Formal Versus Informal Finance: Evidence from Selected African Firms

Abstract

One important factor in firm growth and performance is the availability of financing. Firm financing sources can be either formal or informal. Formal financing sources comprise those institutions regulated both by the government and the central bank, while the informal markets operate beyond the regulatory framework on the financial system. Using the World Bank Enterprise Survey dataset for 13 African countries, this study employs the Relative Distribution methods by Handcock and Morris (1998) and Recentered Influence Function techniques by Firpo et al. (2009), to evaluate whether there exists a growth differential among firms that source their working capital through formal finance relative to those using informal financing sources, and investigate which financing source is more growth enhancing. The study finds formal financing sources to be more growth enhancing than informal financing. The growth differential is however different at different levels of labor productivity and sales growth outcome distributions. It is therefore advisable for the stakeholders to target financing to the right segment of firms, to ensure growth is sustained.