Understanding Informal Financing

This paper offers a unified framework to understand informal financing. We explore various sources of informal financing based on their mechanisms to deal with asymmetric information and enforcement and examine their role in supporting firm growth. We find that constructive informal financing such as trade credits and family borrowings that rely on information advantages or an altruistic relationship is associated good firm performance. Underground financing such as money lenders who use violence for enforcement is not associated with firm growth. Furthermore, constructive informal financing is prevalent in regions where access to bank loans is extensive, while its role in supporting firm growth decreases with the availability of bank loans. Finally, we find that similar relations exist in many large or fast growing emerging economies. Overall, the empirical results in this paper not only reconcile the contradictory evidence in the existing literature on the role of informal financing, but also suggest formal and informal financing can be complements as well as substitutes.