1、 1Formal versus Informal Finance: Evidence from China Meghana Ayyagari Asli Demirg-Kunt Vojislav Maksimovic* March 2007 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 fa
2、stest 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 Chinas growth. This paper takes a closer look at firm financing patterns and growth using a database of 2400 Chinese firm
3、s. We find that a relatively small percentage of firms in our sample utilize formal bank finance with a much greater reliance on informal sources. However, our results suggest that despite its weaknesses, financing from the formal financial system is associated with faster firm growth, whereas fund
4、raising from alternative channels is not. Using a selection model, we find no evidence that these results arise because of the selection of firms that have access to the formal financial system. While firms report bank corruption, we do not find evidence that it significantly affects the allocation
5、of credit or the performance of firms that receive the credit. We find that an important determinant of access to bank loans is the ability to post collateral, which is in turn a function of firm size, level of fixed assets and firm location. Our findings suggest that the role of reputation and rela
6、tionship based financing and governance mechanisms in financing the fastest growing firms in China is likely to be overestimated. _ *Ayyagari: School of Business, George Washington University; Demirg-Kunt: World Bank; Maksimovic: Robert H. Smith School of Business at the University of Maryland. This
7、 papers findings, interpretations, and conclusions are entirely those of the authors and do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. 2Introduction There is a significant body of research on the role of informal or non-market ins
8、titutions1in low income countries in risk sharing and providing credit. The dominant theory in the literature has been that informal institutions have a comparative advantage in monitoring (the peer monitoring view as in Stiglitz (1990) and Arnott and Stiglitz (1990) and enforcement capacity.2A comm
9、on interpretation of this theory is that informal institutions act as a substitute to formal institutions in low income countries. For instance, Besley and Levenson (1996) have argued that economies like Taiwan grew despite an underdeveloped formal financial sector due to informal institutions. More
10、 recently, Allen, Qian, and Qian (2005) suggest that China may be an important counter-example to the law and finance literature since the fastest growing Chinese firms rely on alternative financing channels rather than formal external finance. They argue that private sector firms in China, despite
11、facing weaker legal protections and poorer access to finance than firms in the state and listed sectors, are the fastest growing due to their reliance on alternative financing and governance mechanisms. An alternative hypothesis is that informal financial institutions play a complementary role to th
12、e formal financial system by servicing the lower end of the market. Informal financial institutions serve firms who cannot access the formal financial system due to the lack of good growth opportunities or poor credit ratings or 1By informal financial institutions, we refer to the entire gamut of no
13、n-market institutions such as credit cooperatives, moneylenders, informal credit and insurance, rotating savings and credit associations, etc. that do not rely on formal contractual obligations enforced through a codified legal system. Several of these institutions operate as loan sharks in developi
14、ng countries charging exorbitantly high interest rates. 2Theoretically the informal sector has been modeled as both, a competitor to its formal counterpart (as in Bell et al., 1997; Jain, 1999; Varghese, 2005) as well as a channel of formal funds, where informal lenders who offer credit acquire form
15、al funds to service entrepreneurs financing needs (Floro and Ray, 1997; Bose, 1998; Hoff and Stiglitz, 1998). Both strands of literature emphasize that informal lenders hold a monitoring advantage over the formal lender. 3information asymmetry problems, and are able to use their monitoring and enfor
16、cement advantage to ensure repayment. According to this view however, informal financial systems cannot substitute for formal financial systems because their monitoring and enforcement mechanisms are ill-equipped to scale up and meet the needs of the higher end of the market. 3In this paper, we use
17、detailed firm level survey data on twenty four hundred firms in China to investigate which of the two views are consistent with the operation of the informal sector in China. Does the informal sector act as a substitute to the formal financial system and finance the fastest growing firms or does the
18、 informal sector primarily serve the lower end of the market? To answer this question, we first investigate whether Chinese firms financing patterns are different when compared to those of similar firms in other countries that have been the focus of the prior literature. Next, we explore how the fin
19、ancing patterns, both formal and informal vary across different types of firms in different cities and regions. We then study how bank finance and financing from informal sources are associated with firm sales growth, productivity growth and profit reinvestment. We address these issues using a new d
20、ata source, the Investment Climate Survey4, a major firm level survey conducted in China in 2003 and led by the World Bank. The survey has information on financing choices for firms across 18 different cities. One of 3There is a direct parallel with the prevalence of angel finance (also referred to
21、as informal venture capital) in the US. Business angels are typically wealthy individuals who provide the initial funding to get new firms off the ground. A big rationale for prevalence of angel financing is the capital constraints faced by new firms, especially technology intensive firms. In additi
22、on, venture capitalists tend to make highly concentrated investments and fund only firms with a substantial need for capital. Thus, the segment of young new firms with modest capital requirements rely on angel investors. However, Lerner (1998) argues that there is no evidence that angel financing ge
23、nerates positive financial returns or improves social welfare. 4Other studies using the investment climate survey data on China include Cull and Xu (2004), Dollar et al. (2004). 4the strengths of the survey is its coverage of small and medium enterprises. Hence, in addition to information on commerc
24、ial financing sources such as bank finance, the survey also includes information on sources of financing that are associated with small firm finance such as trade credit and finance from informal sources such as a money lender or an informal bank or other financing sources. We find that 20% of firm
25、financing in our sample is sourced from banks, which is comparable to the use of bank financing in other developing countries such as India, Indonesia, Brazil, Bangladesh, Nigeria and the Russian Federation. However, the breakdown of non-bank financing sources shows greater differences. Compared to
26、other countries, firms in our sample rely on a large informal sector and alternative financing channels as suggested by Allen et al. (2005). Alternative financing channels represent nearly 43% of firm financing in China compared to less than 9% in other developing countries. These other financing so
27、urces could well be the large underground lending in China, which represents several hundred billion dollars in bank deposits according to a recent McKinsey report (Farrell et al. (2006). We also find substantial firm level heterogeneity in financing patterns within China. The firms in the sample co
28、me from five different regions of China: Coastal, Southwest, Central, Northwest, and Northeast. The financing patterns show that the largest amount of bank financing is in the Coastal (23.3%) and Southwest regions (26%) which have been known to have a more supportive investment climate that facilita
29、tes access to formal sources of external finance (Dollar et al. (2004). We find that firms using formal bank finance grow faster than those financed from alternative channels. Our results hold even when we exclude firms registered as 5publicly traded companies or state owned companies and look at a
30、sample of just private sector firms, which are the fastest growing firms in the Chinese economy. We also find that firms financed by formal bank finance experience higher reinvestment rates, and productivity growth at least equal to that of firms financed from non-bank sources. This suggests that th
31、e growth financed by banks is not inefficient growth. We find no evidence that the faster growth rates of bank financed firms is caused by selection of firms that obtain bank loans. Moreover, while firms complain about imperfections in the allocation of bank loans such as corruption among bank offic
32、ers and importance of government help in obtaining loans, controlling for them in the selection models only strengthens the effect of bank financing on firm performance. Our results also highlight the role of collateral requirements in obtaining loans from the banking sector. We find that larger fir
33、ms, firms with more fixed assets and firms located in certain cities and provinces are most likely to post collateral and thus obtain access to bank finance. Overall, our results suggest that, even in fast growing economies like China where the formal financial system serves a small portion of the p
34、rivate sector, the fastest growing firms depend on external finance from the formal financial system. We find no evidence that alternative financing channels are associated with higher growth. Our findings suggest that the role of reputation and relationship based informal financing and governance m
35、echanisms in supporting the growth of private sector firms is likely to be limited and unlikely to substitute for formal mechanisms. 6We discuss the Chinese economy and its financial system in detail in Section 2. In Section 3 we describe the survey data and summary statistics and in section 4 we pr
36、esent our empirical model and regression results. Section 5 concludes. 2. The Chinese Financial System The Chinese financial system is characterized by a large banking sector, dominated by four large state owned banks that have their own specialized role: the Industrial and Commercial Bank of China
37、(provides working capital loans to state industrial enterprises), China Agriculture Bank (specializes in agricultural lending), China Construction Bank (provides funds for construction and fixed asset investment) and the Bank of China (specializes in trade finance and foreign-exchange transactions).
38、 In addition to the big four state-owned commercial banks, there are also several minor players that include Policy banks (eg: Export-Import Bank of China), Second-tier Commercial banks (eg: CITIC Industrial Bank) and Trust and Investment Corporations (ITICs) who capture a very small portion of the
39、lending market. The pervasive state ownership of the banking sector in China has given rise to several disturbing features including a huge ratio of non-performing loans to total loans, poor profitability, poor institutional framework of the banking system, weak corporate governance and reduced comp
40、etitive pressures on the banks to operate as profit making enterprises. A large share of bank funding goes to state controlled companies, regardless of their profitability, leaving companies in the private sector credit constrained.5Lending 5Anderson (2006) argues that Chinese banks do not discrimin
41、ate against private borrowers per se but do discriminate against small borrowers including smaller SOEs without visible cash flow. While they have a short tail of corporate customers, banks do compete aggressively for the business of large private borrowers. 7by banks is also hampered by the lack of
42、 adequate information on borrowers credit histories and financial performance, making lending to SOEs seem a low-risk option, given their government backing. Lack of enforcement by regulatory bodies that are politically connected has created a very weak governance environment. Furthermore, the highl
43、y decentralized structure of the banks prevents them from reaping benefits of scale and also makes lending decisions at the branch level susceptible to local government influence preventing the allocation of loans according to market criteria.6While Chinas banking system is huge, its equity and bond
44、 markets are smaller than most of the other countries, both in terms of market capitalization and total value traded as a percentage of GDP. As stated in Farrell et al. (2006), equity market capitalization, excluding non-tradable state-owned shares, is equivalent to just 17 percent of GDP, compared
45、to 60 percent or more in other emerging markets and corporate bond issues by non-financial companies amount to just 1 percent of GDP, compared to an average of 50 percent in other emerging markets. One of the reasons for the poor performance of capital markets is again the pervasive influence of the
46、 government. The equity markets are largely a vehicle for privatization by the government rather than a market for capital raising by firms with growth opportunities. Most IPOs on Chinas largest exchanges are former SOEs with connections to government officials. Further, government entities hold a l
47、arge share of the non-tradable shares reducing the corporate governance role of the market. 6In the past few years, the banking sector is undergoing comprehensive reforms both to prepare the banks for equity listings and strategic sales and as a condition of Chinas accession to the WTO. These reform
48、s include allowing entry of foreign banks and eliminating special investment regulations for foreign banks which are bound to change the lending landscape but are yet to have a major impact on the operation of the banking sector. 8Consequently, the large and best Chinese companies list on internatio
49、nal exchanges such as Hong Kong for their capital raising needs where as the smaller and riskier companies, whose access to foreign exchanges is limited by government restrictions, list on domestic exchanges within China. Durnev, Li, Morck, and Yeung (2004) show that compared to other transition economies, China has one of the poorest functioning stock markets with highly synchronous stock returns that can be linked to weak property rights, corporate opacity and political rent-seeking. The corporate bond market in China is crippled by excessive governme
