Informal Finance And Household Credit Constraints

PURPOSE:To investigate how prevalent credit constraints are among Chinese households and how the characteristics of households affect their likelihood of being credit constrained. To examine the impact of informal finance sector on household credit constraints, and discuss the reason of this impact.DATA AND METHODS:China Household Finance Survey (CHFS) collected and reported data on Chinese household assets, liabilities, income, consumption, and demographic features. With its explicit information on household borrowing behavior and credit demand, CHFS makes identifying and researching household credit constraints possible.Two kinds of bias are avoided when identifying whether a family is credit constrained in this paper. On the one hand, we take demand for loans into consideration and avoided the upward bias of estimating credit constraints, which occurs when family not borrowing and without demand for loans are considered constrained. On the other hand, we rely on agents’ behavior rather than their words to identify whether they are in need of loans, and by discovering half of the family borrowing only from informal finance sector being not truthful about their credit need, we indeed avoided the downward bias of estimating formal credit constraints.In order to get more robust results, three different ways to define formal and informal credit constraints are proposed. Under the strictest definition, families borrowing from both formal and informal finance sector are considered formally and informally constrained, and families borrowing only from banks are also considered informally constrained. Under the loosest definition, neither of these two kinds of families is considered formally or informally constrained. The binary variable describing credit constraints (formally and informally) are regressed in a Probit model on family characteristics such as total and financial assets, total and wage income, age, risk aversion, health condition, education, and other demographic features.RESULTS:Credit constraints indicated by CHFS are not prevalent, because only fewer than10%households can be classified as constrained when the formal and informal borrowing are not distinguished from each other. The majority of household shows no demand for loans.When formal and informal credit constraints are studied separately, more families can be classified as constrained, yet this increase appears to be more substantial in the formal finance sector.Even under the strictest definition of informal credit constraints and under the loosest definition of formal credit constraints, it’s still obvious that informal finance sector indeed alleviate formal credit constraints. The number of households being constrained falls by48.20%,33.06%, and35.68%respectively for business loans, house loans, and car loans, when moving from formal to informal finance sector.Regression results and marginal effects show that credit constraints react negatively to household assets and income. This effect is smaller in informal finance sector, showing that the informal finance sector favors rich and high-income household less than the formal finance sector. Bad health condition increases likelihood of being constrained significantly, only that in formal sector, all types of loans are affected, and in informal sector, only house loans are affected. Both formal and informal sector favor risk averse borrowers over risk lovers when issuing business loans, yet the preference seems to be less in informal sector. Being younger reduces the likelihood of being formally constrained when applying for a house loan, no such phenomenon is found in informal sector.CONCLUSIONS:There is no evidence supporting Chinese households are heavily credit constrained when the informal finance sector is taken into account, and this can be attributed to the low credit demand of Chinese households.Informal sector considerably reduces the portion of households being formally constrained. No evidence is found to support that informal sector uses better screening and monitoring abilities to get informational advantages. Rather, we find that informal sector tend to favor the rich over the poor less than formal sector, and tend to tolerate the risk lovers more than the formal sector. Also, households are less risk rationed in informal sectors. These finding are in accordance with the fact an unelectable portion of informal loans are more flexible loans without interest and little binding power over the borrowers.