When Do Enterprises Prefer Informal Credit?

This paper tests the hypothesis that enterprises mayforgo formal finance in lieu of informal credit by choice.They do so to avoid the additional regulatory scrutinyand harassment that engaging with the formal financialsector invites. We test this hypothesis using enterpriseleveldata on 3,564 enterprises in 29 countries. In thissample, enterprises finance approximately 57 percentof their working capital requirements with externalfinance. This external finance comes from formalsources, such as commercial banks (53 percent) and informal sources (42 percent), such as trade creditors,or family and friends. In our sample, 14 percent ofenterprises rely exclusively on informal finance. We findthat the likelihood of enterprises preferring to only useinformal finance is inversely related to the quality of theregulatory environment, particularly the quality of taxadministration and overall governance. For example, wefind that when an enterprise has been asked for bribesby tax inspectors, it is 17 percent more likely to preferinformal finance.