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Formal versus informal finance : evidence from China

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Author Info
Ayyagari, Meghana
Demirguc-Kunt, Asli
Maksimovic, Vojislav

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Abstract

China is often mentioned as a counterexample to the findings in the finance and growth literature since, despite the weaknesses in its banking system, it is one of the fastest growing economies in the world. The fast growth of Chinese private sector firms is taken as evidence that it is alternative financing and governance mechanisms that support China's growth. This paper takes a closer look at firm financing patterns and growth using a database of 2,400 Chinese firms. The authors find that a relatively small percentage of firms in the sample utilize formal bank finance with a much greater reliance on informal sources. However, the results suggest that despite its weaknesses, financing from the formal financial system is associated with faster firm growth, whereas fund raising from alternative channels is not. Using a selection model, the authors find no evidence that these results arise because of the selection of firms that have access to the formal financial system. Although firms report bank corruption, there is no evidence that it significantly affects the allocation of credit or the performance of firms that receive the credit. The findings suggest that the role of reputation and relationship based financing and governance mechanisms in financing the fastest growing firms in China is likely to be overestimated.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 4465.

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Date of creation: 01 Jan 2008
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Handle: RePEc:wbk:wbrwps:4465

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Keywords: Access to Finance; Banks&Banking Reform; Debt Markets; Bankruptcy and Resolution of Financial Distress;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  2. Mark J. Garmaise, 2003. "Informal Financial Networks: Theory and Evidence," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 16(4), pages 1007-1040. [Downloadable!] (restricted)
  3. Bekaert, Geert & Harvey, Campbell R. & Lundblad, Christian, 2001. "Emerging equity markets and economic development," Journal of Development Economics, Elsevier, vol. 66(2), pages 465-504, December. [Downloadable!] (restricted)
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  4. Bell, Clive & Srinivasan, T N & Udry, Christopher, 1997. "Rationing, Spillover, and Interlinking in Credit Markets: The Case of Rural Punjab," Oxford Economic Papers, Oxford University Press, vol. 49(4), pages 557-85, October. [Downloadable!] (restricted)
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  7. James Heckman & Salvador Navarro-Lozano, 2004. "Using Matching, Instrumental Variables, and Control Functions to Estimate Economic Choice Models," The Review of Economics and Statistics, MIT Press, vol. 86(1), pages 30-57, 08. [Downloadable!] (restricted)
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  10. Thorsten Beck & Asli Demirguc-Kunt & Luc Laeven & Ross Levine, 2008. "Finance, Firm Size, and Growth," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(7), pages 1379-1405, October. [Downloadable!] (restricted)
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  11. Adel Varghese, 2005. "Bank-moneylender linkage as an alternative to bank competition in rural credit markets," Oxford Economic Papers, Oxford University Press, vol. 57(2), pages 315-335, April. [Downloadable!] (restricted)
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  13. Thorsten Beck & Ross Levine, 2002. "Industry Growth and Capital Allocation: Does Having a Market- or Bank-Based System Matter?," NBER Working Papers 8982, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Inessa Love, 2003. "Financial Development and Financing Constraints: International Evidence from the Structural Investment Model," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 16(3), pages 765-791, July. [Downloadable!] (restricted)
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  16. Peter L. Rousseau & Richard Sylla, 2000. "Emerging Financial Markets and Early U.S. Growth," Working Papers 0015, Department of Economics, Vanderbilt University. [Downloadable!]
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  17. Beck, Thorsten & Demirguc-Kunt, Asli & Maksimovic, Vojislav, 2002. "Financial and legal constraints to firm growth - Does size matter?," Policy Research Working Paper Series 2784, The World Bank. [Downloadable!]
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  20. Besley, Timothy & Levenson, Alec R, 1996. "The Role of Informal Finance in Household Capital Accumulation: Evidence from Taiwan," Economic Journal, Royal Economic Society, vol. 106(434), pages 39-59, January. [Downloadable!] (restricted)
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  22. Arnott, Richard & Stiglitz, Joseph E, 1991. "Moral Hazard and Nonmarket Institutions: Dysfunctional Crowding Out or Peer Monitoring?," American Economic Review, American Economic Association, vol. 81(1), pages 179-90, March. [Downloadable!] (restricted)
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  25. Hoff, Karla & Stiglitz, Joseph E., 1998. "Moneylenders and bankers: price-increasing subsidies in a monopolistically competitive market," Journal of Development Economics, Elsevier, vol. 55(2), pages 485-518, April. [Downloadable!] (restricted)
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  26. Lerner, Joshua, 1998. ""Angel" financing and public policy: An overview," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 773-783, August. [Downloadable!] (restricted)
  27. Art Durnev & Kan Li & Randall Mørck & Bernard Yeung, 2004. "Capital markets and capital allocation: Implications for economies in transition," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 12(4), pages 593-634, December. [Downloadable!] (restricted)
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  28. Armando Gomes, 2000. "Going Public without Governance: Managerial Reputation Effects," Journal of Finance, American Finance Association, vol. 55(2), pages 615-646, 04. [Downloadable!] (restricted)
  29. Christopoulos, Dimitris K. & Tsionas, Efthymios G., 2004. "Financial development and economic growth: evidence from panel unit root and cointegration tests," Journal of Development Economics, Elsevier, vol. 73(1), pages 55-74, February. [Downloadable!] (restricted)
  30. Xiaozu Wang & Lixin Colin Xu & Tian Zhu, 2004. "State-owned enterprises going public "The case of China"," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 12(3), pages 467-487, 09. [Downloadable!] (restricted)
  31. Bose, Pinaki, 1998. "Formal-informal sector interaction in rural credit markets," Journal of Development Economics, Elsevier, vol. 56(2), pages 265-280, August. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Andreas Madestam, 2009. "Informal Finance: A Theory of Moneylenders," Working Papers 2009.69, Fondazione Eni Enrico Mattei. [Downloadable!]
    Other versions:
  2. Menkhoff, Lukas & Rungruxsirivorn, Ornsiri, 2009. "Village Funds and Access to Finance in Rural Thailand," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-417, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
  3. Jahangir Aziz, 2008. "Deconstructing China’s and India’s Growth: The Role of Financial Policies," Working Papers id:1714, esocialsciences.com. [Downloadable!]
  4. C Niranjan Rao, 2008. "The Role of Intellectual Property Rights in Information and Communication Technologies," Working Papers id:1742, esocialsciences.com. [Downloadable!]
  5. Cheng, Xiaoqiang & Degryse, Hans, 2007. "The Impact of Banks and Non-Bank Financial Institutions on Local Economic Growth in China," BOFIT Discussion Papers 22/2007, Bank of Finland, Institute for Economies in Transition. [Downloadable!]
    Other versions:
  6. Jahangir Aziz, 2008. "Real and Financial Sector Linkages in China and India," IMF Working Papers 08/95, International Monetary Fund. [Downloadable!]
  7. Jahangir Aziz, . "Deconstructing China's and India's Growth: the Role of Financial Policies," Indian Council for Research on International Economic Relations, New Delhi Working Papers 224, Indian Council for Research on International Economic Relations, New Delhi, India. [Downloadable!]
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