I have always believed that informal finance serves a very important function in China's growth. Now a paper, an empirical one, forces me to think about it again.
Here is the 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 2400 Chinese firms. 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 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 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 relationship based financing and governance mechanisms in financing the fastest growing firms in China is likely to be overestimated.
Read the paper here.