Bank competition and household informal credit

Abstract

This study examines the relationship between bank competition and informal household credit. Using data from four rounds of the China Household Finance Survey (CHFS), we find that increased competition among banks significantly reduces households' use of informal credit. To establish causality, we create a quasi-natural experiment based on the relaxation policy for city commercial bank branch expansion and obtain consistent results. We further uncover two mechanisms through which bank competition affects informal credit use: reducing interest rates on formal loans and improving financial literacy among households. Moreover, the heterogeneous analysis shows that higher-income and asset-rich households, as well as those residing in urban areas, are more negatively affected by bank competition in terms of informal credit access, whereas its influence on informal credit in agricultural production and medical expenses for households is not statistically significant. Overall, the results imply that fostering moderate competition in the banking industry can diminish the reliance on informal credit markets and offer a more comprehensive understanding of the relationship between the banking sector and household credit.