- 3 See Levine et al (2000) and Levine and Thorste (2004). 6

7 sion of the creditor, thereby circumventing the difficulty of the judiciary not to transfer property from the debtor to the creditor in case of default due to an ideological bias, very usual in Brazil. This has caused the collapse of mortgage in Brazil. The parte of the law called patrimonio de afetação separates the assets of the construction firms from the assets ofthefuturehomeowners. Thethirdpart,lei do incontroverso, says that in case of a dispute between the mortgage owner and the bank only the part interest and principal directed related to the litigation can be stoped. To complement the reform, at the end of 2006 the government implemented new policies to help the housing credit market, allowing the extension of the payroll loans to home loans. 250,000 Figure 2: Amount of home loans (R$millions) 200, , ,000 50,000 0 jan/02 mai/02 set/02 jan/03 mai/03 set/03 jan/04 mai/04 set/04 jan/05 mai/05 set/05 jan/06 mai/06 set/06 jan/07 mai/07 set/07 Source: Brazilian Central Bank 7

8 3 The Brazilian Corporate Bankruptcy Law Reform The new law improves on existing legislation by integrating the insolvency system into the country s broader legal and commercial systems, providing an option to reorganize in or out of court, and striking a reasonable balance between liquidation and reorganization. It should also significantly improve the flexibility of the insolvency legal system by allowing the conversion of recuperation proceeding in liquidation, establishing a period in which debtors can apply for rehabilitation in response to a liquidation proceeding filed against them, and introducing a new out-of-court reorganization system for prepackaged restructuring plans. The new liquidation procedure introduced six key changes. First, labor credit is limited to an amount equaling 150 minimum wages. Second, secured credit is given priority over tax credit. Third, unsecured credit is given priority above some of the tax credit. Fourth, the firm is sold (preferably as a whole) before the creditors list is constituted; this speeds up the process and increases the value of the bankruptcy state. Fifth, tax, labor, and other liabilities are no longer transferred to the buyer of a property sold in liquidation. Finally, any new credit extended during the reorganization process is given first priority in the event of liquidation. The first two changes have direct impact on secured creditors protection. Since at the former bankruptcy law secured creditors comes after all labor claims and tax claims, the protection to secured creditors increased significantly. The third change increases the unsecured creditors protection. From the fourth, fifth and sixth changes in turn, can be expected to increase the value of firms in bankruptcy states and as consequence the amount recovered by creditors. The more creditors expect to receive in the insolvency state, the less they will require firms to pay in the solvency state, thus reducing the cost of capital. Brazil s new reorganization procedure was inspired by Chapter 11 of the U.S. bankruptcy code. Whereas the previous law did not permit any renegotiation between the interested parties and only a few of parties were entitled to recovery of their assets, now managers make a proposal for recuperation that must be accepted by workers, secured creditors, and unsecured creditors (including trade creditors). Creditors play a more significant role in the procedure than previously, including negotiating and voting for the reorganization plan. Fraud in bankruptcy is another key issue addressed in the new law. The first, second, and third changes to liquidation cited above (that is, limiting labor credit and prioritizing secured credit above tax credit 8

9 and unsecured credit above some tax credit), as well as the heightened role of creditors in reorganization, provide incentives against fraud in the bankruptcy procedure. The limitation on labor credit (up to 150 minimum wages) reduces the possibility of abuses by managers that receive hight salaries. Giving secured credit a higher priority than tax and labor claims in a way to increase creditors recovery in case of bankruptcy as well as the important role of creditors in reorganization raises their incentive to monitor the bankruptcy process, mitigating fraudulent actions. 4 Empirical Results In this paper we used firm-specific accounting dataof524firms over the years 1998, 2000, 2002, 2004 and We consider as firm debt the balance sheet short-term and long-term debt plus the suppliers account. The cost of debt is calculated as total year s interest expense for each firm divided by its mean debt over the same period. 4 We used the firms amount of assets and macroeconomic data, as GDP, risk-free interest rate(selic)andtheexchangerate(ptax)tocontrolouranalysis. The variable GDP is used to control our estimation to business cycles, the risk-free interest rate was included to control to the cost of debt common to all firms, and the exchange rate was used to control its the effects on import-export sectors. The data were obtained from both Economatica database and Ipeadata 5. To estimate the impact of changes in creditors protection brought by the New Brazilian Bankruptcy Law on firms credit variables, we will use a panel regression with cross-firms fixed effects represented by the follow functional form: y it = α i + γ 1 d_bl t + γ 2 (ASSET S it d_bl t )+ΓX it + ε it, (1) where the dependent variables to be analyzed are: the cost of debt, amount of credit (aggregated, long-term and short-term) 6 and percentage variation of credit (aggregated, long-term and short-term). The main results comes from the Bankruptcy Law Reform dummy (d_bl) that takes value zero for the period pre-reform and one for the period postreform and from the interaction of the bankruptcy law dummy and 4 The cost of debt variable was winsorized at the level of 2.5%. The winsor procedure is commonly used to treat the outliers problem, very frequent in this variable Since this variable is right-skewed, we will use its natural logarithm as dependent variable in our specification. 9

10 the firms assets (d_bl ASSETS) that was included in the regression to study if the effect was firm-size dependent Table 1 presents the results of the regression (1) when we consider the cost of debt as dependent variable. Notice that the bankruptcy law reform had a significant impact on such variable, pointing that the new bankruptcy law brought a reduction of 22% on average for the Brazilian firms. This result is explained by the higher level of creditors protection, once after the reform they have a higher chance to recover a bigger amount of the loan, and the more creditors expect to receive in the insolvency state, the less they will require firms to pay in the solvency state, thus reducing the cost of debt. Table 1: Panel Regression with fixed effects: Cost of Debt (kd) This table presents the results of panel robust regressions, with fixed effects, of the firm's credit on BANKRUPTCY LAW variable (d_bl), which is represented by a dummy variable codified as 1 after 2005, and its interaction with the firms' size (ASSETS). Panel A present results for total credit, while tables B and C present results partitioning by long-term and short-term credit received by the companies. We control for macroeconomic variables as exchange rate (PTAX), GDP, Brazilian risk-free interest rate (SELIC), and for firm size (ASSETS). Cost of debt is winsorized at 2.5%. Panel A: Panel Regression with fixed effects: Cost of Debt Dependent Variable: kd Robust Standard Coefficient Error P-Value Intercept d_bl d_bl*assets GDP SELIC PTAX ASSETS Table 2 reports the results for the level of credit. First, notice that for Panel A and C that the New Brazilian Bankruptcy Law had a positive impact in the amount of credit of the brazilian firms. This impact is significant at the aggregated level of credit (long-term plus short-term credit) and for the long-term credit, increasing it at 39% and 79% respectively. However, notice that the aggregated effect is only significant because of the long-term credit. Such effect could be explained as a consequence of the reduction in the interest rate charged by secured creditors (long term creditors). The reform did not have effect on the level of the short-term credit, probably because the changes in the unsecured creditors protection were smaller. Also, observe by the interected variable d_bl ASSET S that the positive effect of the new law is stronger to smaller firms. 10

11 Table 2: Panel Regression with fixed effects: Level of Credit This table presents the results of panel robust regressions, with fixed effects, of the firm's credit on BANKRUPTCY LAW variable (d_bl), which is represented by a dummy variable codified as 1 after 2005, and its interaction with the firms' size (ASSETS). Panel A present results for total credit, while tables B and C present results partitioning by long-term and short-term credit received by the companies. We control for macroeconomic variables as exchange rate (PTAX), GDP, Brazilian risk-free interest rate (SELIC), and for firm size (ASSETS). CREDIT represents the natural logarithm of firms credit. Panel A: Panel Regression with fixed effects: Total Credit Dependent Variable: CREDIT Robust Standard Coefficient Error P-Value Intercept d_bl d_bl*assets GDP SELIC PTAX ASSETS Painel B: Panel Regression with fixed effects: Short-Term Credit Dependent Variable: CREDIT_SHORT TERM Robust Standard Coefficient Error P-Value Intercept d_bl d_bl*assets GDP SELIC PTAX ASSETS Painel B: Panel Regression with fixed effects: Long-Term Credit Dependent Variable: CREDIT_LONG TERM Robust Standard Coefficient Error P-Value Intercept d_bl d_bl*assets GDP SELIC PTAX ASSETS We also analyze the effect of the reform using percentage variation of credit, since this variable is more sensitive to shocks due to the fact that it is a flow variable instead of a stock variable. Table 3 shows that for all measures of credit variation (aggregated, long-term and shortterm) the reform had a positive and significant impact. This result can be explained by the fact that the new law improves not only secured creditors protection, but also unsecured creditos protection (despite its increase be smaller than to the secured creditors), increasing their chance to recover their loans in case of firm s insolvency due to higher priority and possibility of firm s rehabilitation. Besides, is still valid the evidence that this effect is stronger for smaller firms. 11

12 Table 3: Panel Regression with fixed effects: Credit Variation (%) This table presents the results of panel robust regressions, with fixed effects, of the firm's credit on BANKRUPTCY LAW variable (d_bl), which is represented by a dummy variable codified as 1 after 2005, and its interaction with the firms' size (ASSETS). Panel A present results for total credit, while tables B and C present results partitioning by long-term and short-term credit received by the companies. We control for macroeconomic variables as exchange rate (PTAX), GDP, Brazilian risk-free interest rate (SELIC), and for firm size (ASSETS). VCREDIT represents the change on credit from year t-1 to year t. GDP was excluded due to collinearity. Panel A: Panel Regression with fixed effects: Total Credit Dependent Variable: VCREDIT Robust Standard Coefficient Error P-Value Intercept d_bl d_bl*assets SELIC PTAX ASSETS Painel B: Panel Regression with fixed effects: Short-Term Credit Dependent Variable: VCREDIT_SHORT TERM Robust Standard Coefficient Error P-Value Intercept d_bl d_bl*assets SELIC PTAX ASSETS Painel B: Panel Regression with fixed effects: Long-Term Credit Dependent Variable: VCREDIT_LONG TERM Robust Standard Coefficient Error P-Value Intercept d_bl d_bl*assets SELIC PTAX ASSETS Conclusion The main goal of this paper was to study the impact of institutional reforms on credit market development. To do this we took advantage of the recent Brazilian Bankruptcy Law Reform where the most significant change concerns the secured creditors, not only increasing their priority order to receive the proceedings under liquidation but also making them to participate actively of the bankruptcy procedure. The old procedure was very inefficient (long - ten years in average - and costly); it rarely achieved an efficient outcome; it reduces the return in bankruptcy states; and it raises the cost of capital. 12

13 Using data from firms balance-sheet, we found that the reform brought a reduction of 22% on average for the firms cost of debt, a increase of 39% in the aggregated level of credit and 79% in the long-term credit, and an increase at the flow credit for both long-term and short-term credit. This result is explained by the higher level of creditors protection, once after the reform they have a higher chance to recover a bigger amount of the loan, and the more creditors expect to receive in the insolvency state, the less they will require firms to pay in the solvency state, thus reducing the cost of debt and motivating firms to take more loans. Also, we find that this effect is bigger for smaller firms. References [1] Acemoglu, D., Johnson, S. and Robinson, J., (2004) "Institutions as the Fundamental Cause of Long-Run Growth", Handbook of Economic Growth. [2] Araujo, A. and Funchal B. (2005) "Bankruptcy Law in Latin America: Past and Future", Journal Economia - The Journal of the Latin America and Caribbean Economic Association, 6(1): [3] Araujo, A. and Funchal B. (2006) How much debtors punishment" Ensaios Economicos EPGE n o 615. [4] Beck, T., Demirgüç-Kunt, A. and Levine, R., 2004: Finance, Inequality and Poverty: Cross-Country Evidence, University of Minnesota (Carlson School of Management), mimeo. [5] Coelho, C. and Funchal, B., (2006): Strategic Default and Personal Credit: The Brazilian Natural Experiment, mimeo. [6] Djankov, S., McLiesh, C., Shleifer, A. (2007) Private Credit in 129 Countries, Journal of Financial Economics, 84(2): [7] Greenwood, J. and Jovanovic, B., (1990): Financial Development, Growth and Income Distribution, Journal of Political Economy, 98: [8] King, R. G. and Levine, R., (1993): Finance, Entrepreneurship and Growth: Theory and Evidence, Journal of Monetary Economics, 32: [9] La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, Robert W. Vishny (1997) Legal Determinants of External Finance, Journal of Finance, 52(3): [10] La Porta, R., Lopez-de-Silanes, F., Shleifer, A. e Vishny, R., (1998) Law and Finance, Journal of Political Economy, 106: [11] Levine, R., Norman, L. and Beck, T., (2000): Financial Intermediation and Growth: Causality and Causes, Journal of Monetary Economics, 46: [12] Rodrik, D. and Iyigun, M., (2004): "On the efficacy of reforms: pol- 13

14 icy tinkering, institutional change and enterpreneurship", Working Paper 10455, NBER. 14