Time: 13:00-15:00 (GMT), Wednesday, 24 March 2021
Presenter: Dr Tianshu Zhao, University of Birmingham
Chair: Professor Victor Murinde, SOAS University of London
Online venue: Click here to join the meeting on Microsoft Teams (For any inquiry about how to join the online seminar, please contact Dr Meng Xie: xm1@soas.ac.uk)

Abstract
The finance-development literature indicates that financial development may not necessarily lead to higher economic growth if financial development is concomitant of debt shift: the increased use of debt and other financing instrument by non-financial firms (NFFs) in the pursuit of capital gains on the real estate and financial asset markets, instead of revenues realized in the productive process. In addition, the literature of corporate finance documents that capital decisions about financing sources can have important implication for the operations of a business, including risk-taking, firm performance, and sustainable development. We bring these two literature together and attempt to understand the driving forces of the joint use of formal and informal finance (co-funding) and its impact on debt shift of NFFs (i.e. financialization), using a unique survey of Chinese firms.

Consistent with the prediction that the use of informal finance provides the potentials to fill the financing gap that not being fully satisfied by formal finance, we find that private firms exhibit a higher probability of using co-funding relative to state-owned ownership (SOE). Also, firms having main bank relationship with national-wide banks and foreign bank (versus the local and regional commercial bank predominately serving a specific province or metropolitan area), firms having longer relationship length with the main bank, and firms having a higher financial leverage ratios are more likely to use co-funding.  Two distinctions between the use of informal finance and that of co-funding are on the length of relationship with the main bank and the small size. Duration with the main bank is significant in co-funding but not in informal finance, implying the information value of bank-borrower relationship for firms’ switching from informal finance only to co-funding. Regarding the size, being smaller is significantly positive for the use of informal finance but not for co-funding. Putting together, the finding suggests that formal and informal finance are complements for firms with debt capacity from bank credit, while informal is a substitute for bank credit for smaller firms whose might face the constrains from the formal finance.

Regarding the impact of co-funding on financialization, we find that co-funding, compared to the exclusive usage of formal finance, increases the likelihood of the higher level of involvement of financial activities and leads to a higher importance of financial gains from financial assets and real estate assets investment for the profit of the firms. However, the use of co-funding does not seem to enhance the likelihood of achieving a consecutive positive profitability. The intensive reliance of informal finance in the co-funding mix further exacerbates these impacts. Our empirical evidence further reveals the impact of co-funding on financialization and the likelihood of sustainable profit is more significant for firms with stronger managerial compensation scheme for shareholders’ value maximization and firms in the industry characterised by higher degree of competition.

The results appear to be robust in the case when the endogeneity of co-funding is dealt by controlling for propensity score in regressions, running the estimation in a matched sample, and applying instrumental variables to instrument the co-funding in the estimation. Also, the empirical results do not seem to be attributable to the higher interest cost, short maturities, and the inefficiency of the monitoring mechanism of informal finance, per se. We argue our empirical result lies in the connection and the coordination failure of the previously segmented formal and informal financial systems.

JEL Codes: G21, G32, P2, G31, D21
Keywords: Informal Finance, Formal Finance, Co-funding, Growth, Financialization

Presenter

Dr Tianshu Zhao

Tianshu is a micro-economist with a particular interest in exploiting the micro-economic foundation of the financial development on economic growth. Her research focuses on empirical questions regarding 1) how the changes in regulatory structure, market structure and organizational structure influence competition, efficiency, productivity and risk taking behaviour of banks, and 2) how those changes are propagated into the financing and investment policies of the real sector.  Her research also covers the topics regarding the role of economy-wide institutional setting on banks’ risk taking and financial intermediation behaviour. Her recent research relates to the impact of the characteristics of regional banking market on the spatial differential of the access to external finance of the real sector. Her current research considers the implication of the organizational aspects and scoring techniques used in the lending process for SMEs’ access to bank finance.