00074918.2014.980376
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Signalling Creditworthiness: Land Titles, Banking
Practices, and Formal Credit In Indonesia
Paul Castañeda Dower & Elizabeth Potamites
To cite this article: Paul Castañeda Dower & Elizabeth Potamites (2014) Signalling
Creditworthiness: Land Titles, Banking Practices, and Formal Credit In Indonesia, Bulletin of
Indonesian Economic Studies, 50:3, 435-459, DOI: 10.1080/00074918.2014.980376
To link to this article: http://dx.doi.org/10.1080/00074918.2014.980376
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Date: 17 January 2016, At: 23:33
Bulletin of Indonesian Economic Studies, Vol. 50, No. 3, 2014: 435–59
SIGNALLING CREDITWORTHINESS:
LAND TITLES, BANKING PRACTICES, AND
FORMAL CREDIT IN INDONESIA
Paul Castañeda Dower*
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New Economic School, Moscow
Elizabeth Potamites*
Mathematica Policy Research
Many land titling programs worldwide have produced lacklustre results in terms of
achieving access to credit for the poor. This may relect insuficient emphasis on local banking practices. Bankers commonly seek to ensure repayment by using methods other than securing collateral, such as targeting borrower characteristics that,
on average, improve repayment rates. Formal land titles can signal these important
characteristics to the bank. Using a household survey from Indonesia, we provide
evidence that formal land titles have a positive and signiicant effect on access to
credit and that at least part of this effect is best interpreted as an improvement in
information lows. These results stand in contrast to the prevailing notion that land
titles function only 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 reduce the signalling value of formal land titles.
Keywords: land title, credit
JEL classiication: O12, O17, Q15
INTRODUCTION
What are the channels through which land titles could affect access to formal
credit? The standard argument posits that formalising property rights equips
landowners with collateral, opening up access to previously unavailable credit
markets. In this article, we present evidence that formal land titles could also have
an informational value by signalling creditworthiness to bankers. This evidence
provides a richer understanding of how poor landowners gain access to credit,
one of the main justiications for largescale land titling programs sponsored
* We are grateful to a number of people for providing us with feedback about this project.
We would like to thank Bill Easterly, Raquel Fernández, Daniel Gilligan, Sergei Guriev, Jonathan Morduch, Debraj Ray, Mario Rizzo, Sergei Stepanov, and Katia Zhuravskaya. We are
also grateful to the Social Science Research Council for providing funding for the ieldwork
discussed in this article and to Bank Rakyat Indonesia for facilitating our meetings with
local bankers. Castañeda Dower acknowledges the support of the Ministry of Education
and Science of the Russian Federation, grant No. 14.U04.31.0002, administered through
the New Economic School’s Center for the Study of Diversity and Social Interactions. Any
errors that remain are our own.
ISSN 00074918 print/ISSN 14727234 online/14/00043526
http://dx.doi.org/10.1080/00074918.2014.980376
© 2014 Indonesia Project ANU
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Paul Castañeda Dower and Elizabeth Potamites
by the World Bank and other aid organisations. The success of these programs
depends on how local banking practices use formal land titles. When bankers use
formal land titles other than as collateral, these programs may have unintended
consequences. In particular, a systematic land titling program would likely eliminate the signalling value of possessing a formal land title.
In Indonesia, as in many developing countries, obtaining a formal title can be
costly, lengthy, and bureaucratic.1 Therefore, having a formal land title can provide information about unobservable characteristics, such as the landowner’s
business acumen, their ability to interact within formal rules, the degree of their
integration into formal markets, or the condition of their asset.2 A 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 exante information about the likelihood of compliance with the loan contract.
To assess the informational role of land titles, we use the 2002 Microinance
Access and Services Survey (MASS). The MASS was conducted by Bank Rakyat
Indonesia (BRI), a publicly owned commercial bank that has extensive experience in microlending, in order to evaluate households’ microinance activity and
potential new markets in rural and urban areas. The survey provides disaggregated data on household economic activities, assets, and loans for 1,438 households in 72 villages and urban neighbourhoods across six provinces. Since not all
borrowers with a land title use it as collateral, we can separately identify the effect
on loan size of having a land title versus offering it as collateral. In fact, only 40%
of those with a formal land title and a formal bank loan in the 2002 MASS used
the title as collateral.3
We ind evidence for our explanation of formal land titles as information by
considering irsttime borrowers. When dealing with borrowers who have had
previous loans, banks have to some degree already solved their adverse selection
1. A title applicant usually requires a letter from the village head, verifying that the land is
in the applicant’s possession. The applicant then needs to have a survey conducted, which
involves funding the boundary markers, the survey fee, and all transportation costs. The
document must then be veriied, mapped, and certiied. In total, the process can easily take
one year. Once the applicant has the certiicate, they must pay a oneoff tax on the right to
have a title on a piece of land. (This is not a property tax or a tax on the sale.) Anecdotal evidence reveals that applicants can also accumulate signiicant informal costs while obtaining
a title. For example, the stated fee of a land certiicate is around Rp 300,000 (approximately
$33 in 2002). Yet when we asked our survey respondents what the actual fee was, their answers ranged from Rp 1 million to Rp 2 million (approximately $111 to $222 in 2002).
2. Even if the land title has been inherited, possession of it increases the incentive to learn
how to interact in the formal sector.
3. The other 60% is made up mainly of salary guarantees, but it also includes other informal land documents, vehicle ownership certiicates, or even no security at all. Of all
irsttime borrowers with a land title, 42% offered it as collateral. The relatively low usage of land title to secure a loan could relect the poor state of land registration overall.
Since the 2002 MASS, the Indonesian government has taken initiatives, such as Regulation 24/2007, to improve land titling (Bappenas 2012). With these initiatives, the use of
land title for securing a loan could have changed. However, a recent World Bank report
evaluating its latest land administration project, lasting from 2000 to 2009, inds mixed
results (World Bank 2014), indicating that there is room for improvement and suggesting
that our indings are still valid in 2014.
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Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
437
problem. In a study of the inancial evolution of irms in Indonesia, McLeod (1991)
demonstrates that more established irms do indeed have better access to credit.4
Thus, if a formal land title has a signalling role, we would expect that it should be
present for borrowers without established credit histories. Our indings conirm
that irsttime borrowers beneit from merely possessing a land title, irrespective
of whether they offer it as collateral. The same is not true for all formal bank borrowers, for whom possession alone does little to increase access to credit. It is
offering a land title as collateral as opposed to other ways of securing a loan that
is associated with an increase in loan size.
We provide supplemental support for the informational role of land titles in
Indonesia’s smallscale credit market by discussing the results of a mail survey of
BRI unit heads that we conducted in 2004. Our mail survey and ield observations
conirm that BRI unit banks use means other than securing collateral in seeking to
ensure repayment of the relatively small loans that we are considering. Moreover,
bankers report that the legal process of foreclosing or collecting on collateral is
too costly for oneoff relationships. In fact, even oficially registering the collateral
may be prohibitively costly.5
Since land titles can also affect credit demand, observed differences between
irsttime and repeat borrowers could relect the impact of land titles on credit
demand. We address this issue by taking advantage of two unique features of
the 2002 MASS. First, the survey asked respondents if they had recently been
rejected for a loan from a formal bank and for what amount they had applied.
In other words, we have the actual amount demanded at the going interest rate
for these rejected loan applicants. Second, for each questionnaire, a trained loan
oficer evaluated whether the respondent household would be feasible to lend to,
according to BRI’s interestrate menu. We use this feasibility measure to predict
whether the household had recently been rejected for a loan, which is independent
of household credit demand. We then use the predicted probability of rejection,
which allows us to identify how land titles affect household credit demand. We
ind that land titles show no statistical relationship with demanded loan amounts.
In addition, we generate household credit demand for all formal bank borrowers
using this rejection probability and, after controlling for our measure of credit
demand, ind that the main results are unaffected.
The group of households that accessed or tried to access institutional lending
is not random, and we cannot claim that these results indicate the relative importance of a land title’s signalling role for nonborrowers (some of whom may have
been excluded from formal credit because of their lack of adequate collateral).
We explore the relation between land titles and having had a formal bank loan
and ind that land titles are also correlated with participation in formal credit.
Based on the assumption that a household’s distance to the nearest formal bank
should affect participation but not loan size, we are able to correct for this selection
4. McLeod (1991) also argues that expanding credit access as a irm evolves is a socially
optimal strategy for lenders, owing to the risk that irsttime borrowers present.
5. Other factors can arise that undermine the possibility of a legal transfer if the borrower
defaults: weak legal infrastructure, political pressure, and a thin land market. See Domeher
and Abdulai’s (2012) study for a discussion of why land registration may not have a positive impact on credit access.
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Paul Castañeda Dower and Elizabeth Potamites
problem—we ind that accounting for the likelihood of having had a formal bank
loan only strengthens our main result. Thus, the main contribution of this article
is that we establish an additional important role that formal land titles play in the
credit market. Land titles can support and develop the credit market by improving the low of information. Namely, formal land titles reveal dificulttoobserve
applicant characteristics to resourceful bankers. The signalling value of land titles
helps explain some recent indings, such as those of Galiani and Schargrodsky
(2010) that households newly titled as a result of a titling program do not have better access to credit. Systematically distributed land titles lack the information component of sporadically obtained ones.6 Hence, incorporating banking practices into
the analysis is necessary to understand the effect of land titles on access to credit.
PREVIOUS LITERATURE
The positive effect of formal land titles on access to credit is purported by Deininger and Binswanger (1999) to be well established. Nevertheless, we observe
mixed results in our survey of the literature. Table 1 lists previous empirical work
on how land titles affect access to formal bank credit. The irst three columns correspond to the study, the region of study, and the empirical results for whether
having a land title improved credit access. In addition, some studies consider
systematic titling programs in which possessing a land title can be viewed as
relatively exogenous to the credit decision, while others, as is the case in this article, study ’sporadic‘ (or individually obtained) titles, endogenously determined
(shown in the fourth column). The results reported vary considerably, relecting
that these studies took place in different countries with different sets of institutions governing the credit and land markets, and, in particular, under different
banking practices. While table 1 consists of demandside studies, there is also
evidence from the supply side. For example, Domeher (2012), who surveys credit
oficers in Ghana, inds little to no additional beneit of land registration provided
that some type of land documentation exists.
Measuring the effect of possession of a land title on access to formal credit
requires separating the effects of land title on the supply of formal credit from
the effects on the demand for credit. Most studies simply assume that there exists
excess demand for formal credit.7 Feder et al.’s (1988) study lets observed credit
equal the minimum of supplied credit and credit demanded but then resorts to
assuming excess demand in the empirical work. The evidence of Johnston and
6. On a more positive note, this argument could suggest that even nontransferable rights
of exclusion to land might positively inluence credit access if the process for receiving
these documents is not automatic. These types of rights are often granted instead of fully
transferable land rights when governments are worried that the formalisation of property
rights will make it more likely for smallscale farmers to lose their land. This practice has
been used in India.
7. Kochar (1997) argues that the existence of informal credit markets may cause the empirical data to misrepresent the extent of credit rationing: institutional credit may be accessed
less, because individuals’ demand for credit may be satisied by the informal sector. Moreover, McLeod (1991) points out that credit constraints are actually the reverse of what is
often assumed—that is, it is institutional credit that lacks access to smallscale borrowers,
because institutions often cannot compete with informal sources of credit.
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TABLE 1 Previous Literature on the Effect of Land Titles on Access to Formal Bank Credit
Study
Region
Positive signiicant effect?
Program
Feder et al. 1988
Lopéz 1996
Place & MigotAdholla 1998
Pender & Kerr 1999
Broegaard, Heltberg, &
MalchowMøller 2002
Carter & Olinto 2003
Field & Torero 2004
Rural Thailand
Honduras
Ghana, Rwanda, & Kenya
Rural India
Yes, especially in markets with welldeveloped credit markets
Yes
No
No
Sporadic
Systematic
Both
Sporadic
Nicaragua
Paraguay
Urban Peru
Both
Sporadic
Systematic
Foltz 2004
Boucher, Barham, & Carter 2005
Do & Iyer 2008
Boucher, Guirkinger, & Trivelli 2009
Petracco & Pender 2009
Galiani & Schargrodsky 2010
Tunisia
Honduras & Nicaragua
Vietnam
Rural Peru
Uganda
Argentina
No
No, except for large landowners
Yes, for public bank loans; no, for private loans (though it
did lower interest rates)
Yes
No
No
Yes, a title reduces the probability of being credit constrained
No, for title; yes, for freehold tenure
Yes, but modest
Both
Systematic
Systematic
Both
Sporadic
Systematic
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Paul Castañeda Dower and Elizabeth Potamites
Morduch’s (2008) study, based on the 2002 MASS, convinces us that excess demand
is not an appropriate assumption for the households in our sample. We address
this problem by using information about the demand of those who have had loan
applications rejected, combined with measures of hypothetical supply. In contrast,
Field and Torero (2004) take advantage of the timing of the implementation of
a systematic titling program. Using matching on observables to difference out
demand, they measure the effect of land title on credit access only among banks
that require title. We cannot employ this method, because a systematic land titling
program did not occur during the period of analysis in the areas that we study.
In general, the endogeneity of land title is a dificult problem to solve. In the
literature, the primary method of tackling endogenous land titles is to exploit a
systematic titling program. In light of the argument in this article, this identiication method risks missing any direct effect of using land titles as information.
Although one could argue that titling programs often fail to produce full compliance, giving scope for an information effect, there are two reasons why this
approach is unsatisfactory. First, the signal is likely to be much noisier (owing to
the time and cost subsidies of the program implementers) than in the sporadic
setting. Second, faced with imperfect compliance the econometrician identiies
the average treatment effect of title only under strong assumptions. The other
common approach, of using instrumental variables, is also problematic, since the
signal is correlated with unobservables. We prefer to take a targeted approach to
endogeneity. We imperfectly address it by employing subdistrict ixed effects,
which should allay concerns about spurious correlation at the subdistrict level,
and a variable that accounts for differences in the supply of informal credit at the
village and urban neighbourhood level. We also present instrumental variables
estimates to verify the noeffect prediction of the signalling hypothesis. While we
believe that our evidence is persuasive, we cannot claim to identify a causal effect
of land title on information lows.
Finally, we should express a word of caution about the importance of social
networks in credit markets. Hoff, Braverman, and Stiglitz (1993) argue that titling
systems can possibly have a beneicial role only in areas where land markets matter and where land rights are not well established by the community. Lanjouw
and Levy (2002) show that strong community relationships in urban areas of
Ecuador can function as well as formal claims on assets. Hence, having a land title
could substitute for social networks that are dificult to observe. Nevertheless, it
may not be effective to rely on social networks for enforcing claims on assets in
collateral arrangements with a formal bank.
CREDIT-MARKET SETTING AND BANKING PRACTICES IN INDONESIA
Indonesia has an extensive rural banking system, supplied mostly by BRI, the
bank most central to our study. In 2004, BRI was the fourthlargest bank in Indonesia, with approximately 10% of market share as measured by the total assets
held by banks. The BRI unit is the part of the bank that deals with smaller loans.8
8. On a relative scale, institutions that focus on microlending were affected less drastically by the 1997–98 Asian inancial crisis than those that did not. In fact, BRI units were
proitable throughout the crisis and it is reported that BRI units subsidised the branch banks
during and after the crisis (Patten, Rosengard, and Johnston 2001; Rosengard et al. 2007).
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Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
441
It has more than 4,000 ofices, reaching roughly a third of all households in Indonesia.9 In general, BRI units attempt to reach a part of the population that may not
have had the opportunity to participate in the formal inancial sector. As such,
the competitiveness (or the lack thereof) of this market must be kept in mind for
policy analysis. In the MASS, more than 80% of formal bank loans were from BRI
units.
We conducted a mail survey of 192 BRI units across the same six provinces
and 12 districts in which the MASS was conducted. Our response rate was above
60%. Most of the surveys were answered directly by the unit manager. We do not
use this novel dataset in the regression analysis, however, because unit managers move around quite frequently, so there is no way to match reported banking
practices to geographical locations. Instead, these data inform our interpretation
of the empirical results.
In our mail sample, on average only 42% of loans that were collateralised were
done so with a land title certiicate. However, almost 40% of all loans were not collateralised; instead they were guaranteed by deductions from future salary (ixed
income). This is similar to what was found in the MASS, in which 33% of the 326
loans recorded at BRI units or branches were collateralised by a formal land title.
Our survey asked if having a land title would increase the likelihood of success
for a loan application. The answer was yes for 60% of our sample, though only
29% said that an applicant with a formal land title would have more chance of
receiving a higher loan amount than someone without a title (holding all other
factors constant).
Instead of relying solely on securing formal collateral, BRI units use other
methods to ensure repayment. These methods rely on an applicant’s reputation
or lending within social networks to bolster group monitoring, in order to solve
both exante adverse selection and expost moral hazard problems.10 The BRI
approach allows discretion within a set of basic rules. For example, loans above
a certain limit, typically around Rp 20 million (approximately $2,200 in 2002),
must be approved by a regional BRI branch, but at the unit level there is no one
formula for accepting or rejecting loan applicants. Unit managers are allowed to
rely on notions such as ‘trustworthiness’ when granting a loan.11 Unit managers are also encouraged to raise repayment rates by using progressive lending,
whereby the lender makes larger amounts of credit available after each successful
repaid loan; interest refunds, whereby the lender gives a rebate on interestrate
payments if the borrower pays the loan on time; and social networks, whereby
the lender relies on borrowers in the same social network to encourage repayment. Successful unit managers are granted greater discretion and higher limits
for lending without branch approval. When asked to assess the most important
9. BRI has been studied in the microinance literature. For more information on the history
and practices of BRI, see Maurer’s (1999) study.
10. See Morduch’s (1999) study for a thorough review of these methods, which are commonly used in the microinance world.
11. Consider, for example, the following method, which is often used: the loan applicant
ills out a description of the condition of their assets, and then the BRI unit manager sends
a bank employee to view the assets in order to make a comparison. What the bank cares
about is not just the value of assets but also whether the description of the assets was honest.
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Paul Castañeda Dower and Elizabeth Potamites
factor in considering whether to grant a loan, 82% of respondents indicated the
character of the individual. When determining the likelihood of repayment of
the applicant (which determines the loan size for which the applicant is eligible),
the most important factors were cash low (66%) and character (20%). Only one
respondent indicated that collateral was the most important factor for determining repayment capacity, and none indicated that collateral was the most important
factor in considering whether to grant a loan. This suggests that unit managers
are aware of the informational problem and that they take personal characteristics
(including the past relationship with the bank) into account in the loan decision,
as opposed to relying solely on securing collateral to align incentives ex post.
Repayment rates are very high in the BRI units, above 95% in most areas (Patten, Rosengard, and Johnston 2001). BRI prefers to avoid using foreclosure to
enforce repayment. Foreclosure is described as a very rare event anecdotally, but
our survey indicates that it does happen; 37% of unit managers report having
foreclosed on a client at least once.12 Since the legal cost of foreclosure is high,
we would instead expect to see forced or encouraged sales of pledged assets. In
our survey, 77% of respondents said that they had encouraged clients, at some
point in the past year, to sell collateral in order to repay their loan. The existence
of encouraged sales of clients’ assets may indicate that the asset is not fully transferable in case of default. BRI and other banks in Indonesia accept, as collateral,
informal land documents that demonstrate ownership but are not legally transferable. Moreover, for individual BRI units the cost of registering a formal land
title as collateral may outweigh its possible beneits, suggesting again that banks
nominally make use of collateral.
The BRI unit’s reliance on having personal relationships with clients also could
make borrowing more dificult for new clients. For instance, when asked how
new clients ind out about BRI and its services, 88% of the bankers said it was
through friends and family. We also enquired about the maximum loan size available to clients without a formal land document. We ind, on average, that old
clients would be eligible for Rp 5 million more than new clients, a difference that
is the average value of a loan at BRI units. New clients without formal land documents thus face tighter credit constraints and are less likely to take advantage of
BRI’s services unless they already know others who do so.
In sum, the results from our survey are consistent with the idea that having
a formal land title signals useful information to the bank, especially if the titled
household is a new borrower. In general, banks use methods other than securing
formal collateral to solve moral hazard and adverse selection problems, and BRI
units provide a good description of how this works. These methods often emphasise the personal relationship between the bank and client, possibly making it
12. This number seems large, leading us to believe that managers have included threats to
foreclose. Formal foreclosure is rare in Indonesia’s smallscale loan market. However, just
because foreclosure is not observed does not mean that collateral is not at work. A simple
gametheoretic framework yields a Nash equilibrium where no one defaults yet the possibility of foreclosure is real. In the Indonesian context, this is probably not the equilibrium.
Borrowers rather than lenders are generally favoured. Foreclosure is a socially sensitive
issue, and the legal practice of foreclosure in Indonesia is unpredictable and lengthy. These
high costs of foreclosure most likely are at the expense of the borrowers, and streamlining
the process could beneit all parties involved.
Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
443
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more dificult for irsttime borrowers. As a signal of borrower characteristics,
land titles can substitute for a history of successful repayment.
DATA USED FOR THE REGRESSION ANALYSIS
For the regression analysis in this article, we use data from two sources. Our
main source is BRI’s 2002 MASS. We also have additional villagelevel and urban
neighbourhoodlevel information from the 2003 round of Statistik Potensi Desa
(Podes), a survey of local leaders, conducted annually by the Indonesian government.13
The 2002 MASS
The 2002 MASS consisted of more than 1,438 households across 72 different villages (desa) and urban neighbourhoods (kelurahan) in West Java, East Java, West
Kalimantan, East Kalimantan, North Sulawesi, and Papua.14 For each of the six
provinces, two districts (kabupaten for rural districts and kotamadya for urban districts) were selected. For each district, three subdistricts were randomly selected
(kecamatan). For each of these subdistricts, two villages or urban neighbourhoods
were selected at random. Finally, respondents of these localities were randomly
chosen using local censuses. Thus, the survey covered both customers and non
customers of BRI, and 58% of respondents lived in rural districts. It slightly oversampled poor households, in both urban and rural areas (Johnston and Morduch
2008). We exclude the landless from all results that we present.
Twothirds of the respondent households had a business enterprise, and nearly
half of these twothirds worked in the agricultural sector. Thus, one should not
equate land parcels with agricultural plots, although lowerincome and rural
households are more likely to use land parcels for agricultural production. For
households that had multiple land parcels, we label them as titled if any of their
land was titled.15 Most of our sample had more than 80% of their total land value
either formally titled or informally documented, and only 53 households reported
no documentation at all. Land documents other than formal land titles refer to
land deeds, customary or traditional land documents, and tax receipts. In general,
titled households are less common in rural areas (29%) than in urban areas (65%).
In 2004, out of the 80 million land parcels on the iscal tax register, less than
27 million were on the legally titled register and about 1.3 million new titles
were registered sporadically. The total number of land parcels was estimated to
be growing by more than 1 million per year (World Bank 2004, 5). The current
system of titling should be understood in the context of how land rights have
13. Statistik Potensi Desa (Podes) stands for Village Potential Statistics, a villagelevel and
urbanneighbourhoodlevel economic census. We use the 2003 census, which was collected
in 2002.
14. In 2002, Papua included the yettobeformed province of West Papua. In West Java, all
sampled households were rural.
15. We could instead use the fraction of the value of the household’s total land assets that
are titled. In practice, this distinction is almost irrelevant in our dataset; even though 352 of
our households report having more than one plot, all but 57 of these households have all
their plots either titled or untitled.
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Paul Castañeda Dower and Elizabeth Potamites
TABLE 2 Summary Statistics
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Variable
Mean
Panel A. 2002 MASS, landholders only
FormalBank
0.29
Has land title
0.47
Total assets (2002 CPIadjusted
Rp ’000)
57,900
Income per capita / poverty line
3.31
Has salary
0.41
Household head’s education
8.01
Household size
4.43
Household head’s age
46.3
Years in current location
27.7
Log distance to bank (km)
2.72
Mean income / poverty line in
locality
3.39
Mean years land held in locality
17.2
Rural subdistrict
0.60
Panel B. 2003 Podes
Population density (adult
population per hectare)
Forest
Locality has a bank
29.70
0.23
0.23
Std
Min
Max
0.45
0.50
0.00
0.00
1.00
1.00
105,000
4.76
0.49
3.93
1.71
11.9
16.1
0.40
24,824
0.01
0.00
0.00
1.00
20.0
1.0
2.30
1,560,000
69.80
1.00
16.00
13.00
87.0
99.0
4.19
2.12
6.1
0.49
0.41
3.0
0.00
13.33
40.0
1.00
53.10
0.42
0.42
0.06
0.00
0.00
270.00
1.00
1.00
Note: Observations in panel A = 1,287; in panel B = 72. FormalBank = 1 if the household reported
having had a formal loan. Forest = 1 if the settlement is near a forested area. MASS = Bank Rakyat
Indonesia’s Microinance Access and Services Survey. Podes = Statistik Potensi Desa (Village Potential
Statistics survey).
been established previously, especially in areas where adat (traditional) law is still
respected. Evidence of ownership can come in a variety of forms. The most formal of these informal rights to land is a land deed, or akte, which represents the
purchase of a piece of land and is oficially stamped and notarised. A less formal
but perhaps locally stronger right is the girik or petok, which is a use claim on land
and comes from customary law. Documents known as Letter C or D are certiied by the village leader and can be inherited. In the MASS, land parcels with
formal land titles are slightly overrepresented (45% of land parcels have formal
land titles; 12% have an akte; 21% have a girik, petok, or Letter C or D; and 10%
have only tax receipts to demonstrate ownership). In our sample, very few households—only 4% of landowners—had no documents at all.
Table 2 gives the summary statistics for the covariates that we include in our
estimations. The variable ‘FormalBank’ equals one if the household reported ever
having had a formal loan. The per capita household income is divided by the local
poverty line. The local poverty line varies by province and, within each province,
there are separate poverty lines for rural and urban areas.
We have data on 405 distinct formal loans made to 374 different households.
On average, formal bank loans are signiicantly larger than loans from other
Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
445
TABLE 3 Average Formal Loan Amounts, by Type of Security Offered
Loan
(Rp ’000)
Std
(Rp ’000)
Panel A. All formal loans
Land title
Fixed income
Other land documents
Other security
No security
Total
16,323
9,655
6,295
6,220
4,870
10,552
28,048
6,447
4,254
9,029
5,002
15,873
Panel B. First-time loans
Land title
Fixed income
Other land documents
Other security
No security
Total
22,841
8,281
4,535
3,132
4,619
11,014
46,177
4,325
2,621
1,858
4,210
24,828
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Security
Min
(Rp ’000)
Max
(Rp ’000)
N
%
643
103
202
201
506
103
235,647
39,984
27,195
26,165
18,762
235,647
99
177
61
13
17
367
27.0
48.2
16.6
4.6
3.5
2,325
1,923
1,025
703
506
506
235,647
24,905
10,098
4,964
13,110
235,647
24
40
10
5
11
90
27.0
44.0
11.1
5.6
12.2
Source: Data from Bank Rakyat Indonesia’s Microinance Access and Services Survey, 2002.
Note: Amounts adjusted by the consumer price index, using 2002 as the base year. N = observations.
sources and most (74%) reported loans are formal.16 Because our loan amounts
are from different years, with most loans having been granted in 1998–2002 (only
9% of the formal loans are from earlier), just after the 1997–98 Asian inancial
crisis, we normalised the loan amounts by converting them to rupiah, adjusted
to the consumer price index (CPI), and used 2002 as the base year.17 Converting to CPIadjusted loan amounts leads to 38 fewer loans—31 because of missing
loan dates and 7 because of other missing data.18 Table 3 breaks down the formal
loan amounts by the type of security offered. Of the formal loans reported with
complete data, 90 went to households for whom this was their irst loan. In both
rural and urban areas, titled households had more formal loans—40% of titled
households had had a formal bank loan compared with only 20% of other land
documented households—and loans securitised by formal land titles tended to
16. In our data, we have 680 distinct loans, 489 of which are from formal banks. Of these
formal loans, 475 report information on how the loan was secured. The difference between
475 and 405 can be explained by our excluding the landless from our analysis. Nonformal
loans consist of microbank loans (14%) and informal sources (12%).
17. The Indonesian CPI is available from Badan Pusat Statistik, the central statistics agency:
http://www.bps.go.id/eng/aboutus.php?inlasi=1. Over the range of years in which the
formal loans were given, there were three changes to the weighting of the CPI and to the
sample of cities included in the costofliving surveys. To account for these changes, we
have run robustness checks for our main results by including dummies for urban and rural
CPIweighting groups. The results are similar.
18. We dropped one loansize observation because of its unrealistic loan amount of Rp
1,000 (less than $1).
TABLE 4 Summary Statistics, by Repeat and First-Time Borrowers
Mean
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Variable
Min
Std
Panel A. All households that have had a formal bank loan
Has land title
0.65
0.48
Total assets (2002 CPIadjusted
Rp ’000)
90,300
133,000
Family income per capita /
poverty line
4.84
4.83
Has salary
0.58
0.49
Household head’s education
9.56
3.82
Household head’s age
47.83
10.83
Log distance to bank (km)
2.59
0.34
Mean income / poverty line in
locality
4.48
2.73
Panel B. Households that are irst-time borrowers
Has land title
0.67
0.47
Total assets (2002 CPIadjusted
Rp ’000)
87,800
172,000
Family income per capita /
poverty line
4.53
4.65
Has salary
0.58
0.50
Household head’s education
9.81
3.81
Household head’s age
46.69
10.28
Log distance to bank (km)
2.62
0.38
Mean income / poverty line in
locality
4.81
3.22
Max
0.00
1.00
25
1,370,000
0.20
0.00
0.00
25.00
2.30
34.80
1.00
16.00
78.00
4.17
1.11
13.30
0.00
1.00
447
1,370,000
0.28
0.00
3.00
29.00
2.31
34.79
1.00
16.00
76.00
4.01
1.11
13.30
Source: Data from Bank Rakyat Indonesia’s Microinance Access and Services Survey, 2002.
Note: We exclude the landless. Observations in panel A = 336; in panel B = 90.
TABLE 5 Distribution of Control Variables for
Households That Have Applied for a Loan
Status
Assets
Income
Rejected
Accepted
17.20*
17.74*
3.30*
4.40*
Education
7.75*
9.72*
Titled
0.58
0.64
Source: Data from Bank Rakyat Indonesia’s Microinance Access and Services Survey, 2002.
Note: Assets in logs of rupiah (adjusted by the consumer price index). Income relative to the poverty
line. Education is in years of schooling. We exclude the landless.
* p < 0.05.
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Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
447
be larger, on average. Firsttime borrowers used the same types of securities and
offered them in roughly the same proportion as the general population of borrowers. In addition, conditional on having a formal loan, titled households and other
documented households were equally likely to offer some type of land document
as collateral (about 40% of the time).19 Since all documented households were
equally likely to offer some type of land document, we infer that the relative beneit of offering a land document is similar to offering other forms of security. That
is to say, if the only effect of a formal land title is as a better source of collateral, we
would expect titled households to have used their land document comparatively
more often.
Table 4 describes in more detail the characteristics of the subset of our sample
that we are particularly interested in. Panel A gives the most important household and localitylevel characteristics for all households that have had a formal
bank loan. Panel B looks at the same characteristics for households that are irst
time borrowers. There are no signiicant differences between irsttime and repeat
borrowers in any of these observable characteristics.20 Therefore, any difference
between a bank’s relationship with a irsttime borrower and its relationship with
a repeat borrower cannot be attributed to differences that are observable to the
econometrician.
Selection into the formal loan market is a different story. Table 5 shows the
distribution of the control variables for rejected applicants. In the MASS, 67 landowning households reported having recently had a loan application rejected.
These households tended to have fewer assets and less income and education.
The MASS data also permits constructing hypothetical loan demand and supply, with which we can address endogeneity. The survey was conducted by BRI
loan oficers who worked in different geographical areas from those surveyed.
The oficers were asked to privately judge how feasible it would be to extend a
loan to the household that they had just surveyed. They reported whether they
would grant the household a loan and what the maximum loan size would be
and under what terms. These questions give us a measure of hypothetical supply.
That is, without considering the effects of title on credit demand, we can evaluate
whether a formal land title affects the amount of credit for which a household is
hypothetically eligible. That these questions were answered by BRI loan oficers
adds to their validity as a measure of credit supply. In general, the average maximal feasible loan amount was almost Rp 8 million (roughly $890 in 2002), comparable to actual loan amounts; but of the 901 households that were attributed with
a feasibility judgment, 565 had never had a formal bank loan. The MASS also
asked households how much credit they would hypothetically be interested in
obtaining if they had not applied for a formal bank loan. More than half of those
with no previous bank loans claimed that they had never applied, because they
19. More than half of all formal loans did not use any type of land document. Instead, the
most commonly cited security was an advance against future salaries, such as ixed income
or the use of a guarantor.
20. We tested all continuous variables by applying both the conventional t-test (allowing
for the variances between the samples to differ) and the nonparametric Wilcoxon rank
sum test. We used a test of proportionality for all binary variables. There were no signiicant differences at the 10% level.
448
Paul Castañeda Dower and Elizabeth Potamites
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did not want to be in debt. They were then asked a hypothetical question about
their possible desired loan amount. However, this measure of demand is problematic; even after giving a hypothetical loan amount, more than 80% insisted
that they had no intention of borrowing formally. Their most common reason,
given by 44%, was that they were concerned about repayment. Those that were
titled were equally likely to be worried about repayment as those that were not.
The 2003 Podes
Panel B of table 2 gives some summary statistics for the localitylevel covariates
from the Podes dataset that we include in our estimations. We have calculated
these statistics by using only the villages and urban neighbourhoods in BRI’s
MASS sample. They are roughly comparable to the full census. We will take
one instrumental variable from Podes, the forestedarea dummy (‘Forest’). The
National Land Agency (Badan Pertanahan Nasional) grants titles only to non
forested land.21 The ‘Forest’ dummy equals one if the settlement is near a forested area. The proximity to forest land should be negatively correlated with the
extent of titling. Since forest land is not under the jurisdiction of the agency, land
titles cannot be issued for any plots under the oficial forestedland designation.
A large amount of deforestation has occurred in Indonesia, and many plots have
been cleared for some time but have not been unmarked as forest land. Settlements near forest land are more likely to contain plots that are cleared but are still
oficially designated as forest land. Indeed, 28% of respondent households in the
2003 Podes were titled in settlements near forested areas, while 53% were titled in
nonforested areas. The ‘Forest’ dummy does not predict the hypothetical desired
loan amounts discussed above.
EMPIRICAL STRATEGY AND RESULTS
The key question and the main contribution of this article is to evaluate whether
having a formal title inluences the size of observed formal loans, and, if so, to
determine whether this is purely an effect of formal land titles being better collateral or whether they also have a signalling value. We will irst consider how
possessing a formal land title affects loan amounts, while controlling for other
observable variables that might also inluence credit access. We then control for
whether a land title was offered to secure the loan, to see if simply possessing a
land title is suficient. Next, we test whether the effect of possessing a land title
is important for irsttime borrowers, since the signalling effect should be the
strongest for this group. Equation (1) gives the econometric speciication for the
preferred empirical test:
yi = α + γ 1Ti + γ 2 Fi + γ 3T ⋅ Fi + γ 4 Ci + Xi β + Ei
(1)
where yi , the outcome of interest, is the most recent loan amount obtained from
a formal bank in household i; Ti is an indicator variable of whether household i
21. Land that has been designated as forest (roughly 60% of land area) is handled by the
Ministry of Forestry.
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Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
449
has a formal title; Ci is whether the household used a formal title as collateral; Fi
is an indicator of whether the household is a irsttime borrower; and Xi consists
of both household covariates and locality and subdistrictlevel covariates.22 The
idiosyncratic error term is denoted by Ei. We use clustered robust standard errors
at the subdistrict level, allowing for correlation within subdistricts, because the
BRI unit lending area is roughly a subdistrict and the BRI framework grants considerable discretion to unit managers.
In equation (1), three effects are important to the signalling story: (a) γ 1, which
represents the effect of merely possessing a land title for repeat borrowers; (b) γ 1 +
γ 3, which represents the effect of merely possessing a land title for irsttime borrowers; and (c) γ 3, which tells us whether possessing a land title but not offering
it as collateral is different for irsttime borrowers than for repeat borrowers. We
reject the hypothesis that a land title functions only as collateral if γ 3 is statistically
different from zero, no matter whether we control for a land title being used to
secure a loan, or when γ 1 + γ 3 is statistically different from zero if we control for
offering a land title as security. We note that if both γ 1 and γ 3 are not statistically
different from zero, we cannot reject the signalling hypothesis. Owing to the high
cost of formally securitising these small loans with a land title, one could argue
that offering a land title as security has some informational content.
In order to interpret equation (1) as a supplyside effect, we should assume that
for borrowing households the supply constraint is binding, which is a common
assumption in developing markets. Under this assumption, loan size is a good
indicator of access to credit, since most households that apply for loans would
demand more than they would eventually receive. One criticism of this approach
is that some households may demand larger loan amounts than others. However,
even if titled households, on average, were to demand higher loan amounts, the
only ways that actual loan amounts would be higher are if the supply constraint
were slack or if the bank relaxed the supply constraint because of the presence of
a land title. The latter case is included in the effect of having a land title, and the
assumption of the binding supply constraint rules out the former case. In ‘Assessing the Role of Credit Demand’, below, we more carefully explore this assumption
by investigating whether the correlation between land titles and credit demand
could explain the results (that is, that the supply constraint is not binding).
While we need to address the endogeneity of the land title variable, we also
want to capture the signalling effect, which by its nature implies that land titles
are correlated with unobservable variables that affect credit access (in particular,
personal characteristics of the borrower that are desirable to the bank) and that
we would like to include in the effect of land title.23 Addressing the endogeneity
concerns by using the standard instrumental variables approach is not satisfac22. A small number of households had more than one loan in the sample because they had
loans from multiple formal banks. In all loansize regressions, we include a dummy variable that indicates these households.
23. Reverse causality is another possible explanation; borrowing households may use the
loan to fund obtaining a land title. Since most loans are recent loans (those in the past four
years) and the titling process is lengthy, having obtained a loan is not likely to mean that
the household has obtained a land title. Unfortunately, we do not have information on
when the land title was obtained.
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ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Signalling Creditworthiness: Land Titles, Banking
Practices, and Formal Credit In Indonesia
Paul Castañeda Dower & Elizabeth Potamites
To cite this article: Paul Castañeda Dower & Elizabeth Potamites (2014) Signalling
Creditworthiness: Land Titles, Banking Practices, and Formal Credit In Indonesia, Bulletin of
Indonesian Economic Studies, 50:3, 435-459, DOI: 10.1080/00074918.2014.980376
To link to this article: http://dx.doi.org/10.1080/00074918.2014.980376
Published online: 03 Dec 2014.
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Date: 17 January 2016, At: 23:33
Bulletin of Indonesian Economic Studies, Vol. 50, No. 3, 2014: 435–59
SIGNALLING CREDITWORTHINESS:
LAND TITLES, BANKING PRACTICES, AND
FORMAL CREDIT IN INDONESIA
Paul Castañeda Dower*
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New Economic School, Moscow
Elizabeth Potamites*
Mathematica Policy Research
Many land titling programs worldwide have produced lacklustre results in terms of
achieving access to credit for the poor. This may relect insuficient emphasis on local banking practices. Bankers commonly seek to ensure repayment by using methods other than securing collateral, such as targeting borrower characteristics that,
on average, improve repayment rates. Formal land titles can signal these important
characteristics to the bank. Using a household survey from Indonesia, we provide
evidence that formal land titles have a positive and signiicant effect on access to
credit and that at least part of this effect is best interpreted as an improvement in
information lows. These results stand in contrast to the prevailing notion that land
titles function only 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 reduce the signalling value of formal land titles.
Keywords: land title, credit
JEL classiication: O12, O17, Q15
INTRODUCTION
What are the channels through which land titles could affect access to formal
credit? The standard argument posits that formalising property rights equips
landowners with collateral, opening up access to previously unavailable credit
markets. In this article, we present evidence that formal land titles could also have
an informational value by signalling creditworthiness to bankers. This evidence
provides a richer understanding of how poor landowners gain access to credit,
one of the main justiications for largescale land titling programs sponsored
* We are grateful to a number of people for providing us with feedback about this project.
We would like to thank Bill Easterly, Raquel Fernández, Daniel Gilligan, Sergei Guriev, Jonathan Morduch, Debraj Ray, Mario Rizzo, Sergei Stepanov, and Katia Zhuravskaya. We are
also grateful to the Social Science Research Council for providing funding for the ieldwork
discussed in this article and to Bank Rakyat Indonesia for facilitating our meetings with
local bankers. Castañeda Dower acknowledges the support of the Ministry of Education
and Science of the Russian Federation, grant No. 14.U04.31.0002, administered through
the New Economic School’s Center for the Study of Diversity and Social Interactions. Any
errors that remain are our own.
ISSN 00074918 print/ISSN 14727234 online/14/00043526
http://dx.doi.org/10.1080/00074918.2014.980376
© 2014 Indonesia Project ANU
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436
Paul Castañeda Dower and Elizabeth Potamites
by the World Bank and other aid organisations. The success of these programs
depends on how local banking practices use formal land titles. When bankers use
formal land titles other than as collateral, these programs may have unintended
consequences. In particular, a systematic land titling program would likely eliminate the signalling value of possessing a formal land title.
In Indonesia, as in many developing countries, obtaining a formal title can be
costly, lengthy, and bureaucratic.1 Therefore, having a formal land title can provide information about unobservable characteristics, such as the landowner’s
business acumen, their ability to interact within formal rules, the degree of their
integration into formal markets, or the condition of their asset.2 A 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 exante information about the likelihood of compliance with the loan contract.
To assess the informational role of land titles, we use the 2002 Microinance
Access and Services Survey (MASS). The MASS was conducted by Bank Rakyat
Indonesia (BRI), a publicly owned commercial bank that has extensive experience in microlending, in order to evaluate households’ microinance activity and
potential new markets in rural and urban areas. The survey provides disaggregated data on household economic activities, assets, and loans for 1,438 households in 72 villages and urban neighbourhoods across six provinces. Since not all
borrowers with a land title use it as collateral, we can separately identify the effect
on loan size of having a land title versus offering it as collateral. In fact, only 40%
of those with a formal land title and a formal bank loan in the 2002 MASS used
the title as collateral.3
We ind evidence for our explanation of formal land titles as information by
considering irsttime borrowers. When dealing with borrowers who have had
previous loans, banks have to some degree already solved their adverse selection
1. A title applicant usually requires a letter from the village head, verifying that the land is
in the applicant’s possession. The applicant then needs to have a survey conducted, which
involves funding the boundary markers, the survey fee, and all transportation costs. The
document must then be veriied, mapped, and certiied. In total, the process can easily take
one year. Once the applicant has the certiicate, they must pay a oneoff tax on the right to
have a title on a piece of land. (This is not a property tax or a tax on the sale.) Anecdotal evidence reveals that applicants can also accumulate signiicant informal costs while obtaining
a title. For example, the stated fee of a land certiicate is around Rp 300,000 (approximately
$33 in 2002). Yet when we asked our survey respondents what the actual fee was, their answers ranged from Rp 1 million to Rp 2 million (approximately $111 to $222 in 2002).
2. Even if the land title has been inherited, possession of it increases the incentive to learn
how to interact in the formal sector.
3. The other 60% is made up mainly of salary guarantees, but it also includes other informal land documents, vehicle ownership certiicates, or even no security at all. Of all
irsttime borrowers with a land title, 42% offered it as collateral. The relatively low usage of land title to secure a loan could relect the poor state of land registration overall.
Since the 2002 MASS, the Indonesian government has taken initiatives, such as Regulation 24/2007, to improve land titling (Bappenas 2012). With these initiatives, the use of
land title for securing a loan could have changed. However, a recent World Bank report
evaluating its latest land administration project, lasting from 2000 to 2009, inds mixed
results (World Bank 2014), indicating that there is room for improvement and suggesting
that our indings are still valid in 2014.
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Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
437
problem. In a study of the inancial evolution of irms in Indonesia, McLeod (1991)
demonstrates that more established irms do indeed have better access to credit.4
Thus, if a formal land title has a signalling role, we would expect that it should be
present for borrowers without established credit histories. Our indings conirm
that irsttime borrowers beneit from merely possessing a land title, irrespective
of whether they offer it as collateral. The same is not true for all formal bank borrowers, for whom possession alone does little to increase access to credit. It is
offering a land title as collateral as opposed to other ways of securing a loan that
is associated with an increase in loan size.
We provide supplemental support for the informational role of land titles in
Indonesia’s smallscale credit market by discussing the results of a mail survey of
BRI unit heads that we conducted in 2004. Our mail survey and ield observations
conirm that BRI unit banks use means other than securing collateral in seeking to
ensure repayment of the relatively small loans that we are considering. Moreover,
bankers report that the legal process of foreclosing or collecting on collateral is
too costly for oneoff relationships. In fact, even oficially registering the collateral
may be prohibitively costly.5
Since land titles can also affect credit demand, observed differences between
irsttime and repeat borrowers could relect the impact of land titles on credit
demand. We address this issue by taking advantage of two unique features of
the 2002 MASS. First, the survey asked respondents if they had recently been
rejected for a loan from a formal bank and for what amount they had applied.
In other words, we have the actual amount demanded at the going interest rate
for these rejected loan applicants. Second, for each questionnaire, a trained loan
oficer evaluated whether the respondent household would be feasible to lend to,
according to BRI’s interestrate menu. We use this feasibility measure to predict
whether the household had recently been rejected for a loan, which is independent
of household credit demand. We then use the predicted probability of rejection,
which allows us to identify how land titles affect household credit demand. We
ind that land titles show no statistical relationship with demanded loan amounts.
In addition, we generate household credit demand for all formal bank borrowers
using this rejection probability and, after controlling for our measure of credit
demand, ind that the main results are unaffected.
The group of households that accessed or tried to access institutional lending
is not random, and we cannot claim that these results indicate the relative importance of a land title’s signalling role for nonborrowers (some of whom may have
been excluded from formal credit because of their lack of adequate collateral).
We explore the relation between land titles and having had a formal bank loan
and ind that land titles are also correlated with participation in formal credit.
Based on the assumption that a household’s distance to the nearest formal bank
should affect participation but not loan size, we are able to correct for this selection
4. McLeod (1991) also argues that expanding credit access as a irm evolves is a socially
optimal strategy for lenders, owing to the risk that irsttime borrowers present.
5. Other factors can arise that undermine the possibility of a legal transfer if the borrower
defaults: weak legal infrastructure, political pressure, and a thin land market. See Domeher
and Abdulai’s (2012) study for a discussion of why land registration may not have a positive impact on credit access.
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Paul Castañeda Dower and Elizabeth Potamites
problem—we ind that accounting for the likelihood of having had a formal bank
loan only strengthens our main result. Thus, the main contribution of this article
is that we establish an additional important role that formal land titles play in the
credit market. Land titles can support and develop the credit market by improving the low of information. Namely, formal land titles reveal dificulttoobserve
applicant characteristics to resourceful bankers. The signalling value of land titles
helps explain some recent indings, such as those of Galiani and Schargrodsky
(2010) that households newly titled as a result of a titling program do not have better access to credit. Systematically distributed land titles lack the information component of sporadically obtained ones.6 Hence, incorporating banking practices into
the analysis is necessary to understand the effect of land titles on access to credit.
PREVIOUS LITERATURE
The positive effect of formal land titles on access to credit is purported by Deininger and Binswanger (1999) to be well established. Nevertheless, we observe
mixed results in our survey of the literature. Table 1 lists previous empirical work
on how land titles affect access to formal bank credit. The irst three columns correspond to the study, the region of study, and the empirical results for whether
having a land title improved credit access. In addition, some studies consider
systematic titling programs in which possessing a land title can be viewed as
relatively exogenous to the credit decision, while others, as is the case in this article, study ’sporadic‘ (or individually obtained) titles, endogenously determined
(shown in the fourth column). The results reported vary considerably, relecting
that these studies took place in different countries with different sets of institutions governing the credit and land markets, and, in particular, under different
banking practices. While table 1 consists of demandside studies, there is also
evidence from the supply side. For example, Domeher (2012), who surveys credit
oficers in Ghana, inds little to no additional beneit of land registration provided
that some type of land documentation exists.
Measuring the effect of possession of a land title on access to formal credit
requires separating the effects of land title on the supply of formal credit from
the effects on the demand for credit. Most studies simply assume that there exists
excess demand for formal credit.7 Feder et al.’s (1988) study lets observed credit
equal the minimum of supplied credit and credit demanded but then resorts to
assuming excess demand in the empirical work. The evidence of Johnston and
6. On a more positive note, this argument could suggest that even nontransferable rights
of exclusion to land might positively inluence credit access if the process for receiving
these documents is not automatic. These types of rights are often granted instead of fully
transferable land rights when governments are worried that the formalisation of property
rights will make it more likely for smallscale farmers to lose their land. This practice has
been used in India.
7. Kochar (1997) argues that the existence of informal credit markets may cause the empirical data to misrepresent the extent of credit rationing: institutional credit may be accessed
less, because individuals’ demand for credit may be satisied by the informal sector. Moreover, McLeod (1991) points out that credit constraints are actually the reverse of what is
often assumed—that is, it is institutional credit that lacks access to smallscale borrowers,
because institutions often cannot compete with informal sources of credit.
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TABLE 1 Previous Literature on the Effect of Land Titles on Access to Formal Bank Credit
Study
Region
Positive signiicant effect?
Program
Feder et al. 1988
Lopéz 1996
Place & MigotAdholla 1998
Pender & Kerr 1999
Broegaard, Heltberg, &
MalchowMøller 2002
Carter & Olinto 2003
Field & Torero 2004
Rural Thailand
Honduras
Ghana, Rwanda, & Kenya
Rural India
Yes, especially in markets with welldeveloped credit markets
Yes
No
No
Sporadic
Systematic
Both
Sporadic
Nicaragua
Paraguay
Urban Peru
Both
Sporadic
Systematic
Foltz 2004
Boucher, Barham, & Carter 2005
Do & Iyer 2008
Boucher, Guirkinger, & Trivelli 2009
Petracco & Pender 2009
Galiani & Schargrodsky 2010
Tunisia
Honduras & Nicaragua
Vietnam
Rural Peru
Uganda
Argentina
No
No, except for large landowners
Yes, for public bank loans; no, for private loans (though it
did lower interest rates)
Yes
No
No
Yes, a title reduces the probability of being credit constrained
No, for title; yes, for freehold tenure
Yes, but modest
Both
Systematic
Systematic
Both
Sporadic
Systematic
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440
Paul Castañeda Dower and Elizabeth Potamites
Morduch’s (2008) study, based on the 2002 MASS, convinces us that excess demand
is not an appropriate assumption for the households in our sample. We address
this problem by using information about the demand of those who have had loan
applications rejected, combined with measures of hypothetical supply. In contrast,
Field and Torero (2004) take advantage of the timing of the implementation of
a systematic titling program. Using matching on observables to difference out
demand, they measure the effect of land title on credit access only among banks
that require title. We cannot employ this method, because a systematic land titling
program did not occur during the period of analysis in the areas that we study.
In general, the endogeneity of land title is a dificult problem to solve. In the
literature, the primary method of tackling endogenous land titles is to exploit a
systematic titling program. In light of the argument in this article, this identiication method risks missing any direct effect of using land titles as information.
Although one could argue that titling programs often fail to produce full compliance, giving scope for an information effect, there are two reasons why this
approach is unsatisfactory. First, the signal is likely to be much noisier (owing to
the time and cost subsidies of the program implementers) than in the sporadic
setting. Second, faced with imperfect compliance the econometrician identiies
the average treatment effect of title only under strong assumptions. The other
common approach, of using instrumental variables, is also problematic, since the
signal is correlated with unobservables. We prefer to take a targeted approach to
endogeneity. We imperfectly address it by employing subdistrict ixed effects,
which should allay concerns about spurious correlation at the subdistrict level,
and a variable that accounts for differences in the supply of informal credit at the
village and urban neighbourhood level. We also present instrumental variables
estimates to verify the noeffect prediction of the signalling hypothesis. While we
believe that our evidence is persuasive, we cannot claim to identify a causal effect
of land title on information lows.
Finally, we should express a word of caution about the importance of social
networks in credit markets. Hoff, Braverman, and Stiglitz (1993) argue that titling
systems can possibly have a beneicial role only in areas where land markets matter and where land rights are not well established by the community. Lanjouw
and Levy (2002) show that strong community relationships in urban areas of
Ecuador can function as well as formal claims on assets. Hence, having a land title
could substitute for social networks that are dificult to observe. Nevertheless, it
may not be effective to rely on social networks for enforcing claims on assets in
collateral arrangements with a formal bank.
CREDIT-MARKET SETTING AND BANKING PRACTICES IN INDONESIA
Indonesia has an extensive rural banking system, supplied mostly by BRI, the
bank most central to our study. In 2004, BRI was the fourthlargest bank in Indonesia, with approximately 10% of market share as measured by the total assets
held by banks. The BRI unit is the part of the bank that deals with smaller loans.8
8. On a relative scale, institutions that focus on microlending were affected less drastically by the 1997–98 Asian inancial crisis than those that did not. In fact, BRI units were
proitable throughout the crisis and it is reported that BRI units subsidised the branch banks
during and after the crisis (Patten, Rosengard, and Johnston 2001; Rosengard et al. 2007).
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Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
441
It has more than 4,000 ofices, reaching roughly a third of all households in Indonesia.9 In general, BRI units attempt to reach a part of the population that may not
have had the opportunity to participate in the formal inancial sector. As such,
the competitiveness (or the lack thereof) of this market must be kept in mind for
policy analysis. In the MASS, more than 80% of formal bank loans were from BRI
units.
We conducted a mail survey of 192 BRI units across the same six provinces
and 12 districts in which the MASS was conducted. Our response rate was above
60%. Most of the surveys were answered directly by the unit manager. We do not
use this novel dataset in the regression analysis, however, because unit managers move around quite frequently, so there is no way to match reported banking
practices to geographical locations. Instead, these data inform our interpretation
of the empirical results.
In our mail sample, on average only 42% of loans that were collateralised were
done so with a land title certiicate. However, almost 40% of all loans were not collateralised; instead they were guaranteed by deductions from future salary (ixed
income). This is similar to what was found in the MASS, in which 33% of the 326
loans recorded at BRI units or branches were collateralised by a formal land title.
Our survey asked if having a land title would increase the likelihood of success
for a loan application. The answer was yes for 60% of our sample, though only
29% said that an applicant with a formal land title would have more chance of
receiving a higher loan amount than someone without a title (holding all other
factors constant).
Instead of relying solely on securing formal collateral, BRI units use other
methods to ensure repayment. These methods rely on an applicant’s reputation
or lending within social networks to bolster group monitoring, in order to solve
both exante adverse selection and expost moral hazard problems.10 The BRI
approach allows discretion within a set of basic rules. For example, loans above
a certain limit, typically around Rp 20 million (approximately $2,200 in 2002),
must be approved by a regional BRI branch, but at the unit level there is no one
formula for accepting or rejecting loan applicants. Unit managers are allowed to
rely on notions such as ‘trustworthiness’ when granting a loan.11 Unit managers are also encouraged to raise repayment rates by using progressive lending,
whereby the lender makes larger amounts of credit available after each successful
repaid loan; interest refunds, whereby the lender gives a rebate on interestrate
payments if the borrower pays the loan on time; and social networks, whereby
the lender relies on borrowers in the same social network to encourage repayment. Successful unit managers are granted greater discretion and higher limits
for lending without branch approval. When asked to assess the most important
9. BRI has been studied in the microinance literature. For more information on the history
and practices of BRI, see Maurer’s (1999) study.
10. See Morduch’s (1999) study for a thorough review of these methods, which are commonly used in the microinance world.
11. Consider, for example, the following method, which is often used: the loan applicant
ills out a description of the condition of their assets, and then the BRI unit manager sends
a bank employee to view the assets in order to make a comparison. What the bank cares
about is not just the value of assets but also whether the description of the assets was honest.
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442
Paul Castañeda Dower and Elizabeth Potamites
factor in considering whether to grant a loan, 82% of respondents indicated the
character of the individual. When determining the likelihood of repayment of
the applicant (which determines the loan size for which the applicant is eligible),
the most important factors were cash low (66%) and character (20%). Only one
respondent indicated that collateral was the most important factor for determining repayment capacity, and none indicated that collateral was the most important
factor in considering whether to grant a loan. This suggests that unit managers
are aware of the informational problem and that they take personal characteristics
(including the past relationship with the bank) into account in the loan decision,
as opposed to relying solely on securing collateral to align incentives ex post.
Repayment rates are very high in the BRI units, above 95% in most areas (Patten, Rosengard, and Johnston 2001). BRI prefers to avoid using foreclosure to
enforce repayment. Foreclosure is described as a very rare event anecdotally, but
our survey indicates that it does happen; 37% of unit managers report having
foreclosed on a client at least once.12 Since the legal cost of foreclosure is high,
we would instead expect to see forced or encouraged sales of pledged assets. In
our survey, 77% of respondents said that they had encouraged clients, at some
point in the past year, to sell collateral in order to repay their loan. The existence
of encouraged sales of clients’ assets may indicate that the asset is not fully transferable in case of default. BRI and other banks in Indonesia accept, as collateral,
informal land documents that demonstrate ownership but are not legally transferable. Moreover, for individual BRI units the cost of registering a formal land
title as collateral may outweigh its possible beneits, suggesting again that banks
nominally make use of collateral.
The BRI unit’s reliance on having personal relationships with clients also could
make borrowing more dificult for new clients. For instance, when asked how
new clients ind out about BRI and its services, 88% of the bankers said it was
through friends and family. We also enquired about the maximum loan size available to clients without a formal land document. We ind, on average, that old
clients would be eligible for Rp 5 million more than new clients, a difference that
is the average value of a loan at BRI units. New clients without formal land documents thus face tighter credit constraints and are less likely to take advantage of
BRI’s services unless they already know others who do so.
In sum, the results from our survey are consistent with the idea that having
a formal land title signals useful information to the bank, especially if the titled
household is a new borrower. In general, banks use methods other than securing
formal collateral to solve moral hazard and adverse selection problems, and BRI
units provide a good description of how this works. These methods often emphasise the personal relationship between the bank and client, possibly making it
12. This number seems large, leading us to believe that managers have included threats to
foreclose. Formal foreclosure is rare in Indonesia’s smallscale loan market. However, just
because foreclosure is not observed does not mean that collateral is not at work. A simple
gametheoretic framework yields a Nash equilibrium where no one defaults yet the possibility of foreclosure is real. In the Indonesian context, this is probably not the equilibrium.
Borrowers rather than lenders are generally favoured. Foreclosure is a socially sensitive
issue, and the legal practice of foreclosure in Indonesia is unpredictable and lengthy. These
high costs of foreclosure most likely are at the expense of the borrowers, and streamlining
the process could beneit all parties involved.
Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
443
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more dificult for irsttime borrowers. As a signal of borrower characteristics,
land titles can substitute for a history of successful repayment.
DATA USED FOR THE REGRESSION ANALYSIS
For the regression analysis in this article, we use data from two sources. Our
main source is BRI’s 2002 MASS. We also have additional villagelevel and urban
neighbourhoodlevel information from the 2003 round of Statistik Potensi Desa
(Podes), a survey of local leaders, conducted annually by the Indonesian government.13
The 2002 MASS
The 2002 MASS consisted of more than 1,438 households across 72 different villages (desa) and urban neighbourhoods (kelurahan) in West Java, East Java, West
Kalimantan, East Kalimantan, North Sulawesi, and Papua.14 For each of the six
provinces, two districts (kabupaten for rural districts and kotamadya for urban districts) were selected. For each district, three subdistricts were randomly selected
(kecamatan). For each of these subdistricts, two villages or urban neighbourhoods
were selected at random. Finally, respondents of these localities were randomly
chosen using local censuses. Thus, the survey covered both customers and non
customers of BRI, and 58% of respondents lived in rural districts. It slightly oversampled poor households, in both urban and rural areas (Johnston and Morduch
2008). We exclude the landless from all results that we present.
Twothirds of the respondent households had a business enterprise, and nearly
half of these twothirds worked in the agricultural sector. Thus, one should not
equate land parcels with agricultural plots, although lowerincome and rural
households are more likely to use land parcels for agricultural production. For
households that had multiple land parcels, we label them as titled if any of their
land was titled.15 Most of our sample had more than 80% of their total land value
either formally titled or informally documented, and only 53 households reported
no documentation at all. Land documents other than formal land titles refer to
land deeds, customary or traditional land documents, and tax receipts. In general,
titled households are less common in rural areas (29%) than in urban areas (65%).
In 2004, out of the 80 million land parcels on the iscal tax register, less than
27 million were on the legally titled register and about 1.3 million new titles
were registered sporadically. The total number of land parcels was estimated to
be growing by more than 1 million per year (World Bank 2004, 5). The current
system of titling should be understood in the context of how land rights have
13. Statistik Potensi Desa (Podes) stands for Village Potential Statistics, a villagelevel and
urbanneighbourhoodlevel economic census. We use the 2003 census, which was collected
in 2002.
14. In 2002, Papua included the yettobeformed province of West Papua. In West Java, all
sampled households were rural.
15. We could instead use the fraction of the value of the household’s total land assets that
are titled. In practice, this distinction is almost irrelevant in our dataset; even though 352 of
our households report having more than one plot, all but 57 of these households have all
their plots either titled or untitled.
444
Paul Castañeda Dower and Elizabeth Potamites
TABLE 2 Summary Statistics
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Variable
Mean
Panel A. 2002 MASS, landholders only
FormalBank
0.29
Has land title
0.47
Total assets (2002 CPIadjusted
Rp ’000)
57,900
Income per capita / poverty line
3.31
Has salary
0.41
Household head’s education
8.01
Household size
4.43
Household head’s age
46.3
Years in current location
27.7
Log distance to bank (km)
2.72
Mean income / poverty line in
locality
3.39
Mean years land held in locality
17.2
Rural subdistrict
0.60
Panel B. 2003 Podes
Population density (adult
population per hectare)
Forest
Locality has a bank
29.70
0.23
0.23
Std
Min
Max
0.45
0.50
0.00
0.00
1.00
1.00
105,000
4.76
0.49
3.93
1.71
11.9
16.1
0.40
24,824
0.01
0.00
0.00
1.00
20.0
1.0
2.30
1,560,000
69.80
1.00
16.00
13.00
87.0
99.0
4.19
2.12
6.1
0.49
0.41
3.0
0.00
13.33
40.0
1.00
53.10
0.42
0.42
0.06
0.00
0.00
270.00
1.00
1.00
Note: Observations in panel A = 1,287; in panel B = 72. FormalBank = 1 if the household reported
having had a formal loan. Forest = 1 if the settlement is near a forested area. MASS = Bank Rakyat
Indonesia’s Microinance Access and Services Survey. Podes = Statistik Potensi Desa (Village Potential
Statistics survey).
been established previously, especially in areas where adat (traditional) law is still
respected. Evidence of ownership can come in a variety of forms. The most formal of these informal rights to land is a land deed, or akte, which represents the
purchase of a piece of land and is oficially stamped and notarised. A less formal
but perhaps locally stronger right is the girik or petok, which is a use claim on land
and comes from customary law. Documents known as Letter C or D are certiied by the village leader and can be inherited. In the MASS, land parcels with
formal land titles are slightly overrepresented (45% of land parcels have formal
land titles; 12% have an akte; 21% have a girik, petok, or Letter C or D; and 10%
have only tax receipts to demonstrate ownership). In our sample, very few households—only 4% of landowners—had no documents at all.
Table 2 gives the summary statistics for the covariates that we include in our
estimations. The variable ‘FormalBank’ equals one if the household reported ever
having had a formal loan. The per capita household income is divided by the local
poverty line. The local poverty line varies by province and, within each province,
there are separate poverty lines for rural and urban areas.
We have data on 405 distinct formal loans made to 374 different households.
On average, formal bank loans are signiicantly larger than loans from other
Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
445
TABLE 3 Average Formal Loan Amounts, by Type of Security Offered
Loan
(Rp ’000)
Std
(Rp ’000)
Panel A. All formal loans
Land title
Fixed income
Other land documents
Other security
No security
Total
16,323
9,655
6,295
6,220
4,870
10,552
28,048
6,447
4,254
9,029
5,002
15,873
Panel B. First-time loans
Land title
Fixed income
Other land documents
Other security
No security
Total
22,841
8,281
4,535
3,132
4,619
11,014
46,177
4,325
2,621
1,858
4,210
24,828
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Security
Min
(Rp ’000)
Max
(Rp ’000)
N
%
643
103
202
201
506
103
235,647
39,984
27,195
26,165
18,762
235,647
99
177
61
13
17
367
27.0
48.2
16.6
4.6
3.5
2,325
1,923
1,025
703
506
506
235,647
24,905
10,098
4,964
13,110
235,647
24
40
10
5
11
90
27.0
44.0
11.1
5.6
12.2
Source: Data from Bank Rakyat Indonesia’s Microinance Access and Services Survey, 2002.
Note: Amounts adjusted by the consumer price index, using 2002 as the base year. N = observations.
sources and most (74%) reported loans are formal.16 Because our loan amounts
are from different years, with most loans having been granted in 1998–2002 (only
9% of the formal loans are from earlier), just after the 1997–98 Asian inancial
crisis, we normalised the loan amounts by converting them to rupiah, adjusted
to the consumer price index (CPI), and used 2002 as the base year.17 Converting to CPIadjusted loan amounts leads to 38 fewer loans—31 because of missing
loan dates and 7 because of other missing data.18 Table 3 breaks down the formal
loan amounts by the type of security offered. Of the formal loans reported with
complete data, 90 went to households for whom this was their irst loan. In both
rural and urban areas, titled households had more formal loans—40% of titled
households had had a formal bank loan compared with only 20% of other land
documented households—and loans securitised by formal land titles tended to
16. In our data, we have 680 distinct loans, 489 of which are from formal banks. Of these
formal loans, 475 report information on how the loan was secured. The difference between
475 and 405 can be explained by our excluding the landless from our analysis. Nonformal
loans consist of microbank loans (14%) and informal sources (12%).
17. The Indonesian CPI is available from Badan Pusat Statistik, the central statistics agency:
http://www.bps.go.id/eng/aboutus.php?inlasi=1. Over the range of years in which the
formal loans were given, there were three changes to the weighting of the CPI and to the
sample of cities included in the costofliving surveys. To account for these changes, we
have run robustness checks for our main results by including dummies for urban and rural
CPIweighting groups. The results are similar.
18. We dropped one loansize observation because of its unrealistic loan amount of Rp
1,000 (less than $1).
TABLE 4 Summary Statistics, by Repeat and First-Time Borrowers
Mean
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Variable
Min
Std
Panel A. All households that have had a formal bank loan
Has land title
0.65
0.48
Total assets (2002 CPIadjusted
Rp ’000)
90,300
133,000
Family income per capita /
poverty line
4.84
4.83
Has salary
0.58
0.49
Household head’s education
9.56
3.82
Household head’s age
47.83
10.83
Log distance to bank (km)
2.59
0.34
Mean income / poverty line in
locality
4.48
2.73
Panel B. Households that are irst-time borrowers
Has land title
0.67
0.47
Total assets (2002 CPIadjusted
Rp ’000)
87,800
172,000
Family income per capita /
poverty line
4.53
4.65
Has salary
0.58
0.50
Household head’s education
9.81
3.81
Household head’s age
46.69
10.28
Log distance to bank (km)
2.62
0.38
Mean income / poverty line in
locality
4.81
3.22
Max
0.00
1.00
25
1,370,000
0.20
0.00
0.00
25.00
2.30
34.80
1.00
16.00
78.00
4.17
1.11
13.30
0.00
1.00
447
1,370,000
0.28
0.00
3.00
29.00
2.31
34.79
1.00
16.00
76.00
4.01
1.11
13.30
Source: Data from Bank Rakyat Indonesia’s Microinance Access and Services Survey, 2002.
Note: We exclude the landless. Observations in panel A = 336; in panel B = 90.
TABLE 5 Distribution of Control Variables for
Households That Have Applied for a Loan
Status
Assets
Income
Rejected
Accepted
17.20*
17.74*
3.30*
4.40*
Education
7.75*
9.72*
Titled
0.58
0.64
Source: Data from Bank Rakyat Indonesia’s Microinance Access and Services Survey, 2002.
Note: Assets in logs of rupiah (adjusted by the consumer price index). Income relative to the poverty
line. Education is in years of schooling. We exclude the landless.
* p < 0.05.
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Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
447
be larger, on average. Firsttime borrowers used the same types of securities and
offered them in roughly the same proportion as the general population of borrowers. In addition, conditional on having a formal loan, titled households and other
documented households were equally likely to offer some type of land document
as collateral (about 40% of the time).19 Since all documented households were
equally likely to offer some type of land document, we infer that the relative beneit of offering a land document is similar to offering other forms of security. That
is to say, if the only effect of a formal land title is as a better source of collateral, we
would expect titled households to have used their land document comparatively
more often.
Table 4 describes in more detail the characteristics of the subset of our sample
that we are particularly interested in. Panel A gives the most important household and localitylevel characteristics for all households that have had a formal
bank loan. Panel B looks at the same characteristics for households that are irst
time borrowers. There are no signiicant differences between irsttime and repeat
borrowers in any of these observable characteristics.20 Therefore, any difference
between a bank’s relationship with a irsttime borrower and its relationship with
a repeat borrower cannot be attributed to differences that are observable to the
econometrician.
Selection into the formal loan market is a different story. Table 5 shows the
distribution of the control variables for rejected applicants. In the MASS, 67 landowning households reported having recently had a loan application rejected.
These households tended to have fewer assets and less income and education.
The MASS data also permits constructing hypothetical loan demand and supply, with which we can address endogeneity. The survey was conducted by BRI
loan oficers who worked in different geographical areas from those surveyed.
The oficers were asked to privately judge how feasible it would be to extend a
loan to the household that they had just surveyed. They reported whether they
would grant the household a loan and what the maximum loan size would be
and under what terms. These questions give us a measure of hypothetical supply.
That is, without considering the effects of title on credit demand, we can evaluate
whether a formal land title affects the amount of credit for which a household is
hypothetically eligible. That these questions were answered by BRI loan oficers
adds to their validity as a measure of credit supply. In general, the average maximal feasible loan amount was almost Rp 8 million (roughly $890 in 2002), comparable to actual loan amounts; but of the 901 households that were attributed with
a feasibility judgment, 565 had never had a formal bank loan. The MASS also
asked households how much credit they would hypothetically be interested in
obtaining if they had not applied for a formal bank loan. More than half of those
with no previous bank loans claimed that they had never applied, because they
19. More than half of all formal loans did not use any type of land document. Instead, the
most commonly cited security was an advance against future salaries, such as ixed income
or the use of a guarantor.
20. We tested all continuous variables by applying both the conventional t-test (allowing
for the variances between the samples to differ) and the nonparametric Wilcoxon rank
sum test. We used a test of proportionality for all binary variables. There were no signiicant differences at the 10% level.
448
Paul Castañeda Dower and Elizabeth Potamites
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did not want to be in debt. They were then asked a hypothetical question about
their possible desired loan amount. However, this measure of demand is problematic; even after giving a hypothetical loan amount, more than 80% insisted
that they had no intention of borrowing formally. Their most common reason,
given by 44%, was that they were concerned about repayment. Those that were
titled were equally likely to be worried about repayment as those that were not.
The 2003 Podes
Panel B of table 2 gives some summary statistics for the localitylevel covariates
from the Podes dataset that we include in our estimations. We have calculated
these statistics by using only the villages and urban neighbourhoods in BRI’s
MASS sample. They are roughly comparable to the full census. We will take
one instrumental variable from Podes, the forestedarea dummy (‘Forest’). The
National Land Agency (Badan Pertanahan Nasional) grants titles only to non
forested land.21 The ‘Forest’ dummy equals one if the settlement is near a forested area. The proximity to forest land should be negatively correlated with the
extent of titling. Since forest land is not under the jurisdiction of the agency, land
titles cannot be issued for any plots under the oficial forestedland designation.
A large amount of deforestation has occurred in Indonesia, and many plots have
been cleared for some time but have not been unmarked as forest land. Settlements near forest land are more likely to contain plots that are cleared but are still
oficially designated as forest land. Indeed, 28% of respondent households in the
2003 Podes were titled in settlements near forested areas, while 53% were titled in
nonforested areas. The ‘Forest’ dummy does not predict the hypothetical desired
loan amounts discussed above.
EMPIRICAL STRATEGY AND RESULTS
The key question and the main contribution of this article is to evaluate whether
having a formal title inluences the size of observed formal loans, and, if so, to
determine whether this is purely an effect of formal land titles being better collateral or whether they also have a signalling value. We will irst consider how
possessing a formal land title affects loan amounts, while controlling for other
observable variables that might also inluence credit access. We then control for
whether a land title was offered to secure the loan, to see if simply possessing a
land title is suficient. Next, we test whether the effect of possessing a land title
is important for irsttime borrowers, since the signalling effect should be the
strongest for this group. Equation (1) gives the econometric speciication for the
preferred empirical test:
yi = α + γ 1Ti + γ 2 Fi + γ 3T ⋅ Fi + γ 4 Ci + Xi β + Ei
(1)
where yi , the outcome of interest, is the most recent loan amount obtained from
a formal bank in household i; Ti is an indicator variable of whether household i
21. Land that has been designated as forest (roughly 60% of land area) is handled by the
Ministry of Forestry.
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Signalling Creditworthiness: Land Titles, Banking Practices, and Formal Credit
449
has a formal title; Ci is whether the household used a formal title as collateral; Fi
is an indicator of whether the household is a irsttime borrower; and Xi consists
of both household covariates and locality and subdistrictlevel covariates.22 The
idiosyncratic error term is denoted by Ei. We use clustered robust standard errors
at the subdistrict level, allowing for correlation within subdistricts, because the
BRI unit lending area is roughly a subdistrict and the BRI framework grants considerable discretion to unit managers.
In equation (1), three effects are important to the signalling story: (a) γ 1, which
represents the effect of merely possessing a land title for repeat borrowers; (b) γ 1 +
γ 3, which represents the effect of merely possessing a land title for irsttime borrowers; and (c) γ 3, which tells us whether possessing a land title but not offering
it as collateral is different for irsttime borrowers than for repeat borrowers. We
reject the hypothesis that a land title functions only as collateral if γ 3 is statistically
different from zero, no matter whether we control for a land title being used to
secure a loan, or when γ 1 + γ 3 is statistically different from zero if we control for
offering a land title as security. We note that if both γ 1 and γ 3 are not statistically
different from zero, we cannot reject the signalling hypothesis. Owing to the high
cost of formally securitising these small loans with a land title, one could argue
that offering a land title as security has some informational content.
In order to interpret equation (1) as a supplyside effect, we should assume that
for borrowing households the supply constraint is binding, which is a common
assumption in developing markets. Under this assumption, loan size is a good
indicator of access to credit, since most households that apply for loans would
demand more than they would eventually receive. One criticism of this approach
is that some households may demand larger loan amounts than others. However,
even if titled households, on average, were to demand higher loan amounts, the
only ways that actual loan amounts would be higher are if the supply constraint
were slack or if the bank relaxed the supply constraint because of the presence of
a land title. The latter case is included in the effect of having a land title, and the
assumption of the binding supply constraint rules out the former case. In ‘Assessing the Role of Credit Demand’, below, we more carefully explore this assumption
by investigating whether the correlation between land titles and credit demand
could explain the results (that is, that the supply constraint is not binding).
While we need to address the endogeneity of the land title variable, we also
want to capture the signalling effect, which by its nature implies that land titles
are correlated with unobservable variables that affect credit access (in particular,
personal characteristics of the borrower that are desirable to the bank) and that
we would like to include in the effect of land title.23 Addressing the endogeneity
concerns by using the standard instrumental variables approach is not satisfac22. A small number of households had more than one loan in the sample because they had
loans from multiple formal banks. In all loansize regressions, we include a dummy variable that indicates these households.
23. Reverse causality is another possible explanation; borrowing households may use the
loan to fund obtaining a land title. Since most loans are recent loans (those in the past four
years) and the titling process is lengthy, having obtained a loan is not likely to mean that
the household has obtained a land title. Unfortunately, we do not have information on
when the land title was obtained.
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