Does Poor Legal Enforcement Make Households Credit-Constrained?
This paper analyzes the relation between the quality of the legal enforcement of loan contracts and the allocation of credit to households, both theoretically and empirically. We use a model of household credit market with secured debt contracts, where the judicial system affects the cost incurred by banks to actually repossess the collateral. The model shows that the working of the judicial system affects both the probability of being credit-constrained and the equilibrium amount of debt. In the empirical part, we test our predictions using data on Italian households and on the performance of Italian judicial districts. Controlling for household characteristics, unobserved heterogeneity at judicial district level and aggregate shocks, we document that an increment in the backlog of trials pending has a statistically and economically significant positive effect on the household probability of being turned down from the credit. Endowing the households living in high-cost judicial districts like Campobasso or Caltanissetta (in southern Italy) with the best enforcement in the sample would reduce the probability of their being credit-constrained by 70% and 63%, respectively. This effect is stronger for poorer than for wealthier households. Moreover, we document that an increment in the backlog of trials pending reduces the availability of credit for poorer households but, surprisingly, has the opposite effect on wealthy households, whose debt volume increases. Again, this effect is found to be significant both statistically and economically.
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- Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer & Robert W. Vishny, 1997. "Legal Determinants of External Finance," NBER Working Papers 5879, National Bureau of Economic Research, Inc.
- RAFAEL LaPORTA & FLORENCIO LOPEZ-de-SILANES & ANDREI SHLEIFER & ROBERT W. VISHNY, "undated". "Legal Determinants of External Finance,"," CRSP working papers 324, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
- Andrew Powell & Marcela Cristini & Ramiro Moya, 2001. "The Importance of an Effective Legal System for Credit Markets: The Case of Argentina," Research Department Publications 3125, Inter-American Development Bank, Research Department.
- Bester, Helmut, 1987. "The role of collateral in credit markets with imperfect information," European Economic Review, Elsevier, vol. 31(4), pages 887-899, June.
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