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Evidence on How African Enterprises Choose Informal Credit

Author(s): Jules Kounouwewa | Deng Chao

Journal: The International Journal of Applied Economics and Finance
ISSN 1991-0886

Volume: 5;
Issue: 1;
Start page: 46;
Date: 2011;
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Keywords: Africa | informal finance | small and medium enterprises | binomial logit model

This research studies the hypothesis that enterprises may forgo formal finance in lieu of informal credit by choice. They do so to avoid the additional regulatory scrutiny and harassment that engaging with the formal financial sector invites. We use the maximum likelihood estimates of the binomial logit model of enterprise sectoral choice and test this hypothesis using enterprise level data on 1559 enterprises in 16 African countries from the World Bank Enterprise Surveys. This external finance comes from formal sources, such as commercial banks (59.65%) and informal sources (40.35%), such as trade creditors, or family and friends. A key result is that better institutional mechanisms increase the attractiveness of formality by making market interactions more efficient. In the sample used, 29.73% of enterprises rely exclusively on informal finance. We find that the likelihood of enterprises preferring to only use informal finance is inversely related to the quality of the regulatory environment, particularly the quality of tax administration and overall governance. For instance, we find that when an enterprise has been asked for bribes by tax inspectors, it is 35.82% more likely to prefer informal finance.
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