Institutional quality plays a central role in determining the ceiling of external debt. However, the Literature has not attempted to unbundle the effects of domestic institutions which regulate solely domestic transactions, and foreign institutions which emphasize the protection of foreign creditor rights. This paper estimates a negative correlation between domestic institutions and private sector external debt stocks. A possible supply-side explanation for this pattern is that strong domestic institutions can support reliable outside options for potential defaulters on external debt, and thus lead to tightened debt constraints ex ante. I then build a complete-market model with decentralized borrowing and default decisions under exogenous variations in both sets of institutions, and show that a centralized arrangement for international debt is no longer necessarily welfare-superior to decentralized setup. That is, there is a rationale for capital account liberalization.