Gustavo is a young doctor who lives in a country with a relatively inefficient legal and financial system. When Gustavo applied for a mortgage, he found that banks usually required collateral for up to 300% of the amount of the loan. Explain why banks might require that much collateral in such a financial system. Comment on the consequences of such a system for economic growth.

The legal system has an impact on the standard of living because it protects the rights of the citizens of the country. There will be fewer defaults if the legal system is efficient. Loan backing with collateral refers to a secured loan that is backed by collateral security.

In countries with inefficient legal and financial system, lending out is more riskier as compared to other countries. If a borrower defaults, the lender would be at risk of losing their money. So, lenders charge a very high collateral so that they are ale to recover their money in case of a default. By providing loans backed by more collateral securities, the lender can avoid the problem of adverse selection.

This system would make borrowing expensive, thus causing a reduction in investment and in turn slower economic growth.