In a recent paper Dower & Potamites argue that having a land title helps getting a loan not only because it represents collateral but also because it signals important unobservable characteristics about the borrower.
In Indonesia, as in many developing countries, obtaining a formal title is a lengthy, bureaucratic and costly process. Therefore, having a formal land title can provide information about unobservable characteristics, such as an ability to interact within formal rules, the degree of integration into formal markets, business-minded characteristics or the condition of the asset. The bank may prefer to lend to formally titled households not only because the title mitigates the bank’s risk in the case of a default, but also because the title provides ex-ante information about the likelihood of compliance with the loan contract. [Italics added].
The abstract of the paper:
Many land titling programs have produced lackluster results in terms of achieving access to credit for the poor. This may reflect insufficient emphasis on local banking practices. Bankers commonly use methods other than collateral to ensure repayment, such as targeting borrower characteristics that, on average, improve repayment rates. Formal land titles can signal to the bank these important characteristics. Using a household survey from Indonesia, we provide evidence that formal land titles do have a positive and significant effect on access to credit and at least part of this effect is best interpreted as an improvement in information flows. This result stands in contrast to the prevailing notion that land titles only function as collateral. Analysts who neglect local banking practices may misinterpret the observed effect of systematic land titling programs on credit access because these programs tend to dampen the signaling value of formal land titles.The title of the paper is "Signaling Credit-Worthiness: Land Titles, Banking Practices and Formal Credit in Indonesia" (September 2012). It is here.
H/t: Mark Lee.