The ex-ante Effect of Law and Judicial Efficiency on Borrower Discouragement: An International Evidence
2021
We investigate whether cross-country differences in the legal system influence demand-side
credit constraints. We explore the notion of discouraged borrowers — firms that choose not
to apply for bank credit because they anticipate rejection. Employing survey data from 46
economies, we find that rapid and less costly court proceedings, lower procedural complexity
in court processes, and higher recovery rates under bankruptcy lead to the lower likelihood
of borrower discouragement. These results are more pronounced in countries with strong
creditor protections in relation to company reorganization and liquidation. The results corroborate
the supply-side view that strong creditor rights and their efficient enforceability alleviate
banks’ participation constraints in the loan market, thereby encouraging small and
medium-sized enterprises to apply for credit in the first place. We also find that differences
in institutional settings, such as higher regulatory quality, better control of corruption, and
the rule of law, lead to lower rates of credit self-rationing in the loan market.
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