Credit Markets, Creditors’ Rights and Economic Development

Kenneth Dam
Kenneth Dam Max Pam Professor Emeritus of American & Foreign Law - University of Chicago Law School

February 1, 2006

Credit markets are just as important as equity markets to financial development. And in most countries far more finance is generated in credit markets than in public equity markets. Even in the United States, which is usually thought the country with the most pronounced equity culture, far more money is raised in credit markets than in equity markets.

The Role of Banks

The central institution for large-scale lending, the bank, is therefore the point of departure for any analysis of financial development for developing countries. It is true that some developing countries have corporate debt markets, especially the more developed of those countries, but even the countries of Southeast Asia that have been successful in developing stock markets are still at the early stage of developing corporate debt markets.1 Hence, the focus of the first part of this chapter will be on banks. The discussion will turn to special problems that creditors—not just banks but all creditors— face when the borrower cannot pay or fails to pay. The core of the legal issues turns on creditors rights law and bankruptcy law.

Because banks play such a central role in developing world economies, it is important to look at the special role of banks in those countries. The fundamental economic role of a bank is to be an intermediary between savers and the ultimate users of savings, who invest those savings in nonfinancial assets. (Of course, in some countries the public sector deficit is large and financial intermediaries use the flow of savings to increase their holdings of government bonds, which from the standpoint of the real economy is not investment but rather a dissipation of savings.) The efficiency of the transmission of savings to those ultimate users is essential to economic development. To the extent that banks are the principal channel of that transmission, as is the case in most developing countries, banks play a crucial role in the development process.